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Capital Decanted
S3 | Episode 3: Total Portfolio Approach, Part 2 - Implications for the Broader Investment Ecosystem
01:33:43
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- [00:01]
John Bowman
So I think it's clear for TPA that there's this fever pitch on the LP side of all flavors of all sizes and really around the world. And yet it seems to me very few GPs are talking about this. So if this is truly the shape changing form and motivation that I think we all agree it will be, then there should be massive implications it will follow for the whole ecosystem. And yet, as I said, GPS just don't seem to be on top of this.
- [00:27]
Unnamed Industry Expert
Yeah, I think it's a really good observation. I think GPS aren't on top of it because GPS don't want to be on top of it. They like the old model. The model is, hey, you have a subsect of asset allocations. If you look at CalPERS, essentially what they're doing is taking 11 different asset classes and collapsing them all into one total portfolio approach. But GPS like the narrative of hey, we have this asset allocation, we got to go and fill it. And oh, by the way, we happen to be one of those managers that you can work with and fill in it. Very few GPs ever take the time to acknowledge what their commitment does to the total portfolio. So I'll give you an example. We win a billion dollar mandate or we're awarded a billion dollar mandate. That is a phenomenal achievement for us, and we're not dismissing that. But very few GPs in a billion dollar mandate and a $300 billion plan, don't pay attention to the other 299 billion. Now, if you think about it, in your own investments, how many times do you think about the 30 basis point consideration? Not a lot. I know I don't, maybe I should do it more. But the manager, one of the things we always ask when we go in for the first times is what is our role and how do we complement the rest of the program. The TPA approach, the total portfolio approach is what does the entire organism do? Not what does the arm or the leg or the nose do. It's what does the entire body of work represent and what is my role in doing that? And I've talked about this a little bit, but I think the alternative industry is undergoing a huge amount of having to grow up right now. I think in the past you had a period of low interest rates, people were under allocated to alternatives and managers got in this very comfortable situation where it was easy to generate strong returns because money was free essentially and there was a very strong demand for their product to fill these allocation buckets. So the narrative was we're in market with a fund thank you for the money. We'll see you when we're in market with the next one. The work that had to go into that, the client engagement was very much in the hands of the manager. We have to do as little work as possible and we get to consistently get these allocations. Oh, what? We raised a $2 billion fund. The next one's for the next one's 8. The next one's 10. Well, things have changed.
- [02:58]
John Bowman
Welcome to Capital Decanted. In this show, we say goodbye to tired market takes and superficial sound bites because here, instead of skimming the surface, we dive into the heart of capital allocation, striking the perfect balance and exposing the subtleties that reveal the topic's true essence. Prepare to have your perspectives challenged as we open up the issues that resonate with the hearts and minds of those shaping capital allocation. We've enlisted the wisdom of visionary leaders in the industry, and just like a meticulously crafted wine, will allow their insights to breathe, unfurling their hidden depths and transforming our understanding. This is season three, episode three TPA 2.0, implications for the broader ecosystem. I'm John Bowman.
- [03:48]
Aaron Filbeck
And I'm Aaron Filbeck.
- [03:49]
John Bowman
And we are your hosts. Well, for the third year in a row, our title sponsor is once again our friends over at Alternatives by Franklin Templeton. They, of course, have been a constant. If you've been a longtime listener in supporting Kaya's efforts to bring compelling educational content to life. With over 40 years of alt investing and over 260 billion of AUM, Franklin Templeton specialist investment managers have expertise across six different asset classes. Real estate, private equity, private credit, hedge strategies, venture capital, and digital assets. And of course, all of them operate with the client first mentality that has always defined Franklin Templeton to help prioritize investment outcomes. So thanks, as always. Alternatives by Franklin Templeton. Well, Malcolm Gladwell might be a name that many of you recognize. He is, of course, the Canadian bestselling author who wrote in probably his most famous book that the tipping point is the moment of critical mass, the threshold, the boiling point. It's when an idea, a trend or a social behavior spreads rapidly like a social epidemic. He said, well, total portfolio approach is nearly 25 years old, by the way. That's about the same vintage of Kaya Association. And yet, like any movement or new platform, it has been a very slow start. But that all seems to be changing in the last year or two. So I think the question we want to ask today in part is has it arrived at its own tipping point? And we'd like to think the CHI association and maybe certainly our good friends over at the Thinking Head Institute have played a small role in this acceleration, perhaps even serving as one of the important actors in Gladwell's Tipping Point rubric. He calls them mavens. Mavens he describes, are information specialists who are experts at gathering and sharing knowledge, and they are driven by a desire to educate others and act as trusted, quote, data banks that provide the crucial information for a social epidemic to spread. So I don't know, sounds a bit like the role we played a little bit, Aaron, but we'll let the audience decide for themselves. But certainly I think we can all agree that the fever pitch in the media, at conferences and in the boardrooms of big asset owners, as we'll talk about in short order, has escalated very quickly. The pace of change has been really hard to follow to keep up with, and the adoption curve has accelerated exponentially in recent months. So we therefore felt it was important to revisit this important topic at what we think is probably a monumental inflection point we're going to look back on in TPA's life cycle. So this is TPA 2.0, our Redux here at Capital Decanted. You may want to listen to our first episode on TPA in season one as a starting point if you would like to pursue this chronologically. So here's what we'd like to do today. We'll start by providing an updated adoption curve history. We did a bit of this in our first one, so I won't replay everything, but with some brevity and perhaps a different lens on the history. I'd like to try to bring some foundational context to the recent news flow. And I'm gonna start briefly with the original pioneers, the Original founders Over 20 years ago, through some of the other early adopters, and to today's modern influencers. And of course culminating with what we think is TPA's tipping point, the calper's recent formal adoption. But even leading up to this Sacramento, California moment, we'd like to unpack and examine why we've seen such a step function change in popularity and experimentation at this moment in time, and how today's very unique, perhaps even foreign to most of US capital market environment might have contributed a bit to that. We'll then spend some time reviewing what Kaya's Second Thought Leadership paper in two years on the subject taught us about those that are on the TPA journey and how that might provide some advice, perhaps some caution for those considering or beginning their own adventure on the subject. We believe with the help of the global asset owner community, that this second paper is what you might call filled in some gaps, some between the lines wisdom that were left unanswered in that first report. And I think it's worthy of our time and attention. Third, we're going to confront some rising circumspective challenges to tpa, very natural at this point in the cycle that have become common mantras, perhaps some lightning rod topics. And then finally we'll finish by addressing the topic that we think has been most avoided in the entire TPA debate, and that is the implications for the gp, which we believe are as profound as the LP or the asset owner themselves. As counterintuitive as that might sound, I think it has been overlooked. And then of course we're going to be joined along the way you're going to hear plenty of sound bites from a number of experts and TPA leaders on this particular topic, including Charles Hyde of New Zealand, Super Jeff Rubin of cpp, James Clark of Blue Owl and Gene Pod Commoner of Capital Group. So that is our blueprint. So Aaron, just quickly turning to you. You've been on this journey from the very beginning here at Kaya. I have been perhaps one of the deepest researchers amongst our staff. I'd love to hear the biggest misconception that maybe you once believed early in your own study of the topic that now you're much more laser eyed about, you might say, as you've been sitting upon this and talking with more folks for a period of time.
- [09:12]
Aaron Filbeck
So we've been on this journey here at Kaya, certainly as we've done a lot of research. But I think one of the things that I've benefited from, especially on the second paper that we've just released, is the interaction that we've had. This has been a very conversational 18 to 24 months around this topic. And I won't spoil my segment of today's episode, but I think what is interesting to me is that the first time we introduced the four dimensions of tpa, we laid them out and it was presented almost equally in a lot of ways. There's some culture, there's some governance, there's some portfolio implications and the technical side of managing the portfolio and all of that is interesting. But what I think I've learned since releasing that piece and conversations we've had with different asset owners around the table on this journey is, is that it really is more of the soft stuff. That is one most challenging, but also what unlocks a lot of these asset owners to move towards tpa. So I'll leave it there, but that maybe is a bit of a preview for later on. But my biggest takeaway.
- [10:14]
John Bowman
Yeah, I think that's well said. I think ultimately I've learned that this is at its roots a human endeavor, and that's so different and perhaps unnatural to the way we're often wired in this industry. So we'll talk a lot more about that, but I do think it sometimes inhibits our ability to grasp really what TPA is. So again, we'll come back to much of that a little bit later. But as I said, let me take a different approach on TPA history than I've done in the past, and I hope this is a fresh look at the same 20 years leading up to this CalPERS moment. So as with most new platforms, TPA has followed an S curve cycle. Now, S curves are typically historical constructs, the shape of them that helps us understand the rise of disruptive new social phases like fashion trends, for example, or political movements or new tech innovations. But just as with the tipping point science I begun with, I think the adoption psychology has something to teach us about TPA as well. And it's an interesting lens, as I said earlier, in which to view the last several years in particular, of this TPA adoption. So let's think together about what an S curve is and how it's shaped. So at first, the innovation or whatever product or movement you're talking about, it starts out on the fringes. A few distant narratives perhaps. Sometimes they feel as if these narratives are orbiting around real life. They are out there. They're the other guys. It was interesting. I thought back to our Blockchain episode of season one, and Chris Dixon of A16Z described this stage of the cycle as toys without a lot of commercial appeal. Most people write this early stage proofs of concept off as novelty. So adoption is slow as these fundamental concepts are being figured out. Again, they're proofs of concept at best. They are models. They are solidifying in the minds and the hearts of individuals. They're studied, perhaps at arm's length only, and examples are still what I would say are caricatured instead of emulated at this point.
