Crisis or challenge? Chaos or opportunity? Call it what you will.
But according to Amundi’s chief allocation advisor Eric Tazé-Bernard the current investment environment, which has left many in the industry scratching their heads as to where to go next, is with us for some time to come and a total portfolio approach (or TPA) is an effective way to navigate it.
An event like the Lehman bankruptcy in 2008 is something Tazé-Bernard said he would describe as a crisis, an instantaneous disruption. What we are experiencing now, he said, is different, a simmering crisis, if you like, something which is going to last a few years and which is going to have a lot of consequences.
Today’s investment landscape is uncharted territory. Low yields, low interest rates, the increased spectre of inflation, production bottlenecks in certain sectors such as semiconductors, low expected returns on assets (even though performance has been spectacular in a number of markets, this is not expected to continue.)
Increased regulation in terms of introducing ESG criteria and action taken by major central banks, especially the Fed and the ECB, in terms of conduct of unorthodox monetary policies in response to Covid have all added up to traditional portfolio balances and constructions being questioned. So much so that many industry pundits are calling the “days of the 60/40 portfolio dead”.
Technology and geopolitics
There’s also the question of technology which, said Tazé-Bernard, is pervading the whole world and which cannot leave the asset management industry untouched.
“It is clearly questioning the way we are managing portfolios,” he said. “How is technology going to influence the choice between active and passive management? To what degree should you introduce quantitative methods? There’s the issue of intraday trading… some investors are able to trade very quickly on some markets, affecting the structure of the market.”
But all this is also taking place against an increasing fragmentation of the world, increasing protectionism amid tensions between the U.S. and China, all adding geopolitical risk to an already risky investment scenario.
This uncertainty is triggering a shift, globally but also in Australia, from traditional assets to alternative assets, for example, to private equity infrastructure and real estate. But this doesn’t come without its own set of risks according to Tazé-Bernard. He sees these big, long-term trends as inflating bubbles in some areas.
A wholistic approach
So in these unchartered times how best to manage a portfolio? Tazé-Bernard sees a Total Portfolio Approach (TPA), a holistic, goal-based system of portfolio construction which focuses on factors rather than breaking the investment universe down by asset classes, regions or sectors.
“I’m a firm believer in the fact that when you construct an asset allocation, you have to have in mind factors, which are driving the asset allocation,” he said. “So it’s not so much how much should I allocate to Australian equities, foreign equities and so on, for example, but what weights of my portfolio should I give to growth to inflation, to interest rates, so, think of how your portfolio is going to react to a number of macro drivers that you think are key in structuring the portfolio.”
He says it’s also an exercise in breaking down silos and avoiding fragmentation within an organisation given that thinking about the total portfolio return is a key element. So, in effect, the spirit of TPA is to bring solidarity within the decision making within an organisation and ensuring that all the teams within the portfolio are working towards the same objectives to achieve the same investment goals.
Importantly in today’s investment climate, the integration of ESG is another element of TPA. “I think that it’s a broader approach to allocating assets that takes into account elements that are not traditionally integrated in the financial world,” he said.
Stewart Brentnall, CIO NSW Treasury Corporation (TCorp), said his organisation started the implementation of a TPA system back about five years ago when TCorp, in a governance sense, evolved, at the time, from being responsible for $12 billion in funds to about $65 billion, when the three investment processes of TCorp, State Super and Workcover were centralised into one, under TCorp’s responsibility.
“I looked around the world for best practice, investment management of scale, state-based assets, and found some very interesting themes across the world, particularly in Canada, New Zealand, Singapore, and small parts of Europe, where, let’s call it, a more total portfolio oriented approach to managing investments was practiced,” he said.
The fundamental principle as far as Brentnall was concerned was that each of TCorp’s clients had one objective only and the dichotomy was that when you looked at traditional asset management processes the capital was divided up into “silos” and measured against numerous different benchmarks where each of those subsidiary benchmarks may well not have had much to do with the client’s mission oriented benchmark.
“Why can’t we have a process where every aspect is just looking at the client objective, (for example inflation plus four or three and a half or 3 per cent, over rolling 10-year periods), and go for that? And so, lights went on at that stage!” he said.
When asked what was needed to be done to implement such a TPA process he outlined four crucial steps:
1. A better governance framework. A change from the board reserving all the investment decisions to themselves to delegating them to an empowered investment team.
2. An investment model where the investment decision making was joined up so that the entire strategy, setting and execution in the portfolio all revolved around thinking about the best possible way of delivering the highest risk-adjusted return and best quality portfolio for each client’s needs. The thinking, the analysis, the decision making and the implementation that ultimately happens in the sectors must always consider the whole of the portfolio’s needs and complexion and not just the sector’s.
3. Data. Brentnall said: “In order to run this model, we very quickly worked out that this actually isn’t about asset allocation. It’s about risk allocation” So you need a mechanism which sources the right data from the security level upwards and has the right risk analytics bolted to it. This then feeds into the client’s objective and risk appetite and allows the building of the best possible portfolio. A custodian-based portfolio valuation service cannot provide this and a fit for purpose portfolio analysis and risk model is needed.
4. Getting the right people, organizational structure and culture. “You’ve got to get the right cultural set that is appropriate for the model that you’re trying to run,” he said. “This requires a team who are prepared to share ownership of the outcome, supporting decisions that are best for the corpus even where they might not suit the individual. You’ve got to get the right people on the bus early.”
For Brentnall there is a clear differentiation between a TPA model and a strategic asset allocation one; and it’s as much a mindset as anything else – it’s where an organisation chooses to put itself on the spectrum of decentralisation.
He said easiest way of thinking about it is that over time, a total portfolio model will be based on a real time competition for capital, over time taking risk and capital away from asset sectors as well as giving it to them.
“Whereas you look at a strategic asset allocation model, and capital is pretty static between sectors, he said. “So a sector manager will know how much capital they have to operate over time, whereas in a TPA model, it’s a an ongoing competition for capital across the sectors to deliver the best possible return for an agreed level of portfolio risk.”
“Our belief is that that a TPA model in the long term can deliver probably between 50 to 100 basis points of extra return for a given the amount of risk,” he added.
Adopting the approach
For Jason Huang, Senior Portfolio Manager, fixed income and alternatives at ANZ Private Bank, the biggest advantage of TPA is the collaboration across different segments or markets and different asset classes.
“I think the importance is to how you break that barrier between asset classes. That’s a very important element,” he said.
He maintained while ANZ Private hasn’t adopted the approach entirely there are elements of TPA his team have adopted having seen the advantages of some of the dynamism the system brings.
He made the point that the flexibility of TPA would have been demonstrated well in March last year when amid the start of Covid, it didn’t take long for the market to tank and then it rebounded almost as quickly.
He argued that it would have been harder and taken a much longer time to manage the downside and take advantage of the upside using a traditional model. With a TPA approach you’re much more adaptive in terms of the market environment.
But he agrees with Brentnall and stresses the importance of getting the culture of your organisation right to make sure the approach is successful.
“I think it’s a team culture and people-led issue. If you’re considering shifting to a TPA approach, you really need to carefully think about your existing talent and how the varying skillsets can be applied to this model. That can be a challenging task.
“To adopt TPA you need to have very, very technical people, that have a broad experience across numerous asset classes but are also SME’s in specific areas too.”
This story was produced in partnership with Amundi Asset Management