Earlier in our Lessons in Agility series, we homed in on the growing pension fund interest in a Total Portfolio Approach – a strategy allowing for faster reactions to market movements in a shift away from traditional siloed, strategic asset allocation.
While some funds are embracing this shift, others face significant operational constraints, making it challenging to adopt a TPA with no restrictions. The director of portfolio strategy at a large US public pension fund highlights the difficulties of navigating between the TPA ideology and the realities of pension fund governance.
“To fully embrace a TPA, the guardrails need to come off. You need to divorce yourself from typical constraints, which is tough for certain pockets of the allocator community, particularly those that live in glass houses, like ourselves, and who answer to higher powers within state, local and federal agencies,” he notes.
The senior investment director explains how the fund’s governance structure lacks the freedom to take tactical positions across its portfolio, thereby preventing full adoption of TPA. Rather, the fund applies the approach selectively. It can make “microcosm” applications within certain asset buckets, allowing managers to make changes in response to short-term macro developments or market movements.
However, even here, any changes need to be process-oriented and documented in great detail to satisfy the fund’s governance requirements. This can slow the investment process and make it cumbersome, potentially diluting the agility benefits expected from a TPA approach.
“It risks just looking like a very complex strategic asset allocation, which is really the space we operate in. We’re SAA focused and oriented,” he says. “We try to do things as nimbly as we can within those strategic allocation buckets to engender a higher degree of efficiency or value add, but I just don’t see us moving more towards a full TPA.”
Governance, staffing and resources remain central barriers to fully endorsing TPA. According to the senior investment officer, whether a fund moves to implement TPA depends on having the right variables in place, including autonomy, trust from overseeing entities, dedicated staff and budget. Without these, “it’s difficult to move off the systematic and well-defined sandbox of SAA,” he says.
A TPA can also run the risk of orchestrating its own problems: “When you introduce biases, emotion and subjectivity, you could shoot yourself in the foot by being overly tactical. And I think TPA lends to that a little bit.”
Despite this risk, the investment director acknowledges that having a more agile, tactical approach could breed efficiencies. For example, running part of the portfolio uncapped or unbridled could lead to better performance. The director believes it allows investors to be creative, to think outside the box and be willing to do things that go beyond the mundane.
“Practitioners supporting a TPA pride themselves on being able to access pockets of alpha or uncorrelated returns in a manner that an SAA practitioner is unable to achieve given the guidelines and constraints they have in place,” he says.
When all is said and done, both models have value, depending on what a fund needs. While SAA offers discipline and transparency, a TPA brings tactical flexibility and creativity.
For some pension funds, particularly public funds, the challenge is about balancing these approaches with their governance structures and processes. “Both have their merits, but investors must be equally aware of the risks,” he concludes.
Angele Spiteri Paris is a senior research consultant at CoreData Group, a global specialist financial services research and strategy consultancy. To find out more about our industry insights and research programmes, you can reach her at [email protected]