Adoption of diversified growth funds (DGF) by UK defined benefit (DB) schemes was underestimated, after 2013 witnessed £10bn of inflows, new research shows.

Data, from market intelligence provider SpenceJohnson, showed the entire DGF market may reach £201bn by the end of 2018, up from £97bn at the end of 2013.

It grew £22bn over 2013, with nearly half of all inflows coming from UK DB schemes.

“The speed of adoption by DB schemes witnessed in 2013 was much faster and more significant that expected,” the report said.

“£10 billion flowed from this source in 2013, off a previous estimated base of only £30 billion.”

The popularity of DGFs among the DB schemes is set to grow, as inlflows get close to £80bn by 2019, according to SpenceJohnson’s projections. DC schemes are expecetd to be allocating £20bn, up from £6.6bn currently.

Much of the increase comes with an implicit requirement for DGFs to provide investors with more alpha, rather than static allocations.

“The ‘diversified beta’ portion of a DGF is becoming less valued,” SpenceJohnson said.

“This is combined with the emergence of risk factor investing where these sources of beta can be more accurately targeted using smart beta funds.

“We believe that there will be an increasing onus in selection on exposure to market returns within DGFs being cost effective.

“This will sit alongside DGF managers needing to be more explicit about how they provide alpha.”

The current market is dominated by institutional allocations, with a share of 78%, according to estimates that include an educated guess of non-UK allocations coming from pension funds abroad.

Dynamic DGFs also dominated the £97bn market, attracting over 60% of assets.

Popularity of the dynamic strategy is underpinned by its preference among DB investors who allocate 70% of their own assets to the strategy.

Average allocation within DGFs saw equity allocation reach just over 40%, with alternatives creeping over 20%.

The data showed fluctuating allocations over the previous years, with the use of equities ranging from over 50% in 2009, to as low as 30% in 2011, before stabalising.

Funds had shifted away from alternatives in the last year but placed greater emphasis on cash, with bond allocations also falling.

Within the 27 funds analysed, allocations varied dramatically, with equity holdings ranging from well over 60% to as low as 15%.

Similarly, the use of cash, and alternatives, also varied depending on the manager, and the targets set by fund.

Alternative allocations went as high as 75% in one fund, compared to others that had less than 5% invested in the classes.

Within equity portfolios, average allocations to UK equities hit 6% and emerging market equities 4%.

The firm also predicted emerging markets would soon account of 15% of DGF allocations.

“We believe this to be the case for two reasons. Firstly, the broader trend within UK pensions to diversify away from UK equities. Secondly, the increasingly international investor profile of the DGF market,” the report said.

Within alternatives, real estate was still the most common, followed by commodities and absolute return investments.

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