Back to basics on diversified growth funds

Diversified growth funds, a type of investment fund that uses a broad range of asset classes, are becoming more common in defined contribution (DC) pension schemes.

Back to basics on diversified growth funds

A diversified growth fund is managed actively so that the range of asset classes changes over time, with the aim of delivering a reasonable rate of return but with less risk than a single asset fund.

If you read nothing else, read this …

  • A diversified growth fund invests in a broad range of asset classes and is managed actively.
  • Such funds have been traditionally used in defined benefit pension schemes, but are becoming more common in defined contribution plans.
  • No two diversified growth funds are alike.

Simon Chinnery, head of DC at JP Morgan Asset Management, says: “It is a multi-asset strategy which, depending on its benchmark, is designed to try to achieve growth with a limited amount of volatility.”

The word ’diversified’ is key to these types of fund, because they are invested in a range of equities, bonds and alternative asset classes. Michael Allen, chief investment officer at Momentum Global Investment Management, says an investor will want good returns that are comparable to equity markets. Varied investments can achieve this by balancing out the market ups and downs.

Diversified growth funds have traditionally been used in defined benefit (DB) pension schemes, but are now becoming more common on the DC side. Nick Robert-Nicoud, head of institutional business at Momentum Global Investment Management, says: “It’s been a big evolution. We have seen these funds replace the old balanced funds and the old multi-asset funds. We’ve seen a huge uptake in investment across the DB side, but now we’re also seeing it across the DC side.”

According to the report Investing in diversified growth and multi-asset fundspublished by Clear Path Analysis in October 2013, diversified growth fund managers’ assets in the UK and Ireland rose by £20 billion in 12 months to reach £50 billion in 2012.

Increased interest

Stephen Bowles, head of DC at Schroders, says he has seen increased use of these funds, particularly in trust-based pension plans and schemes that are advised by employee benefits consultants. “We are certainly seeing that most schemes have looked at diversified growth funds and a few have been implementing them as part, if not all, of their default fund,” he says.

“The reason we think these funds are appropriate in DC and for default funds is that, generally, DC members need to grow their contributions. They aren’t keen on taking excessive levels of risk and prefer certainty.

“The theory makes sense: let’s diversify, let’s try to capture a lot of the upside you might get from equities, let’s try to eliminate the erratic nature of the way equities deliver that return by diversifying into a range of other asset classes, such as property, commodities or infrastructure.”

But diversified growth funds do have some downsides. They typically cost more than other funds because they are managed actively, and a long-term investor may be better off riding the ups and downs of equities.

But DC members will not want the volatility associated with single-asset funds, says Bowles. “As they get older, their ability to deal with that volatility gets less and less,” he says. “You could make an argument that equities are still the best solution for very young members, but as they get older and their pension pot grows, their capacity to withstand that volatility decreases and that’s when diversified growth funds become a much better option for them.”

There is also a longer-term challenge around diversified growth funds, says Chinnery. “No one diversified growth fund is the same as another,” he adds. “Employers should keep an eye on whatever fund they have put into their plan because, although it may have done what it said on the tin in terms of reducing volatility, often [these funds] have cash or some inflation-plus target as their benchmark.

“While that has been relatively easy to achieve in the last few years because of market volatility, I’m not sure they will all make the grade in equity returns over the longer period.”