One of the most experienced practitioners of the total portfolio approach (TPA), Sue Brake, says its edge over the strategic asset allocation (SAA) comes from being long-term, being nimble and being innovative in portfolio construction.
As the former chief investment officer of Future Fund and now an independent investment consultant, as well as sitting on the high-profile five-member investment and risk advisory panel for the Monetary Authority of Singapore, Brake says she was not surprised at the finding in the recent Thinking Ahead Institute (TAI) research – that among 26 asset owners surveyed, the organisations with TPA have outperformed those with SAA by 1.8 per cent per annum in the past decade.
In fact, she tips that the value-add of TPA could be even higher.
“I’ve done some work for a client where I showed then it was 2.4 [per cent per annum], so I very much believe those [outperformance] number,” she tells Investment Magazine.
The industry is moving away from an SAA mindset where “some ivory tower boffins have decided what the portfolio looks like” and individuals can only make the best of the piece of portfolio they got, she says.
“It’s a very elbow-out, hungry, innovative and efficient [kind of culture in SAA] – efficient if you’re trying to optimise the value of that small component.
“But what the total portfolio research is telling you is that the sum of all those efficient components is not equalling the whole that you get when you run it as one portfolio that is more coordinated.”
Brake says that the extra return does not come from where people usually think – namely, taking on more risks.
“A large chunk of it is coming from being nimble,” she says.
“There’s been a number of large institutions kicking around for a number of years trying to work out how to do it in a way that’s not too scary.
“Because if you aren’t anchoring yourself from a strategic asset allocation, and you suffer from hubris – which we all do – you can burn a lot of money thinking that you’re more skilful than you are, moving the portfolio around and costing money.
“But there is good evidence for it, and there’s a way to do it in a disciplined way and a mindset that you require, and the total portfolio approach is a good way of summarising what it is.”
Benchmark agnostic
Another element of the argument is that TPA is “quite agnostic” to benchmarks or relative performance, which means funds can afford to do things differently, Brake says.
“That is part of the necessary ingredient to be a long-term investor, and if you’re really fixated on short-term relative performance, then you can’t be a long-term investor,” she says.
Brake is of the view that short-termism is one of the most prominent investment angsts – many asset owners realise that, but not all of them consider it a problem. Some asset owners are believers of the view that “the long-term is just a series of short-terms”, she says, recalling a recent boardroom conversation.
“It’s just not true in the investment space…a relative performance makes you short term unless you know the strategy of your competitor,” Brake says.
“There are some situations where competition is a marvellous thing, but there are others where it doesn’t help – and the investment industry is one where it doesn’t help, because it forces you to become so focused on not being the bottom that you’re short-term.
“If you’re short-term, you now have to rely on skill to beat indices, because the long-horizon opportunities are not available to you, and skill is incredibly rare, difficult and expensive.
“It’s just not a game that most of us should be playing.”
Crucial for asset owners
Brake says TPA is crucial for asset owners because they fundamentally operate differently from other investment organisations like asset managers. Managers work well in silos because they are “paid to worry about beating a benchmark”, which is why the total portfolio is irrelevant to them, but asset owners have more considerations in their purpose and TPA is a valuable tool to implement that purpose.
“Great investment organisations, great asset owners, have got such clarity with their stakeholders, because the foundational law that you have or whatever other regulatory or mandate guidance you have cannot do justice to the nuance of the risk appetite and aspirations of the actual owner of the money,” she says.
“You are the asset owner in the sense that you’re managing it on behalf of someone, because you’re the investment expert.
“The whole industry just gets so obsessed with relative performance I think they lose sight of what it is that you’re actually trying to do.”
In some ways the central banks are great examples of organisations with a clear purpose with their sole focus on an inflation target, Brake says, but they still feel the pressure when knock-on effects such as unemployment start to emerge. That’s not dissimilar to what asset owners are experiencing with the politicisation of their investment processes and the need to invest in, for example, nation-building areas, she says.
“If everything is geared towards achieving that [purpose], then you’ve got a better likelihood of achieving it rather than divide and conquer where you’ve divvied up the problem,” Brake says.
“It’s a philosophical thing.”
Hi Sue, this there a simple explanation what the difference is between TPA and that of SAA with strategic tilting is??