Dynamic Asset Allocation: A Key Strategy for Effective Risk Management

As an investor, risk management is a key component of your portfolio management strategy. This is especially relevant in today's volatile markets, where economic downturns and market risks can have a significant effect on your investments. One of the ways to protect yourself is through a strategy known as dynamic asset allocation.

What is Dynamic asset allocation?

Dynamic asset allocation is an investment strategy that involves actively adjusting the mix of assets in a portfolio in response to changing market conditions. The goal of this approach is to reduce risk and increase returns by making strategic shifts in asset allocation based on current economic and market trends.

How is it different from what Wealthfront and Betterment currently do?

They currently rely on Static asset allocation which involves dividing the portfolio into different asset classes, such as stocks, bonds, and cash, and then maintain a fixed allocation of these assets over time and sticking to it regardless of market conditions. While this strategy may seem like a logical way to manage risk and build wealth, the problem with this approach is that it doesn't take into account market conditions. In a bear market, holding on to a fixed allocation of assets can lead to significant losses. Similarly, in a bull market, a static allocation may miss out on potential gains.

Why is Dynamic Asset Allocation better than Static Asset Allocation?

There have been several instances in history where dynamic asset allocation has outperformed static asset allocation (SAA). One example is the 2008 financial crisis, where many investors who had a SAA portfolio with a high allocation to equities suffered significant losses. Dynamic portfolios, on the other hand, had the flexibility to adjust their allocations to less risky assets such as bonds, which helped to mitigate losses.

Another example is the current COVID-19 pandemic. The pandemic has led to a significant shift in market conditions, with some sectors, such as technology and healthcare, performing well, while others, such as travel and leisure, have been hit hard. Investors with a dynamic portfolio were able to adjust their allocations to take advantage of the strong performance in certain sectors, while reducing exposure to sectors that were underperforming.

There are several different types of dynamic asset allocation strategies, each with their own unique approach to managing risk and achieving returns. Some of the most common types include:

1. Market timing: This strategy involves attempting to predict market movements and adjusting the portfolio accordingly. For example, an investor using market timing may shift assets out of stocks and into bonds when they believe the stock market is about to drop, in the hopes of avoiding a market downturn.
2. Sector rotation: This strategy involves rotating investments between different sectors of the market, such as technology, healthcare, or consumer goods. For example, an investor using sector rotation may shift assets out of technology stocks and into healthcare stocks when they believe the healthcare sector is poised for growth.
3. Value investing: This strategy involves identifying undervalued assets and investing in them with the expectation that they will eventually reach their true value. For example, an investor using value investing might purchase stocks of companies that are trading at a low price-to-earnings ratio, in the hopes of achieving a higher return when the stock's true value is realized.
4. Momentum investing: This strategy involves identifying assets that have recently performed well and investing in them with the expectation that they will continue to perform well. For example, an investor using momentum investing might purchase stocks of companies that have recently seen a significant increase in their stock price.
5. Risk parity: This strategy involves balancing the portfolio's risk by allocating assets based on their volatility and correlation to other assets. This can be achieved by using various instruments like futures, options, and swaps.

Saay Finance uses various dynamic asset allocation strategies which involves algorithmically monitoring market conditions, identifying different market trends, and making adjustments to the portfolio based on sectors performing well. This is particularly important in today's rapidly changing and uncertain economic environment, where traditional long-term investment strategies relying on static allocation are not that effective.

Sign up for our waitlist here.