- [12:17]
Aaron Filbeck
So, John, before you go on, I thought your conversation with James on how this crossed his radar really helped illustrate how the interest in TPA has both waxed and waned over the past few decades. And it's been mostly market driven as volatility has picked up and equity markets have drawn down at least from his perspective. So let's listen in on what he said here.
- [12:37]
Unnamed Industry Expert
I started off pretty much in the long only world, in long only equity and fixed income. And you know what's really interesting? When you actually take a step back to look at asset allocations. When I first started doing this, it was all around the 60, 40 model, 60% equities, 40% bonds. And then pretty much on the very early stages of my career, you had the tech wreck of April 14, 2000, I believe it was, and equity markets over 2000, 2001 and 2002, the S& P was negative the entire time. So all of a sudden you had these very large institutional investors that were shackled to very poor returns from 60% of their portfolio. So the nomenclature of alternatives started to make its way in. I mean, this is an astounding fact. If you actually looked at the S&P 500 over the last hundred years, the annualized return is 10%. If you asked how many times in a calendar year did it fall between 8 and 12%, you'd be shocked. I'm not going to put you on the spot here. It's six. So that shows the volatility of it. And what they were looking for was a more consistent way to hit their actual rates of return. Obviously the funding ratios had been crippled by these. You'd had some spectacular corporate scandals and failures, predominantly Enron and WorldCom. So it moved to alternatives. And I think that the TPA discussion started to make its way when you saw all these sovereign wealth funds of significant scale start to pop up in the mid part of the 2000. There was obviously the Australia's Future Fund and there was a number of other Middle Eastern institutions that grew up. And I think that what happened was everybody just felt like a little bit constrained around strategic asset allocation. They felt that they had to operate within these bands. And you have a situation where you have what's called the denominator effect right now, which is where equities sell off. And now all of a sudd through no rebalancing, you're overallocated to private markets and you can't put any more capital to work until you rebalance in the public equity space. So the TPA approach has been really to demystify asset class buckets and think about things more holistically at the total portfolio level.
- [15:01]
John Bowman
Yeah, I think James illustrates the reason why this was not only so intriguing back then, but even more so today. And I also love how Gene, in addition to James, framed and looked at this so when we talked to Gene about why he thought this was garnering so much interest, I would say he both called and then raised what James said to an even bolder level on the limitations of SAA in a market like today. So let's listen into him here.
- [15:29]
Gene Pod Commoner
When I think through strategic asset allocation and I have a lot of thoughts on saa, most of them are orthodox, but not all of them. When I think about the evolution of SAA over the last, let's say, 70 years, what I've observed is a real over specification in the way that portfolios are put together and in potentially what constitutes an asset class or what people think an asset class is. And as you get to this point where you have so many different slivers of the pie chart and SAA and you have these overly specified, highly, highly correlated pieces of the portfolio, at some point you take a step back and you ask yourself what's the common thread across these? What is the common factor? Exposure. And there's a pretty short gap, small gap from that mindset to wait a second, there is a more holistic way to think about the entire portfolio. Once I've got this understanding and these tools and I can see some of the friction that is being provided by today's more traditional SAA framework.
- [16:34]
Aaron Filbeck
So John, as I think think we've discussed already, a lot of the adoption is driven by the need for flexibility while also being more dynamic in a market that doesn't sit still. I think now is a good time to go back to our history lesson.
- [16:46]
John Bowman
So in our first TPA episode back in season one, we relive the early years of these pioneers in the early 2000s, starting with new Zealand super personified more deeply with the birth of Future Fund a couple years later and then ramping up of course with CPP and gic. And these were our four that we previewed in the first paper. Wtw, we also said had a huge influence at the time on what you might call TPA genetics that would eventually flow through all of these founders. So when Kaya first began researching, writing about talking to other asset owners, as Aaron just mentioned, outside of these four several years ago, our conversations with these other partners that we were talking to, they would tell us that they largely viewed these four's TPA wiring as unique to them. Well that's fine for them, works for them. It's suited for mega sovereign pools of capital only given of course they have the luxury of a very hands off governance structure and a time horizon that was effectively perpetual. So while Most found these early role models fascinating, intriguing, and the alternative approach was actually, I think, attractive. We were admittedly Kaya, that is manufacturing interest, I would say at that time. Back then, I don't know about you, Aaron, but I would often hear refrains like, well, this would never work with my board, or we could never implement this at my five person endowment, or even a little bit more snarky. That's easy for them to say when you got hundreds of billions of aum. Of course they can adopt tpa. And so to some extent, it appeared that they were correct. For a while, these naysayers. Almost 20 years after KiwiSuper and the Future Fund birthed this new model, these four were largely still the only games in town around the COVID period. And really, this shouldn't be a surprise. I mean, if we're honest, what TPA was doing was challenging decades of investment orthodoxy. As we'll talk about later, it was not just a tune up or a little bit of polish around the edges. This was a fundamental rethinking of how institutional capital should be allocated, how it should be governed, how it should be measured. And so all of our industry assumptions about portfolio construction were in the dock. As my English friends would say, SAA was being cross examined and it was uncomfortable and perhaps even a little offensive to some. Again, that is very common in the early stages of the S curve. So as with all new platform adoptions, it appears to stagnate for a while. The early stage stays early and stays small for what feels like a disproportionately long time if you're watching closely. Similar to that cardinal rule of never staring at the time on your treadmill or the elliptical, it appears that nothing ever changes and progress is just crawling along. So nonetheless, our first seminal paper, Innovation unleashed in early 2024, attempted to give these courageous four prototypes a megaphone, a PR agent, maybe you might call it, an authoritative historical text that told their stories in depth. It described their thought processes in the early stages, allowed us to experience live vicariously through the ascent of their own TPA worldview and the specific flavor that had matured at each of these funds. And then using the common threads amongst the four of them, even though of course they had variations and customized alterations, we attempted to describe the common dimensions that define what TPA actually was and how it was a departure from saa. And those were, number one, a unique kind of governance, number two, the competition for capital, number three, a factor lens on portfolio construction, and four, a unified one fun culture that was the first paper. Well around that same time, the S curve eventually began to get S E to get curvy. The S curve began to do its S curve thing. And just as history teaches us, those small sparks, the original toys and novelty in Dixon's language, slowly, surely, they begin to move from this smoldering ash to a small flame. So through the 2000 teens, up into the COVID period and largely let's give credit where credit's due to thinking ahead Institutes leadership and consulting and convening power Several asset owners quietly but deliberately begun their own TPA transition. Rail Pen and USS in the uk, QIC and T Corp in Australia, OP Trust, hoopp, USS in Canada and ATP in Denmark. And even KIC and mps, the stereotypically quiet and conservative big funds in Korea, made very public statements, initiating their own moves towards TPA under new leadership. So these metamorphoses, they were far from overnight, far from radical. In fact, even today all these examples exist on a continuum from what you might call enlightened or enhanced SAA to TPA light. But they all have made material steps nonetheless up that curve. And in the us, while there were no big announcements, no wholesale adoptions, there were moves as well by Molly Murphy over at osers, Jonathan Grable at La Sera, Edwin Denson at Swibb and some others to upgrade and broaden their own portfolio construction, production tool set, some of their risk management systems and dashboards, compensation structures, team decision making that you could say begun to look taste and smell a little bit more like tpa. Pseudo reference portfolios begun to be used even if they were still run alongside of the traditional SAA policy portfolio. And some CIOs were aggregating their portfolios into fewer super categories that were grouped more by the purpose for the fund. So think growth or income or capital preservation for example, rather than the hyper fragmentation of most SAA asset class structures. And we even begun to see new titles job descriptions appear, Chief of Total Portfolio Management, Head of Total Fund Management for example. And all of this was aimed at moving the industry apparatus to more of a holistic portfolio focus with the idea to better align governance, accountability and culture. And even we at Kaya experienced a bit of this slow build as well. So when the smoke started igniting after this first paper, we begun to be invited to speak on bigger public stages as well to partner with CIOs and educating their own boards. We were asked to join pension trustee gatherings and asset owner executive retreats at our chapter events. I think it's fair to say around the world. It gradually, not overnight, but gradually became one of the more popular topics that was requested for these events. And these were not all home runs. They ebbed and flowed like a good S curve. But despite those hit and misses directionally, things were beginning to change and accelerate. So, rhyming with Gladwell's tipping point language that we begun with during the intro, Ernest Hemingway and I had to look this up. Aaron, I didn't know where this came from, but in his novel the Sun Also Rises, it was Hemingway that memorialized the adage of slowly and then all at once. Which of course the VC industry has co opted and adopted as their own. When you think about tech platforms, Bill Gates of course, famously said, most people overestimate what they can achieve in a year and underestimate what they can achieve in 10 years. So the S curve limps along and then seemingly you wake up one day and it's exploded as you turn up the curve. So at the time of this recording, TPA has just had, in our view, that big bang, its tipping point, its arrival at critical mass in Gladwell's language. So on November 17, 2025, CalPERS, the largest pension and largest asset owner for that matter in the United States, under the leadership, not ironically and not coincidentally at all, of CIO Stephen Gilmour. He of course is the former CIO of New Zealand super, one of the aforementioned pioneers of TPA. CalPERS became the first US public pension plan to formally adopt TPA. They have effectively collapsed 11 asset classes into one overall pool, adopted a 7525 equity fixed reference portfolio that's a little bit lower than CPP and New Zealand super, but nonetheless they've got a Reference portfolio of 7525 as a single primary point of reference rather than a potpourri of asset class specific benchmarks. And I would say this is a huge deal that I will suspect will add a key social proof that you might say will further grease the skids of this S curve and the adoption acceleration. So Aaron, I'd like to pause here. Do you think the significance of this CalPERS news is as big as I do? And how would you frame this in the overall history?
