Considerations for a modern DGF strategy

Diversified Growth Funds (DGFs) have been around for over a decade now. They have a place in a global portfolio, in our view, given the diversification benefit and the governance easing they aim to deliver. The experience of 2020 within DGFs has also been an eye-opener for many investors.

Pension plan tolerance for drawdowns is reducing rapidly for many, given the maturity of membership. The increasing maturity, combined with increased regulations, has meant that investors are more sensitive to the magnitude of negative returns. Similarly, the increased use of private assets has meant that capital waiting to be ‘called’ needs to find a liquid home in the meantime. Many insurers and other investors are also placing greater value on strategies that are less reliant on single risk drivers and are liquid.

Traditional DGFs (whether beta-based or alpha-based) have continued to focus on reducing volatility. However, the experience in 2020 has shown the shortcomings of many such approaches. Many beta-based DGFs - strategies that mainly rely on markets to generate returns - fell in the range of 10-20% in March 2020 (some by even more) and a number of investors found out that their portfolios did not have daily liquidity. Most alpha-based DGFs – strategies that go long-short with low overall market exposure – continue to significantly lag markets over the past 3 to 5 years. Overall, to address these challenges, our view is that investors need to look at strategies that target attractive returns combined with having a specific focus on drawdown management.

Our design combines a beta-based DGF, complimented with well-understood sources of alpha, and an explicit drawdown management framework. We believe this helps to potentially achieve both the strong market performance that many beta-based managers enjoy, as well as the low drawdowns that alpha-based managers aim for. This year has been a great testament to our process and its resilience. We have out-performed most of our peers in March 2020 and have been able to participate in the market rebound since.

Finally, as pension plans de-risk, we believe the liquidity for DGFs need to improve in order to provide the required flexibility. This is also an important feature of our portfolio design. Our trading process and the liquidity profile of our strategy has remained robust throughout 2020 given liquidity is both an input and an output of our process.

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