Dynamic asset allocation has moved out of the shadow to become a key competitive tool for superannuation funds as they face pressures from peers and regulators alike
Historically, institutional investors have used dynamic asset allocation (DAA) to manage shorter-term risks that stem from pursuing a long-term investment strategy.
Defined in their strategic asset allocation, these long-term views are prone to short-term volatility due to stock market bubbles, geopolitical risks and regulatory surprises.
By reducing positions in poorly performing asset classes and adding to positions in well-performing assets, funds can avoid the worst of these short-term dislocations and offer members a smoother ride.
But today institutional investors see DAA less as a risk management tool and increasingly more as a separate return stream that adds alpha to their overall performance.
Using DAA to Gain Competitive Advantage Over Peers
In a world where superannuation funds feel the pressure to mimic each others’ portfolios in order to perform in line with their peers and minimise tracking error against the Your Super, Your Future (YFYS) benchmarks, DAA offers a way to add just a little bit more return and set funds apart from their competitors in the league tables.
At the recent [i3] Investment Strategy Forum, a majority of participants that run DAA programs indicated they had made money from their activities, with 44 per cent saying DAA had added 0 to 25 basis points a year on average since the inception of their program, while 21 per cent said it added up to 50 basis points to the overall results.
A further 19 per cent said they had made more than 50 basis points per annum since inception of their programs.
Not only does this position a fund better in the league tables, but an additional return of 50 basis points could also be the difference between passing and failing the YFYS performance test.
Source: Investment Innovation Institute [i3]
Relative Value Trades are a Key Tool in DAA
DAA was a recurring topic of discussion during the forum and investors indicated they are using increasingly sophisticated methods to implement their views, with much attention going to the application of relative value trades to eke out an edge.
An example of such a trade discussed at the forum involved taking the view that United States productivity will remain elevated, while artificial intelligence (AI) will create winners and losers.
This trade assumes we are at the beginning of a productivity cycle that will drive
investments in infrastructure, software and cybersecurity. Companies will look to automate most repetitive and labour-intensive tasks through AI agents, general AI technology and
software improvements.
But inevitably, some businesses will be slower to evolve and those that have a business model centered on repetitive or automatable tasks will likely see market share losses.
Investors can benefit from this dynamic by buying stocks of companies that are likely to experience a productivity boost from automation, while shorting stocks that will see their business models challenged by AI.
Another example involved a trade with a shorter time horizon and relied on mean reversion to see the sharp outperformance of the Magnificent Seven in 2023/24 versus the rest of the world break down. Investors anticipating this scenario could profit from this view by shorting the Nasdaq against equity markets in the rest of the world.
Governance and Delegation Key to Successful DAA Implementation
In these cases with shorter time horizons, investors need to move quickly as some opportunities only exist for a few days. Having clear delegation lines in place is critical to success, one participant said.
“We weren’t able to put the trade on fast enough. We’ve made money, but we could have made more,” they said.
Participants in the forum also agreed delegation must come with clear oversight and solid governance processes. After all, these trades can represent significant positions since they need to move the dial for the large funds.
“The key to making DAA work is governance; the more of it, the better,” one participant said.
Senior management and the culture they foster among staff are also important ingredients in executing on a successful DAA strategy. Inevitably, DAA teams will get some trades wrong and how they deal with these losses is an important part of their ability to absorb future losses.
“If we get 55 per cent of the bets right, then we are doing a good job by members. But it does mean that we will be wrong 45 per cent of the time. It is my job to make sure the team feels comfortable with making mistakes,” one participant said.
The majority of participants in the forum indicated that while DAA was worth the effort and resources spent on it, they agreed it is not easy to do. Not only do ideas need to be scalable and repeatable, but they also need to be implemented in such a way that they are proportionate to the conviction the team holds in the trade.
“Is your fifteenth idea as good as your first? No. So you size the trends according to conviction,” one participant said.
Matching Investment Risk With Stakeholder Risk Appetite
Not everybody felt DAA was a fundamental element of a superannuation fund’s investment process. Being wrong 45 per cent of the time happens a lot and this inevitably leads to periods where the fund experiences a losing streak.
Not all members are willing to take the hit, especially when they are closer to retirement, or are already in retirement and bank on steady income streams. Funds with older member bases tend to have little appetite for the higher levels of volatility that DAA can cause from time to time, especially when pursuing alpha.
One participant indicated they only had a limited risk budget for DAA decisions.
“We discovered a few years ago that the risk appetite of our stakeholders was different from what we thought it was. They cared a lot more about losses [than relative performance]. So we probably spend less of our risk budget on DAA [compared to other funds],” they said.
Additional [i3] Insights Coverage of DAA:
https://i3-invest.com/2025/03/diversification-when-managing-liabilities/
https://i3-invest.com/2024/11/cbus-starts-phase-ii-of-daa-program/
https://i3-invest.com/2025/02/amp-moves-daa-to-be-mostly-systematic/
https://i3-invest.com/2023/12/a-deep-dive-into-nz-supers-strategic-tilting/
https://i3-invest.com/podcasts/fulcrums-suhail-shaikh/
https://i3-invest.com/2021/03/the-importance-of-asset-allocation/
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.