- [25:10]
Aaron Filbeck
I think this is a big deal and maybe just to sum it up, all it takes is one in order for this to move forward. And as you mentioned, some of these asset owners in the US have been experimenting and been along this journey, but this is the moment that we've had a full governance shift at the asset owner level and the US in particular. Has this very strong governance structure, a lot of approval processes. It's probably the most developed that we see in the us which has its benefits, but it also has its drawbacks when it comes to making changes. So a lot of these early adopters that you mentioned earlier on the S curve have either started with a TPA mindset or it's been much easier for them to kind of make that shift because they don't have so much legacy processes and procedures in place. So for someone like Steven to be able to come in and there's obviously been a lot of experimentation leading up to this moment, but for the formal approval at the governance level to move towards this TPA concept and again, the tangible elements of this, of collapsing 11 asset classes into two in a reference portfolio and broadening out the active risk budget for the fund, all of this, I think will open the doors for others who are in that experimentation phase to potentially move towards this direction as well.
- [26:22]
John Bowman
I think that's a good point. New Zealand Super Future Fund, we've talked about as being born that way. And that's not to take anything away from them, but they started with the framework of tpa. CPP had this wiring of the Canadian model that I think, again, not to take anything away from them, made it slightly easier and culturally more digestible to move that way. I think GIC is the one that fits the more massive transition challenge that CalPERS does. So we will watch this. But I do agree that I think this is huge, huge news that again, will be a iconic moment on the lineage and any of those time period visuals that are put on the wall, if TPA ever has one, I think you'll see a line, an important icon for November of 2025.
- [27:08]
Aaron Filbeck
And John, you did miss an opportunity. So you've quoted Hemingway and Malcolm Gladwell, but with an S curve, the Beatles, the Long and Winding Road, I think is also very appropriate for this.
- [27:18]
John Bowman
Yes, that is good. Leave it to the music guru to help me out on that one. Good one. So I think, as I said, I think the history can be interesting. But before we get lost in this ticker tape parade on the CalPERS news, I do think it's helpful to pause, perhaps even back up a little bit, reflect on why this has accelerated so quickly. Why from a few years ago, I mentioned earlier that we felt like we were manufacturing interest, that it was just a few. When I tell the story of that original conversation in the Starbucks at the bottom of GIC and my shock when basically the head of Asset Allocation says in Answer to my question of who else is doing this? It's three others. It's just a handful of us. How did we go from there to here? We've seen this couple shifts upward in velocity that took us to the precipice of this tipping point in very short order. Well, I want to start with offering two main explanations and I really would love your feedback, your editorializing, your disagreement here to Aaron on the why of all of this. The first and perhaps most important, I think, and I'm going to use some fairly dramatic hyperbolic, arguably language here, is this new global order, the regime change, as is often talked about from stages and papers that we find ourselves in. To put it simply, many CIOs I talk to around the world are concerned that their existing playbooks are simply no longer fit for purpose. We have structurally higher interest rates. We have a return to maybe what you would call more normal historical inflation levels. The laissez faire philosophy of Reagan and Thatcher beginning in the early 80s, things like free trade and globalization seems to be reversing. Volatility is much higher. We've got this binary supply chain and tech stacks occurring and emerging and everything from semiconductors to AI to social media between east and West. And of course, we have much more geopolitical instability and probably the most delicacy around the world with allies and others and blocks than we've seen since the Cold War. So the world and the set of economic assumptions that most professionals in our industry have grown up in, been taught about, invested in, and experience seems to be unraveling very quickly. So doesn't it follow that we should at least consider whether we need to think differently about designing investment portfolios that can deliver investment outcomes in this new normal rather than in the past? We need a new institutional framework that perhaps is more optimized towards uncertainty versus the academic processes of old that are optimized to stability. So there is this growing consensus that we are sorely in need of, of a new mousetrap that I think is the first and the biggest one. Second, however, is that not only does TPA offer the dynamism and the coordination that may be a better antidote to this chaotic world, but we've also begun to see some evidence that it could be a better performance option. So I think those that study the underlying tenets of TPA inherently grasp that on paper, it does seem like an upgrade because at its very essence, you're liberating the portfolio from arbitrary constraints. You're removing the shackles of what you might call Bucket limits providing much more flexibility to chase the most attractive risk return unit for each marginal dollar. So again, makes sense that at least it should in theory produce better returns. Marcy Frost, CalPERS CEO, said it really well in their release at the time of this recording. This is just last week announcing the positive board vote. She said, quote, this is an evolution in our investment decision making approach at Calpers and I commend the board for taking such a bold step. TPA encourages greater collaboration among the investment teams so that their collective wisdom is harnessed to judge investments based on their potential to benefit the entire portfolio, end quote. So I think it's a very good summary of the advantage, again, at least in theory, for tpa. So it seems to be TPA that is optimizing fiduciary capability in the way SAA can't quite compete with in its purest form. I had this vivid memory in my preparation Aaron, when I was at CFA Institute and we were in a planning discussion with what was called the Global GIPS Council, the Global Investment Performance Standards Council. So these were advisors that were helping us move and champion the GIPS standards across the world. So our intent, our publicly stated goal at CFA was to have GIPS officially adopted at the largest 25 asset managers in the world. And one of our approaches, which I think was very sound, was to use CIOs of major asset owners to provide a bit of pressure moral suasion on their gps. And I recall there was this moment in this meeting where we suggested one tactic is that they use GIPS compliance as a filtering mechanism for their manager due diligence. And I remember very clearly, as I said this CIO of one of the largest public pensions in the us. Now remember he sits on the GIPS Council, so he's a huge proponent of the standards and the spirit of what it's trying to accomplish. But he responded very directly and he said that to do that would violate his fiduciary duty and inhibit returns because we were forcing him to limit his investment universe. And I think that often in the context of this competition for capital and tpa, I think that rings true a little bit. Where by definition an SAA model has upper limits on asset class ranges and it will therefore at times crowd out it has to the best new ideas, at least from time to time. So as that CIO rightly pushed back many years ago, does SAA at its core restrain the purest, at least purest of fiduciary investment management because of this rule based structure? And I just throw that out there as food for thought as a corollary. So again, I think the underlying theory aligns with our instincts. But beyond that, as I said, we're beginning to see some social proof of this being demonstrated quantitatively in practice. So two performance studies are data points that are admittedly not perfect, but they begin to validate this. So number one, when we released our first paper a couple years ago, we looked at the first four movers again. New Zealand Super Future Fund, CPP, GIC compared their annual performance over the previous 10 years against and the control group was the US Nacubo Endowment Universe, which of course many around the world, not just in the US will commonly refer to university endowments as the smart money. They typically are those that are most flexible, most sophisticated, have the ability to follow their idiosyncratic opportunities and instincts without any constraints often. And what we found with that comparison was a 140 basis points of annualized outperformance, 1.4% for the four TPA shops versus the average US university endowment. So that's one data point. Admittedly that's a small group, but that's the first four second and this was actually the data set that CalPERS used last week as part of their pitch to adopt TPA to their board. Our friends over at Thinking Ahead Institute did a similar study, but they surveyed a group of 26 large funds and those within that group that were using TPA outperformed their SAA brethren by 130 basis points, 1.3%, very similar outperformance, or alpha, you might say, for the same 10 year period. So we're starting to see a pattern develop there. Whether that's precise, I would not argue. But I have no delusions that these studies are complete, that they are determinant, that they are statistically precise, or even that this outperformance, if it does exist, will persist. All I'm expressing is that we're starting to see some signs of data that echo these qualitative expectations. So I think that's interesting. Aaron, further explanations, disagreements or other reasons that I've missed here for this rise of adoption in tpa?
