How will the DGF market develop over the coming year?

Andy Cheseldine: For most it is a no-brainer as few trustees – certainly in defined contribution – have the capacity to review asset allocation on a daily basis. Passing the responsibility to a DGF manager means they can delegate active asset allocation.

Graham Wardle: I am grateful that trustees are not allowed to make tactical investment decisions and therefore rely on their investment consultants, and to some extent, investment managers.

Peter Sparkes: Yes, that leaves the trustees free to do what they are best at: engaging with their members, helping their members understand, dare I suggest, what they are trying to do.

Martin Dietz: The future is uncertain. What is important in a DGF is to retain a diversified investment structure and to size adjustments to the asset allocation appropriately because people want, especially in DC, something relatively predictable and stable.

What could be most important is to adjust portfolios to the changes in the market environment if we believe in bonds and cash rates staying as low as they are for an extended time period.

Andrew Soper: My experience is trustees do not meet often enough or make decisions fast enough to implement tactical decisions. DGFs provide an effective way to pass that decision on to an expert and leave trustees able to focus on their areas of expertise.

DGFs are equally, in later years, a way to help manage the risk, in terms of the overall client structure.

Craig Nowrie: Back in early 2007, many people thought DGFs were probably fads and only small and medium -sized schemes were going to use them. Now they are a recognised asset class and are used by large schemes as an outsourced CIO-type of arrangement, so therefore no significant developments over the next year.

Focusing on markets, equity returns over the past three years have been driven by forward valuation, which has accounted for more than 100 per cent of the returns, with earnings detracting over this period, so targeting markets where the potential earnings growth is strong should be most rewarded over the next year.

My experience is trustees do not meet often enough or make decisions fast enough to implement tactical decisions

Andrew Soper, State Street Global Advisors

Dietz: I always find it surprising how much consultant opinions differ on DGF offerings. These differences in opinions actually drive the huge proliferation of funds we see.

Sparkes: And the job of a trustee gets harder by the day because you get more options and more funds. Therefore, the relationship between you and your investment adviser becomes more important.

Cheseldine: Different consultants can be hot or cold on different managers, but it should not be because of the consultant’s view, as the advice should be focused on the trustees’ position: culture, objectives, etc. It should matter less whether I like bonds or a particular DGF manager, but whether the manager fits the trustees’ objectives.

Soper: The funds that have lots of assets flying in do not necessarily have the incentive to innovate because they are attracting lots of assets anyway.

A lot of innovation occurs in the new portfolios, so if trustees are looking to diversify existing managers, they may have to look outside the top 10 managers.

Nowrie: That creates a repeatability of the performance. If they are smaller and investing in more niche, esoteric assets, can that be replicated at the billions of pounds level? That questions the performance track record as well.

Cheseldine: There are two issues there: capacity, but also survivor bias. I would not say everybody can be top-quartile over a year, 25 per cent can be; but succeeeding consistently over 10 years is rather more of a proof statement.

Dietz: That is a point for all the DGFs out there because nobody has a representative 10-year track record, as funds were much smaller and fund management teams have changed since, plus you have the survivor bias.

Cheseldine: I put DGFs into a DC scheme 10 years ago and that worked really well, but that result was because we then had a stock market crash and everyone thought the derisking was wonderful. However, it was pure fluke.

Pensions Expert: You showed the vision to put them in there in the first place, Andy. Don’t hide your light under a bushel.

Is anyone going to be daring enough to come back with something like a with-profit tag, because that seems to be what everybody wants, is it not?

Cheseldine: Nothing wrong with with profits in theory, if you can make it transparent, but how do you apply the charge cap?

Cowburn: How do trustees compare these funds? Is there a framework?

Pensions Expert: A kind of yourDGF.com- type of thing?

Wardle: Most of them are doing cash-plus or libor-plus, but that has not been a hard target to hit.

I put DGFs into a DC scheme 10 years ago and everyone thought the derisking was wonderful. However, it was pure fluke

Andy Cheseldine, LCP

Dietz: The problem is many funds take market risk to target equity-like returns over the long term and then put a cash-plus number onto that return. By using a cash-plus target, they look brilliant if equities do well.

If we had had a down market over the past couple of years, they would all look horrible versus the cash-plus target and would probably emphasise an equity comparison by now. So, you have a cash and equity target and investors need to look through a full market cycle to actually assess if funds are on track.

Nowrie: Volatility is part of that as well, in combination with performance.

Soper: Despite all the risk warnings, everyone likes to look at past performance for delivery of returns. The challenge there is there is a survivorship bias, but also those funds that have survived often were much, much smaller when they had their best returns and attracted lots of assets.

I would encourage trustees and consultants to look forwards and think, philosophically, about how is the fund designed and whether it aligns with their requirements.

Cheseldine: From a consultant perspective, I would say you must challenge overperformance and understand its drivers, because it casts a big question over risk management.

Sparkes: If there is a reasonable and justifiable explanation for it, then great, we will all pile into it, but that challenge is absolutely right and proper.

Wardle: Then there is the issue of scalability, which must be a concern for consultants, as it is for trustees.

This roundtable series was chaired by freelance journalist Pádraig Floyd

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