Diversified growth fund (DGF) managers must reassess their strategies and allocations to ensure survival in the next market phase, according to AQR.

Research by the multi-asset and smart beta group found that, despite DGFs performing in line with their stated aims, much of the investment return from the funds could be explained by beta.

DGFs were highly correlated to a passive benchmark of 50% stocks and 50% bonds, AQR said.

In addition, in the five years to the end of 2016, a 50-50 portfolio of the MSCI World index and Barclays Global Aggregate Bond index, hedged to sterling, gained an average 8.2% a year. A group of DGFs targeting cash plus 5-7% a year posted 6.6% annual returns – in line with their aim but trailing a passive substitute.

According to AQR’s calculations, the DGF group had a correlation of 0.89 to the passive portfolio, where 1 is completely correlated.

The report was written by AQR portfolio managers John Huss and Laura Serban, with Adam Akant, associate in the company’s portfolio solutions group.

The authors said: “Over the past five years, the average DGF has likely met its return target by riding the strong performance of stock and bond markets, but it failed to provide much diversification or excess returns relative to these traditional beta exposures.”

They also warned that in many areas “traditional assets are currently elevated by historical standards”. This raised questions about the future performance of these assets and DGFs, the authors said, as most economic environments would be “less favourable” than the past five years.

“Unless DGF managers change their strategies to be less correlated with traditional portfolios, they may be unlikely to match recent performance going forward,” Huss, Serban, and Akant wrote.

They added: “High starting valuations mean that investors or strategies that rely primarily on exposure to a traditional portfolio to generate returns may have much more difficulty reaching their total return objectives going forward than they have had over the past several years.”

AQR’s findings echoed those of Willis Towers Watson. Writing for IPE last year, Alice Lee, investment consultant at the firm, warned that investors needed to be “discerning between genuine skill and market beta” and “urge managers to create more modern, cost-effective, and better-structured solutions”.