- [34:57]
Aaron Filbeck
No, I think maybe just to underscore a couple things. One is I love that example on performance measurement as an example of restricting your universe and therefore maybe violating your fiduciary duty. The shift towards TPA introduces flexibility where SAA doesn't allow for that flexibility, but that doesn't mean that the rigor doesn't go away either. So you can see that in the performance numbers and Even some of the interviews that we've had over the past year or so with these different asset owners, very, very sophisticated ways of managing portfolios, the level of granularity of the data that they have available, there is still a high level of rigor and analysis and process that goes into all of this. What is different about it, though, is that flexibility to respond to those market conditions and be able to be much more targeted in terms of sectors or themes or macro environments where an SAA type of framework wouldn't necessarily allow for it in the same way. And the example, and this will be a bit of a preview on the portfolio implication, is SAA requires you to own asset classes. So in the CalPERS case, you had 11 asset classes that if you didn't own one of those 11, you were making an active bet, and it might be the right bet, but you've got this mental weight that you don't own it and you've got to explain it to your board and you're measured against all of that. But in a TPA framework, you don't have to own it if it's not the best idea for the portfolio, or there's a theme that doesn't make sense. So it's harder in some ways in terms of the process of managing because you still have to have that level of rigor, but it's almost easier and more liberating because you're allowed to be much more flexible in managing towards those goals.
- [36:37]
John Bowman
Aaron, I think that's a really important point, and it actually reminded me of the conversation that you had with Charles about how liberating that reference portfolio can be. So certainly it serves as a strong governance tool of separating responsibilities, but I think of much more importance, it enables the investment team to invest with a lot more flexibility. So let's listen to Charles here.
- [37:00]
Charles Hyde
So we set out on our journey way back in 2010 when we adopted a reference portfolio. And that was really, for us, I think, the most important catalyst towards adopting a total portfolio approach and indeed, in many ways, the foundation of it. So we adopted a reference portfolio, and at that time the board agreed that it made sense for the board to focus going forward on governance and for management to take ownership of. Of the investing. And that might sound simple and obvious, but a lot of places don't have that clarity of division of labor, if you like, between governance and management. And that great clarity that we have and that was put in place at that time that we adopted the reference portfolio, which is a governance mechanism, has really been the foundation of Our total portfolio approach, it gave great clarity to us as to who owns what, but it also importantly gave management the flexibility to take an approach to building a portfolio and managing it that is different from what you would typically see out there under that rubric of the SAA approach. It allowed us to be more dynamic in terms of the way that we managed the portfolio. We didn't have to engage with the board with every investment decision along the way. And it also freed us from some of the constraints of the SAA approach. So we weren't tied to using the classical standard asset class definitions that you would see in an saa. And it also allowed us to get away from that idea of having a fixed cycle of asset allocation reviews every year or two years or whatever it is. It allowed us to return to the allocations on a much more frequent basis. So that was the beginning of our total portfolio journey. But that was, As I said, 15 years ago, certainly by no means the end of our journey. It's been very much a work in progress over a long period of time. There have been some meaningful changes to the way that we've done things since then. We adopted a risk budgeting approach in 2014 or so, which was a big step forward. So going back to that split between governance and management, our board retained two key investment decisions. One is the structure of the reference portfolio. What combination of asset classes should we have in that, and the sizing of our active risk budget that management has to use to build a better portfolio. So we've done a lot of things along the way to enhance collaboration and maximize, if you like, the efficiency with which we share information within the fund and more generally, trying to build a culture that underpins that need to have strong collaboration across the teams within the fund.
- [39:50]
Aaron Filbeck
So I think Charles really illustrates a lot of what Stephen is trying to bring at CalPERS, which makes sense given he was at NZ during the later years of this adoption curve. The other thing I find interesting about both Charles and what Stephen is doing is the work isn't done. Charles mentioned that reference portfolio is just the start, and I imagine the current market environment has Stephen feeling the same way.
- [40:10]
John Bowman
Yeah, I think this new regime, you could argue, has pulled some history forward a bit in the adoption curve, steepened that portion of the S to use my framework from earlier sometimes conditions, just as with a good VC investment, you can have a great founder, you can have a great product market fit, but you need the market conditions to cooperate and be the right timing for the perfect storm of opportunity. And stars aligning to happen. So I think that is maybe a summary of what I was trying to articulate through all those things coming together the last three to four years. So I walked you through this adoption history, Aaron, and I want to set you up to talk a bit about our second paper on TPA itself. This was a portion of the adventure story that I didn't want to interrupt with a commercial break. I wanted to get through the history first. But I do want to just take a quick step back to talk about that 2.0 chapter in Kaya's case, specifically because I think it's a progression in our own understanding, which is why I started with that very first question to you on misconception that maybe we've resolved or progressed in our own minds. So I want to double down on this for the benefit of the profession, for the benefit of the listeners here, because I think we certainly learned a lot through it. I'm going to let you bring to life the specific outcomes and messages that we learned, but I wanted to just quickly sharpen the context a bit that led up to this revelation that we even needed to do a second paper. So as I already alluded to, after that original thought leadership, we road showed the concept and described what we learned. And often with the help of our new friends at those four participating funds, held lots of events, had lots of discussions, and they were, I think, as thrilled as we were to finally have a voice, an authoritative canon, as I said earlier, to point other interested parties to as a starting point for their own experience. But the more we talked and engaged about this around the world, I think it's fair to say the more questions arose. And honestly, these were questions that we didn't quite have the answer to and they challenged us. So we heard things like, well, how do I start? Where should I even begin with all of this? I'm locked in on saa, so this is really daunting to know. It's like writer's block for the author. What's the first sentence of that first chapter? Second, what are typical mistakes or pitfalls or challenges that I will encounter and perhaps that I can avoid? Can you help me with that? Third, how do I convince my board it would be advantageous to frankly relinquish some control that is counterintuitive, that is against human nature? And fourth, what type of resistance should I expect? What should I prepare for in addressing my own investment teams? What has been your experience in the trenches on building or rebuilding or rewiring the entire culture around tpa? So about Six months into this roadshow, it became clear that while the first paper properly described what TPA was, how it differed from saa, there was this growing appetite for us to go deeper, to get more granular. So the blockbuster sequel was in demand. Now. I just paused there. By the way, sequels are rarely good, Aaron, so you had a difficult task. I was at Wicked For Good's opening night on Friday. Sequels are rarely as good as their first. Can you think of great sequels that.
- [43:19]
Aaron Filbeck
Come to mind besides Empire Strikes Back? That's a tall order.
- [43:23]
John Bowman
That was on my list too. I think top gun, good one, 40 years later actually did a pretty good job, but he had 40 years to prepare for that sequel. So perhaps, certainly an exception versus the rule. But in this case, despite our fear that sequels are bound to fail, in this case, CIOs were hungry for this practical guide with real stories, real case studies from the trenches. As I said, that provided unfiltered perspectives, not just theory. So to do that, we knew we needed to widen our aperture a bit from those first four. And so this time we interviewed 12 asset owners from around the globe about their own TPA journeys and ask them what worked, what failed, and why. So these implementation narratives were not sterile best practices, but real, raw human stories. So by definition, each of these experiences was different. Aaron, but talk us through how you pulled this all together and extracted a couple common themes and lessons that we can take away from this mosaic of interactions you had with these 12.
- [44:21]
Aaron Filbeck
Absolutely. And it's funny, I mean, as we've been doing these events and the more public facing conversations with different asset owners, some, as you said, John, have gone really, really well and we've had a lot of engagement and questions. There were also some controversial ones. And I remember distinctly about a year ago I walked out and this is where I texted you and one of our colleagues to say, I think we need to write something on this because I'm having trouble answering a couple of these questions. But there are some non believers in the crowd and continue to be some non believers in the crowd. And I think that's okay because this is not a prescriptive model by any means. That is similar to like the endowment model or an SAA model. These are more experiences more than anything, and so everyone does it a little bit differently. So my job, and I think our collective job on the SQL, was to try to take all 12 of these different asset owners who have very different constituents, beneficiaries, investment teams, areas of competencies, and boil it down to a couple of Things that are actionable for the broader industry. So I would encourage everyone who's listening to read the full paper. We have a ton of examples as we walk through different implications for your portfolio and how you think about governance and all of those things. So I won't get into that specifically, but the big three takeaways from this paper, and I alluded to this earlier on in the episode, was first and foremost that it's the soft stuff and that's governance and culture, the two of the four pillars from the first paper that are the most important. I think then anything else. And it's figuring out who's accountable for what. Who actually ultimately has decision making authority in terms of how you build the portfolio, how you manage around the portfolio, and then once you get that decision making rights conversation established, it's bleeding that through to your culture in the organization. And how do you create incentives, how do you structure teams, how do you enable collaboration amongst your different investment staff so that they're not only focused on their area of specialty, which is important, that specialization is important. And that was a question that we got was what do I do with all my specialists? My private equity person is not going to easily be able to move over to hedge funds or public equity for that matter. And the answer that we found was that you still need those people, you just need them to talk to everyone else in the team. So that is collaboration. It's also incentives, making sure people are driven towards achieving a overall portfolio return type of profile rather than just focusing on their individual silo. The second one, which is what John just walked through on the S curve, is that with a few exceptions, almost every single organization that adopts TPA or is closer to TPA did this slowly. It was a journey that they went on. And that journey was really, really important for a couple of reasons. One, because it's just tough conversations, governance and culture and reorienting your staff. But also because there's a lot of experimentation that's involved in moving towards tpa. And a lot of these organizations would try something and maybe it worked, maybe it didn't, and they go back and try something new. And you can only do that if you go through more of a incremental type of journey with a longer term goal in mind, but still a journey instead of an overnight shift. And then the third thing is the portfolio. And I'm going to talk mostly about this because I think that's interesting to the investment nerds, but the portfolio was really a byproduct of the first two how you organize governance, how you think about culture. The journey that you take on these allocations shifted over time. Again, it wasn't an overnight shift. The only thing I'll say on the portfolio side, which we'll cover here, is that while it is a byproduct, it's actually where a lot of the experimentation starts. So it's almost a circular conversation around portfolio. You may be in an SAA type of framework, and then your CIO is going off to the side and saying, what if we tweak this? Or what if we introduce this new strategy into the portfolio? And so you kind of do that for a little bit. You focus on your systems and your data. You start to figure out how do you collaborate, how do you get more isolated exposures. But it isn't until you get that first pillar correct, until you've opened the floodgates for a more TPA type of philosophy. So I just think that's really interesting as we walk away from all of this, because as investment professionals, we gravitate towards the portfolio. And again, a lot of the questions were around the portfolio side of the equation, which is important. It's obviously what you're investing in, but it's all the other stuff that is the enabler of you being able to ultimately shift the portfolio at the end of the day.
