Bob Dylan's decision to play an electric guitar at the Newport Folk Festival in 1965 was a pivotal moment that symbolized the resistance to change in the music world. Similarly, the investment community has long been anchored in the traditional SAA model, which is rooted in modern portfolio theory. Strategic asset allocation has been the standard, emphasizing a static and formulaic approach to asset allocation. However, just as Dylan's electric guitar was met with skepticism and criticism, the shift towards TPA has faced its own resistance.
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 recognizing the benefits of TPA and are beginning to adopt this framework.
In the following Q&A, we delve into the journey from an SAA-dominated landscape to a more dynamic, TPA-driven future, and discuss the 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:
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:
MSCI ACWI and BBgBarc Global Aggregate Index Return Correlations Used
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.
Q4: What are a few simple ways for asset owners to begin the transition from SAA to TPA?
SAA and TPA are not necessarily binary decisions and exist on a spectrum. This lets asset owners who want to transition to TPA change their current SAA framework without having to suddenly dismantle it.
One step to consider could be the introduction of reference portfolio benchmarks into a client’s reporting materials. Presenting longer-term total portfolio performance against a simple equivalent-risk or equivalent-return portfolio can highlight value added from drivers such as diversification, dynamism, and manager alpha. This can complement performance analysis against a traditional SAA benchmark.
Asset owners could also revisit SAA targets more frequently to increase flexibility. This creates the opportunity to practice a TPA mindset. Over time, asset owners can build upon simple steps like these examples to drive that continued evolution toward TPA.
Q5: What are the limitations with the SAA approach within this new environment?
| Category | Problem | TPA Advantage |
|---|---|---|
| Interest Rate Volatility | SAA traditionally relies on bonds to provide stability and income. With central banks hiking rates aggressively, bond prices have declined sharply, undercutting their role as safe assets. | TPA flexibly reallocates away from underperforming bonds by focusing on total portfolio objectives rather than fixed asset buckets. It emphasizes risk-adjusted returns and diversifiers that better fulfill the portfolio’s defensive role. |
| Inflation Uncertainty | Persistent inflation driven by supply shocks, labor market tightness, and deglobalization, complicates return expectations, especially for fixed income and traditional 60/40 portfolios. | TPA can prioritize real return objectives, allowing increased allocation to inflation-sensitive assets like commodities and real assets. It adapts to inflationary regimes by avoiding rigid reliance on 60/40 structures. |
| Geopolitical Risk | Rising geopolitical tensions introduce volatility and shift global capital flows. | TPA integrates scenario analysis and dynamic risk management across the entire portfolio, enabling better response to geopolitical shocks. It uses overlays and tactical shifts to adjust exposures without disrupting long-term strategy. |
| Liability Hedging | SAA traditionally uses a mix of long government and credit bonds to hedge the interest rate risk of the liability with physical bonds. The hedge ratio is constrained by the capital allocated to liability hedging (per the SAA), and credit bonds can be expensive to trade. | In TPA, derivatives and overlays can boost the hedge ratio while conserving capital. A treasury-based liability hedging portfolio can also function as a tail risk hedge. Additionally, asset owners can use their return-seeking assets as an indirect hedge to the liability’s credit spread risk, given the positive correlation between credit bonds and these assets. |
Q6: Is there a real-life example of an asset owner progressing on the path from SAA to TPA?
The Endowment Model, popularized in the mid- to late-1980’s by David Swensen at Yale University, represented the first large-scale evolutionary breakthrough from the traditional SAA model. Rather than relying only on traditional, liquid public market assets, the Endowment Model embraced significant allocations to alternatives such as private equity, hedge funds, and real assets. This capitalized on the illiquidity premium and diversified away from conventional market beta.
By accessing different types of risk premia, particularly manager skill (alpha) and illiquidity, the Endowment Model broke through the rigidity of the SAA framework. This innovation laid important groundwork for the development of TPA. TPA builds on the idea of managing portfolios holistically and dynamically across asset classes and strategies.
Q7: Can TPA completely replace SAA for all types of investors?
TPA cannot completely replace SAA for all types of investors. TPA involves active, short- to medium-term shifts based on market conditions, which require constant monitoring, skill, and often, higher costs. For many investors, especially those seeking to navigate uncertainty and capture short- to medium-term opportunities, TPA can be complementary and in some cases, a more effective core strategy than traditional SAA.
The shift from SAA to TPA reflects the evolution in investment thinking, from a static board-driven model to a more dynamic, integrated approach. As markets become more complex and interconnected, the need for flexibility, real-time decision making, and alignment with long-term goals has never been greater. While TPA provides the tools and structure to meet these demands, the transition from SAA doesn’t need to be abrupt. It can be gradual and customized to each investor’s needs and governance structure.
If you're currently on board with a SAA mindset, we hope this paper provides the insight and inspiration to embark on the journey towards TPA, and to experience your own ‘Dylan going electric’ moment.
Willis Towers Watson Investments GmbH, NL Branch (LEI code724500ZTOZ41VQJYNF89 registered at AFM) is a branch of Willis Towers Watson Investments GmbH („WTWI“). WTWI (Ulmenstraße 30, 65325 Frankfurt) is authorised and regulated in Germany by the German Financial Supervision Authority (BaFin – Bundesanstalt für Finanzdienstleistungsaufsicht) and incorporated in Germany with Company Number HRB 54178, registered in Frankfurt/Main. LEI 875500ZEA057SAXDQ134
