Looking inside dynamic asset allocation

Dynamic asset allocation — a go-anywhere approach that sometimes is described as a hybrid of strategic stock and bond investing, and market timing — is becoming more popular.

With the buy-and-hold strategy discredited by the market collapse and with market timing a minefield of risk, the appeal of a completely flexible approach to portfolio strategy is obvious.

And while flexibility is the strategy’s hallmark, what is also important is that practitioners generally manage risk by avoiding the mean-reversion tendencies of large pools of correlated assets.

A unique characteristic of dynamic asset allocation is the absence of a baseline investment allocation. This is evident in the holdings of some leading funds.

The Ivy Asset Strategy Fund (WASCX), for example, is 32% invested in cash and has its next largest allocation, at 12.5%, in gold bullion.

Meanwhile, the Goldman Sachs Dynamic Allocation Fund (GDAFX), another popular dynamic fund, is most heavily weighted in U.S. Treasuries and has less than 3% in cash. The fund was launched in January with the objective of keeping annualized volatility at 9%, which happens to be the long-term volatility rate of a strategic 60/40 stock/bond portfolio.

In order to help achieve that goal, which is designed to produce a smoother ride for investors, the portfolio cut its exposure to U.S. stocks to 12% in June, from 29% in March.

Envestnet Asset Management Inc. recently contracted with hedge fund manager Brian Singer of Singer Partners LLC to manage a dynamic separate-account strategy for financial advisers on the Envestnet PMC platform.

He employs a strategy that manages risk by measuring value across multiple asset classes. Mr. Singer’s analysis is leading him to tilt the portfolio primarily toward equities and away from sovereign debt in developed markets.

“We look at the value of an asset class, and we dynamically position in and out of asset classes, based on the value but not based on predictions or forecasts of performance,” he said. “We can go anywhere, but we don’t have to.”

Whether in the form of a mutual fund or a separately managed account, dynamic asset allocation is clearly a strategy that still needs to be sold to investors. And financial advisers will be responsible for doing much of the research legwork themselves because the category is still being defined in the broadest possible terms.

At Lipper Inc., dynamic-asset-allocation funds mostly are found in the global flexible-portfolio group. At Morningstar Inc., the funds mostly fall into the world allocation category.

“We’re starting to see a lot more of these kinds of funds, and there’s definitely a lot of interest,” said Ryan Leggio, a Morningstar analyst. “But a lot of them are still unproven, so investors might want to wait for some kind of track record.”

Although designed as a relatively conservative alternative to a traditional balanced fund, dynamic asset allocation provides the freedom that allows portfolio managers to go anywhere on the capital structure and sometimes use leverage.

“It all depends on the definition you’re starting with, but the premise seems to be to give the portfolio manager wide latitude,” said Jeff Tjornehoj, a senior research analyst at Lipper.

“These strategies are designed to be less volatile and offer a lot more diversity in one package,” he said. “It’s a break from the traditional balanced fund, and they tend to go far away from just U.S. stocks.”

Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].