December-January 2016

INSIDE VIEW: How was your journey?

Diversified growth funds in the UK have grown almost fivefold over the past five years. Steve Butler of Punter Southall Investment Consulting considers their success at providing equity-like returns with a smoother return stream. The financial crisis in 2008 left many investors licking their wounds and reassessing the traditional concept of diversification. The response from a number of investment managers was to roll out the multi-asset mandates they had been running in the shadows for larger pension schemes and to make these strategies available in a pooled fund format.  As a result, we saw an explosion in what we now call diversified growth funds (DGFs). Although the history of these products can be traced back to the early 2000s, it was during the credit crunch that they faced their first real test: could they preserve capital, or at least not experience the same deep drawdowns as equity funds? Whilst some didn’t survive, others – such as Barings’ DAA fund and Standard Life’s GARS fund – did, proving the DGF concept and carrying on to become significant success stories.  Since then, assets in DGFs in the UK have grown almost fivefold in five years. The total amount of assets under management in DGF products today stands at £126 billion (€178 billion), up from £25 billion in 2010.  The amount of products has also significantly grown; as of June 30, 2015, there were 85 sterling-denominated products available to investors; 67 of which have a track record of three years or more, according to Camradata figures.  Funds such as DGFs are designed to provide equity-like returns but with a ‘smooth ride’, reducing volatility and overall drawdown risk. Seven years on from the mass introduction of DGFs, and their wide take-up by the market, it’s time to assess just how smooth a ride it has been for investors and providers. Objectives reached From a high-level performance point of view, it would certainly appear that DGFs have achieved their overall objective. According to Punter Southall’s own research, DGFs achieved monthly returns of between -3% and 3% over a three-year period, a much more stable performance than the FTSE All Share, which achieved monthly returns of between -6% and 8%.  As expected in the current rising market, the MSCI World Index achieved higher returns than DGFs. However, the asset class showed its value during December and January 2015 when the volatility of the markets meant the majority of DGFs outperformed the MSCI World Index. It’s no surprise then that the flows into DGFs have been consistent, despite a reminder in the latter half of 2014 of the inherent risks related to actively managed investment products, when Percival Stanion and his team left Barings and the industry flagship Dynamic Asset Allocation fund. The reaction by the market was as swift as it was stark: circa £6.5 billion was withdrawn from the fund over the subsequent six-month period. The speed with which the redemptions occurred meant that, in all likelihood, many of the funds were placed into holding accounts while investors considered their options. The majority has now been reinvested into the market: for example, Euan Monroe, one of the architects of Standard Life GARS – or Global Absolute Return Strategies – has taken significant flows to his new venture at Aviva Investors. Given the success of the DGF concept, most of the big investment houses are trying to get a slice of the assets on offer. That said, the majority of funds are controlled by a very small number of players.  Standard Life has over £42 billion under management in DGF products, controlling a third of the market and making it by far the manager with the largest share of assets. Alongside the two next-biggest players, Ruffer
and BlackRock, over a third of
the market is managed by just three players.  However, despite the concentration of assets in these funds, it is a refreshing change to the norm that each fund has kept its own individual identity rather than returning to the peer group herding of old. Future success for DGFs isn’t solely down to investment managers, however. The outcome-based approach of these funds naturally leads to further invention and innovation.  Investors need to reward such innovation by not simply following others into the big three funds (albeit Ruffer is now closed to institutional flow). There is plenty of reward in looking further afield – Invesco, Nordea Investment Management and Insight Investment Management have all muscled in over the past few months, with flows to the tune of circa £1.5 billion combined in the second quarter (Q2). Newton Investment Management and Schroder Investment Management are also hot on the heels of the three big managers, managing assets worth £9.6 billion and £6.3 billion, respectively.  Fund managers are certainly confident of continued growth in the DGF market. In Q2 of 2015, DGF assets grew by £2.5 billion, with Standard Life receiving inflows of £1.4 billion and First Quadrant having the largest flows by percentage (circa 24%).  Fees lowered Growth in the market could be considered good for investors
too. Punter Southall research
has found that DGF fees appear
to be coming down as new products launch. As an example, the maximum fee for DGF products with an objective of
cash plus three to five and with a track record of less than three years is 0.8%. This compares to 1% for products with a longer track record. However, DGFs come with their own warnings. Outcome-based innovation can bring many benefits to investors, but without a benchmark to ‘herd’ around we need to be aware of the risks that the outcome is not as expected. It is vital that investors make the effort to understand the market, and managers educate their clients in order to avoid potential pitfalls. The early 2013 and 2014 global equity run meant, for example, DGFs finished behind the traditional alternative. However, if recent market shocks are anything to go by then investors with a DGF holding are likely to be sleeping comfortably. Steve Butler is a managing director at Punter Southall Investment Consulting

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