The popularity of Diversified Growth Funds (DGFs) was borne from investors’ discontent regarding their investment experience during the 2008 global financial crisis. For a cohort of investors this period highlighted the shortcomings of growth assets, such as global equities and traditional balanced Multi-Asset portfolios. Over the last decade there has been unprecedented growth in the number of DGFs and assets raised within these strategies. More recently, investors have voiced a number of concerns regarding DGFs as many have failed to deliver on their objectives.
The current low-yield environment challenges investors’ reliance on traditional asset classes, such as equities and bonds, to provide sufficient returns to meet their investment goals. Investors are increasingly looking for products that can give them the required level of return, whilst balancing risk and protecting capital during market downturns.
The challenge of comparing DGFs
As a multi-asset product, DGFs are not like single asset class funds that can be easily compared to a passive index. They do however provide investors with a guide on their objective for returns. The advent of objective-based investing has provided greater focus on the achievement of specific outcomes, rather than ‘beating the market’ like actively managed equity funds.
While investors will know that they can allocate to a number of DGFs, they are faced with the difficulty of trying to compare funds in the DGF universe. Due to varying return objectives stated by providers, it’s hard to compare like-for-like. Peer groups are being developed to address this challenge, but they are hard to define with fund managers taking different paths to achieve returns and protect investors’ capital.
Flexible and dynamic approach
DGFs have the flexibility to use numerous outright and relative positions, such as equities, bonds and derivatives. This can make it difficult to grasp the return drivers for each fund; as such it’s important for investors to understand what they are investing in, how asset classes are mixed and how instruments are being used in a portfolio. For example, people may think of derivatives as being risky instruments but they can be used in a balanced way which supports a funds’ return objective. There is a compelling case for their use to navigate a low return environment and an uncertain outlook for markets, particularly with the absence of volatility.
This environment requires investors to adopt a flexible and dynamic framework to meet their return objectives. Many existing DGFs operate under design constraints such as long only, unlevered, fund-of-funds or set-and-forget asset allocations that may not be fit for purpose in the future. Flexibility and dynamism should translate into an unconstrained portfolio which is well equipped to deliver on its objectives.
Delivering on investment objectives
The central principle of objective-based funds was to decouple the path of an investor’s returns from the underlying market’s performance. Investors should identify what they require from their investment in the form of return, their risk tolerance and investment horizon – this will help in matching their needs to multi-asset offerings.
Nobody begins investing with the aim of outperforming a benchmark, they invest to achieve financial goals or to meet their liabilities. As such return objectives which target real returns over a stated time horizon, like Retail Price Index +4% over a rolling five year period are more tangible for investors and therefore easier to evaluate the performance of the fund at the end of that investment horizon. While many funds are compared with a peer group and target above benchmark returns (net of fees), this approach is not necessarily suitable for funds operating in the DGF universe.
A flexible and dynamic investment process, aiming to deliver sustainable returns in all market environments will always be an attractive proposition for investors, particularly when growth and income are hard to achieve. However, delivering on investment objectives should not involve taking unnecessary risks, and investing in an irresponsible manner. Utilising a range of tools within a strategic and dynamic asset allocation strategy to balance risk-return will put investors in the best position to meet their investment needs.
A DGF’s asset allocation strategy should reflect a portfolio’s economic and return expectations which are adjusted for shorter term market developments. They should also tactically exploit market inefficiencies by focusing on key fundamental drivers of returns such as value, momentum, carry, macro-economic and market structure.
The lack of homogeneity among DGFs presents an issue for performance comparison. Investors should look beyond performance and towards outcome based models, as real returns and meeting or surpassing objectives are more meaningful for those with liabilities and specific financial goals
Andrew Harman is portfolio manager at First State Investments