- [48:42]
John Bowman
So, Aaron, I think that's really well said. I particularly like this idea of. We've talked a lot. I've often used the phrase, a fish doesn't know they're in water. And I think, don't be fooled that getting out of the water by virtue of a board vote clears the path for the rest of your time. I think this circular redux, gravitational pull back to what you know is enduring, it's always there, and particularly in difficult times of whether it's board turnover or poor performance or maybe a bad deal, all these things are going to pluck on nerves of the past and you got to stay very focused on continuing to tell the story. I think you described that really well. I mean, ultimately, when I've described this new paper a couple times, Aaron, I don't know if you've gotten this, but I will hear things like, well, wait a second, governance and culture. Those were two of your four. The first one, what's changed? And I think that's a very good response. But the reality is that, like you said, it's not that they are held equally, I think, any longer. What we've learned is that governance and culture have graduated to first principles. And I think it's easy to get caught up in the technical and the performance comparisons, and I've played a role in this even in this episode. But the portfolio implications are clearly what sometimes draw our attention. But at the very essence of the adoption of TPA is fundamentally about behavior and cultural transformation, navigating change, overcoming resistance, building coalitions, aligning purpose with communication. As I just described, matching incentives with values, creating momentum.
- [50:14]
Aaron Filbeck
So, John, I think this is a good time to refer to a conversation that I have with Jeff now on the spectrum of SAA versus tpa. I think many of us would agree that CPP is on the very far end of that TP TPA spectrum, and they're also very technical and scientific in how they build portfolios and look through exposures and factors. But when I asked him about the important tenets of successfully integrating and moving towards tpa, his first answer was governance. Let's listen to him here.
- [50:44]
Jeff Rubin
I know governance, it doesn't sound terribly sexy to talk about the structures within which we invest, but it's vitally important for the total portfolio approach that management, the investment team, has full accountability for the development and delivery of investment returns. There is no preset asset allocation. There's no preset portfolio, fundamental underlying portfolio composition that is given to management. Management in a total portfolio approach really has full discretion to design a portfolio that meets the risk expectations of governance, but is otherwise free to build out that portfolio in ways that they think is going to best deliver against the objective that is set by the governance. Without that governance piece, the rest of it really isn't going to hang together. And I don't think that clarity of governance is necessarily the province of larger or smaller funds. I think funds of all size can do it, but it's difficult. And there are reasons why the historical governance is used by most institutions. There is a clarity of accountability. We know exactly who is responsible for the setting of the asset allocation and who is responsible for beating the benchmarks that are effectively attached to those allocations.
- [51:56]
Aaron Filbeck
So isn't it funny that some of us just want to immediately jump to the portfolio and the metrics when it's really the human side that makes all the difference?
- [52:03]
John Bowman
Yes, exactly. Aaron, the left brain analyst in many of us, I think, simply want to plug and play, and I think that's really a danger here, is that we almost view this as we're swapping out a water heater in our home and we're going to be terribly disappointed if that's the way the frame in which we think about moving from SAA To TPA because this change will take a ton of patience, a ton of vigilance to navigate what is a messy meandering of humanity. And it starts with the hearts and the minds. So I think that second paper is worthy of reading because it gets very crunchy and human and emotional and gets into the idea of motivation and behavior. So I appreciate the summary. Before we move to this closing segment on implications for gps, I want us to address two nagging questions. Maybe we could each take one of these that I think continue to come up as this TPA s curve gains steam. So they're not always asked in an intellectually honest tone. As you know, there's often some snark in some of these. But nonetheless, whether they come through snark or intellectual honesty, I do think we should always be circumspect. And so these are, in fact, good challenges. And so those two questions are, is TPA really all that different? What is the fuss really about? And second, with all of this trouble and labor that we keep describing, hearts, minds, and the technical process changes. I mean, I said a moment ago that the messy meandering of humanity, that's a lot of work and heartache. Does the process of building the portfolio and maybe even more importantly the outcome of the portfolio really even change? And if it doesn't change that much, is this all really worth it? I think those are fair questions. So why don't you take the one on the portfolio and I'll respond with, is this really that different as a build on your piece?
- [53:47]
Aaron Filbeck
So on the portfolio, I would break this into two groupings. One is the process and how you actually go about making decisions, which we talked a little bit about. And then the second is the actual portfolio itself. And I want to use a couple of examples that we found during some of these different interviews. So if I think about the first component of this, which is what is the change to the process, the investment approach, within the capital pool, there are some important changes. They're all a little bit separate, but I think highly correlated to one another. So first, as we've talked about, these funds move from a more benchmark driven investment strategy to a total fund mandate, which then leads to the second part, which is asset class strategies being disrupted in favor of more enterprise capital allocation. And then third is that this is all measured differently. So moving away from policy portfolios, like the CalPERS case of 11 asset classes and a prescriptive benchmark to more reference portfolios. So I'm going to take each of these in Turn. By the way, there is a great piece in the FT that came out I think last week at the time of this recording that goes really in depth in terms of trying to decompose some of this and get into some of those allocations. So we'll link that in the show notes, but would highly encourage you all to check these out. But let me take these a little bit more in depth. So first, from benchmarks to mandates. So as we all know, under saa, asset classes have fixed roles and are often benchmark driven. All of us are trained this way. Build an investment policy statement, provide a prescriptive allocation that acts as guardrails for the investment team, and then lay out basically all the quote unquote rules that the investment team can follow. TPA moves away from that in its simplest sense. So rather than a rules based approach, it shifts to more of a mandate driven philosophy. And what this means practically is that the governing body focuses on the long term return targets, maybe some risk appetite, and that's about it. The conversation shifts from asset allocation studies at the board level and what should we put in this asset class versus that asset class and then hand it over to the CIO to manage against it, to conversations around things like inflation protection or asset liability management, liquidity tolerance, drawdown risk, and then other sources of risk like are we actually going to be able to pay our beneficiaries at the end of the day? And that conversation completely shifts you away from what's going on with the S&P 500 or what's going on with emerging market indices. So when you actually get into the management of the fund, this tends to lead to broader risk bands instead of narrow asset weightings that need to be updated frequently by the governing institutions. Institution performance measurement that shifts in total fund terms rather than relative value terms. And one of my favorite framings here is that TPA really moves you from an alpha driven conversation to more of a beta driven conversation. And then third is the decision making opportunity being driven by opportunity cost and mission alignment, which we tend to call competition for capital, instead of trying to fill up each of those buckets. So this leads into that second component, the transition from asset class silos to enterprise level capital allocation. And that's where it gets a little bit trickier in terms of implementation because it requires many of these organizations to reorganize their teams in a way that supports greater collaboration, cross team transparency and so on. So TPA integrates portfolio construction across teams that were historically siloed. You had your equity team, you had your real estate team, fixed income, private markets. And as I said before, I want to stress this doesn't remove the need for those specialists, but they just need to communicate with one another, which seems simple in concept, but maybe difficult in practice. So we got a lot of those questions on the road shows talking around tpa. So maybe the headline here is specialists, you're safe for now, but you do actually need to have conversations with the rest of your colleagues. So rather than filling up those asset classes that are central to saa, TPA allocates capital where it's most efficient, regardless of legacy organizational boundaries or turf wars.
- [57:53]
John Bowman
Aaron, I want to go back to Jeff here. He had some really good examples of how he's seen these teams interact with one another. And again, each organization is slightly different. We have to understand that. But I do think it's worth pausing and hearing a few real examples of what this looks like in practice.
