Dynamic asset allocation can play a role in managing portfolios during periods of volatility in the global macro environment, says Zenith Investment Partners Head of Asset Allocation, Damien Hennessy.

Dynamic Asset Allocation (DAA) considers the potential risk to portfolio positions and how markets might move over a three-month to two-year horizon, compared to strategic asset allocation (SAA) that reflects return and volatility assumptions typically over a 5-to-10-year period.

Hennessy says DAA is increasingly recognised as a valuable portfolio construction option, as it seeks to enhance returns and smooth risk by altering the short-to-medium-term weightings to assets based on factors such as valuations, the business cycle, policy developments, momentum and other major events.

“It’s about tilting a portfolio away from the underlying SAA – typically something fixed for a long period of time – in order to take into account major macroeconomic changes, policy developments and changes to asset valuations,” he says.

“The other important thing to note with DAA is that investors shouldn’t be moving their actual portfolio positions outside of the range they would have expected from their SAA.

“If an investor is in a conservative portfolio, DAA does not involve taking positions that push them up into a balanced or a growth-type portfolio setting.”

Further, Hennessy says we are perhaps in one of the most interesting periods in years for asset allocation.

“In addition to considering shorter-term cyclical and policy developments, a DAA process also needs to recognise that the longer-term drivers of the disinflation and low and declining interest rates we’ve experienced over recent decades may be in the process of changing,” Hennessy says.

“Demographic changes, productivity trends, de-globalisation and geopolitics tend to shape the broad growth and inflation outlook over the long term.

“Central banks are trying to deal with rising inflation through higher interest rates. However, if they push too far too soon, there’s the possibility of recession. A DAA approach needs to be hyper-aware of these risks when it comes to portfolio positioning, aiming to add value by minimising risk while enhancing returns through both directional and relative portfolio positions.”