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I have seen several articles lately about a "Total Portfolio Approach" (TPA) that some pension funds are exploring in managing their assets as opposed to the traditional "Strategic Asset Allocation" (SAA) using the Nobel Prize winning approach of Markowitz using mean-variance optimization. How are they different and what is the benefit of this new approach?

As best I can gather from the public press on this, TPA is bringing the asset class numbers back down to 2--Equities and Bonds (a reference portfolio). And all allocations not in this reference portfolio is considered an "active" bet. As best I can gather from this description, it appears that this methodology forces the asset manager to constantly (or at least more frequently) revisit the capital market assumptions (CMAs) of SAA and adjust the portfolio weights accordingly. Isn't this similar to what the "Global Tactical Asset Allocation" (GTAA) products of the 80's were offering? Aside from the dynamic asset allocation feature of this new approach, is there something else that is being done with this new approach? Is this even feasible with the illiquidity in some of the asset classes like Private Equity and Real Assets, like we are currently experiencing? What am I missing?

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    $\begingroup$ A significant difference to classic SAA is a focus on risk factors, not asset classes ("capital competition instead of silo thinking"). Also, institutional changes with more flexibility and power to the CIO and an integrated investment team ("one fund culture"). Whilst there is room to respond if CMAs need updating, it's not fast-paced momentum trading as in TAA (esp with non-public asset classes). $\endgroup$ Commented Aug 14 at 12:59
  • $\begingroup$ I've worked in a SWF and this is correct. I didn't work in the portfolio optimization department, but perhaps you can provide some references to the articles you've read? $\endgroup$ Commented Aug 19 at 14:42
  • $\begingroup$ @KaiSqDist I saw this on Pensions&Investments. Here is a link: pionline.com/pension-funds/… $\endgroup$ Commented Aug 19 at 23:24

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I found a useful article (also from P&I) that (partially) answers your question and I can attribute from my (limited) experience that this is true -

https://www.pionline.com/pension-funds/large-institutional-investors-embrace-total-portfolio-approach-new-and-innovative-way/

I will summarize (differences and benefits of this approach):

  • Approach: SAA (more traditional, focuses on asset allocation, diversification, and benchmarking) vs TPA (best investment ideas that can help the portfolio meet its return goals) - Bowman noted, TPA eschews the traditional concepts of asset allocation and passive benchmarks in favor of picking the best investment ideas for the portfolio designed to meet a total return goal consistent with the fund’s actual purpose.
  • Flexibility: SAA (more rigid, with approaches limited to active bets on the benchmark) vs TPA (allows asset owners to implement investment ideas that are more suited to their funds) - In the CAIA report, Jayne Bok, head of investments-Asia at Willis Towers Watson, stressed that TPA is not a specific model with a singular destination. Rather, it comprises a range of approaches that can be tailored to each asset owner in order to design a portfolio that best represents the team’s long-term investment thesis
  • Performance: SAA (beating the benchmark) vs TPA (hitting absolute return goals) - To further delineate some of the differences between total portfolio approach and strategic asset allocation, while SAA seeks to outperform benchmarks, TPA focuses on the fund’s absolute-return goals.
  • Diversification (as mentioned by Kevin): SAA (by asset classes) vs TPA (by risk factors) - While SAA seeks diversification via asset classes, TPA wants diversification through control of various risk factors.
  • Capital Allocation: SAA (teams competing for capital) vs TPA (synergised capital allocation) - And while in SAA-centric organizations, portfolio decisions tend to be implemented by multiple teams competing for capital, in a TPA house, there is just one team collaborating together on decision-making.
  • Final Verdict: SAA (Board) vs TPA (CIO) - And crucially, while the board dominates the portfolio construction under the SAA model, the chief investment officer is much more empowered in a TPA approach.

Hopefully this helps! Happy to discuss any other clarifications.

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