Diversified growth funds still have a “valuable role to play” for defined contribution savers despite recent criticism, according to Aon.

In a new report, The Role of Diversified Growth Funds in DC Schemes, Aon stated that with DGF funds it is important to be aware of the different types of strategies pursued and how these are expected to perform in different market environments. Therefore, Aon recommends schemes take the process back to first principles to better align DGFs with member risks.

“By using DGFs in a more considered and targeted manner we believe DC schemes can expect to achieve better outcomes for members, net of fees,” the report said.

DGFs invest across a wide array of asset classes, changing their asset allocation in anticipation of, or in response to, changing market conditions, Aon noted. Their broad aim is being to produce stable returns above inflation or cash (over a period of three to five years) with lower volatility than equities. “It is worth noting that we didn’t describe the performance objective as being to achieve ‘equity-like returns’ as this is not representative of all DGF mandates,” the report said.

Aon explained that many DC schemes utilise DGFs during the mid-career phase of a member’s working life, such as when the focus is typically on avoiding significant capital losses whilst retaining the ability to provide positive real returns.

“The perceived diversification benefits of DGFs when compared with equities, as well as, their capital preservation qualities in volatile market conditions can make them an effective choice in such circumstances.”

Analysis by Aon also found that DGFs are a useful way to mitigate key investment risks such as opportunity cost, inflation risk and capital risk. However, Aon said it is “crucial” that schemes fully understand the investment objectives of their members, as well as the different types of DGFs, in order to mitigate these risks efficiently.

Commenting, head of DC investment advisory Chris Inman said: “Many investors have questioned the role of DGFs in their portfolio, with criticism focusing – often quite rightly – on their under-performance compared to what was expected of them.

“We would question those expectations. Is performance the only attribute to consider when evaluating DGFs? In this paper we have aimed to take the wider view and examine what DGFs are actually trying to achieve and the broader role they can play in a DC investment portfolio.”

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