Roundtable: LCP's Andy Cheseldine, Legal & General Investment Management's Martin Dietz, Columbia Threadneedle's Craig Nowrie, State Street Global Advisers' Andrew Soper, Peter Sparkes of the Association of Member Nominated Trustees, and Bestrustees' Graham Wardle discuss what makes an ideal diversified growth fund, in the first of this four-part roundtable series.
Martin Dietz: It needs to focus on diversification and to be designed to generate growth. It does not necessarily require something that is dynamic or any kind of absolute return. It is a wide selection of funds, ranging from old-fashioned balanced with a little bit of extra diversification to multi-strategy hedge funds with very aggressive alpha targets.
Andrew Soper: There is not a lot of standardisation about what the words mean, but it is diversified and it is a growth return. Rather than the growth phase, it targets a growth return in excess of cash or liabilities. The majority have some degree of dynamism.
Craig Nowrie: They are actually looking to reduce the volatility compared to equity-only strategies.
Andy Cheseldine: We need to differentiate between multi-asset funds or managed funds and diversified growth funds. DGFs are focused on risk mitigation, or the management of volatility.
Graham Wardle: Yes, for defined contribution schemes I think they will be increasingly used in the drawdown phase, because of the reduced volatility.
Peter Sparkes: From our scheme’s perspective, we have used DGFs as a way of reducing that volatility, with the acceptance that you also – potentially – miss out on the very peak of any returns cycle.
Pensions Expert: Where are DGFs best used within pension schemes?
Wardle: The growth of their use has been enormous. Every one of the 12 trustee bodies I sit on uses a DGF for their defined benefit section and I am sure will use for DC.
Every one of the 12 trustee bodies I sit on uses a DGF for their defined benefit section and I am sure will use for DC
Graham Wardle, Bestrustees
Dietz: There are very different DGFs. Some are designed as a core portfolio while others are suitable as satellites and replace funds of hedge funds. Other DGFs serve a specific function. DGFs may differ widely in risk and costs.
Soper: For DC, it is about limiting path dependency, giving increased certainty of outcome towards the end.
You might also use DGFs as a means of keeping some growth on the table while managing the volatility of the portfolio more effectively.
Cheseldine: We will see DGFs used post-retirement as they do a perfectly reasonable job post-retirement – certainly those with an absolute return objective.
Pensions Expert: Is there a danger that trustees use DGFs as a one-stop-shop strategy?
Cheseldine: There is a danger. I would argue that is part of the consultant’s job to make sure it does not happen.
Nowrie: You must understand the biases within the diversified growth portfolio manager you already have and make sure you do not pick one exactly the same.
You must understand their path dependency, how they would react in different scenarios and then how it would interact with other investments.
Sparkes: We have used it to complement our existing investment opportunities with our long-term growth fund as part of the accumulation phase.
Until now – from a DC perspective – most investment strategies have all been annuity-focused, but now we may see DGFs used in long-term, medium-growth and defensive, and as longer-term investment vehicles in the decumulation phase.
Cheseldine: Yes, freedom and choice is not just about being able to take money as a lump sum, but when you take the benefits. There is a good chance someone will take them between 55 and 65, so even an equity-based DGF might be better than pure equities.
Soper: The problem now is that we do not know what they are going to do at retirement or when they are going to do it. So, you need to maintain some growth but equally have something that is managing your volatility more dynamically or effectively than simply equity allocations.
The four key risks as you approach retirement are: income, capital preservation, providing a real return and longevity
Craig Nowrie, Columbia Threadneedle
Cheseldine: Some of our DB trustee clients have said they are concerned that a significant proportion of their members might want to take transfers into DC to make use of the freedoms.
That might direct investments towards DGFs to maintain more stability when you are paying out transfers, but it is a relatively short-term issue.
Nowrie: The four key risks as you approach retirement are: income, capital preservation, providing a real return and then the final one is longevity. Longevity is the great unknown.
There are things we can do in terms of income-orientation, capital preservation solutions or strategies that target a real return. But dealing with individual longevity is more of an issue.
Pensions Expert: The trouble, particularly in DC, is the vast majority of people are in the default and really want somebody else to make decisions for them.
Sparkes: The fear is that members have taken a DB mentality into the DC world and the shock will be the amount they get at the end could be substantially less. DGF is another tool trustees have available to provide for the best interests of their members.
How they choose to deploy that will depend on their approach to risk and their members’ perceived approach to risk.
Wardle: For one particular large DC fund, we have three lifestyling strategies – one targeting annuities, one targeting cash and one targeting drawdown. The default is the one that targets drawdown and is basically DGF-based.
Soper: The solution needs to be fairly low risk but maintain some growth. There has to be a balance, and DGFs fit that mix.
Dietz: There is a bit of a temptation to see low-risk DGFs as one-size-fits-all, which means they might not fit anyone well. They don’t hedge the annuity risk and might not produce enough return for people with a long time horizon.
This roundtable series was chaired by freelance journalist Pádraig Floyd
