What is Dynamic Asset Allocation?

Dynamic asset allocation is an investment approach that makes use of a wide range of investment products to maximize the opportunity for realizing a higher rate of return. This type of strategy will often include an eclectic mixture of index funds, credit derivatives, hedge funds, mutual funds, and guaranteed link notes as a means of reaching investment goals. The idea is to allocate assets where there is currently the most promise of return, shifting those allocations on an as needed basis.

One of the other tools that is often used in the creation of a dynamic asset allocation scheme is known as constant proportion portfolio insurance, or CPPI. Essentially, CPPI is a type of guarantee that is often related to some type of zero-coupon bond and an underlying investment of some sort. As one means of helping to keep the portfolio in a state where it is constantly producing a return, the assets are shifted back and forth between these two components, based on what is happening in the marketplace. This process allows the investor to move quickly to take advantage of short-term movements in the market, often increasing returns as well as minimizing losses.

When used to best advantage, dynamic asset allocation makes it possible to secure the right balance of investments with an acceptable level of volatility, and be in a position to earn consistently high returns. By structuring the relationship between the various assets in the portfolio so that losses in one area are effectively offset by gains in others, investors can aggressively respond to upcoming market shifts and protect their interests. Over time, this approach can lead to a significant amount of return that increases the overall worth of the portfolio considerably.

The very nature of a dynamic asset allocation strategy requires that the performance of the assets within the portfolio are monitored closely. While there are ways to position some of the investments so that exposure is reduced when a downturn in the marketplace occurs, such as using CPPI, this does not totally eliminate the need for investors to respond quickly to any new information or events that could have an impact, positive or negative, on the investments involved. For this reason, smaller investors sometimes find that this type of investment strategy is not a good fit for their activity. In like manner, both small and large investors who tend to be more conservative in their investment activity and prefer to focus on modest returns in exchange for assuming less risk are less likely to utilize dynamic asset allocation.