The investment methodology Total Portfolio Approach (TPA) is making big waves at the moment.
Funds in large numbers are thinking about ways to make the transition to TPA with CalPERS the most prominent, as covered in Top1000funds.com recently. But the paradox is that not much money is run this way yet. My estimate is that only about one-third of the very big funds and well under 10 per cent of mid and small funds do TPA. What’s the back-story?
Strategic asset allocation (SAA) grew up in the 1980s, turning the horse-race of outperforming peers into a more intelligent race against benchmarks. It did that well but more as a comfortable arrangement that solved a governance problem than good investment design. I was there and I worked on it. This was when asset and liability management (ALM) and risk budgeting were proving their mettle which to this day are valuable tools for asset owners.
But as risk became more complex and stakeholders more demanding, it fell behind par in meeting performance goals. In short, like a lot of things, it worked well until it didn’t. And when a few brave souls in the 2000s went against it and evolved the TPA methodology, we had what looked like a better model.
Fast forward 20 years – where are we? The change has been small-scale. TPA is still in a minority position largely because it can only be implemented with a type of stretchy governance that is both very capable and nimble to make a good job of the transition an ongoing challenge. And that type of governance is in very small supply.
It hasn’t helped that the industry is conservative (that’s ok) and has an aversion to change (that’s not so good). And there has been no burning platform to mobilise change. The TPA ask is onerous and a transition to TPA needs the stars to align. On top of a change to the investment model, you need changes to the people model, risk model and governance model, and often the sustainability model too.
These multiple asks led the Thinking Ahead Institute to design the TPA scale that adds up to a TPA signature. That signature runs from the pure SAA (score 0 on TPA-scale) to pure TPA (score 5 on TPA-scale). The big asset owners interestingly are often in a hybrid model where they have some of the TPA features, but retain some of the SAA features (so they are 2 or 3 out 5). The TPA exemplars – four are often mentioned: CPP, Future Fund, NZ Super and GIC – are 4 or 5 out of 5. The benchmarking of TPA follows from these pillars.
First, in the investment model there is the goal-oriented framework moving from success as the outperformance of benchmarks to success in a scorecard centred around meeting goals in a multi-factor orientation that is systemic not fragmented
Second, in the risk model the mindset shift is from volatility and tracking error to the downside and drawdowns from the total portfolio and the risk tolerance that drives the yin and yang of risk and return. The TPA method is supported by risk measures that are wider, softer and longer than the equivalents in SAA.
Third, in the people model there must be a stronger teamwork ethos and collaborative proposition straight from the superteams playbook (see Top1000funds.com) by governing better via effective scaffolding and working smarter via better culture, T-shapedness and cognitive diversity, all motivated by a mind-set shift.
Fourth, in the governance model the best boards are strategic not investment strategy-focused, and highly tuned to speed, agility and joined-upness principles.
Finally, in the sustainability model it’s applying the joined-upness in practice – integrating risk from ESG onto the portfolio, risk from the portfolio onto the real world, and integrating their intentional impacts both short- and long-term.
There is no killer app here, but it is critical to work with some governance guidelines and guardrails to thrive in a more complex world experiencing rapid cultural evolution, technological transformation, environmental degradation and a dose of political dysfunction.
The big driver to better governance is first about basics: dependency on division of roles, comparative advantage, primacy of goals, speed of action, culture of collaboration and critically checks and balances. And second, it’s about ‘ologies’. Here the methodology, technology, futurology and anthropology are critical to making sense of the present and the future and reflecting that sense in the current portfolio.
This way of thinking aligns in the normative picture of organisational maturity captured in the scientific, speed and superteams principles spelt out in Andrew McAfee’s book, The Geek Way. The book explores how the tech industry applies those organisational principles to produce the exceptional results that the Mag Seven and others in the Silicon Valley set have achieved.
The rapid progress that geek companies have made can be traced back to organisational innovation and their high rates of learning through applying speed in all facets of the business, notably the commitment to and system for learning.
Humans do not learn primarily by studying. We learn primarily by watching the people around us, finding those who are good at what they do, and picking up on their behaviour and integrating the best bits.
The application to investors is clear: the best have the greatest intelligence processed from basic data into collective intelligence at speed and scale. And TPA works by streamlining that process.
Making the TPA transition needs this stretchy governance. Stephen Gilmore, CIO at CalPERS in his public account of their TPA plans lays out a path forward. There is no silver bullet. Just a well-ordered series of steps starting with the vision and strategy, the common purpose, the unified language, the competition for the best ideas for capital and risks, through to implementation using multiple channels, and reinforced in a culture shift. And all this shaped by a building body of experience that this is a transition worth making waves for. Because asset owners need help with a faster world that has higher stakes and considerably more uncertainty.
Roger Urwin is global head of investment content at WTW.
