From the blog: With markets volatile and growth opportunities scarce, diversified growth funds retain their popularity by providing exposure to a wide range of assets within a single fund and dynamic management.
DGFs have experienced high growth, with assets rising to £117bn from £25bn between 2010 and 2015, according to Cambridge Associates. We predict they will increase another 27 per cent by the end of 2016, reaching £160bn.
This year, we expect growth in the DGF space to be driven by a number of factors. Firstly, defined contribution fund allocations to lower-price solutions are growing significantly.
We expect pension funds to increasingly allocate across more than one manager, mitigating key manager risk and potential future capacity issues.
Finally, we expect the reduced volatility and drawdown risk to attract investors.
We are seeing more searches for DGF mandates as an increasingly diverse range of investors look at the approach, and existing investors look to diversify across DGF styles.
Where the typical allocation funding comes from depends on the DGF chosen; many come out of the equity allocation as part of a derisking strategy, given that the objective of many DGFs is to provide equity-like returns at lower volatility.
UK-led market
The DGF market is predominantly UK-led, driven primarily by the relatively small size of UK schemes – assets per scheme in the UK are more than 500 times smaller than in Denmark for example – hence the challenges of scale, diversification, and constrained governance budgets, which DGFs seek to address.
There is emerging interest in Germany and Italy as well, whereas the fiduciary-led Dutch market has little need for such a solution.
Due to the wide variety of DGF approaches, many asset owners categorise them into fund groups with similar characteristics to analyse performance against peers.
Over the period 2010-2015, the top 25 per cent of funds outperformed the bottom 25 per cent by 110 basis points a year, according to Cambridge Associates, showing the disparity in the market.
Institutional investors need to be aware of manager risk as many teams’ insights are effectively driven by small asset allocation teams.
It is also important for investors to understand the style and type of DGF they are investing in.
The use of third-party managers can incur costs not captured in the total expense ratio, but rather at the net asset value level, so investors should also understand the related costs.
Hani Redha is portfolio manager multi-asset at PineBridge Investments
