When investing, it is imperative that you are selecting a suitable asset allocation style that aligns with investment objectives. There are typically 3 asset allocation styles investors use to build and maintain their portfolios. These are strategic, tactical, and dynamic asset allocation. In this month’s edition of WD Life, we will compare these allocation styles against each other and how they relate to Wealth Depot’s Investment Philosophy.
Strategic Asset Allocation
What is Strategic Asset Allocation:
Strategic asset allocation (SAA) is where an investor sets a target allocation for various asset classes and rebalances the portfolio periodically. The portfolio is rebalanced to the original allocations when the portfolio deviates significantly from the initial allocation due to differing returns from the various assets.
This type of portfolio is relatively easier to maintain due to it’s simplistic asset allocation method and passive diversification management.
SAA is typically more cost effective then other allocation styles as a result of less involvement of fund managers and less frequent portfolio adjustments which can save money on brokerage and other transactional costs. As such, a strategic allocation may be more suited to smaller account balances.
The greatest risk that comes from using SAA compared to the 2 other styles is that your investment holds may be more exposed to economic shocks and conversely, fail to capitalise on market opening. This is a result of SAA being a more static allocation style rather then reacting to economic trends. As such, DAA and TAA may offer greater returns over the long-term.
Wealth Depot View:
SAA is used as a starting point for clients as it is important to construct a Cost Effective portfolio to minimise costs at all times. However, that will not necessarily mean delivering the cheapest solution. Our portfolios are designed to achieve the best after fee results for our clients ie targeting the best value.
Dynamic Asset Allocation
Dynamic asset allocation (DAA) is a portfolio management strategy that continuously alters the mix of asset classes to suit market conditions bases on macro trends. These alterations typically involve reducing positions of the worst-performing asset classes while increasing the position in the best-performing assets.
Performance: Investing in the best performing asset classes can help ensure investors’ portfolios have the greatest exposure to momentum and positive trending assets. Equally, portfolios that use DAA reduce asset classes that are trending lower to help miminse losses.
Diversification: DAA exposes a portfolio to multiple asset classes to help diversify risk. Portfolio managers may make investments in equities, fixed interest, mutual funds, index funds, currencies, and derivatives.
As a result of the continuous portfolio management activity and frequent transaction costs (buying and selling assets), DAA is generally more expensive then more conventional and less active allocation styles. As such, this style of asset allocation is more suited to larger account balances that can cover the higher ongoing cost.
Wealth Depot View:
We believe DAA is the best approach. Although strategic asset allocation is used as a starting point for clients, we believe that portfolios should have the flexibility to invest in asset classes only if it makes sense to do so. If the reward isn’t worth the risk, we should be able to avoid the asset class completely.
Tactical Asset Allocation
What is Tactical Asset Allocation:
Tactical asset allocation (TAA) is an active management portfolio strategy that adjusts the percentage of assets to take advantage of market pricing anomalies or strong market sectors. This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace.
A tactical asset allocation may be more suited to clients that are looking to grow their investment in the short term rather than for a defined long-term goal and capitalise on a market downturn and changes in economic conditions.
Similar to the DAA style, Tactical asset allocation can result in higher ongoing costs as a result of a result of the continuous portfolio management activity and frequent transaction costs.
Wealth Depot View:
TAA is very similar to Dynamic asset allocation however we typically tend to favour DAA as it provides a more comprehensive and active management of portfolios as opposed to only capitalising on anomalies within the market.