The ability of dynamic asset allocation to enhance return and reduce risk in volatile markets was questioned at our most recent Investment Management Consultants Association (IMCA) seminar in Sydney.
Nader Naeimi, head of dynamic asset allocation at AMP Capital, and Mark Wills, head of investment solutions at State Street Global Advisors (SSgA), both described their processes.
The conclusions drawn by both the strategists was that, unsurprisingly, a disciplined process subject to monthly or even daily reviews can indeed achieve the desired outcome.
Naeimi, pictured on the website, adopts a philosophy of “patient opportunism” based on his view that market inefficiencies don’t last for long and tend to arise at the extremes of investor sentiment. He observed that the pendulum of investor sentiment is a dependable feature of capital markets, with “the swing back from extremes more rapid than the swing to the extreme”.
His objective is to first work out where you are in the cycle and then decide what you should do. This may sound simplistic, but every cycle is different, which works against purely quantitative approaches that are backward-looking in terms of volatility and correlations.
Wills, pictured right, defined the objective of SSgA’s process as de-risking portfolios at times of stress into defensive assets, such as fixed interest and cash, and away from equities. He sees equity volatility displaying greater predictability than equity returns and has constructed a process to identify “risk regimes” that are rated from one extreme at crisis to another, euphoria. The regime measure takes into account implied volatility for the major equity markets, implied volatility of the major currency pairs, and spreads on risky credit. For each regime there is an appropriate adjustment to the risk budget of the portfolio. In essence, the SSgA process is designed to take advantage of market inefficiencies, a similar objective to AMP’s. SSgA just goes about doing so from more of a quantitative perspective than AMP.
Back-testing for both processes indicates that substantial enhancements to risk management in portfolios are likely, although fees and transaction costs were not included in the back-test results. The growing demand for outcomes-based investing should support these dynamic asset allocation models, especially when the client is truly peer group-agnostic and has liabilities that are measureable and well understood.