“The best way to avoid that is to focus on risk and control exposure to adverse events.” That’s not to say that DAA can’t serve both purposes. Watson Wyatt believes super funds should allocate between 5 and 15 per cent of their risk budget to “dynamic strategic asset allocation”, or DSAA (its own catchphrase), for a three-or-more-year timeframe and expect an increase in returns of 1 to 1.5 per cent per year above the strategic allocation. Jeffrey Chee, investment consultant – regional asset allocation specialist at Watson Wyatt, suggests funds adopt a tracking error relative to SAA of between 2 and 4 per cent as a result of the DSAA process. A net information ratio (the ratio of excess return to tracking error) in the order of 0.25 to 0.5 per cent is appropriate, he adds, resulting in the expected excess return of 1 to 1.5 per cent.
Examples of decisions taken for DSAA include: exposure to a specific sector, such as investment grade credit; new niche risk premia, such as catastrophe bonds; to benefit from macro themes, such as emerging market growth; to provide downside protection in a market bubble; to exploit pricing anomalies; and, to invest in new asset classes, such as carbon credits. Chee says markets are going to be mispriced from time to time, since nothing ever sits at fundamental value, and funds should act to capitalise on that. “We think investors can take advantage of medium-term pricing over a three-to-five-year timeframe and generate excess returns in that way,” he says. “It’s a three-step process. Assess the economic trends; assess fundamental value; and then assess whether the deviation between fundamental [value] and market pricing is sufficiently large enough that you have confidence that you can take a DSAA position within your portfolio. In that regard we see DSAA as high conviction, relatively low frequency events.”
Seizing the DAA Asset consultants are keen to stress that the evolution of DAA is not an exploitation of the events of 2008, although it’s unlikely that none of the proponents is motivated by financial incentive. Most claim to have been giving clients DAA-type advice for a number of years and say the recent promotion of the service is in response to client demand for a formalised DAA framework. JANA Investment Advisers, for instance, is probably most recognised for encouraging client funds to make significant shifts in asset allocation, often against the trend of peer funds. It was well underweight international shares, for instance, in the late 1990s and the funds wore some pain before the tech bubble burst and the decision was finally vindicated. It has also advised against any listed property trusts for the past seven years. “We have always done it,” says Ken Marshman, JANA’s head of investment outcomes, “it’s more a matter of terminology”.