Dynamic Asset Allocation

What Is Dynamic Asset Allocation?

Dynamic asset allocation is an asset management or investment strategy that allows the investment manager to change the asset composition of the portfolio frequently. Thus, it helps in re-balancing the mix and weights of the assets included in the portfolio according to market conditions and macrotrends.

In other words, it is decreasing or increasing the size of fund allocation in a particular asset class or security to match the market volatility. Hence, the fund manager can downsize the investment in poorly performing assets or securities that involve high risk and upsize the investment in promising assets.

• Dynamic asset allocation is a fund management strategy that provides for frequent revision and re-balancing of a portfolio's asset mix to decrease the composition of non-performing assets and include more of the high-performing assets.
• The funds are actively managed to avail impressive returns (sometimes even higher than the benchmark returns) while ensuring the portfolio's safety.
• Such hybrid or balanced advantage funds are suitable for adjusting or modifying the investment portfolio with changing market conditions or trends; however, they involve high transaction costs compared to other funds.
• It is different from strategic asset allocation, which is an investing strategy for constructing a portfolio of assets with fixed weights allocated to achieve long-term goals.

Dynamic Asset Allocation Explained

A dynamic asset allocation strategy aims to derive higher returns than benchmark returns while frequently readjusting a benchmark investment portfolio and its asset composition. As we know, a diversified investment portfolio comprises different asset classes, including equity funds, debt funds, real estate, bonds, stocks, and commodities; these assets require revision as their risk and return profiles change with the dynamic market conditions.

Thus, investing in balanced advantage or hybrid funds is essential for dealing with market volatility, risk management, widespread investment, and allocation flexibility. It helps to shed off the assets that are performing way below expectation due to economic slowdowns like recession, being in an unhealthy sector, changes in the market trend, etc. Also, it ensures that high-performing assets are added to the portfolio for superior returns.

While there are multiple other strategies, such as strategic, tactical, and static asset allocation, the dynamic asset allocation fund is considered the most suitable for generating high returns due to active asset management; however, this strategy has certain drawbacks that cannot be overlooked. Such funds involve huge transaction and taxation costs. Also, the success or failure of this strategy depends on the investment manager's expertise. Fund managers must refrain from taking their hands off such a fund since it requires regular analysis and observation.

Examples

Let us look at some examples to understand the concept better:

Example #1

Suppose a balance advantage fund has an asset allocation as follows with their respective average returns:

• 20% in bonds with 6% annual returns
• 65% in equity funds with 21% annual returns
• 10% in debt funds with 10.5% annual returns
• 5% in real estate stocks with 19% annual returns

The price of real estate stocks starts falling with the news that the government has increased the charges of property registry. Also, the inflation rate has surpassed the bond's rate of return. Therefore, the investment manager adjusted the portfolio accordingly. The new asset allocation was as follows:

• 10% in bonds with 7% annual returns
• 75% in equity funds with 21% annual returns
• 12% in debt funds with 10.5% annual returns
• 3% in real estate stocks with 19% annual returns

Example #2

Say a mutual fund portfolio has the following asset allocation:

• 30% in corporate bonds
• 50% in small-cap equity funds
• 20% in government bonds

However, with the falling returns of the bonds, the fund manager needs to adjust the

portfolio as follows:

• 10% in corporate bonds
• 10% in government bonds
• 60% in small and mid-cap equity funds
• 20% in large-cap equity funds

This dynamic asset allocation strategy increased the overall portfolio returns by 2.7% annually.

Dynamic Asset Allocation vs Strategic Asset Allocation

Dynamic and strategic asset allocations are investment strategies for preparing and managing investment portfolios. However, the following are the known dissimilarities between these two asset allocation techniques:

Basis	Dynamic Asset Allocation	Strategic Asset Allocation
Meaning	It is a portfolio management strategy that ensures frequent re-balancing of a portfolio's assets' weights and mixes to keep up with changing market conditions and macrotrends.	It is an investing strategy for creating a portfolio comprising assets with fixed weights allocated to attaining long-term targets. It allows only periodic re-balancing of a portfolio's asset classes.
Purpose	Re-balancing the benchmark portfolio, investment diversification, risk management, and holding top-performing assets.	Setting a benchmark portfolio, sustainable growth of investment in the long run, and realization of financial goals.
Time horizon	Medium-term	Long-term
Suitable for	All types of investors have different risk appetites.	Long-term investors with minimal risk appetite.
Frequency of adjustment	High	Very Low
Approach	Downsizing the non-performing assets and increasing the investment in the best-performing assets.	Target allocations of assets and their re-balancing based on prospective long-term risk and return.
Key factors driving change	Changes in market conditions, macrotrends, asset valuation, market sentiments, and timings.	Changes in the inflation rate, risk tolerance level, the long-term risk involved in assets, the long-term investment goal, and expected returns in the long run.
Limitations	Requires active management and involves colossal transaction costs.	Fails to value the current opportunities.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to what is Dynamic Asset Allocation. Here, we explain the concept with examples and comparison with strategic asset allocation. You may also have a look at the following articles -

• Tactical Asset Allocation
• Assets Under Management
• Asset Allocation Fund