Managing Portfolios in 2023: The Total Portfolio Approach

In recent years, there has been a chorus of leading investment managers advocating a new approach to portfolio management. Existing methods appeared frail, were beginning to fail or appeared ill-suited to the current and prospective world. Ultra-low interest rates had decimated returns from bonds and cash. At the same time, record fiscal stimulus pushed risk assets such as property and equities into bubble territory while the macroeconomic environment deteriorated.

Many forward-thinking managers and those with an eye on market history, such as the Future Fund and Dynamic Asset, have highlighted the impending change in the economic and market cycle. These changes clearly challenge the existing approach of the vast majority of investment and super funds on offer to retail advisers and their clients.

Now, here we are in 2023, and the world is very different. Interest rates and inflation are both elveated, markets are highly volatile, and bonds, property and equities are falling. These issues have provided evidence that the problem is real. A lack of compelling investment options has necessitated a rethink.

Portfolio management in 2023 calls for an integrated mindset. As traditional approaches fail, new methods are required to enhance decision-making, seek alternative ways to achieve income and positive returns, and more effectively target clients' real needs over time. 

The challenge has inspired the use of the Total Portfolio Approach for retail investments and super – a well-known institutional method that has been deployed successfully by leading endowment funds such as Harvard, Warburton, Yale, MIT and the Future Fund for decades but has not previously been available through retail offerings.

The Total Portfolio Approach (TPA) embraces factors beyond strategic asset allocation to manage risk and return better, and more fully consider the macroeconomic environment. Critically, TPA aims to manage risk better and achieve greater asset diversification. It utilises Dynamic Asset Allocation and alternative assets to align portfolios with an absolute return framework. The approach is better suited for adjusting to economic and political risks such as inflation and global conflicts.

A report by the Thinking Ahead Institute, Total Portfolio Approach, found that funds that switched to TPA expect to perform better than strategic asset allocation. This will be increasingly important for investors and advisers, with predictions of poor long-term returns and unstable inflation and interest rate outcomes.

The Total Portfolio Approach embodies three key facets:

1. It seeks to clearly articulate the portfolio's investment objective, with all investments focused and working together prospectively on achieving this single goal, considering the changed investment environment and prospects for investing. This contrasts with strategic asset allocation, which commonly derives a return and risk target based on extrapolation of historical asset class returns and correlations.
   Success under a Total Portfolio Approach is typically measured by whether the total portfolio has achieved positive targets rather than returns relative to a benchmark that may have lost money. This creates greater scope for targeting risk and return outcomes relevant to retail investors with less dependency on index-type investments in equities and bonds.
   
   
2. The portfolio is managed holistically. The investment team determines where to allocate capital from the entire investment opportunity set. Greater regard is given to absolute investment risks rather than naïvely following pre-determined strategic asset allocations and tracking market indices up and down. The process promotes and broadens decision-making and the available tool kit to target returns and considers a greater range of opportunities and risk-mitigating benefits.
   
   The investment team considers potential investments that promise sufficient returns for the assumed risks and is better able to build a portfolio that is more resilient to a broader range of economic and political risks. The portfolio is not tied to assets that may be overvalued and can access unique investments that would not usually be considered meaningful under a strategic asset allocation approach. For example, the investment portfolio management team may find opportunities in alternative assets, foreign exchange, precious metals and commodities. It can position the portfolio to capitalise on contemporary themes that offer higher return potential and be more responsive to regulatory and political interventions.

Therefore, the holistic approach actively seeks out, in detail, a significantly more optimal approach to achieving the stated investment objectives.

3. The Total Portfolio Approach adopts Dynamic Asset Allocation. This sees portfolios being adjusted in response to future market developments to avoid large drawdowns or capitalise on significant opportunities. Again, this differs from the more passive nature of Strategic Asset Allocation, where dynamic asset allocation is given a diminished role. In a changing world, dynamic asset allocation is better placed to adjust than a strategic asset allocation approach. Asset allocations need to be changed meaningfully to make a significant difference to portfolio outcomes which strategic asset allocation fails to do.

The principles espoused by the Total Portfolio Approach are being applied within the financial advice industry in the form of 'Goals Based Investing', which brings a similar approach and benefit to client portfolios. Advisers that use goals based investing begin by uncovering their client's personal financial goals. They then dynamically invest the client's capital across a wide range of more diversifying assets with positive expected outcomes to lower risk and generate sufficient returns to achieve these goals. They are ensuring that the portfolio is adjusted to a considerably changed economic environment, including more volatile inflation and greater geopolitical risk, than that found in the disinflationary and peaceful prosperity era of the last 40 years.

In Australia, the future fund provides a compelling example of this approach with compelling returns historically compared with that of superannuation funds. Furthermore, they recently warned that superannuation funds need to change their approach now if they are not to be caught out in the next few years and are now highlighting that they'll need to change now to be effective in coming years and to adjust to a rapidly changing investment environment.

The Future Fund's Peter Costello, in his Chairman's report, said: "I think the most important thing for the board is to read the way the world is going and to make sure that our portfolio can be adjusted to meet those changes".

"The world is moving. It's going to a different world over the next ten years to the world we had over the last ten years, and the board's got to be on top of its game to be ready for that".

Employing a forward-looking investment focus via Dynamic Asset Allocation is complex and requires specialist expertise and experience. To overcome this challenge, small and medium-sized advice firms often choose to partner with an experienced managed-account service provider with proven capabilities in implementing a Total Portfolio Approach over many years, such as Dynamic Asset.

Dynamic Asset provides advisers with straightforward access to professional investment services that apply the Total Portfolio Approach's core principles. Advisers can select, mix and match from five actively managed model portfolios that target various liquidity and risk-return outcomes, allowing clients' capital to be specifically allocated to achieve their investment goals. 

If your firm is ready to reap the benefits of contemporary portfolio management, contact Dynamic Asset today.