Total Portfolio Solutions

Historically asset owners have constructed their portfolios on the basis of asset classes such as Public Equities, Fixed Income, Absolute Return (or hedge funds or liquid alternatives), Real Estate, Infrastructure and Private Equity. This worked very well couple decades ago when allocators’ assets and investment teams were much smaller and comprised generalists, and markets and instruments were less sophisticated. This was when portfolios were constructed internally or by the help of an external actuarial consultant using long-term capital market assumptions ("LTCMA") based on long-term expected returns of each asset class typically over a 10-15 year horizon or longer which was based on the length of the pension or insurance liabilities or the time horizon stipulated by the asset owners. Then the asset class mix that would most likely be able to hit the fully funded status (i.e. a unit of asset per unit of liability) or the long-term return target of the asset owner over that 10-15 year horizon would be selected and invested in over the long term with little or limited focus on what would be happening in the markets or global economy year over year. This process is called Strategic Asset Allocation (“SAA”).

While this approach gives a good directional sense of what a portfolio should look like over the next 10-15 years, it is an extremely difficult task to forecast returns of all asset classes with a strong level of confidence over such a long-time frame, and it is a more difficult task to sit tight for that long without taking into account the market fluctuations and secular changes in markets and global economy that could lead to visible erosion in value of the underlying assets or underperformance versus the cheaper passive benchmarks. After all, long-term return expectations are made up of shorter-term return forecasts which tend to change over time, and therefore could render any SAA driven asset mix irrelevant.

What has further complicated the task of asset owners, their Boards and stakeholders is the fact that over the last period the investment landscape has evolved with an increase in the variety of investments available to allocators and the sophistication of the investment industry, where delivering returns consistently higher than the passive benchmarks has become more challenging due to increased efficiency and faster dissemination of information across all asset classes. Consequently, the asset owners, their investment teams and the Boards and Committees overseeing these investments have also become more sophisticated prompting more sophisticated and robust processes to deliver returns above these passive benchmarks in this highly competitive and challenging environment.

While SAA is still utilized by institutional investors for creating their long-term asset mix, portfolio construction over the last decade has started to move from an SAA approach that relies on LTCMAs to a more holistic total portfolio approach that takes not just long-term returns but also the long-term risks as well as short- and medium-term returns and their risk-adjusted returns into account (i.e. return per unit of risk taken in the portfolios).

The evolution of portfolio management tools and risk systems also allowed for more granular views of the underlying portfolios. This revealed the fact that portfolios were not just made up of asset classes but in fact comprised a number of macroeconomic factors such as inflation, growth, emerging markets as well as other factors and betas such as volatility, equities, credit etc. This allowed for a better see-through of the portfolios based on their drivers of returns as opposed to just asset classes. For example, public equities, private equity, infrastructure and real estate while all are considered different asset classes, they are all driven by equities to some extent. However, this equity exposure is hard to measure and manage unless a total portfolio approach that dissects all asset classes into standardized return drivers (i.e. macroeconomic factors) is utilized. Total portfolio approach also creates the ability to not just measure but also construct more resilient portfolios where certain exposures such as equity or credit or inflation beta could be measured, managed and if need be mitigated or offset accordingly.

Please connect with us to discuss our Total Portfolio Solutions for institutional investors in more detail.