We've tried a couple of times to get into the total portfolio approach (TPA) process for managing endowment/foundation accounts. It's sort of a nebulous concept but Meketa Investment Group did a good job of dissecting the concept to separate what might be useful for individual investors versus parts of it that don't apply. For example, there's a lot related to governance which is a whole involved thing that I only scratched the surface of in my time with the Del E. Webb Foundation.
Meketa says "TPA represents a meaningful evolution in how institutional investors can think about portfolio construction." Maybe it's a meaningful evolution or a little more humbly, a way to makes a few changes that can lead to a better understanding of what you own and a more wholistic approach to how you view your portfolio.
It starts with a reference portfolio which I would say isn't that different than a benchmark. The public pension of New Zealand is an early proponent of TPA and its reference portfolio is 75% global equities, 5% New Zealand equities and 20% bonds. That's not their actual portfolio. The reference is more like asking, how do we add value versus just indexing 75/5/20? That is probably a simplification but states it very plainly and I think is useful for individual investors.
We've talked here, in terms of just having a plain vanilla 60/40 portfolio or adding different exposures to try to improve against just buying VBAIX. Improve against VBAIX could mean several different things like outperforming, being less volatile and so on. We add BTAL and managed futures along with a couple of other things to try to smooth out the ride. That will either add value over the long term or not (I believe it does) versus just buying VBAIX. While the NZ reference portfolio is a simple 75/5/20, the fund allocates about 15% to private equity. Indexing 75/5/20 would get it done but they believe adding private equity will be better than just indexing 75/5/20. It also owns 10,000 hectares of farmland, again the managers must believe they are adding value versus indexing 75/5/20.
It is not clear to me that adopting a reference portfolio is different than benchmarking. It seems instead like creating a more accurate benchmark. For example, the Permanent Portfolio Fund (PRPFX) is a quadrant based strategy that invests 25% equally into stocks, long bonds, gold and cash. Sort of. It is an actively managed fund and can take some liberties. It benchmarks to both the S&P 500 and a 3 month T-bill index. If it were to adopt TPA with a reference portfolio then maybe the reference would be 25% to SPY, 25% TLT, 25% in GLD and 25% in some sort of cash proxy. Then as the managers make active decisions, I think it has owned silver off and on for example, they'd be able to measure the effect of those active decisions.
The most useful concept from TPA is the central premise is that the portfolio should be managed as a single unit rather than as a collection of separate holdings. Focus on the bottom line of the portfolio not how the individual holdings are doing. Things like BTAL, managed futures and gold are probably not going to be your best performers. If they are your best performers then chances are things in the world aren't going very well. Long time readers, how many times have I said that phrase?
It is quite clear that holding the right type of diversifiers will smooth out the ride over the long term. If you believe in the concept of diversifiers smoothing out the ride then your view of BTAL or whatever you use is that it is insurance. It's role is to go up when stocks go down. Yes, in some random event that may not happen, but its contribution (that is a key word for TPA) is protection against declines.
We've talked many times about tech and consumer discretionary tending to outperform the broad market over the long term. Their contribution is to provide a lot of a portfolio's growth. A utility stock or food stock's contribution is to be a little steadier and maybe provide some yield to the portfolio.
In a TPA construct, each holding contributes something to the bottom line result of the portfolio which are terms we've talked about many times before. Calling it TPA might just be a fancy way to rephrase and old concept, rephrase a top down concept anyway.
Another component of TPA is risk budgeting. That can mean anything but the application is to quantify the risk taken by deviating from your reference portfolio. Risk in this context equates to tracking error not necessarily return, yeah that's fuzzy. I will need spend a little more time digging into that to see how it could be applied to individual investor accounts.
Last thing for today is this screengrab.
The Future Fund of Australia references CPI plus 4-5 which is interesting in the context of a couple of our recent posts.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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