Comment: Not all diversified growth funds depend on beta
Recent criticism of diversified growth funds (DGFs) has suggested that their returns have been highly correlated to a passive benchmark of 50% equity and 50% bonds.
In other words, much of the returns can be explained by beta, and annual returns have generally fallen short of this passive benchmark.
The criticism has also suggested that prices of traditional assets – the passive benchmark – are elevated by historical standards so future returns are likely to be disappointing.
Different DGF managers employ a wide range of investment approaches. Not all of these approaches involve heavy reliance on market betas and a general critique of the average strategy is not valid for every individual strategy.
We agree with the general top-down thesis that traditional assets are elevated by historical standards and that future returns are likely to be low relative to history – and the implication that a quasi-passive multi-asset investment approach will generate low returns.
Not all [DGFs] involve heavy reliance on market betas and a general critique of the average strategy is not valid for every individual strategy.
However, there are still many attractive bottom-up investment opportunities in both traditional asset classes, equities and fixed income. Investing in customised, benchmark-agnostic portfolios of securities that possess attractive pre-defined characteristics ensures that a fund has maximum exposure to securities with positive attributes, rather than securities that are heavily represented in market indices.
Several alternative asset classes offer both high risk-adjusted returns and attractive diversification benefits. This combination is highly attractive for a DGF strategy. However, we would caution against a blanket approach to investing in alternative assets because not all of these offer attractive levels of diversification.
For example, the term ‘infrastructure’ spans a wide range of investment opportunities. Private partnerships, which involve private investors funding public infrastructure projects such as schools and hospitals, are a relatively low risk and stable investment sector. On the other hand, toll road investments may be highly sensitive to levels of economic activity and, despite the ‘infrastructure’ label, may behave very similarly to traditional equity.
Opportunities in financial markets constantly evolve – not just in traditional asset classes but also in alternative asset classes. An approach that is active and has the flexibility to allocate according to opportunity and circumstance maximises the likelihood of investors achieving their long-term objectives.
Not all DGFs simply offer market betas.
Colin Dryburgh is an investment manager at Kames Capital, a UK-based asset management company.