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What Is Dynamic Asset Allocation And How To Benefit From It

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A Complex Strategy For Diversification

Dynamic asset allocation is a complex strategy of portfolio management that can be applied to any asset class but most often found in multi-asset portfolios. The idea is to allocate more funds to the best performing sectors and investment vehicles, less to the worst, in order to maximize portfolio returns. While simple, in theory, the strategy is labor intensive requiring up-to-the-minute awareness of market conditions and frequent portfolio adjustments.

The risk of multi-asset funds employing a dynamic asset allocation strategy is associated with the fund’s manager. Managers have to spot trends and take advantage of market downturns at the right time in order to beat their benchmarks. In most cases, and that has been the trend lately, average money managers have been having a hard time beating the benchmarks because of volatility.

Advantages And Disadvantages Of Dynamic Allocation

There are advantages to a dynamic allocation that investors should be aware of. The first is performance. Because these portfolio’s overweight the best-performing sectors investors have the best chances of catching trends early and riding them out.

In order to overweight one asset class or sector dynamically allocated portfolios cut their exposure to the worst performing sectors which further enhances gains. Dynamic Allocation also ensures diversification. Diversification is usually achieved across asset classes and sectors providing an ample safety net against adverse market conditions.

The main disadvantage of a dynamic allocation portfolio is cost. Because managers are actively monitoring conditions and changing allocation fees, both management and transaction, tend to be high. This is offset of course by expected performance and dividends but there is never any guarantee an investment will meet expectations.

Dividends among actively managed, dynamic allocation funds tend to be high but even that is a two-edged sword. In many cases, the dividends are supported by the return of capital (ROA) or other tax-sensitive means.

There Are Many Dynamic Allocation Funds To Choose From

Brookfield’s Real Assets Income Fund (RA) is a dynamically allocated fund with something else going for it, it’s focused on the real assets asset class. Real assets include real estate, natural resources, and infrastructure, one of my favorite long-term investments at this time. Notably, the Real Assets Income Fund has increased its exposure to infrastructure equities significantly over the past year.

This is from the Real Assets Income 2018 Annual report,

“While we do see evidence of modest growth in the global economy, we also acknowledge an uptick of the market and economic risks across the globe. We believe these conditions make listed real assets even more attractive for investors to own in their portfolios. These companies—which provide critical infrastructure and make up the backbone of the global economy, have been shown to produce resilient cash flows throughout economic cycles”

By comparison, the Pimco Dynamic Income Fund is focused almost exclusively on bonds with less than 5% allocated to stocks. The Ares Dynamic Credit Allocation fund is exclusively (at this time) bonds and worse, all corporate where the Real Assets Income Fund is allocated roughly in thirds between securitized credit (mortgage-backed securities), bonds (diversified across sector and rating), and equities.

The Cohen&Steers Infrastructure Fund is one of the closest comparisons you will find to the Real Assets Income Fund. It is a true multi-asset fund with allocation spread across bonds and equities if skewed heavily toward equities. What makes it less attractive is the yield which is only about 7.5% compared to the Real Assets Income Fund’s 11.25%.

The Bottom Line

The bottom line is simple. Dynamic allocation has some advantages for a portfolio. The best way for retail investors to benefit from it is through a fund like the ones I’ve mentioned today. Because there are some tax implications with these high-yield funds it is best to hold them in tax-deferred retirement accounts as part of a long-term income strategy.