Dynamic asset allocation boosts returns 3.5% a year – Aviva Investors

UK - UK pension funds could have improved their long-term investment performance by as much as 3.5% a year if trustees had applied a dynamic asset allocation to their portfolios, according to new research published by Aviva Investors.

Aviva Investors constructed two hypothetical portfolios, both based on the typical asset allocation of a UK pension fund in the beginning of 2001, with 71% in equities, 20% in fixed income, 5% in property and 4% in cash.

The first portfolio was managed dynamically over the last 10 years, with a quarterly, forward-looking review of asset allocation and shifted weights in relation to changing return, risk and correlation properties.

The second was managed in a more static way, rebalancing allocations once every 12 months, in line with the average UK pension fund.

Aviva Investors' results show the dynamic portfolio outperformed the static one by almost 3.5% per year.

The company also noted that the dynamic strategy helped reduce overall volatility, while downside risk was cut by 4% compared with the static portfolio.

Mirko Cardinale, head of strategic asset allocation research at Aviva Investors, said: "The market provides adequate signals on prospective returns across different asset classes, which can be employed to recommend dynamic shifts in the asset mix.

"Most of these indicators can move relatively quickly, even in a short period of time, so it is imperative trustees review their portfolios' asset allocation at least once every six months.

"Although a daunting task, our analysis shows that, when applied correctly and systematically, a forward-looking approach to asset allocation can ultimately lead to a significant uplift in long-term portfolio returns."

The analysis also shows forward-looking models can help to determine optimal allocations to asset classes.

According to Aviva Investors, the dynamic portfolio improved its performance by using current metrics - such as price earnings ratios or dividend yield (equities), price to rent ratios (real estate), yield to maturity (bonds) and purchasing power parity (foreign exchange) - which can help pension schemes to better forecast returns for the respective asset classes and adapt their allocation adjustments in line with their changing long-term return prospects.