The changing nature of volatility in financial markets and a more client-centric approach that allows allocations to be tailored is helping more institutions adopt a total portfolio approach (TPA) to investment management.
In a discussion at the Fiduciary Investors Symposium at Stanford University, a number of large asset owners outlined their efforts and the challenges they are tackling to achieve a comprehensive total portfolio view amid an evolving investment landscape.
“What we have figured out is that volatility is changing and you have to be more dynamic,” said Pedro Guazo, the CEO for investment management at the US$95 billion United Nations Joint Staff Pension Fund (UNJSPF). “You have to adapt your portfolio, still respecting a disciplined approach, but also understanding your total risk in the total portfolio.”
Guazo says the fund is aiming to have a convergence of both systems, by starting with the total portfolio approach information, then using it for tactical deviations to the strategic asset allocation (SAA).
He says the comprehensive approach has excited his investment team, because they will have more flexibility for deviations or take more risks, while the risk management people are also big defendants because the approach is a good model to start bottom-up and include responsible investment factors that they consider important for portfolio creation.
AIMCo’s director of investment strategy research Jean David Tremblay-Frenette says the US$170 billion Canadian pension fund’s client centric approach required the move towards TPA because it allows tailoring of allocations for clients on the basis of liquidity, maturity profiles, and other specific considerations
“The TPA approach is the way to go, to be able to have that unified view of all those risks and different factors on a client by client basis,” he said.
Unified Approach
The total portfolio approach involves taking a unified view of all the risks and returns of the entireportfolio. The approach focuses on the fund’s absolute return goals, in contrast to the strategic asset allocation, which seeks to outperform benchmarks.
TPA does not use a specific model, but instead comprises a range of approaches that can be tailored to each asset owner’s long term investment thesis.
A recent global study by the Thinking Ahead Institute found TPA can add between 50 and 150 basis points of return above the SAA. Its exponents emphasise that the two portfolio allocation approaches are targeted at different problems.
The study found the trend towards TPA is continuing, with 20 of the 26 funds survey stating they were either at their maximum TPA or moving more towards TPA. The approach has also been successfully deployed for years by both Australia’s sovereign wealth fund, the $272 billion Future Fund, as well as Kiwi sovereign fund New Zealand Super.
James Wingo, the head of the quantitative analytics at the US$46.7 billion pension fund, South Carolina Retirement System Investment Commission, says its important to ensure a unified view through TPA is by focusing on regular interactions between the risk and investment teams.
“One of the big things as we move beyond the basics, is really creating that culture and fostering a common language between investment and risk teams in order to have good conversations around risk and around TPA and understanding what risks in different parts of the portfolio are impacting others.”
Governance, technology challenge
The biggest challenge that fund manager’s struggle with in implementing a total portfolio approach is adapting the institutions culture and governance, as well as the use of technology.
AIMCo’s Tremblay-Frenette said as an asset manager, he is targeting consistency, swiftness and accuracy to ensure capital allocation across both public and private assets, but that has been difficult from a cultural standpoint, because of different operational teams or even investment teams.
“This becomes a real challenge, because everyone has their own little version of what the total portfolio, or even the portfolio component they’re responsible for is looking like,” he said.
“We’d want to really veer away from that state of the world towards a place where we feel we can truly come up with insights on the total portfolio, because the whole package is really what matters here.”
Allen Zimmerman, the head for Americas at technology provider SimCorp., says part of the governance problem is the data problem, taking the example of an institution running a private book completely separate from where it runs a public book, meaning it struggles to confirm in real time that all investment guidelines are being adhered to.
“Absolutely correlations are important from that total portfolio perspective, because oftentimes people think that they’re making an investment and it’s a diversifier. Sometimes they don’t recognize that it’s actually an amplifier. Sometimes you take a specific bet and you don’t realize that it’s primarily a FX risk,” he said.
“The only way to do this is to start bringing things together, whether this be because I’m looking at correlations or, how risks are always changing.”
