Going electric: Transitioning from SAA to total portfolio approach

The total portfolio approach represents a more holistic and dynamic approach to investing, one that considers a broader range of factors and allows for more flexible decision making. Despite the initial reluctance, more and more asset allocators are recognising the benefits of TPA and are beginning to adopt this framework. In the following Q&A, this paper delves into the journey from an SAA-dominated landscape to a more dynamic, TPA-driven future, and discuss steps necessary to make this transition.

Q1: Why was SAA (the board-led approach) considered the 'gold standard' for so long, before TPA's emergence?

From the 1980s through the 2010s, asset owners were primarily governed by boards. The investment world was simpler, and boards were comfortable setting an 'asset allocation' -beta, while delegating investment selection and performance-alpha-to managers. SAA worked efficiently for this type of governance.

Here are the reasons why SAA was seen as the 'gold standard' for so long:

Board-driven governance: Most investment decisions are overseen by boards operating on a calendar-based schedule. These boards preferred long-term policy targets and rebalancing rules that could be reviewed at regular intervals. SAA aligned well with this governance model by offering a structured approach to portfolio oversight.

Prevailing investment philosophy: The investment world was anchored to modern portfolio theory, which included the efficient frontier and mean-variance, which fed into SAA structure. This was the backbone of investment philosophy at the time.

Data and operational practicality: In the late 20th century, technology was limited, and reliable financial data were constrained. Making dynamic, real-time portfolio decisions, as required under TPA, simply was not possible. The SAA's periodic rebalancing and long-term orientation were more operationally realistic.

Stakeholder communication: Stakeholders-sponsors, regulators, committees-can easily understand an SAA portfolio and relate it to expected long-term outcomes.

Q2: How has the market environment changed since SAA was developed?

The investment landscape has evolved significantly since the 1980's, creating conditions more conducive to the adoption of TPA.

Key changes include:

Rise of alternatives: There were less available asset classes and alternative investments in the SAA era. Investing in alternatives like hedge funds, private equity and real assets were seen as niche and not easily accessible.

Technology advances: There have been huge technological advancements since the SAA era, with financial data and systems improving tremendously. TPA requires a better ability to access financial data to make more complicated and live decisions.

Market environment changes: Globalisation has led to asset classes having higher correlations.

Rise of investment expertise: Expertise within the investment world whose job is to build portfolios based on clients' overall goals has improved considerably. This has afforded the ability to make real-time decisions and less calendar-based decisions.

Mission-oriented objectives: Pension or superannuation funds became more liability-driven and mission-oriented. Objectives became outcome-focused and less focused on performance relative to an SAA benchmark.

Q3: What is the decision-making process in TPA and how does it differ from SAA?

An early step that asset owners should consider in their transition from SAA to TPA relates to team and governance structures. Creating executive teams or sub-committees with clear goals can be a simple, effective way to free up time for the board or committee. It can also help the committee think more strategically. However, organizational change and a shift in cultural thinking can involve significant disruption and effort to break the inertia and get the buy-in of all stakeholders.

A board-executive governance model with a main committee and one or several sub-committees can greatly improve the investment decision-making process. The board's job is to define and set the goals for the portfolio and assign a reference portfolio that matches the goals. Then, the board delegates specific investment decisions-allocations to risk factors, asset classes, dynamic positions-to the executive team(s). The executive team(s) are better able to make those decisions by having more capacity and expertise. All investment decisions with TPA should be made on the basis of whether they improve the portfolio's ability to meet its objectives or outperform its reference portfolio. The executive team reports regularly to the board.

Under an SAA framework, committees often retain ownership for strategic and specific investment decisions. The drawback is that committees may be slower moving, constrained by time, resources and expertise, ultimately leading to sub-optimal portfolios.