Institutional investor understanding of the differences between strategic asset allocation (SAA) and total portfolio approach (TPA) is growing, according to the Thinking Ahead Institute’s (TAI) latest global asset owner peer study report, and SAA is “by and large losing the argument”, with more and more investors set to embrace TPA over the next few years.
TPA, which emerged in the mid-2000s as a variation on the endowment model of asset class bucketing and which has found proponents in the NZ Superannuation Fund, the Australian Future Fund and TCorp (NSW government fund), focusses on the factors and exposures that are most important for a fund’s risk/return profile; each investment is assigned an exposure to those factors, allowing a clearer mapping of them to a risk budget or reference portfolio.
“(With SAA), you do a policy benchmark aligned to goals but go out there with asset class buckets and implement it through mandates,” TAI co-founder Roger Urwin told a Sydney event on Thursday. “That’s not so joined up. The success of TPA is outperforming your goals; the success of an SAA is producing alpha over your benchmark – which is strange, because the policy benchmark is the crucial part of the return. There is a theoretical edge to TPA.”
Respondents to the TAI study said that TPA helped them frame and make their investment decisions better and enabled “greater dynamism”.
“(A large number of respondents) said that the TPA approach eats the SAA approach for breakfast,” Urwin said. “It was a very, very clear-cut proposition that people were looking at there. SAA basically solved a governance problem and did it well, but it didn’t solve the investment problem. We think it’s a time to call out the merits of the TPA approach, while recognising that there are quite big governance issues attached to it.”
TPA take-up is currently 35 per cent and set to grow among the investors surveyed, though its adoption is more a spectrum than an all-or-nothing consideration, with different institutions advanced to different points based on how radically they want to change their investment approach. But based on public disclosures and data sourced from Global SWF, the performance difference for the top TPA-adopters is “considerable”: circa +1.8 per cent p.a. over the last 10 years.
“That’s a very, very substantial margin in our industry, and quite honestly I’ve never seen a margin out of one factor as big as that before. There are reasons to think that’s not quite the figure going forward (ed: TAI believes some of the difference can be explained by governance choices), and we support the idea that TPA compared with SAA like-to-like is worth somewhere between 50 and 150 basis points. It really surprised us when we saw that.”
Meanwhile, it’s obvious that 60/40 “was buried a number of years ago”, Urwin said, and replaced by 40/30/30 – 40 per cent equities, 30 per cent bonds and 30 per cent in alternatives: private markets, hedge funds, etc. But a good half of investors are keeping their SAA relatively static even as the other half moves to alternatives.
“That’s more of the same, but the key factor is the characteristics of the SAAs we see, they tend to be a bit anchored and slower to move, and through a big change in the investment macro it’s really quite surprising that those SAAs haven’t moved at all,” Urwin said. “The rise and rise of systemic risk, when you look at it that way, geopolitical confrontation, you recognise that that’s at a different level in the world, and climate change.”
Lachlan Maddock is editor Investor Strategy News (Australia)