Experts predicted the continued growth of the diversified growth fund market this week, even as the asset class comes under increased scrutiny over performance and competition from advisers.
A report by research provider Spence Johnson, released this week, found the DGF market had grown to £194bn by the second quarter of 2016, up from £139bn at the end of 2014. The market has grown at an average rate of 24 per cent each year.
However, the sector faces a variety of threats; from disgruntled customers turning away from the asset class to regulatory pressure to consultants-cum-fiduciary managers eating into market share.
The rhetoric about equity-like returns with low volatility is borderline misleading
Roger Mattingly, Pan Trustees
Performance criticism
Richard Butcher, managing director of professional trustee company PTL, said the asset class was coming in for unwarranted criticism, as some investors expecting equity-returns with less downside have unreasonable perceptions.
“At the moment they’re being blasted a little, but they’re designed to capture most of the upside but [minimise] the downside,” he said.
This has led to disappointment as equities have delivered strong returns, leading investors to expect the same from DGFs.
Source: Spence Johnson
“They’ve been doing what they’re supposed to do, as opposed to keeping up with the market,” Butcher added.
He explained that they should be viewed as a relatively commoditised way of buying diversification for a scheme, “not quite the last free lunch”.
Managing expectations
The responsibility for the misconception about expected returns falls in part on the marketing of DGFs, Roger Mattingly, director at professional trustee company Pan Trustees, said.
“The rhetoric about equity-like returns with low volatility is borderline misleading,” he said. “It will be the exception that now will get equity-like returns. One would expect them to underperform equities over the medium-to-long term.”
He also criticised the commitment to a specific style of strategy within individual DGFs. The market is made up of a wide variety of DGFs with differing approaches and philosophies, not the homogenous profile the catch-all name might suggest.
Mattingly said funds were often too committed to their specific style, and as a result were vulnerable to changes in the market.
He said: “Sometimes you’re buying an approach or a style that is like a product… actually what you want to do is put your members' money in the hands of someone who is going to make changes and move with the times. So many funds are what they say on the tin irrespective of what is going on outside the tin.”
Competitive pressure
The report also highlighted the mixed role consultants play in relation to DGF providers, ranging from independently reviewing and recommending funds; setting up partnerships with providers to provide funds to clients; and actively competing against providers with in-house fiduciary management capabilities.
Jonathan Libre, senior analyst at Spence Johnson, said low equity allocations coupled with this competitive pressure would put DGF flows under strain.
“DGFs have traditionally been an equity replacement. Now equity allocations are very low and there’s competition from other solutions such as fiduciary management,” he said, predicting a “lot of growth over the next few years in fiduciary management”.
The report itself states: “With some of the large investment consultants increasingly offering services that had previously been offered only by asset managers, the FCA has recognised potential conflicts of interest. Any further action would have significant implications for the competitive landscape.”
Despite this, the report anticipates that the DGF market will grow to £289bn by 2020.
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Regulatory pressure
Libre also predicted that the 75 basis point charge cap for defined contribution default funds would lead to an increase in the adoption of “strategic” DGFs, those that follow a more factor-based approach than the more tactical “dynamic” approaches.
Strategic DGFs tend to have lower costs than others, making them well suited to cost-constrained DC funds.
The report states: “Largely as a result of the high cost pressures faced by DC pension funds in the UK… net flows will be highly concentrated in strategic DGFs, which are generally cheaper that other market segments.”
It continues to say strategic DGFs are expected to account for the largest share of net flow from UK defined benefit too, as there is “growing cost sensitivity and feeling that the performance of some dynamic and absolute return funds does not justify the higher fee.”
