Adopting a total portfolio approach (TPA) could add 50 to 150 basis points of returns per annum above a strategic asset allocation approach (SAA), according to new research from the Thinking Ahead Institute in partnership with the Future Fund.
In its latest Global Asset Owner Peer Study, the institute observed, over a 10-year horizon, TPA funds had produced a 1.8 per cent per annum higher performance than SAA adopters. This was based on performance data sourced from funds’ public disclosures and data platform Global SWF.
Surveying 26 funds representing over US$6 trillion in capital, the study noted TPA take-up stands at around 35 per cent, compared with 38 per cent for SAA and 27 per cent for a hybrid model.
However, TPA adoption among investors looks set to grow, with SAA, by and large, “losing the argument” as understanding of the differences between the two approaches rises.
Of the 26 funds surveyed, around 10 funds expect to stay still while 16 expect to move in the TPA direction in the next five years.
“TPA excels in decision framing and execution by focusing more on goals, not benchmarks, and whole funds, not asset classes,” Roger Urwin, co-founder of the institute, told InvestorDaily.
TPA seeks a more holistic approach to portfolio construction, focusing on diversification through portfolio factor exposures over asset class exposures, in contrast to traditional SAA that is structured around more asset class-based allocations and benchmark comparisons.
With funds increasingly concerned about managing complexity – around 73 per cent said it remains a top concern among external factors – being “joined-up” through approaches like TPA “positively leverages diverse thinking across people, teams, partners and ideas”, he said.
“Being joined-up works well in TPA situations but is hard to achieve in SAA arrangements. The Peer Study revealed a strong view that the complex environment is very hard for individuals to address on their own and is best addressed by teams,” Urwin said.
Other systemic risks top of mind for funds, according to the survey, include geopolitical confrontation (84 per cent), escalating climate change (72 per cent), and inequality and social challenges (48 per cent), with almost 90 per cent of the world’s largest investment teams predicting systemic risks will grow in incidence and size.
With this, Urwin highlighted a “rocky road ahead” for asset owners, explaining: “All investors should prepare for a bumpier ride by building more resilience into their organisation – thinking ahead, more agile organisational design, better culture and stronger risk frameworks will all play their part.
“Facing such global challenges, the structures and teams across the investment world need to be rethought.”
He added: “Organisational design and how organisations are run will be one of the main drivers of investment ‘alpha’ in this portion of the 21st century.”
Getting on the front foot
Amid the evolving market landscape of recent years, Peer Study participants using TPA spoke to the “adaptability and dynamic response” the approach supported during the recent macro changes from lower to higher interest rates and inflation, Urwin said.
Meanwhile, he said SAA users had moved “more slowly and less decisively”.
TPA, which has grown in prominence in recent decades, includes local proponents like the Future Fund, which adopted TPA around 15 years ago, and the NSW Treasury Corporation (TCorp), among others.
However, Urwin cautioned, a shift to TPA “is not a plug-and-play change”.
“Funds shifting from SAA to TPA have to establish a new investment process, adapt to new governance arrangements and align behaviours and priorities to a new culture,” he said, adding the governance and cultural adjustments are often more challenging than the technical aspects of the transition.
“The transition to TPA involves multiple stakeholders being taken on a change journey – both Future Fund and TCorp planned and implemented their journey over a period of time. It is not a plug-and-play change.
“While those funds that arrive in a TPA framework are sure of the investment merits, they are concerned by the complex nature of aligning the organisation to a one-team philosophy. It is hard work.”
Earlier this year, Alicia Gregory, former deputy chief investment officer at the Future Fund, explained how TPA assisted Australia’s sovereign wealth fund in identifying major paradigm shifts in markets, including constructing portfolios for a high interest rate environment as early as 2019, which ultimately assisted with $2 billion in value added to the portfolio.
Speaking at the Australian Wealth Management Summit in May, she described an additional benefit of TPA as ensuring the fund is not “too diversified” compared with its peers who adopt an SAA approach.
“Sometimes it can feel like it takes many conversations to get anything done, but [the approach] really is all about having great resources and the very best current opportunities based on where we think global risks are, and looking forward and forming a view on the very best portfolio to have today given the assessment of markets,” Gregory said.
