For more than 30 years, strategic asset allocation has formed the framework for many institutional funds’ operations. Recently, however, total portfolio approach has gone from niche usage to an increasingly popular framework for modern investors.
A new white paper from the CFA Institute, “The Total Portfolio Approach (TPA): A Practical Guide for Navigating the Transition to TPA,” offered insight as to how asset allocators can implement TPA, drawing on the experience of more than a dozen allocators who cited TPA as contributing to their organizational thinking.
The paper noted that SAA has structural limitations that are becoming harder for asset owners to ignore. Total portfolio approach—which views a portfolio through a holistic lens, rather than through separate asset class buckets—has been offered as an evolution of SAA that is able to address those limitations.
“In the markets today, the rise of technology, concentration risk and geopolitical risk, thinking about sustainability from a systemic lens—all of these really touch a lot of different assets that aren’t neatly categorizable by asset class,” says Genevieve Hayman, the CFA Institute’s senior manager of macrosystems and foresight and a co-author of the report.
“You’re going to want to understand how that risk permeates across the entire portfolio,” Hayman says. “For that, you really need a total fund perspective. … What are the core objectives of the fund? Ultimately, it’s not to outperform a benchmark for a particular asset class, it’s to ensure the sustainability of the fund and provide intergenerational income and to manage liquidity in the long run.”
Implementing TPA is not an overnight project: The transition requires changes to governance structures, technology capabilities and investment processes, according to the report. For organizations willing to invest in the foundations of TPA, the report stated, it can serve as a gateway to catalyzing stronger resilience, more adaptive decisionmaking and better portfolio alignment.
The Importance of Governance, Culture
The largest barriers to adopting TPA tend to be organizational, rather than technical, as the report’s interviewees noted cultural change, team coordination and governance as some of the challenges, all compounded by the difficulty of changing to a TPA mindset from an SAA one.
“[Strategic asset allocation] has,] basically, allocation into asset-class silos, and then those asset classes are managed within that silo,” Hayman says. “That is, in many ways, easier to govern and gives you kind of a defined scope. So when you take away some of those boundaries or that silo, then it becomes a little bit more complex.”
“Rather than leaving individuals to operate in their own designated area, they now have to collaborate and coordinate across different teams,” Hayman says. “Their incentives are tied not to just their own performance, but the performance of the total fund, which, of course, is dependent on many different variables. So it becomes a little bit challenging to shift that mindset from thinking in terms of, ‘I’m managing this well-defined area of the portfolio’ into thinking in that total fund way.”
Five Levels of the Spectrum
The CFA Institute’s report examined a spectrum of TPA, from Level 1—“total fund thinking”—to Level 5—“full TPA integration.” The paper noted that partial transitions may still offer significant benefits, and a full transition to TPA may not be the best solution for every fund.
The report defined five levels of transitioning to TPA as:
- Level 1: Enhanced SAA – organizations that retain their existing SAA framework, but begin to adopt total portfolio thinking and to prioritize total portfolio goals;
- Level 2: Mindset TPA – a reset of a fund’s governance model and the inclusion of a reference portfolio;
- Level 3: Top-down TPA – a strategic reset of fund goals, including an organizational redesign that introduces an enhanced CIO function and a total portfolio officer role;
- Level 4: Joined-up TPA – external manager relationships are designed around total portfolio objectives; and
- Level 5: One-fund TPA – a portfolio operating as a fully integrated fund with a TPA mindset.
