By Sean Thompson, Managing Director, CAMRADATA 

CAMRADATA has recently published a new whitepaper on the investment outlook for Diversified Growth Funds, (DGF) which also considered the key question, can DFGs can protect last year’s gains, as the longest bull market ever teeters on the point of massive draw-down due to the Coronavirus pandemic?

The whitepaper includes the views and expert insights from representatives of firms including, Newton Investment Management, PineBridge Investments, Cartwright, PiRho, Punter Southall Aspire and PwC, who attended a virtual webinar in March.

They shared the insights of DGF providers and investors, and the impact the Coronavirus has had on the markets in China and the rest of the world. They also discussed the parameters for DGFs; how DGFs are not a like-for like equity replacement and how different DGF strategies may be suitable for the current economic climate.

The DGF landscape

Over the past year outflows have been a notable fixture of the diversified growth fund (DGF) landscape. In the third quarter of 2019, CAMRADATA revealed that net redemptions from this multi-asset class were £4.46 billion.

The reasons for this include the fact it was a time of some turbulence due to Brexit and a UK general election had been looming, plus there had been a sudden reversal in monetary policy in the US and Europe.

Despite this, our research highlights that at this time more than 90% of funds in the DGF universe had achieved breakeven or positive returns for the second quarter in a row.

Outflows from DGF last year, despite the positive performance seen in the sector, came about because some investors had doubts about the ability of DGFs to meet their return targets.

DGF returns are usually related to cash and almost always with some form of absolute-return element. However, it was not just about the DGF returns; the outflows were also because of sentiment about DGF risk management.

Much has changed this year because of the coronavirus emanating from China and the lockdown measures that have been implemented globally. The question is how will DGF be protecting its gains of last year for investors and adapt to this new phase of uncertainty?

Key considerations for investors

For investors, a variety of benchmarks are applied to DGFs. The most obvious of these relates to equity market returns.

Data suggests global equities have outstripped the average DGF by at least 50% since October 2009. But investors should remember that DGFs were never a like-for like equity replacement, not least because there was always greater emphasis on risk management.

Right now, some investors may be considering whether a risk-return ratio of half the volatility of equities for two-thirds of the return would be a better frame for expectations. However, for many this will not be suitable for their strategy.

Since 2008 the world has been disinflationary. Markets became ridiculously distorted by the policy of authorities (notably the Central Banks) and they will be even more distorted due to this crisis. The upshot has been that diversification hurts, which is why two-thirds of equity return is a figure most DGFs have languished far behind.

Other investors suggested that it depends on the DGF, but most were not designed to do two-thirds of equity return for one-half of the risk.

Since the start of 2007, Pre-Global Financial Crisis, DGFs have achieved greater than 80% equity return for less than 50% of the risk, i.e. better than their typical objective. More recently, both risk and returns have been lower.

For the three years to February 2020, the average DGF has achieved only one-quarter of equity performance for one-third of the risk.

Performance generally had been “disappointing in the good times,” but our experts highlighted that it is important to measure each strategy in accordance with its stated objectives, rather than forcing them into less helpful generalisations.

Some investors recommend different active as well as passive strategies according to each client’s preferences and risk-appetites. As market volatility increases, due to the current economic environment, the dispersion between manager performance is expected to widen.

While the bear market would make DGF managers’ numbers look better relative to equities, if a manager could not achieve two-thirds equity return for half the equity volatility, then our experts argue that they are too expensive.

Currently, there is also downwards pressure on fees from new entrants, and it is hard for managers to beat a multi-asset passive strategy at this time.

The times are changing

Some suggest that DGFs may be better suited for the volatile times ahead. However, policymakers can often destroy normal market pricing and it has been noted in recent bear markets that they do not fall in a straight line. Such zigzagging can confound investors seeking some rationale for re-risking.

It also confuses certain defensive measures such as buying gold. Early into the current crisis, however, gold exposure had proven costly rather than defensive. More recently it has acted more as expected, rising rapidly in price.

Investors have been hampered too by a host of extraordinary market pressures. Liquidity has all but dried up after the fastest sell-off in history, plus peculiar to the COVID-19 crisis, many investment management employees are now working from home, but technology was not always up-to-speed to carry on business as normal.

DGFs could serve clients well but so far some have not. One solution going forward would be to invest a proportion of the DGF allocation in passive rather than active management and use more than one active DGF manager. This would diversity organisational risk which would mean there is less change that things can go wrong.

There is much lower key-person risk with passive management in comparison, although the time for active managers to differentiate themselves could lie ahead as markets have entered a new phase of uncertainty.

However, for the months ahead, some experts have warned that passive will not be the best strategy. Since the crisis began, corporates have leveraged their balance sheet to buy back stocks because CEOs are remunerated by stock options.

There will be a chance for fiscal policy to step in. At its most extreme, that means helicopter money, which began last year in Hong Kong, but this spring, is evident falling in several countries; along with several other forms of fiscal largesse, which transmit into the real economy far more effectively than quantitative easing.

There is more spending to come in the USA too given there is a presidential election this year and President Trump will want to please voters before November.

To conclude

These unprecedented times will be felt in the markets for the foreseeable future. The coronavirus and the increased volatility so far wrought on markets will be an acid-test for these funds. The claims made for DGFs and other multi-asset funds, is that they can deliver equity-like returns for a lower level of risk. The current market environment will be a stress test for this. and it will be interesting to see how DGFs perform for investors over the coming months.