- [58:12]
Jeff Rubin
I think even a loose grouping and understanding of your assets by their performance in different environments, even that can provide the kind of insight that allows you to think not about the asset class labels, not about building a portfolio of asset class types, but of building a portfolio of investments or assets that have certain types of exposure or performance to different risk environments. That's what we're talking about here. And it can be done quite simply. I've seen institutions that simply group their equities, both public and private, into high growth, and they will group their infrastructure and their fixed income and maybe some of their real estate into rate sensitive assets and credit into assets that are more sensitive to credit conditions within the market. So just some broad categories of asset performance can be enough to start sorting through and thinking about your portfolio not in terms of its asset allocation, but in terms of the balance of exposures, the balance of performance that you will get from that portfolio. That can be done quite simply. That can be done with teams that are either doing their own work or using off the shelf risk models that will give you some of that insight in ways that again, doesn't necessarily have to be a large team, but it has to be a team that's really thoughtful around not the labels of asset classes, but the underlying exposure, underlying performance of those.
- [59:35]
Aaron Filbeck
So from a cultural perspective, we sometimes talk about this and doing this effectively, meaning that everyone on the team can actually lose capital pretty well. You may lose capital within your sleeve, but you're so focused on the overall fund return that you don't care because you want what is best for the portfolio. And that again, it comes down to Collaboration incentives, which then leads to. And the most important part, which is that shift that we saw at CalPERS, which is moving from policy benchmarks to reference portfolios. A policy portfolio, as we all know, is an expression of the strategic asset allocation in an investable form. And that's also the benchmark that you're setting out to beat. So your entire decision making process is anchored to whatever is in that policy portfolio, whether you care about the overall fund or not. You can clearly perform performance attribution, performance measurement against it. You can break down the value add on allocation decisions and where manager selection adds value and you really get into describing what drove performance where, and that's really comfortable for a lot of the more analytically minded types of investment professionals. The reference portfolio throws all of this out, and at least at the highest level, the governance level, it throws all of it out. Reference portfolios are often simple and are used more as an expression of risk tolerance than something to manage against. I think that's important. A lot of these reference portfolios is basically the board saying, here's a comfortable risk profile that we're comfortable with. We may have a absolute return objective that we need to hit. A lot of them are more CPI plus types of objectives. But then you need some parameters around comfort with different levels of risk. So this isn't the board saying you have to manage against this. This is the risk profile that's being handed to the investment team. So it's more of a governance tool, not an investable portfolio, which means that the fund's actual performance will typically deviate on a much wider spectrum relative to that reference portfolio. Now, not everyone uses a reference portfolio, at least not explicitly. CalPERS is shifting to that at the time of the vote, moving from 11 asset classes to a simplified portfolio of two. But it is a big shift for a lot of these organizations to move from a measurable allocation to more of a macro conversation. So that leads to the second component of the portfolio, which is the observable portfolio changes over time. So when we conducted all of these interviews, again, all of these organizations do this differently. Some insource, some outsource, some have preferences for certain asset classes. But a few key portfolio trends did emerge and I'll highlight four of them, which. The fifth one is the GP conversation, which we'll save for the end. So I almost steal John's thunder for that one. But there's four that I do want to highlight. First is directionally a higher allocation to illiquid assets. Not every organization is heavy here, so keep in mind, that could have been from a lower base. But by removing some of the benchmark constraints, it actually opened up the possibilities for these funds to invest both through managers and through their own internal capabilities in private markets and treating them more as a strategic part of the portfolio as opposed to an off benchmark type of allocation. So we heard this overall increase explicitly from a number of funds like apg, GIC and Rail Pen, whereas others mentioned specific private asset classes that they had allocated more capital towards. Second and related was more instances of non benchmark assets in the portfolio or investing in sleeves of broader strategies. So two examples I'll highlight here was one fund mentioned introducing insurance linked securities when they got the opportunity and it presented itself in an attractive way, not typically something you find in the strategic asset allocation, but contributed to the overall fund. And then another fund highlighted that they would sometimes ask managers to create custom funds with a single solution that would only invest in a small portion of their strategy instead of getting the broad diversified mix. So for example, if you're trying to play a theme on healthcare or technology, rather than accepting the overall strategy, they might create a single sector based strategy and isolate certain parts of the fund. So sometimes these non benchmarks assets were mapped based on the overall risk profile. One fund talked about infrastructure not being part of the normal allocation in the portfolio. And so they're decomposing the factors of infrastructure and fitting it in accordingly, whereas some would just introduce it as is and it was more about the contribution to the overall fund. Third is the use of the fund's balance sheet to create overlays, hedges, completion portfolios to either offset or counterbalance other parts of the portfolio. When you don't have an SAA mandate, you can be much more flexible and tactical. So two examples I want to highlight here are CPP and apg. Two very different funds, but both utilize this concept as part of their investment process. So CPP has built up a team of internal specialists that deploy capital when they see opportunities from a bottom up perspective. However, there's another team that takes more of a top down view of the world and they create offsetting positions or sometimes they'll even lean in further to what those bottom up specialists are doing. So creating an allocation that again contributes to the overall portfolio, but doesn't actually disrupt each of those specialists from doing their thing. And that could be hedging out interest rate risk. Or it could be if the bottom up team sees opportunities in a certain country, the overlay team could completely hedge out that country's currency exposure. Whatever the case might be it contributes to the overall portfolio. APG also does this using more of an overlay program that actually predates their move towards tpa. But again they're trying to balance out this bottom up view with top down risk. And both of these are meant to express that without disrupting the specialists. Fourth was a completely new lens for looking at the world in terms of geographies, sectors and factor exposures. So New Zealand super takes a very broad unconstrained approach to how it expresses geographic and sectors exposures across countries. So rather than looking at these countries or markets on an individual basis like an asset class or how you might look at an asset class, they actually look at it on a much more targeted, granular, individual basis. So they might find a couple of themes around healthcare or financials or blockchain technology and then they just cut across all the different asset classes, geographies and sectors. CPP obviously does this as well, more from a factor based exposure. And then Future Fund also does this in a more thematic type of exposure. So again, you're not looking at the world and here's the asset class. Do I like it or not? It's what do I take out of this asset class as well?
- [66:11]
John Bowman
So Aaron, one of the additional interesting things Charles shared was how moving to TPA created this sense of clarity but also again, maybe some liberation, this freedom in terms of what they wanted to own versus not owned. Because the reference portfolio is the only bogey, it's the only framing reference or benchmark. So you don't have to own asset classes that you don't want to or that don't make sense anymore. So let's listen to Charles walk through this.
- [66:41]
Charles Hyde
There was a real clean out of the portfolio in the first few years after adopting the reference portfolio and total portfolio approaches. The other thing that was notable, I think distinctive, was that we were more comfortable not necessarily having all asset classes represented in our portfolio. And this goes back to that idea that you want to have competitive tension in your portfolio and you want to be including those things that are attractive and being willing to not include things that are not attractive. So for example, there was a period there when for a few years when we didn't have any real estate to speak of in our portfolio, which I think you would agree is quite distinctive, makes it a distinctive portfolio relative to most of our peers. Although that said, as we've grown in size, we acknowledge that it becomes harder and harder to pivot into and out of a whole asset class through time. So there are some things you can do in a total portfolio approach when you're small that you can't do when you're large. And I'm not saying by any means that we're large on the global scale, but the way that we think about the total portfolio approach I think is slightly different from the way that some of our peers think about it, who are much larger and who just can't do the things that we do.
- [67:52]
Aaron Filbeck
There's one final thing want to talk about here which is going back to process a little bit, which is the important distinction between tactile asset allocation and competition for capital. And I think that's worth pausing on. This was actually one of the most common questions that we got during this journey that we were on around implementation. I remember getting into a debate which I wasn't expecting at this event with someone who was shaking their finger at me and saying, well there's no difference between what you're describing of competition for capital and tactical asset allocation. That's the same thing, you're just putting a different label on it.
- [68:22]
John Bowman
It.
- [68:22]
Aaron Filbeck
So of course that inspired me to write a blog post on this which we'll link to try to explain how these two concepts differ for one another. And the way I would describe this is that it's really that gravitational pull that you feel during your decision making process. In a TAA program. Your center of gravity always goes back to that policy portfolio, the saa, the prescriptive asset class weightings that have been handed to you by the board. So maybe you go over by a couple percent or under by a couple percent, but you're always driven to move back to that SAA because that is what you're being measured on. Whereas on a competition for capital type of framework, your center of gravity is the overall fund. You just want what is the best mix of different assets in the portfolio that are going to achieve the objective. And in some cases that might mean that you don't own certain asset classes at all. I remember talking to NZ super and Charles mentioned for the longest time they didn't own real estate in the portfolio, which in a typical SAA might be a core component of your private market's allocation and it just wasn't attractive to them. So being off benchmark because there's better opportunities that are out there is really the shift. The analogy that I make in the post is comparing tactical asset allocation to chess and competition for capital to Monopoly, both very fun games with very different objectives. So in chess you have all the pieces on the board. There's Rules that you have to follow in order to win. You can only win by doing one thing, which is to take out the king. But in Monopoly the goal is just maximize your wealth. And however you decide to do that based on where you land on the board is a more competition for capital. You may decide, I don't need to buy this particular property because I've got a different opportunity that is a couple spaces ahead. I think that's important because it gets down to the process, but also what you own in the portfolio. A lot of these different funds will own things that are strange off benchmarks or they won't own anything at all in particular asset classes. So I'll stop there. But John, I think that might lead nicely into the whole question of how is this different or is it different at all?
