Dynamic asset allocation is an investment strategy that involves the frequent adjustment of the weights in a portfolio based on the overall market performance or the performance of certain securities.
Under the dynamic allocation strategy, a portfolio manager assesses the current market conditions and the performance of each asset class. He uses the results of the assessment to reduce the weights of assets with bad performance and to increase the weights of assets with a strong performance.
Generally, a dynamic strategy is used in reaction to existing risks and market downturns. Unlike the strategic asset allocation strategy, dynamic asset allocation does not involve a target mix of assets. Thus, portfolio managers enjoy a high degree of flexibility in the choice of investments.
Dynamic allocation requires active portfolio management. Therefore, the success of the strategy depends not only on the market conditions but also on the portfolio manager’s ability to make good investment decisions and to adequately respond to changes in the market.
Advantages of Dynamic Asset Allocation
The investment strategy offers some advantages over other types of allocations, including:
The frequent adjustments in the mix of assets can possibly provide higher returns on the investment portfolio. The portfolio adjustments can prevent losses from unexpected market downturns and capture the momentum to increase the returns.
In addition, proficient portfolio managers can use dynamic asset allocation to achieve returns higher than the average market returns. In other words, the strategy can be utilized to beat the market.
2. Adjustment to market changes
Unlike static asset allocation, dynamic allocation is highly flexible. The strategy can quickly respond to market changes and market risks.
Disadvantages of Dynamic Asset Allocation
The strategy is not flawless. The potential user should be aware of the following disadvantages:
1. Transaction costs
The frequent rebalancing the weights within the portfolio is associated with transaction costs. However, the constant buy and sell transactions diminish the overall returns of the portfolio.
2. Active management
The nature of dynamic asset allocation requires tight control of the investment portfolio and constant observation of emerging market trends. Therefore, the asset allocation strategy requires the skills and knowledge of a professional portfolio manager and may often demand extensive sources (e.g., employees for research).