As institutional investors have been hit hard by events of the past 18 months, there has been a surge of interest in the adoption of an additional, mid-term, time frame in which to provide investment
targets. Watson Wyatt believes pension funds should allocate between 5 and 15 per cent of their risk budget to dynamic asset allocation.
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“Dynamic Strategic Asset Allocation” (DSAA) sits between the fund’s traditional strategic asset allocation, which Watson Wyatt defines as at least 10 years, and the tactical asset allocation decisions of a few months.
Watson Wyatt believes that a pension fund should allocate between 5 to15 per cent of its risk budget to DSAA, for a
three-or-more-year timeframe, and expect an increase in returns of 1 to 1.5 per cent per year above the strategic allocation.
DSAA has traditionally involved tilting a fund’s asset allocation towards or away from certain asset classes. But Watson Wyatt believes other forms of implementation should be considered. Examples of such decisions taken for DSAA include: exposure to a specific sector, such as investment grade credit; new niche risk premia, such as catastrophe bonds; to benefit from macro themes, such as emerging market growth; to provide downside
protection in a market bubble; to exploit pricing anomalies; and, to invest in new asset classes, such as carbon credits.
In a research note to clients, however, the consulting firm warns that for a fund to make DSAA decisions, which are usually taken at the board level and not outsourced to managers (unlike tactical asset allocation), requires strong governance.
There needs to be a sufficient range of opportunities, a broad range of inputs and analysis, a sound and consistent
basis for the decisions and a tolerance for short-to-medium-term underperformance.
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