How will the DGF market develop?

Percival Stanion: I have to make a confession, which is that the DGF industry has been selling fear for the last decade. It has all been about getting some return at a lower level of risk, and I suspect that everybody has bought that.

If we are right about the structure of our returns being a lot lower, at some point buyers will say, ‘Well, what about the returns? Where are they?’ We have seen a little bit of that in the last year or so. I suspect we will see a lot more of it.

We have been telling our clients for the past two and a half years at least that if they can stomach equity risk, they should be focusing on equities and they should not be selling equities to buy a DGF.

What I suspect happens is that there is initially a creeping and then a bit of a rush towards greed, with people looking for higher-return strategies. And maybe some DGFs cannot provide those because their message has been in lower volatility offerings. They will lose out as those more aggressive strategies, and the higher returns that go with them, are what people desperately need.

Naomi L’Estrange: I would like DGFs to be cheaper. One of the reasons why the returns have looked so bad is because pension schemes have paid so much for that disappointing return and they need trimming a bit. The pressure will come from defined contribution as transparency improves, and it will be much more visible exactly where the money is going.

I cannot imagine there are many investment managers out there who would not want a piece of the cake

Murray Taylor, JLT Employee Benefits

Neil McPherson: Not all of it has been disappointing performance; it has probably done what it has said on the tin, but it has not been the same as equity returns. But schemes did not buy equity returns. And the risk, as Percival says, is greed. It’s saying, ‘That’s it, I am going to ditch my DGF and go active US equities’. And then the regret risk kicks in.

Murray Taylor: In terms of how that market will develop, there are 48 or 49 players within multi-asset. And that number is going to continue to grow.

McPherson: Grow? I was going to say shrink.

L’Estrange: I thought you were going to say consolidation.

Shuntao Li: There are still new managers jumping up.

Stanion: Lots of them have not got past £100m.

Taylor: I cannot imagine there are many investment managers out there who would not want a piece of the cake, and I think the number is going to continue to rise.

McPherson: And that is where the risk is, the me-too, Johnny-come-latelys.

Taylor: That is the major risk. Perhaps this is dependent on how long monetary policy stays like this and is accommodative to the likes of equities.

What is driving the equity performance is low cash rates; what is suppressing DGFs is low cash rates. The longer we stay in this environment, the more people’s mindsets will get turned away from the multi-asset universe.

Li: I would like more managers to focus on what they are better at doing, rather than launching multi-asset funds just because other people are doing it.

Stanion: Are you going to increase the number of multi-asset managers on your buy lists? I have not come across a consultant who wants more.

Li: No.

Taylor: The only way we would want more is if the size of our business multiplied in that context.

Li: I would also like to see managers who consistently apply their philosophy and approach throughout, no matter what the market environment is.

McPherson: And do you see much dispersion on that?

Li: The performance dispersion has widened quite a bit over the last two years. I do not know whether the lack of consistency is because of the disappointing performance, but we have seen these changes.

Some managers change the way they manage money, change their performance objective or are not true to what they used to do or what they tell you they are doing, which I think is very disappointing.

Pensions Expert: Do illiquid assets have a role to play in DGFs?

Taylor: If the underlying liquidity of the asset class does not tie up to the fund, there are minimal allocations which one can make to these things. Diversified alternatives funds have been around for a few years now. They are illiquid, DGF-type funds, and are coming more and more to the fore.

Stanion: But they are only really available to DB schemes. We approve of accessing other risk premiums, but it is just not one that we can access for a public, daily-dealing fund.

L’Estrange:

The problem is, even for DB schemes, even where you have in theory got access to illiquidity, you actually do not know. If you suddenly reach buyout funding in three years’ time, you want to be able to jump swiftly.

Also, nobody can guarantee that their sponsor is going to be around for 20 years. It is a shame, because these are long-term investments and in theory, these long-term assets should be perfect.

I have some schemes with extremely strong sponsors and we use alternative investments. And if you have that stability, then absolutely, some of the best returns are in illiquids. Cash flow is going to be the story over the next 10 years. It is about standard DGFs in DB, producing versions that will allow you to take income out instead of reinvesting it.

McPherson: If we look for the future for the young people today who are in DC funds, DGFs are fantastic, depending on the scale and purpose of the DGF. They address the issue we have with our DC market, which is that you are on your own, folks.

In Holland and Australia with collective DC and superfunds, these are — in effect — mega DGFs. They are professional funds, professionally managed. Our DC funds, as a whole, are not. The components are professionally managed, but if you do not know how to cook, you do not know which bits to pull together. So the DGF has a good position there; it is just how it is positioned on the cycle of where you are within your DC journey.