DAA portfolio construction can be implemented using both active and passive strategies, or a combination of both, depending on the respective capital markets’ views and the objectives. Regardless of how DAA is implemented, adequate resourcing is paramount.
POSITIVES AND NEGATIVES OF DAA
There will be times when traditional SAA portfolios will outperform DAA on a head-to-head basis, but advisers must remember that DAA is about meeting objectives, not beating market benchmarks. Explaining this concept to investors can be challenging and requires education if DAA is being adopted.
A DAA strategy could require more administrative action and communication with clients and could at times generate higher turnover and potentially be less tax-efficient.
The positives of DAA are that there is a strong alignment with an investor’s actual objectives, as opposed to their portfolio being statically structured in accordance with general, attitudinal char- acteristics. DAA can be more bespoke, whereas SAA tends to follow more of a non-tailored approach in the retail environment.
DAA is also intuitive, in that the investment process weights the portfolio to attractive and fundamentally valued assets at times when the market cycle favours such allocation. Diversification is maintained and arguably DAA is better placed to provide the benefits of diversification in all market conditions due to its consideration for short- and medium-term factors and its ability to allocate away from problem areas. For example, it could significantly reduce risk asset exposure in favour of cash during periods of market dislocation and stress. This is a particularly relevant consideration for those already in and about to enter their retirement phase.
DAA REQUIRES UNDERSTANDING
Following the global financial crisis, advisers are increasingly adopting objectives- and outcomes-based portfolio construction, as their obligations in relation to “knowing the client” become more focused on meeting the client’s particular needs and objectives. The DAA portfolio construction methodology is one that intuitively aligns with this, as portfolios are largely objectives-based and are an outcome of what should be an extremely rigorous process. As with any methodology, there are no guarantees that DAA will achieve its objectives; however, if appropriately managed, the probability is higher, in our view.
DAA can be implemented in various ways, from a hands-on active approach to outsourcing to a manager or consultant to provide an objectives-based outcome. It can incorporate active and passive strategies and does not necessarily alter an adviser’s value proposition in relation to the provision of investment advice. However, while the benefits are obvious, DAA does represent a change to the traditional SAA methodology and the implications of this change need to be fully understood by practitioners, as it requires a greater level of understanding on the part of both advisers and their clients.
Jeff Mitchell is director of S&P Wealth Management Services.
