Do DGF strategies differ enough from one another?

William Bourne: Part of the genesis of these funds is that in the 1990s many asset classes were quite highly correlated, with the exception of Japan.

Over the past eight to nine years, because of quantitative easing, that has been very similar.

Pretty well every diversified growth fund I look at seems to have a weighting in Japan, because it is rather less correlated with other markets and therefore, from a risk perspective, it is obvious to put money into Japan.

Finding managers who have the ability to stand back and analyse their own success and failure with any degree of objectivity is quite rare

Percival Stanion, Pictet Asset Management

That is not true of mainstream managers. So if they are all working off the same correlation-based, risk-based process, are they all too similar?

Nicola Ralston: I would say they are not similar at all.

Pensions Expert: Is the problem there are strategies that you do not like, or a lack of transparency about what they are actually doing?

Ralston: Lack of transparency is a problem for some of the funds.

Percival Stanion: There are those who are long-only and pretty plain vanilla, that is our breed, and it is probably more than half of the funds. Then there are the hedge fund-lite offerings.

Pete Drewienkiewicz: On a risk-adjusted basis, that category has substantially outperformed the rest and also, because they are taking more frequent decisions, it is an area where it is actually easier to assess skill, if you understand what is going on.

Ralston: Just because a manager has made quite a lot of good individual decisions in the past does not necessarily mean they will be good in the future.

I have nothing against holding those skill-based funds, as long as investors understand that – in my opinion – they are not really appropriate for very large proportions of assets; they should not be your only holding.

Stanion: It is a question of how much the managers also understand the nature of their own luck or skill and the separation between the two, because we use a number of third-party managers in our products, and finding managers who have the ability to stand back and analyse their own success and failure with any degree of objectivity is quite rare.

John Nestor: I am not a fan of multiple appointments, especially under the banner of DGFs. You can easily find yourself, maybe, concentrated with the wrong view, or having too many DGFs that look and are pointing in exactly the same direction.

Bourne: I don’t believe all DGFs are similar, but a lot of them use similar processes based on risk.

The similarity arises because they use the same correlation data.

Looking forward, it seems to be a world where bonds cannot deliver very good returns, and equities are quite highly valued, but you need to find some strong growth somewhere.

I would argue it is not deliverable without actually using some different asset classes.

Nestor: It depends on your timeframe.

If you have a very short timeframe it is, in this current environment, very difficult.

But trying to recognise how someone builds up a pot of wealth in order to translate that into some form of comfortable retirement, you need an aggressive target [like Libor plus 4 per cent or retail prices index plus 5 per cent] to ensure you outpace inflation.

For a pension product I would take inflation plus 3 per cent as a long-term guide of reasonable success.

There is still an issue that over the past five years DGFs have been disappointing in terms of generating return

Nicola Ralston, PiRho

In defined benefit, many schemes are still in deficit, yet we have had a fantastic period of investment since 2009 and I am not sure why many pension funds have not participated.

Bourne: That has had nothing to do with the performance on the asset side and all to do with what has happened to the discount rate.

Ralston: There is still an issue that over the past five years DGFs have been disappointing in terms of generating return.

Drewienkiewicz: Again, it comes back to solving the wrong question.

Someone said how did we arrive at Libor plus/minus 4 per cent, or Libor plus/minus 5 per cent, or whatever the target is, but it was just someone’s best guess of the equity risk premium.

But the equity risk premium is not delivered in a straight line.

They came up with this target and then, in the biggest equity bull market since forever, they achieved it by the skin of their teeth and everybody turns around and says it is a success.

But equity returns are episodic and in order to make up for what is going to happen now, you needed to capture a heck of a lot more of that equity upside, while taking risk appropriately and asking if risk was compensated.

I am not sure that DGFs have delivered, given that point.

Bourne: Perhaps the point of a target is to actually make sure they do take enough risk and that the target should be Libor plus 5 per cent or 6 per cent, not because they are going to make it, but simply because it encourages the right behaviour.

Stanion: It occurred to us that pensions had become equity-focused because equities provided the highest risk premium available to them and they represented the cheapest way of funding pensions.

There are other risk premia available but, of the liquid ones, equities are the biggest available and we need something that gives us an incentive to go for the returns, when they are available.

But having absolute return means when we do reverse course – which happens about once every four years – when we think the equities are vulnerable, we take a hell of a lot of risk off.

Ralston: Most DGFs were not created for DB schemes, perhaps part of the problem is that mismatch.

Stanion: Originally, ours were for charities and endowments that did not have any type of structure of their thinking as to why they had particular asset allocations – they were not even advised by investment consultants in those days.

Nestor: In my view, asset allocation plays a vital role in overall, long-term investment returns. If you do not understand how this all works and you believe the volatility is against us – well, of course it was in 2008. But it was also a brilliant time to rerisk the portfolio and so many people missed it.

High-yield debt is a fantastic asset class to get in when it is paying you to be there, but I found no one asking the question: “Why are we still here?”

My challenge to the industry is, why do we find ourselves sleepwalking into asset classes with no exit plan? The DGF has a professional under the umbrella to implement those decisions.

Drewienkiewicz: And that is why, again, something like multi-class credit is another panacea; an investment strategy, because it is a highly unconstrained strategy, but effectively it is an outsourced governance tool.

Bourne: So you would almost say it is asset allocation-lite for those schemes who cannot, for good reasons, do it themselves?

Nestor: Yes.