Rather than look towards diversification via a SAA or TAA structure/strategy to address the volatility of markets and the marginal impacts that tilts to those structures can deliver, clients may consider another approach that seeks Capital Preservation and/or Absolute Returns to achieve better risk weighted returns. A DAA strategy has a medium term (3 to 7 year) capital growth and return objective and chooses to be invested in the asset class that offers the best likelihood of achieving the objectives without the volatility of capital valuations or fluctuations in income received typically experienced in unruly markets.
This is achieved by not relying on being invested statically across the asset classes, as with a SAA type approach, instead only maintaining exposures to those asset classes that are believed to be “least at risk” together with a higher probability of positive returns and avoiding the asset classes seen to be “most at risk” from potentially, negative returns. As such, DAA approaches will tend, by design, to be constructed more risk adverse or have an absolute return (a positive return) bias. Much of the DAA investment strategy tends to be based on capital preservation or implementing downside risk mitigation techniques when markets fall.
The main attraction is that the portfolio is effectively unconstrained both in the type of assets held and the portfolio weights that capital is allocated. Portfolio exposures are allowed to be 100% overweight or 100% underweight either growth or defensive assets. This is a substantial change from the SAA/TAA approach and may potentially involve several alternative assets being held in the portfolio to achieve the preferred results. Again, this is the “risk on” and “risk off” investment approach like the TAA strategy however, the focus is on the medium term (3 to 7 years) factors to derive the underlying portfolio goals and exposures.
For example, this approach enables the client to avoid being over invested in “high risk” growth assets when the economic climate is in a medium-term decline, such as a recession. The problem with the DAA approach is when to respond to market signals to reduce or add investment risk to the client’s portfolio. As an economic and/or resulting business cycle typically last between 3 and 7 years (hence the suggested timeframe) then this approach would require the client and their investment adviser to have a good sense of timing the “risk-on” and “risk-off” trades to ensure the changes are in-sync with the broader market variables.
This attention to detail is quite important as there have been market “correction days” that have seen markets jump or fall, sometimes more than 10% to 20%. To miss this correction may adversely impact the overall return objectives. Normally the investment management of this style of portfolio is outsourced to a known and respected Fund Manager who has years of experience and a big team supporting the implementation of the required changes to the asset allocation.