Published by Jemma Arfield on
Estimated reading time: 4 minutes
Over the five years to 31 May 2019, global equity markets have returned almost 8% per year on average in local currency terms*. Returns were even greater for UK investors that do not hedge their currency risk. However, the day-to-day volatility of stock prices, whilst at relatively low levels historically, can and does have a material impact on asset prices and by extension, pension scheme funding levels.
It is with this backdrop that many trustees have sought to diversify their return, seeking assets away from the foibles of equity markets. A vast number of schemes have swapped some or all of their equity holdings to diversified growth funds (DGFs). A term that covers a wide range of approaches, but essentially involves gaining exposure to an array of asset classes with the aim of generating growth at lower volatility than equities.
One of the key benefits to investors relates to governance. Through a single pooled fund, trustees can gain access to a range of asset classes without the need to find, select and appoint specialist managers for each type of asset. However, this comes with a need to carefully appoint and control that individual manager risk. Over this latest long period of attractive returns from equities with relatively low volatility, many DGFs seem to have disappointed. This has left many trustees questioning their faith in the DGF approach. However, is this justified?
We would argue on the whole, no they haven’t.
The chart below illustrates how a number of well known DGFs have performed over the past 3 years:
Our key comments on this chart are:
Whilst DGFs provide diversification within liquid public markets, they cannot provide exposure to illiquid assets. This means that when returns are scarce across public markets, DGF returns will suffice. Diversification can only protect so much against losses when most of their investment universe is falling. The chart below shows that the 2018 calendar year was a great example of this:
The investment universe is vast and constantly evolving, however we would argue there is really only four ways to make money;
A DGF can provide exposure to three of the above areas and we must be mindful of this when comparing fund performance to a broader spectrum of returns.
We suggest trustees consider how well their current growth assets contribute to the above return sources as a whole.
Illiquid markets are an area that is increasingly being considered by pension schemes, given their investment time horizon is in many cases, longer than retail investors.
Attractive opportunities still exist outside public markets, however there are some practical considerations that need to be considered before investing:
* Source FTSE (FTSE All-World total return index [7.7% p.a.])
Contact your local Investment Consulting contact, if you would be interested in exploring this topic in more detail.