- [70:19]
John Bowman
The wrong question that I think you've challenged and helped us think through is is this portfolio really going to look different tomorrow versus today? The answer is of course not. This takes a while for these processes. It's very ethos of TPA is about process, cultural governance, change that frees up degrees of freedom to pursue the best opportunity for the marginal dollar, as you said. And so your healthcare example is a great one. Or let's just say you're playing data centers and it's currently in your real estate private book. But you think there's a better approach on a different part of the capital stack, whether through public equity or through mezzanine debt offerings. The gymnastics it would take to change that where you were playing on that capital stack in an SAA model is massive. And lots of board meetings and lots of headaches and lots of changes in allocation. And that's just when you step back and think about the arbitrary constraints as I've described earlier, that is obviously suboptimal. So I think you're right though, that's the investment element of this. But I also think that misses the bigger question, or it perhaps is a distraction to the even bigger question of how different this really is at its very foundation because there's a growing chorus of challenges or party poopers that will say things like this is just a new title for what we've been doing forever. It's a fancy new naming convention. You kind of said this that has some feel good branding nature to it, but really there's nothing to see here. Keep moving on. And I respectfully disagree with that sentiment because this is not simply new wine and old traditional skins. I should also say that I also think it's reductionist to suggest that this is a linear progression from SAA with a few upgrades and a fresh paint job. So it's neither something that has always been around nor is it just an incremental change. I think it's something completely different. I think that's part of the reason we struggle to nail this down is that I think tpa, you could say, exists on a parallel path to our current model. So let me just explain what I mean by that. So let's think about some of the framing language or definitions that we've heard from some of the contemporary leaders here, just to set up my attempt at a definition or a distinguishing language. So Charles Hyde of New Zealand, super. Called TPA more a quote state of mind versus a distinct process or workflow. Jeff Rubin of CPP summarized TPA as one unified means of assessing risk and return of the whole portfolio. The Future Fund, of course, uses language like joined up for both describing behavior and portfolio construction. Sui Chang Chum, who was my first conversation again that Starbucks meeting at the bottom of gic, describes TPA as the fourth realm of fund management, following Norwegian Endowment and Canadian. And I think Chum's language or vocabulary of realm is a good one because it doesn't suggest that it's chronological or straight line progressive. It exists as a realm does in a different sphere or reality. So I think the best way I can think of to describe the difference is that TPA is a fund model and SAA is an investment model. So the reason I say that is that strategic asset allocation was birthed out of Markowitz's mpt, Sharpe's capm. It was never designed, let's just be fair to it, it was never designed to speak to or opine on things like culture and governance and separation of duties between CIO and board or fund purpose, or who the beneficiaries are and how demanding they will be on liabilities and payouts. TPA in many ways provides the stitching to more closely align the fund's purpose and goals with its investment program. Now I do think Chum is right in placing TPA closest to the Canadian model in his realm. Discussion we spent some time, by the way, in episode one of season two, that was the episode on longtermism reliving the Canadian Pension management Act of 1990. Just real quickly, because I think this is interesting, back when the regulators and working groups were constructing what we now call the Maple Model, they made the case that these pensions need not just be allocators of capital, but actually world class organizations. Now what did that mean to them? Well at the time, what they said was that it placed much more emphasis on not just investing capability, but also building competency across the full set of systems, technology, talent, et cetera. So the Canadian model has always been about cultivating a durable culture that promoted innovation, repeatable and defensible processes, robust operational and risk infrastructure, etc. And importantly, it's overseen by an independent board of fiduciaries that's free from conflict, removed from political agendas that we see often in the US and simply focused on maximizing outcome for beneficiaries. So the originally managed Canadian model in its purest form was about the entire system and the fund being positioned for generational success and continuity of purposes. But, and here's the big but. All that said, which is why Canadian, I think tells the story that's closest to tpa, but until CPP began actually practicing one fund tpa, this was more dream and regulatory speak than reality. And the idea of world class organizations and world class portfolios were adjacent at best. They were not cohesively interconnected. So hence TPA was this glue, this stitching, as I said, that I think finally brought to life maybe what those regulators and those legislators had in mind. Roger Irwin, in only Roger Irwin language, reminds us that TPA at its essence is investment governance reimagined through a system lens. And he's been harping, by the way, as you know, Aaron, on governance and culture as superpowers for enabling investment outcomes for two decades. So while we've had the components of TPA around for years, asset liability, matching, risk attribution, team incentives, board, CEO decision rights, definition of success, all these things have been part of our vernacular and part of the apparatus. But TPA provided that connection of the underlying liability and beneficiary much more explicitly to the risk budget and the return harvesting of the portfolio. So that's where I think that idea of fund model versus investment model to me was the best framing exercise to understand the true differences.
- [76:23]
Aaron Filbeck
And when it comes down to the portfolio part of this too, I love that realm. Living in a parallel universe in a way, but it's not a linear evolution necessarily. Some of these organizations will have SaaS within a TPA construct. So you can borrow the best of all the different realms that are out there, if you will. It's just who is making the decision and how are you organizing yourself within the organization. So again, why it comes back to the soft stuff, the governance and the cultural side of things, is because within the organization you can do it in a lot of different ways. Maybe a more targeted example of that fund model versus an investment model. You can see that in practice with some of these organizations.
- [77:06]
John Bowman
Agreed. Okay, let's finish up. Aaron, as I said, I wanted us to finish on a word and some back and forth on GP implications. I think this is probably the part of the TPA story that is most ignored, least appreciated. Some of that could be the fact that gps are ignoring it because they assume it just has to do with with asset owner structure and fund culture. Maybe they remain aloof that the transition does in fact impact them. Or perhaps they give it lip service but haven't really embraced some of the radical change they need to address to be successful in this new TPA model versus their comfort zone. But I do think, regardless of which reason it is, that gps are way behind in thinking through how they need to adjust and rethink their relationships and their business models. So we've used new words like playbook, mousetrap, institutional framework for allocating and governing capital. These are big broad changes and words and claims. And when the wiring of the system is replaced or upgraded, the entire ecosystem by definition has to be affected, not just the top of the food chain at the asset owner. So again, I think asset owners have been, yes, the catalyst for this change. Consultants are beginning to adjust, but GPs have really, as I said, been lagging in my view on how they're thinking about this. So I want to provide a three step roadmap here for you to react to in how I think the three categories in which gps need to most adjust to or think through. So the first one I'm going to call the GPS need to move on from their pattern of box filling beauty contests to really shaping their posture around portfolio impact. So from beauty contests to portfolio impact. So if you're a direct lending gp, for example, you have to realize you're no longer competing, at least mostly competing, with several other direct lending GPS for a claim on the 2 to 3% vacancy that happens to be available in the portfolio. You are now in a TPA model competing against a litany of every good idea across asset classes and risk premia. So what does this mean? Well, you need to understand the whole portfolio, obviously. How is that portfolio positioned the tendencies and the current investment thesis of the cio, the overall goals of the fund. So the entire organism needs to be in your sights and mind versus the one small piece that you're used to competing against the historical performance of your strategy, which is usually your headline at the front of your pitchbook against its peer group. May actually now be the third or fourth most important thing on the list of considerations that the CIO is thinking through and wrestling with. Portfolio fit is the most critical factor now, which means, and this is really counterintuitive and really hard that you may need to be willing to identify when you are not a good match for the asset owner. Your goal is to be an extension of the CIO and helping her with the portfolio cohesion story versus this transactional parts provider as Gene gave me the.
- [80:06]
Aaron Filbeck
Language of so John, I just want to interrupt you for a second because I think it's worth hearing more from Gene on this. I love the way that he frames this in some tangible ways, both in terms of reorienting the conversation to the total portfolio but also understanding the constraints of the organization. So let's listen to him walk through that here.
