Diversified growth funds (DGFs) are expected to reach £200 billion ($307 billion) in three years’ time—but the products are failing to deliver what they promise, according to Cambridge Associates.
The consultancy firm found the average return from DGFs lagged behind that of a “simple, old style balanced fund” in the period since it launched its first index of the funds in 2007.
“Even a moderate return differential between DGF managers can be impactful in the low absolute return environment.” —Alex Koriath, Cambridge Associates“In our view, the DGF’s aim to generate long-term growth with lower volatility than equities, while intuitively appealing for pension funds, is inherently difficult to achieve,” said Alex Koriath, head of the UK pension practice at Cambridge Associates.
The company’s study—involving 35 DGFs with at least £30 million in assets—found that the median DGF manager’s return was 3.3 percentage points below that of a traditional “balanced” fund, split 60:40 between equities and bonds. DGFs are typically invested across a wider range of asset classes.
“In our view, the DGFs aim to generate long-term growth with lower volatility than equities, while intuitively appealing for pension funds, is inherently difficult to achieve,” Koriath said.
In addition, the difference between the best and worst performing DGFs was 1.1 percentage points a year over the period measured. In the 12 months to March 2015, the latest data point in the study, the top 25% of funds outperformed the bottom 25% by 26 percentage points, making manager selection “critical”.
“Even a moderate return differential between DGF managers can be impactful in the low absolute return environment that [pensions] face today,” Koriath said. “But these are really quite enormous differences in performance.”
On top of this performance data, Cambridge Associates claimed its research showed many DGFs “were not constructed in a way that would deliver inflation-plus returns”, despite such products often targeting returns in excess of inflation.
“In most cases, we believe these targets to be aspirational at best,” the group said in a press release announcing the research.
Koriath said most DGFs did not demonstrate a significant proportion of inflation-linked assets, suggesting the managers were not explicitly targeting inflation. Cambridge’s research showed the median DGF “was highly correlated to a 60:40 mix of equities and bonds mix but exhibited little or no link to inflation”.
Cambridge highlighted that “absolute return” DGFs, which have the ability to use derivatives and take short positions, have performed in line with traditional DGFs but with “less equity upside and downside”.
The findings were detailed in a report, “Navigating the Diversified Growth Fund Maze”, written by Alex Koriath, Himanshu Chaturvedi, and Max Gelb.
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