What should trustees look for in a DGF manager?

Neil McPherson: In a universe where the number of providers has expanded, a manager who has managed diversified growth funds over the cycles is an important factor. Someone who has a clear view on size and capacity is a factor, and someone who is going to forego future growth of the fund to protect existing investors always goes down well with trustees.

Transparency is also very important, as is understanding what is under the label, in order to set expectations of what you are going to get at the end.

You have to ask yourself, ‘Which are the ones that are going to fall by the wayside going forward?’

Percival Stanion, Pictet Asset Management

Naomi L’Estrange: It is a bit easier with defined benefit because then you can have the conversation among your trustee board as to what you want the DGF for. If you consider two contrasting ones then it is about the strategy, and then it is about the conviction and whether they have done what they said. In defined contribution it is much harder, and you start to get into more practical situations which relate to the platform that you are on. There are also structural points about decumulation, and the mechanisms you will have for easing those members into.

McPherson: DC members do not necessarily have the information or skillset to choose between North American growth equities and emerging equities, for example. So paternalising it, to an extent, by employing a manager to make those asset allocation decisions can only be a good thing in DC.

L’Estrange: But clearly you are going to be looking more at the directional DGFs rather than the strategic ones, because obviously the volatility is very important and the downside risk is important but you have to have some of that growth in there.

Shuntao Li: The transparency point is very important. We have to make sure that we absolutely understand what the fund is trying to achieve and how it achieves it and then we will be able to bring it in front of trustees and let them select.

When I look at how people manage funds, I pay attention to accountability, particularly with a fund that is managed by a team. Whenever there is a team process, you do not know who is accountable for which decision and when things go wrong, who can you talk to? Who can you blame?

Murray Taylor: The key thing for trustees is to say, ‘Look, this is what the fund is, this is what it does, this is when we think it will do well, this is when we think it will do badly’. We are then measuring the manager against whether it does what it says on the tin.

In the past, we have removed fund managers because they have not carried out the role we originally appointed them for, despite performing well in absolute terms. They are appointed for a specific purpose and it’s about being clear with trustees from the start with regard to what that purpose is and how the manager is going to be assessed. And that way, there should be no ambiguity down the line when you come to changing your mind, or sticking to your guns about a certain manager if you’re getting a tough time from the trustees about them.

Percival Stanion: Some of the most interesting experiences I have had have been as a trustee or a member of an investment panel appointing managers. It is fascinating being on the other side of the table and hearing stories being presented to you and the way people respond to the same questions.

Assuming that your investment consultants are not going to put an incompetent manager in front of you, or somebody with a really bad track record, managers are always going to be good. But we know that statistically, performing well consistently is actually very difficult.

I would question having DGFs within the fiduciary model; I think that is fees on fees on fees, potentially

Neil McPherson, Capital Cranfield Trustees

So even if you are seeing a subset of what are now well-performing managers, you have to ask yourself, ‘Which are the ones that are going to fall by the wayside?’ Even the longest DGFs have only got track records of 15 years, and there is only literally a handful of those.

You really have to scrutinise the manager on where their performance has come from, and you have to probe on issues like sizing and positions. There is no right answer to it, but in actually asking the manager how they did it and how they sized it, I think it really starts to test the manager as to how they think about running the portfolio and what their real risk-taking appetite is.

McPherson: Is there a structural issue, to challenge my consultant friends? It is well-known that some of you have parked your tanks on the fund managers’ lawn with fiduciary management. With DGFs you are effectively parking the asset allocation decision with the manager, not with the investment consultant. Is that a threat to the business model of the investment consultant?

If it is within your fiduciary model, that is fine because it is all captured within your remit anyway. But if you are not doing fiduciary and you appoint DGF managers who, over the medium term, will be doing the asset allocation, then the switch from European equities to US equities, or from large cap to small cap, is all being done by the fund manager.

Li: That is a really good question. On a very high level, yes, in theory, maybe a DGF manager can just replace investment consultants because they do the asset allocation. But I think in reality, investment consultants tend to understand pension funds, or understand the specific clients a little bit better, or they probably have more of an insight from an actuarial point of view as well.

McPherson: I would question having DGFs within the fiduciary model; that is fees on fees on fees, potentially.

L’Estrange: I would see it as effectively a choice between fiduciary and a normal advisory model. It is horses for courses. There is an extent to which DGF is fiduciary-light that might be more comfortable for trustees because you do not have all your eggs in one basket, even though you might have most of your growth in one basket.

Taylor: There is also the key component of practicality. DGF managers can ultimately implement the decisions much faster on our behalf.

McPherson: So is there a conflict between the fiduciary model and the DGF model in terms of speed of tactical response to the market?

Taylor: Rather than say that DGF is an amalgamation of a number of asset classes, we would actually say DGF is its own thing, it has its own return profile, its own risk characteristics.

If we want to allocate to DGFs to get those characteristics, we will allocate to DGFs, but if we want to ramp up the risk around the edges, whether it be with equities or whatever, we also have the ability to make that decision as well. So we do not see it as a competition; we see it as something which is part of our tool kit.