Market dislocations can be missed opportunities for funds without dynamic or tactical asset allocation processes. But the benefit of having an opportunistic lever may be more about risk mitigation than a guaranteed value add for asset owners.
Avant Mutual Group chief investment officer John Lucey warned that asset owners should not be engaging in an overlay program or dynamic allocation unless they have the attribution skills, systems and capabilities to measure it.
“There is a fine line between what comes out on the asset allocation and what comes out on the stock selection,” Lucey said.
While dynamic or tactical allocation processes don’t have a long track record relative to other strategies, Lucey said successful implementation is seen more regularly among disciplined investors who are able to ignore short-term market noise.
“One of the risks with a [dynamic asset allocation] program is that you become too reactive,” he said, pointing to the 15 per cent drop in equity markets in the first six weeks of 2016 as one such potential distraction.
Lucey spoke as one of the participants in a panel titled Market Dislocations and Dynamic Asset Allocation at the Investment Magazine Fiduciary Investors Symposium, held in the Blue Mountains, NSW, May 15-17, 2017.
First State Super investment strategist Zoe McHugh said that fund uses a quantitative tactical allocation process run daily across US equities, Australian equities and Australian bonds. McHugh said the system signals whether the team should tilt the allocation in those markets up to 10 per cent either way from their strategic allocation.
“The sorts of positions we take would very rarely be at the extreme,” she said. “That’s quite important to make clear.”
Half of the signals come from measures of value across the relevant markets, overlaid with 25 per cent momentum signals. That reliance on value negates the need for a frequent churning of the book, McHugh said, avoiding potentially high transaction costs. Cyclical or economic indicators make up the remaining 25 per cent, implemented qualitatively.
But AMP Capital head of dynamic markets, Nader Naeimi, who uses an an objective-based process, warns that solely relying on a systematic process won’t work because quantitative signals can cancel each other out. “When valuations are cheap, your momentum and economic cycle indicators are going to be bad. It’s really hard to have a high-conviction position when signals continue to cancel each other out.”
Unlike AMP Capital, which uses dynamic asset allocation across the entire book, Avant Mutual still uses strategic allocation as its main driver of returns. Lucey said the fund’s dynamic process is expected to add between 10 and 15 per cent of the portfolio performance and is seen as an opportunistic lever, although “the returns come as risk is mitigated on the downside,” he said.
For First State, dynamic asset allocation has not contributed any excess returns since implementation in mid-2014; however, McHugh noted it has had an impact by lowering the volatility of the returns, which is one of the program’s objectives.