Total Portfolio Approach: A New Way to Construct Asset Allocations

The Chartered Alternative Investment Association, in partnership with several asset owners—all based outside the U.S.—is endorsing a new approach to institutional investing that eschews asset class benchmarks in favor of total portfolio outcomes, a tact proponents say could take a generation of change to implement.

The group this week presented a paper on the Total Portfolio Approach, written in collaboration with Australia’s Future Fund, Canada’s Canada Pension Plan Investment Board, the New Zealand Superannuation Fund and GIC, Singapore’s sovereign wealth fund.

The TPA strategy relies on the CIO, with support from the organization’s board, to set asset allocation using investment-team focused processes, which CAIA President John Bowman says could make it a difficult strategy for public pension funds to implement.

The TPA measures success based on total fund returns, rather than relative value in relation to benchmarks, and uses factors to achieve diversification, rather than asset classes.

The report, “Innovation Unleashed—The Rise of Total Portfolio Approach,” was released by CAIA at the AltsLA Conference March 18-20 in Los Angeles.

The approach is presented as the “next realm” of portfolio construction, succeeding the Yale, Canadian and Norwegian models, which are versions of traditional strategic asset allocation, centered on fixed-target asset allocations.

Principles of Total Portfolio Approach

The Total Portfolio Approach is “one unified means of assessing risk and return of the whole portfolio,” wrote Geoffrey Rubin, a senior managing director and chief investment strategist with CPP Investments in the CAIA report.

It does not have specific guidelines that an investor must follow; rather, it is a “state of mind, rather than a policy or process,” according to Charles Hyde, head of asset allocation of the New Zealand Superannuation Fund, in the CAIA report.

Performance of a fund using the TPA should be measured based on total return against fund goals, instead of benchmarks, according to a report by WTW’s Thinking Ahead Institute. Success opportunities for investment are defined by contribution to the total portfolio outcome, rather than particular asset classes. Diversification is principally done via risk factors, rather than asset classes.

TPA does not merely view asset classes through broad labels such as “equities” or “real estate,” wrote Rubin and Derek Walker, managing director and head of portfolio design and construction at CPP Investments.

“Armed with this understanding, we can more accurately achieve our preferred mix of factor exposures designed to maximize returns at our targeted market risk level,” the two wrote.

The portfolio strategy is implemented by one team collaborating, rather than by multiple, asset-class teams competing for capital. By doing so, an allocator’s investment team can be nimble and make “meaningful changes to a portfolio in shorter periods of time,” according to Steven Novakovic, managing director of curriculum, and Christie Hamilton, director of content and research, both at CAIA.

WTW’s report emphasized that asset owners can vary in how much emphasis they put on different attributes that make up TPA.

Governance, Culture and Competition for Capital

In the report laying out the Total Portfolio Approach, CAIA noted it is not as “prescriptive”—meaning it does not abide by strict rules—as other investment models like the Endowment, Norway and Maple models.

CAIA identified four common practices of TPA already exhibited by the investors that contributed to the report. These have powerful CIOs unencumbered by rigid rules and outside pressures; invest through a factor lens; pick only the best assets; and possess a single portfolio culture, instead of a cluster of competing groups.

Governance and Flexibility: Australia’s Future Fund practices what it calls a “joined-up-whole-portfolio approach.” This means it has an empowered CIO office and no asset allocation targets, which enables the fund to “discuss the state of the world and competing opportunities without the constraint of labels or buckets,” wrote Ben Samild, the Future Fund’s CIO, in the CAIA report.

Factors: Rubin and Walker, of CPP, endorse a “factor lens” approach when categorizing asset classes and when understanding the drivers and risk and return of a diversified portfolio. “The foundation of a multi-factor lens begins with setting an appropriate market risk appetite before allocating that risk across exposures that they believe will yield the best risk adjusted return outcome through the course of market cycles.” the report stated.

Picking the Best: “At the core of the Total Portfolio Approach is the idea that each investment should earn its way into the portfolio,” wrote Hyde, head of asset allocation for New Zealand Super. “That is, each investment should be sufficiently attractive relative to the set of available alternatives to warrant its inclusion in the portfolio.” He described this method as “competition for capital.”

Unified Culture: Organizing investment offices as separate fiefdoms often fails to deliver the best result for an organization overall, so TPA outlines a collaborative setup. In a fund that adopts TPA, the CIO should “nurture a collaborative team and set of norms built on agility and long-termism,” wrote Swee Chiang Chiam, head of total portfolio policy and allocation at Singapore’s GIC.

Implementation challenges

The implementation of the Total Portfolio Approach will vary across different allocators. What works for a university endowment might not work for a public pension fund, and vice versa.

“By now, it should be abundantly clear that adopting TPA is a full-on transformation exercise, and not something to be embarked on lightly,” wrote Jayne Bok, head of Asia investments at WTW, in the CAIA report.

Implementing a Total Portfolio Approach starts at the board level, says CAIA’s Bowman, and is not something that happens overnight.

“The board really is the fulcrum of the whole process,” Bowman says. “If the board is not aligned and cheerleading and fully supportive of moving toward a different level of empowerment and separation of responsibilities down to the CIO and the staff, then it’s going to be a very short change management process that is not going to work very well. So this is a baby-step process that has to start with, probably, the CIO engaging the board [about] some of the benefits of taking a multi-year progressive approach to try implementing some of these elements in small form and testing them out, getting more and more support, and eventually continuing down that path.”

Implementing TPA can be especially difficult for public pension funds, Bowman says.

“I think public pensions in the U.S. probably have a bigger challenge, all else equal, than most other types of asset owners,” he says. “If you’re going to break things, change things, take risks—which is what good leaders do—that requires things to become inefficient, that requires them to become uncomfortable, that requires probably some attrition and some change-up and some tough discussions, all of which eventually leads to progress. But that’s a really hard thing to ask of a public pension CIO that might only be there four years that has a board that has all of these other competing masters and motivations.”