About Dynamic Asset Allocation:
- DAA is an investment strategy that involves the frequent adjustment of the weights in a portfolio based on the overall market performance or the performance of certain securities.
- Most of the funds in this category are invested and spread across various sectors, including equity funds, real estate, stocks, and bonds.
- Under the dynamic allocation strategy, a portfolio manager assesses the current market conditions and the performance of each asset class.
- He uses the results of the assessment to reduce the weights of assets with bad performance and increase the weights of assets with strong performance.
- Generally, a dynamic strategy is used in reaction to existing risks and market downturns.
- Unlike the strategic asset allocation strategy, dynamic asset allocation does not involve a target mix of assets. Thus, portfolio managers enjoy a high degree of flexibility in their choice of investments.
- Dynamic allocation requires active portfolio management. Therefore, the success of the strategy depends not only on the market conditions but also on the portfolio manager’s ability to make good investment decisions and to adequately respond to changes in the market.
- Dynamic Asset Allocation Example:
- Suppose global equities enter a six-month bear market.
- An investment manager using dynamic asset allocation may decide to reduce a portfolio’s equity holdings and increase its fixed-interest assets to reduce risk.
- For example, if the portfolio was initially equities heavy, the manager may sell some of its equity holdings and purchase bonds.
- If economic conditions improve, the manager may increase the portfolio’s equity allocation to take advantage of a more bullish outlook for stocks.
- Advantages:
- Returns: The frequent adjustments in the mix of assets can possibly provide higher returns on the investment portfolio.
- Adjustment to market changes: Unlike static asset allocation, dynamic allocation is highly flexible. The strategy can quickly respond to market changes and market risks.
- Disadvantages:
- Transaction costs: The frequent rebalancing the weights within the portfolio is associated with transaction costs.
- Active management: It requires tight control of the investment portfolio and constant observation of emerging market trends. Therefore, the asset allocation strategy requires the skills and knowledge of a professional portfolio manager and may often demand extensive sources (e.g., employees for research).
