Total portfolio approach (TPA) is not a method, it’s a mindset, according to University of Toronto finance Professor Redouane Elkamhi.
Elkamhi, who is also a senior advisor to the chief investment officer and total portfolio group of Canadian pension giant HOOPP, said if he were to summarise TPA in one sentence, it would be: “How to be prepared for different market conditions.”
A mindset of being prepared goes beyond simple scenario planning, which Elkamhi argues probably has the opposite effect, because “when there is a new scenario that comes up, you turn out to be unprepared at all”, he told the Fiduciary Investors Symposium at Harvard University.
“[TPA] means what team you have, what tools you have, what capability you have, and what mindset you have as a CIO or a CEO, so that you can face uncertainties,” he said.
TPA has been the focus of much investment industry literature, but it has no universally agreed upon definition. Canadian pension funds are well-known practitioners of the approach, but its adoption is also becoming more prevalent among US, European, Asian and Australia asset owners.
The concept also has various pseudonyms. At NZ Super and Australia’s Future Fund, for example, it is known as the “[joined-up] whole-of-portfolio approach”; at CalSTRS, it is “total fund management”; at OPTrust, it is “member-driven investing strategy”; and at CPP Investments, it is “One Fund”.
But Elkamhi said there are four common characteristics of TPA across iterations: a philosophy of fund-wide decision making; an alignment of actions with total fund objectives; the breakdown of asset class silos; and the optimisation of capital and risk allocation within and across asset classes.
“Ask everybody, everybody will tell you we’re doing TPA these days. But look at what is the governance, what is the benchmarks, it’s going to come clearer to you guys,” he said.
TPA’s rise in popularity is no coincidence, as Elkamhi said asset owners are fundamentally re-evaluating their assumptions about investing under which strategic asset allocation (SAA) has thrived. The first two are the interwoven factors of evolving market dynamics and changing risk premia.
“Risk premia is changing – the idea of how much compensation you are for each risk,” he said.
“Traditionally, you had to be compensated this way, maybe the compensation is now too high.
“If risk premia is changing across asset classes going forward, then how am I going to build a portfolio that is based on history, to come up with some weight that are strategic and keep them forever?”
There are also structural limitations facing funds, including liquidity constraints and liability management.
But the final factor, which Elkamhi believes is the most influential, is investors realising there are flaws in benchmark-driven thinking.
“I think for the last 10 years, we became scapegoat of benchmarks,” he said. For example, while asset owners realise the need for more geographical diversification compared to, say, the country composition in a global equities benchmark, their capacity to do so might be constrained due to risk budgets.
“The reason we talked about TPA so much is because there are structural… illiquidity and flaws in benchmark, and there are now new views about asset returns,” he said.
For any asset owners thinking of pivoting to TPA, Elkamhi recommends some deep thinking about fund structure and investment process design first.
“Check the legacy structure. Because generally, what people do if they have an SAA [and want to be adaptive], they start to patch in it with different things,” he said.
These organisations may want to start by establishing a good risk sandbox, re-examining their liability hedging and stakeholder alignment among a slew of other considerations.
“TPA will change [your organisation]…it requires risk change, requires incentive change, requires you understand risk premia correctly, and requires a different mindset of being prepared,” Elkamhi said.
“There are many smart people that will tell you SAA is good…but I believe that smart is common, courage is rare.”
