Spence & Partners is urging schemes that have invested in diversified growth funds (DGFs) to dump them in favour of funds with a heavier equity weighting.
The actuarial firm says the volatility protection that DGFs offer does not compensate for the missed returns from equities. Spence points to the 25 per cent average return from DGFs since 2011 compared to the near 50 per cent return on overseas equities over the same period.
The call follows a recent report from Willis Towers Watson that argued that while DGFs provide diversification and breadth advantages over traditional balanced portfolios, returns have been largely driven by equity and credit beta and most traditional, liquid DGF managers have actually detracted value through tactical asset allocation and other forms of active management. The Willis Towers Watson report said risk management is not an explicit focus for many DGF managers and the fees charged are generally not commensurate with the alpha achieved.
Spence & Partners head of investment Simon Cohen says: “DGFs are a pretty common part of an allocation strategy for smaller schemes, as they allow them exposure to lots of different asset classes they wouldn’t ordinarily get access to due to issues of scale. However, schemes should be careful when investing in them – yes, they are less volatile and have somewhat protected schemes against the fall in equity markets at various points in time, but schemes need equity. DGFs aren’t a direct equity replacement and shouldn’t be treated as such – and, of late, their performance has been particularly disappointing too.
“Schemes that bought into DGF strategies a few years ago are missing out on some of the good returns we’ve seen in the markets in recent years. Since June 2011, overseas equities have grown by nearly 50 per cent, almost managing to track the 65 per cent increase in UK gilt prices that is used as a benchmark for pension liabilities. The 25 per cent return on the average DGF falls massively short of what schemes needed to protect their funding position and, to add insult to injury, schemes using DGFs are also paying higher investment charges than those using passive management, for the privilege.”
Standard Life Investments investment director Malcolm Jones says: “When DGFs were launched in the 1990s the aim was equity-like returns with two-thirds of the volatility of equities. Most have done a good job on volatility but have disappointed on the returns. Our GARS fund has done what it set out to do, which was cash plus 5 per cent on a rolling 3-year basis. But consultants told us they wanted something with the diversification, but without capping the upside. So we launched the Enhanced Diversification Gorwth Fund to do that and that is slightly ahead of equities over two-and-a-half years, with 60 per cent of the volatility.”