Rolling out a total portfolio approach is rarely a linear process, as even its most experienced practitioners have warned that without careful resistance to old language, culture and structure, asset owners can easily slide back into the “comfort” of strategic asset allocation.
Despite having adopted a TPA mindset since it was established in 2006, Australia’s Future Fund is still constantly resisting a “gravitational pull” back towards SAA-like tendencies, according to its former chief investment officer, Ben Samild, who was interviewed for a TPA report published on Tuesday.
The A$318 billion ($209 billion) fund avoids words such as “my portfolio”, “benchmarks”, “sleeves” or “asset classes” in its institutional language and promotes “growth”, “income”, “portfolio impact” and other whole-of-fund focused terms. But old ways of thinking often re-emerge especially during times of stress.
Externally, peer comparison, consultant inputs, board renewal and media narratives can impact the sentiment of investment teams.
“When most of your peers are using SAA, it’s hard to be the odd one out,” read the report published by the CAIA Association and the Thinking Ahead Institute.
“No TPA shop has actually ‘made it.’ For these organisations, it’s not about achieving or arriving at TPA status, it’s about resisting regression.”
The TPA framework can also become less effective following a change in organisational structure resulting from a rapid expansion of mandate, assets or team headcount, but solutions to this problem can look different for various asset owners depending on their set-up.
Some, like Australian state sovereign wealth fund TCorp, facilitate TPA collaboration by intentionally keeping a localised office and leveraging the proximity of its investment team.
But Canada’s CPP Investments addresses the problem by expanding the usage of its completion portfolio, which was originally a “quasi-balancing/overlay portfolio” and has evolved to amplify or offset views from positions held by its bottom-up team. This maintains the flexibility allowed by a top-down view while benefitting from inputs from its on-the-ground, geographically diverse investment professionals, the report said.
Asset allocation impacts
In shifting away from SAA to TPA, asset owners are switching from a tracking error-driven to an opportunity cost-focused mindset, and one of its biggest manifestations is the way assets tend to be funded.
For example, CPP Investments coordinates capital allocation decisions through a central investment committee which helps avoid “rigid deal-by-deal trade-offs” among bottom-up teams. Singapore’s GIC manages an overlay portfolio from the CIO’s office which addresses short-term funding needs or thematic exposures without disrupting long-term allocations.
The report points out that this leads to a difference between tactical asset allocation in SAA and its equivalent in TPA: while the former is always in a mindset of “deviating from the constraints set forth by the governing body”, which are the policy benchmarks, the latter can act without them and identify what’s truly beneficial for the portfolio.
Another asset allocation impact of TPA is that it gives funds ways to embrace more “esoteric” asset classes, such as insurance-linked securities and volatility-linked strategies.
It also allows for more creative allocation decisions. Australia’s Future Fund combines defensive hedge funds with zero-to-negative beta and “substantial” venture capital exposure, for example.
“While Future Fund didn’t go through a transition from SAA, this is a great example of how a TPA portfolio deviates meaningfully from peer portfolios that maintain more long-only beta benchmarks and exposures,” the report said.
“These diversifying positions, while unconventional by SAA standards, were integrated for their utility in improving resilience and achieving objectives like inflation protection or return asymmetry.”
Total view of risk
The report observes that under TPA, funds tend to be willing to tolerate higher tracking errors relative to a reference portfolio, which is a low-cost, index notional portfolio that aligns with an investor’s risk appetite and investment horizon.
This could be a result of TPA practitioners focusing more on the total fund objectives, rather than prescriptive measures in risk management, the report said. TPA funds can focus on a variety of key risk indicators including shortfall risk, surplus variability, or drawdown and recovery resilience rather than “measuring volatility for its own sake”.
Canada’s University Superannuation Scheme (USS) focuses on funding gap volatility as a key risk indicator to manage its liabilities and responsibilities to beneficiaries.
GIC, meanwhile, keeps a close track of long-horizon strategic risks and short-term market dislocations by managing risk across three layers: long-term policy portfolio, 10-year strategy buckets, and 3-5-year overlays.
There is a lot of creative room afforded by TPA for investment problem-solving, but the report highlights that one of its drawbacks is complex governance.
“Boards must trust management to make judgment-based decisions that align with long-term goals. Management must trust teams to collaborate rather than compete. And investment professionals must trust that their value is measured beyond a benchmark,” it said.
“As Geoffrey Rubin, senior managing director and chief investment strategist of total portfolio management framed it: The role of the governing body is to set the problem up very clearly. Then the question is: how much latitude does management have to solve it?”
