New approaches to asset allocation
Asset allocation may have fallen out of favour prior to the GFC, but it is now critical to investment returns. That is the key finding of a new report from AMP Capital, which examines how financial planners and private wealth managers can maximise client wealth in the new, post-boom environment.
According to the report, during the long bull market from 1982 to 2007 investment managers moved away from asset allocation, focusing instead on individual manager selection at the asset class level. This reflected the generally strong performance of all asset classes, as well as the mixed record of traditional tactical asset allocation (TAA) approaches within diversified funds.
However, the GFC turned this strategy on its head, with global markets now plagued by volatility and slower growth. With performance now varying widely between different asset classes, asset allocation has made a comeback and is here to stay.
Post the GFC, asset allocation’s focus has shifted towards taking advantage of extreme swings in the relative performance of various asset classes, an approach often referred to as dynamic asset allocation (DAA) or active asset allocation. This sits between the short-term trading focus of TAA and the medium to long-term focus of strategic asset allocation (SAA), which is less well equipped to respond to market swings and shorter term opportunities.
Instead, an active asset allocation process can play a key role in achieving portfolio objectives by capturing shorter-term market opportunities and inefficiencies to enhance returns. It involves varying the asset mix in a portfolio through the investment cycle, increasing the allocation to assets when they are “unloved” and out of fashion and reducing the allocation when they are overly popular – essentially overweighting assets when their potential return is the greatest, and vice versa.
By blending both dynamic and strategic asset allocation, investors can maintain a long-term focus on their investment strategies and outcomes, while keeping sufficient flexibility within their portfolios to take advantage of medium-term market movements. It should also result in less variability in the overall portfolio when blended with SAA.
For example, blending the AMP Capital Dynamic Markets Fund, a fund which employs active asset allocation, with a balanced fund such as the Super Easy Balanced Fund, which uses SAA, results in a superior risk-return outcome than a standalone SAA portfolio. Of course, past performance is not a reliable indicator of future performance.
With asset allocation now critical to returns, taking advantage of new approaches can deliver critical performance in a growth-constrained world.
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