May 2012

PRODUCT TRENDS: The rise of diversified growth

DiversificationPension schemes are turning to a set of funds that spread their risk across a wide range of assets. But with naming conventions still vague, investors must do their due diligence to be sure what they are investing in. George Mitton reports. Diversified growth funds, which invest in a wide range of growth assets, such as commodities or high-yield bonds, have become popular in recent years. For small to medium-sized pension funds, they offer a convenient way to gain exposure to a range of assets and sidestep the regulatory hurdles involved with investing in alternatives. Diversified growth funds have also benefited from good performance relative to traditional “balanced” funds due to their use of “absolute return” type strategies, which employ derivatives and other tactics to target positive returns in all market conditions. Research by investment consultancy Aon Hewitt has identified diversified growth as one of the fund types institutional investors are likely to increase exposure to in the coming months. But which funds will they choose, and which fund providers will benefit? Data provider Lipper has a fund category that captures most of the products using diversified growth strategies, called “asset allocation” funds, defined as: “Funds with no asset allocation restrictions; they can invest up to 100% in equities if markets are bullish and swing to 100% in bonds if markets are bearish.” The tables show the top five funds by assets under management and the top five by inflows in the three months ending February 2012. The larger table shows the top ten providers by assets under management. The results indicate a clear leader: Standard Life’s Global Absolute Return Strategies (GARS) fund, which had more than €12 billion in assets in February and gained nearly €1 billion in the preceding three months. This fund, which invests in an array of asset classes and currencies, and uses various derivatives to hedge risk, has returned an average of 12% a year in the past three years. BNY Mellon’s Newton Real Return fund has roughly half the assets of Standard Life’s product and has attracted high inflows in recent months based partly on good performance. Below it, products from Barings, Deutsche and Allianz have high assets under management but did not attract as much new money as products from Invesco, DZ Bank and Assenagon in the quarter. However, it is notable that most do not define themselves as diversified growth but use terms such as “real return”, “absolute return” and “total opportunities”. What do these names mean? Peter Halligan, who is co-head of multi-asset research at Aon Hewitt, says the differences may be slight. His team holds regular meetings when, along with diversified growth funds, his colleagues consider multi-asset funds, global tactical asset allocation funds and risk parity products. Any or all of these funds might use the words “absolute return” or “total return”  because this is what they target. For Halligan, the important thing is that these kinds of funds generally target risk of between 8-12% and aim for returns of 7-8% (though funds define their returns in different ways; it might be Libor plus 3-4% or a target based on an inflation index, but it normally works out the same). He is clear that discussions of these funds are taking up more of his time. “There is a willingness for pension funds to get rid of their governance headaches by picking diversified growth funds and new money is also being sourced from balanced funds,” he says. “There are many more managers springing up who say they have this capability.” But if what matters are the risk/return targets, why not go further and include other funds in the same category as diversified growth? There are some hedge funds with similar risk/return targets. And what about absolute return bond funds, which typically invest in sovereign and corporate debt and use short-selling and other derivatives? “Some of the big managers have five products which all have the same risk/return targets,” says Halligan. “Some in bonds, some multi-asset, some diversified growth, some lifestyle pension funds. The product differentiation is getting blurred.” These funds might fit in the same section of a pension scheme’s portfolio, so it makes sense to consider them in aggregate. But that does not mean the underlying asset classes are irrelevant. Institutional investors must still do due diligence and decide if they are happy that a portion of their money is invested in real estate or private equity, for instance. This due diligence is becoming more important as the number of diversified growth funds increases. They can be complex, so it takes time for investors to understand them. A drawback is that fees can be high. One cause is that managers of diversified growth funds invest part of their portfolio in other funds. This means additional manager fees must be paid by the end investor. But these disadvantages are unlikely to stop the spread of diversified growth and the myriad of other products aiming for similar investment outcomes. ©2012 funds europe

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