This Monday our team had a robust discussion of the Total Portfolio Approach (TPA) and its merits. The Total Portfolio Approach stands in contrast to Strategic Asset Allocation, the framework that defined much of our careers as institutional investment consultants.

Under Strategic Asset Allocation, an organization will set a long-term targeted return for its investment portfolio – typically spending plus inflation plus growth. The organization – typically the CIO or consultant in conjunction with the investment committee or board – will then determine the most efficient allocation of the portfolio across the available asset classes. Strategic Asset Allocation requires long-term return expectations for each asset class, while taking into account the volatility of the returns (geometric return), as well as the relationship between the asset classes (covariance). Based on the organization’s ability to assume risk – including illiquidity – strategic allocation targets will be set for each asset class and written into the investment policy statement. When markets or spending move the portfolio away from its long-term allocation (or ranges), the portfolio is rebalanced back to its strategic asset allocation. The portfolio strives to outperform a policy benchmark based on its strategic asset allocation through implementation (for example factor tilts or active management).

Total Portfolio Approach recognizes that a strategic approach to portfolio construction often ignores shifting market conditions, may not fully capture portfolio sensitivity to economic factors, and can introduce conflict between asset classes and investments. TPA strives to move beyond thinking of the portfolio as a set of distinct asset classes focusing instead on the purpose of the portfolio. It requires a unified approach to asset allocation taking into account the best available opportunities in any given moment under a framework that forgoes competing interests (siloed teams). Under a Total Portfolio Approach the organization (or individual, or family) establishes a reference portfolio and allows for broad allocation and implementation that strives to meet or exceed the results of the reference portfolio on a long-term, risk-adjusted basis.

The correct model for any investor will depend on a variety of factors, not least of which are governance and structure. Strategic Asset Allocation keeps oversight and implementation siloed and is well suited to the traditional endowment model where the governing Board or investment committee meets infrequently and stays at an arm’s length. TPA requires a reimagining of governance, allowing greater freedom for an appropriately aligned, resourced, and incentivized team.

As yet, TPA’s primarily an institutional investor construct. Our explorations continue on what such an approach would look like for taxable investors – would tax realization offset benefits of a more dynamic approach to portfolio management, or would the more holistic approach provide opportunities for greater tax efficiency?

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