Embracing a Total Portfolio Approach (TPA) as an asset owner, fiduciary manager or OCIO is nothing new. Yet for many firms, the complex data, system and cultural transformations required to put TPA into action can take years to bear fruit. 

TPA puts the ultimate objective of a portfolio at its forefront. It seeks to connect what are often siloed processes within different asset classes so all teams, systems and investment decisions work in harmony. 

Many teams, systems and processes to connect

The reality is many investment organisations and systems were built from the bottom-up, based around traditional asset classes. 

As asset owners have looked further afield in pursuit of diversified returns, pressure on traditional operating models has increased, leaving a tail of fragmented systems, processes and teams.

This disconnect makes it increasingly difficult to deliver on an investment objective that is asset class-agnostic. For instance, an actively-managed single asset class portfolio can’t be considered in isolation. It is only relevant in how its market and idiosyncratic risks impact the total portfolio. 

Disconnects also arise from teams having different investment horizons. For example, managing risk within a single public asset class requires models calibrated to shorter horizons. That compares to asset allocation or private markets teams making decisions with much longer horizons in mind. 

Challenges also exist in the way portfolios are implemented. Complex portfolio structures and hierarchies are the mainstay of capital allocators. A total portfolio may consist of allocations to pooled funds (public and segregated), fund-of-funds, specialist private market vehicles, in addition to single-security and derivative exposures. 

Pragmatism over perfection 

While TPA is a well-founded ambition, it requires significant transformation in the people, processes, systems and data of an investment organisation. Therefore, we believe firms should adopt a pragmatic approach and prioritise the following:

1. Ensure a strategic risk model is central to the process

While TPA may downplay traditional strategic asset allocation approaches, it’s not a case of throwing the baby out with the bath water. To deliver on a multi-year portfolio objective, a strategic risk model that looks long into the future is needed. It should set the framework for how a portfolio can deliver on its goals, accounting for all potential asset returns, risk, correlations, stresses and regime shifts long into the future. 

This contrasts with security-level risk models that are typically calibrated to shorter horizons. For example, finely-granular bottom-up analytics on a 3-year bond or single stock held today may offer limited insight into how those exposures will help to deliver on paying out member benefits in 20 years time. While a bottom-up risk model is integral to risk management within an asset class and shorter horizon decisions, it’s important to recognise that it’s the strategic risk model that is most central to TPA. 

2. Balance the pursuit of data precision with judgement

The data required to put TPA into practice is immense, such that it often morphs into its own expansive change programme. The temptation is to jump immediately to the bottom –  i.e. assemble each line item of asset exposure (funded, unfunded, public and private) into an organised database and then aggregate up to the total portfolio. 

That approach is predicated on an assumption that all the data exists. The reality is there are extensive gaps and inconsistencies at the underlying asset and security level. So many subjective decisions must be made. 

For example, a breakdown of country exposure on a total portfolio requires decisions on how best to marry different country classification approaches ( across equity vs bond, risk vs domicile, public vs private assets), how to treat treat derivatives, what to do with cash items, and handling gaps in data (e.g. filling forward if data is lagged, using proxies or re-scaling where data is unavailable). 

A pragmatic approach is to balance bottom-level precision with equal attention on the processes and logic to overcome data gaps. Importantly, the quicker that is put in place, the quicker a firm has ‘minimum viable’ data with which to make decisions. Otherwise projects may linger, stalling the entire TPA initiative. 

3. Accept an ever-widening asset reach

Much of the disconnect across systems and processes today stems from the differences across asset classes. A future-proofed TPA recognises the asset reach will widen even further. This is a natural consequence of investment teams constantly scouring further afield for investment opportunities. Firms must expect entirely new asset classes and specialist teams to appear sometime in the future.  

With that in mind, TPA should emphasise the flexibility, openness and interoperability of its data, systems and processes. For example, a TPA management system should easily support the incorporation of new asset types, loading and extracting data, connecting with other systems, and providing flexibility to add new functionality. Conceptually this is simple, but the reality is change programs often anchor solely on today’s mix of assets and requirements.  

4. Simpler portfolio structures may be best

Total portfolios typically stretch across asset classes, combining a mix of in- and out-sourced capabilities at multiple levels. These multi-layered, ‘nested’ portfolios add significant complexity to the systems, data and processes underpinning TPA. Even the simplest analytical or review exercise can become highly onerous.

In embracing TPA, a firm should question those structures where they may be a hindrance. Simpler may be better if it improves the ability to make ‘total portfolio’ investment decisions and deliver on a scheme’s objective. For example, modelling an asset class sleeve as a single portfolio exposure, as opposed to various sub-asset class mandates, may sufficiently capture that asset class’s overall contribution to total portfolio risk and return, without the additional complexity of separately accounting for and modelling each mandate. 

While some asset owners, OCIOs and fiduciary managers have already enacted a total portfolio approach, TPA is an ongoing journey in many firms. To reap the benefits, firms should be pragmatic in prioritising their efforts. They should also not be afraid to resist any entrenched norms that led to such a disconnect in investment processes, systems and teams to begin with.