TPA on Tap as Emerging Approach to Holistic Portfolio Construction

Portfolio construction is having a bit of a moment with one approach gaining traction. It's pretty simple and boils down to this: the whole matters more than the parts.

The theory called Total Portfolio Approach, or TPA, is when a manager optimizes the portfolio as a whole rather than looking at each asset class independently, whether that's private equity, credit, real estate or infrastructure. To paraphrase the CFA Institute and other research, TPA evaluates every investment according to its contribution to the total-fund objectives instead of the individual silos built around asset classes.

Traditionally, investors divided their portfolios into silos and then specialist teams produced the best returns within each one. If you invested in well-managed businesses or properties, you would end up with a well-managed portfolio. No big 33,000-foot view was taken into consideration in the tried-and-true Strategic Asset Allocation approach.

TPA changed that thinking by asking the question: What does a particular investment do for the entire portfolio, and is it a much better use than anything else the investor could own?

The idea is not entirely new and utilized outside of the US for at least for a while by a select few that include CPP Investments of Canada, as well as Future Fund in Australia (which calls it "One Team, One Portfolio"), Superannuation Fund of New Zealand and GIC from Singapore.

And fairly recently, CalPERS, one of the closely watched LPs in the US, approved the approach in November and implemented the shift at the start of July, prompting more conversation around the approach in recent months and a lot more papers crossing my desk on the topic from analysts and clients.

The approach sounds simple but putting it into practice can be a bit of a journey. According to an article in CAIA from the New Zealand sovereign wealth fund last October called "No Sacred Cows: New Zealand Super's Journey to TPA," the fund's managers decided to build what they called a "reference portfolio," which served as a benchmark with a mix of global equities and fixed income. The board would define the risk appetite and approve the benchmark, and managers would then own the best way to invest against it. The result, according to the article: clear governance and no need for the board to sign off on every investment decision. In short, stick to the objective of delivering returns.

The benefits seem obvious: Better competition for capital and management of private-market liquidity, more realistic diversification, greater flexibility and some could argue even increased organizational incentives (less talk of beating benchmarks and more talk on did the investment improve the total fund).

Challenges of course exist and can be substantial. This is a completely different way of thinking, which leads to governance and measurement issues, as well as organizational politics where turf battles could erupt under a new investment culture.

But here's the real rub. The multi-asset managers seem like the ones to benefit the most. If an LP sees great relative value in credit or infra and likes the manager, the switch out of PE can be easy. If the manager, however, offers a single asset, and credit or infra is more in favor, he or she can lose an investor. An opportunity and a threat all at once. No doubt, we will be keeping tabs as the approach takes on more importance in portfolio construction.

Mark Kollar
Partner, Prosek Partners

Mark Kollar's monthly Letter from America can be read at The Alternative Investor.