Dynamic asset allocation

A portfolio's SAA is constructed in a way that maximises the probability of achieving a return objective over a given longer-term horizon. For example, an SAA for a typical balanced portfolio may include a 20-40% allocation to Australian equities, a 20-40% allocation to international equities, a 20-30% allocation to cash and bonds and a 10-20% allocation to other assets, including alternatives and other unlisted assets. Each investment manager manages their portfolio with the intent of keeping their allocation to those asset classes within those bands.

However, investment markets are not static. With recent events particularly front of mind, we know that markets can be extremely volatile, with assets performing differently to the longer-term assumptions used in the SAA.

This is where dynamic asset allocation comes in.

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What is dynamic asset allocation (DAA)?

Increasingly recognised as a valuable portfolio construction option, dynamic asset allocation (DAA) seeks to enhance returns and smooth risk by altering the short-to-medium-term weightings to assets based on factors such as valuations, the business cycle, policy developments and other major events. It is about tilting a portfolio away from the underlying SAA-typically something fixed for a long period of time-in order to take into account major macroeconomic changes, policy developments and changes to asset valuations.

A dynamic asset allocator considers the potential risk to portfolio positions and how markets might move over a three-month to twoyear horizon. Remember, the SAA for a portfolio reflects return and volatility assumptions over a 5-10-year period typically.

The other important thing to note with DAA is that investors should not be moving their actual portfolio positions outside of the range they would have expected from their SAA. If an investor is in a conservative portfolio, DAA does not involve taking positions that push them up into a balanced or a growth-type portfolio setting.