Diversified Growth Funds: look for robust risk management

by Brendan McLean   •  

Diversified Growth Funds (DGF) are often a core component of pension schemes’ strategic asset allocations. Therefore, their performance makes a material impact to the funding level of the scheme. DGFs invest into a wide variety of asset classes providing a large range of return drivers and offering the potential for high risk adjusted returns; this makes them an attractive solution for pension schemes.

In recent years, DGFs have underperformed and investor appetite for these strategies has decreased. However, DGFs have recently produced the highest 1-year return in several years, with the average DGF returning 18% in the period 1 April 2020 to 31 March 2021.

As most DGFs have an absolute return target of cash+3-5%, many have shown significant outperformance. The reason for these high returns is that 1 April 2020 was very close to the bottom of the market due to the pandemic – since then, most capital markets have had an impressive recovery supported by government intervention/stimulus. Global equities are up 40% over the period and the passive 60:40 (60% equities, 40% bonds) portfolio is up 21%, therefore the high DGF performance is expected.

Large returns are always welcome; however, trustees should realise such returns are unlikely to continue and avoid allocating to DGFs that have had a particularly high return as it may not be sustainable. Trustees should select DGF managers that have robust risk management processes will be able to limit volatility and future drawdowns.

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