- [80:25]
Gene Pod Commoner
There's such a sharp contrast between being an arm's length transactional parts provider for an asset owner versus a strategic partner that requires a consultative engagement and a much deeper awareness of what's going on. And I want to break this down into a couple of different points here. You and I have probably observed very very skillful focus asset managers with strong track records in their areas that are myopically focused on what they do really well but have very little context or awareness for the big picture problem that the asset owner is trying to solve. They may be an amazing let's use an example here. US Equity, Deep value Shop or a private equity firm focusing on venture they may be great at what they do and when they talk to an asset owner, they use the contextual language of what they do and hope that that resonates with somebody across the table that is equally skilled in speaking that language and can then take that and translate it to what does this mean for the whole portfolio? I think that as TPA gains more adherence and by the way, even if it doesn't, even if so many asset owners don't get to the promised land of TPA but they're thinking in more of this solutions mindset, what you're going to find is a greater awareness is required for what the asset owner is actually trying to do. Are they trying to be more liability driven? Do they have inflation exposure that they're seeking that they might not be getting? Are they looking for more diversification within their manager sleeves to help them in a different part of the portfolio that you have no visibility into at all? It's being able to really think at a different altitude. It's not where do you fit in in the asset class sleeve that you happen to play in, speaking with maybe the investment staff that are again, very skilled at underwriting those types of managers. It's taking a step back and almost asking yourself, if I were the CIO for this asset owner, what am I worried about? And how do I move the needle with the capabilities that I, the asset manager, have at my disposal internally, how do I marshal those capabilities in a way that actually helps the asset owner accomplish what they need? So, emphasis on awareness. And there's a couple of other points I'd love to make too, on that being able to understand how your investment organization and your investment results are viewed by the asset owner is crucial. I've seen this in multiple organizations that I've been a part of and I've underwritten managers when I was on the consulting side as well, that the way that you view what you bring to the table and what your results are aren't necessarily the same way that the asset owner views them. And we talked about this earlier with, with risk systems. If an asset owner has a sophisticated risk system or if they have a gatekeeper or a consultant that can help them with that, they will be evaluating you and your strategies in ways that perhaps you're not looking at them the same way internally. And so bridging that gap, I think is really important. Having the awareness, understanding, how am I being evaluated? What does success mean from the asset owner's perspective versus from your perspective? I think that an emphasis on risk and on risk factors are really, really important. And I've seen this through the lens of quantitative managers that have that in their DNA. They're pretty good at being able to express that to the market. For other more traditional asset managers and those that deal in asset classes that don't really lend themselves to a quantitative approach, that's not an excuse. You need to be able to understand what are the risk factor exposures of your strategy. What exposures do you bring to the asset owner portfolio? So. So there's really this multidimensional understanding of as the asset owner, I'm assembling a collection of strategies. They need to be coherent. How can I help in that coherence? So again, first, understanding what the asset owner's problem are, this is not a product pitch, this is not a transactional relationship. And then being able to understand how you really fit in. And I've observed that there's been a long running convergence from trying to be a parts provider to trying to be a partner, that this is something that's been going on for my entire career. I don't think that we're all there yet, but we're certainly moving in that direction. But being able to zoom out and ask yourself, what am I solving for? How do I go beyond just filling a perceived gap in the portfolio? And I think that honestly, it's really hard to reposition. This takes effort, it takes work, it takes resources. It's a different mindset for asset managers that need to be able to flow into what the asset owner is doing and the framework that they're working in.
- [85:13]
John Bowman
This takes a tremendous amount. As you can hear me even talk, imagine that this is going to be hard work in self control, in self awareness, in active listening, et cetera. Which leads me to my second related point. So parts provider to portfolio fit. Second, you need to position yourself as a chief problem solver for your client. We overused the word partner, so I didn't use that in the title. But. But it's accurate as a contrast with how we often think of GPs as agents or subcontractors or hired hands. Now that's unfair to I think a lot of the intent of most gps, but nonetheless, that's the way the system has been structured, that's the way incentives work, that's the way the contract is facilitated, is that they are agents or subcontractors. So GPs now need to be in the business of providing solutions instead of selling products. So again, this means you'll need to devote a ton of time getting to know what is important to the client, not why. Your strategy is awesome. Who are their beneficiaries, who's on their board, what are their agendas, how are the decisions made? What are the liabilities? What is the cultural identity? What is their benchmark or their goal? So instead of myopically pitching a strategy, grasp what the CIO is worried about and make them look good by contributing to mitigating that worry or that risk. What keeps them up at night. And this is really going to challenge many of our default mechanisms and attitudes and particularly how GPs think about scale, how they think about customization, how they think about separately managed accounts. You alluded to this multi strategy capabilities, flexible mandates. May I even say that being in and out of market through this traditional every two to three years fundraising model for one strategy focused on one geography and one sector is kind of an anathema to the idea of solutions provider. It is very parts oriented. So even the drawdown fund, I think may be at risk here. There will be much fewer GPS needed in a long term TPA partnership model CIOs are going to significantly rationalize their managers, so the successful ones need to learn to operate at this much higher altitude. So solutions provider third and finally, you'll need to employ a different language and tools and all these are interrelated. But words matter. Words matter in our relationships and they matter in business. So logos, if you will, is foundational. How you speak and what you talk about is a reflection of what you think and your underlying values. So in a TPA shop, asset classes, benchmarks, relative performance against peer groups asking what your quote PE book is or your private credit sleeve is lpgp, alignment contracts. This is SAA vocabulary. I use it all the time, so I am as guilty as anyone. But we need to completely rewire the words and the phrases that we use. We'll need to learn a new contextual language to translate all of that as far as what we can provide and what we're hoping to quote sell into what it means for the whole portfolio. And this should not be underestimated. Again, when our entire pitch book is based on that beauty contest mentality or that us versus them, we've got to completely change things. And CIOs are going to need help in addition to the language and vocabulary with risk assessment technology, solutions, data sets, thought leadership and intelligence that assist them in actually understanding the overall positioning, not just the benefit, the incremental alpha of your strategy, but the overall positioning and exposures of the portfolio. So there is lots there again that is moving away from parts provider to total portfolio to solutions provider and to changing your vocabulary. But Aaron, I'd love to get your reactions on that three part agenda if you will for gps.
- [88:44]
Aaron Filbeck
I think those three are great. I have written a couple of notes down as you were talking as I'm hearing this live, so maybe a couple things to further expand on the three points that you made. So one is the idea of I love the beauty contest versus fitting into a broader portfolio. And I think some of these asset owners, when you talk to them about their relationship with gps, talked about the GPS being an extension of their investment team. But that information flow went both ways. So rather than the GP providing a service for hire to the asset owner, there was an exchange of information from the investment team on the asset owner side to the GP as well, what they were seeing and how their strategy might have stacked up relative to others. And so that may not necessarily lead to dollars and flows moving in to every single strategy, but it was more of an open, honest, transparent relationship amongst the two. And that I think is a shift for this industry because we're very transactional in how we build portfolios. The information share might come after you've already bought into a fund or you've created that transaction. But in a lot of cases, some of these asset owners would work with gps on information share even if they weren't actually invested in that particular strategy. So I thought that that was a good point to raise is that partnership or chief problem solving officer is a good one as well. The other one that was part of this and I don't know if this is problem solving or if it's the beauty contest, but as I mentioned before, a lot of these GPs and funds will co create mandates with managers. And so gps going from a mindset of maybe this gets to your drawdown fund comment of I'm fundraising for this particular strategy and I'm going to do this every two years. It's coming to the table and saying what do you need? What are you trying to solve for and what's the theme that you're trying to express? And let's co create something. I might actually be able to solve your problem that my more broad based strategy is not going to be able to solve. So I think that that co creation of products and investment strategies is another one. And then you mentioned this as one of the three. But a lot of these asset owners, one of the big shifts in terms of external management is that they did have fewer, deeper relationships with GPs and that ultimately led to stickier money for the GPS because they really vetted who they wanted to work with. But it also meant that at certain times, let's say you've got a multi strat private market shop, they've got credit, they've got equity infrastructure, real estate, but at different times the asset owner would invest in different parts of that business, but they've got an overall enterprise relationship with the gp. So I've heard some conversations where the GPS said well maybe we just need to come to market with a multi asset class strategy so that the plug and play into a TPA framework is more scalable for us. And that might be a solution, but what I think is a more elegant solution is establishing an enterprise level relationship with these GPs and then being okay with dollars and flows moving across each of their different strategies. And that could be a standard strategy or a co created mandate. So I don't know if that's anything new in terms of the headline three that you identified John, but those are maybe some examples of how that can be expressed in practice.
- [91:59]
John Bowman
No, I think they're great. I love this idea that the relationship, I don't want to say the contract, but the relationship now is going to demand and expect much more than just the quantitative delivery of returns. It is a connection and an extension and an intertwining that will go much deeper, therefore be much longer term, be much stickier. Switching costs will get harder. It will be more challenging to unpack and unwind. And all of that eventually is good, though, if you're a solutions provider. So, by the way, I should just say this clarion call on this agenda is not set out of judgment, it's set out of encouragement. Because ultimately, if our goal is optimizing and improving investment outcomes, every piece of this ecosystem to go back to where we started has to be moving at a similar pace. And if we've got some pieces of the value chain resisting moving slower, maybe less aware of how it works, then eventually it's the beneficiaries that are going to suffer. So that's why we're harping on so much of this.
- [92:58]
Aaron Filbeck
And there's examples of this working well, to your point, that's encouraging because you've got asset owners that employ TPA and they do this already. It's just more of them are coming.
- [93:06]
John Bowman
To market and I think learning from them is a good thing, as we've done through portions of this episode. So we're going to have to leave it there. Aaron, there you have it. Decanters TPA 2.0. I hope that's been helpful for you. It's always enjoyable. This is one of my favorite topics, if it's not abundantly obvious. But we look forward to continuing conversations around the world on TPA and its adoption and perhaps a few more tipping points beyond the CalPERS moment. So thanks for listening and we'll see you next time on Capital Decanter.