TPA - Total Portfolio Approach - Is this a fad?

 

I am trying to understand the relatively new concept of the Total Portfolio Approach (TPA), which is being embraced by many large pension funds and endowments. Now, we know the foundations of SAA (Strategic Asset Allocation) and TAA (Tactical Asset Allocation), but there does not seem to be a clear definition of TPA.

SAA is structured around an investment committee allocating capital to major asset classes based on expected returns for each class. This is a long-term perspective, and in the short run, it will be applied for the year. TAA is a short-term. Both of these involve a top-down process in which the focus is on identifying asset classes and then making assumptions about future returns, volatility, and correlations to determine a set of portfolio weights. The allocations are then given to specific investment groups that aim to beat the benchmarks for each asset class. The investment committee monitors the performance and the weight for each asset class. The foundations of this approach are modern portfolio theory, with a focus on diversification. 

The reality is that many endowments have not been able to beat their SAA portfolio benchmarks, and the benchmarks themselves have not been effective because the underlying return and risk assumptions have proved ineffective. The process does not seem to work, so there is room for an alternative approach.

The new approach is the total portfolio approach, which still embraces diversification and modern portfolio theory. It also embraces the idea that allocations should be more flexible, drawing on the principles of tactical asset allocation. Still, there is no new theory behind the concept.

There is a belief that allocations should be more flexible and that endowment portfolios should not be siloed into fixed asset-class weights. There is a shift in investment staff to compete for capital across all asset classes. It argues that siloed thinking will not be effective for generating alpha or for adjusting to a dynamic market environment. TPA is more of an approach to managing the portfolio and not setting goals. The objective is to maximize surplus (assets - liabilities), subject to a downside or volatility constraint on surplus risk. 

This all sounds good, but it is not clear that there is a single acceptable definition of the concept. Hence, TPA may be in the eyes of the beholder.

Hedge fund performacne mixed for October

 

Hedge fund return performance was mixed in October, with the overall HedgeIndex Main, a combination of all Hedge Fund managers asset-weighted, declining for the month. The stand-outs were with convertible arbitrage and Global Macro, while multi-strategy and emerging markets were a drag on performance.

The overall performance of hedge funds has been positive this year, with managed futures the only strategy not generating positive returns. 

Creditworthy - An interesting history

 

We take for granted the process of receiving a credit score and the distribution of our credit history across banks and retailers, yet both are recent phenomena. We also assume that retailers' credit extensions are relatively simple. Pre-Civil War, most retail purchases were made in cash or with simple extended terms from a local grocer or retailer. Credit amounts or ratings were held by an single institutions and only extended to those that were know. 

As cities grew and consumers, this was not a workable solution. Even in a city, there began sharing arrangements regarding customers' credit histories. Runners would move from store to store to gain information on a new customer. The transaction costs were high, but not knowing the consumer was costly. 

Suppliers placed pressure on retailers to pay their bills so retailers had to better know who they were extrending credit to. Lists were made, and the process started to be centralized through local credit bureaus. As more credit was extended, there was a need for more credit professionals and further automation to track and rate consumers. This was furthered through the use of comutuers and the ascent of credit cards.

There is not much to apply to trading with this history of credit information. Still, Creditworthy: A History of Consumer Surveillance and Financial Identity in America by Josh Lauer is a fascinating history that makes you think about the fundamentals of credit information and ratings. 

The current credit bezzle

 

With the bankruptcies of First Brands and Tricolor, there are clear signs that we are facing mounting credit issues. More importantly, we are seeing the classic Bezzle described by John Kenneth Galbraith in his book on the 1929 crash. We are not faced with a downturn in the business cycle. There is no recession; however, there is an exuberance that has been described by Minsky in his financial instability hypothesis. When overly optimistic views of the economy are coupled with extreme asset values, there is a higher likelihood that some will take advantage of the situation and cut corners, potentially committing fraud.

A review of the bankruptcies and new reports suggests that, in both cases, there was potential fraud or financial complexity that did not provide debtors with accurate information about the economic health of the firms. If we are seeing this under current healthy conditions, we can imagine more bankruptcies if asset prices fall. This is called the "febezzle" by Charlie Munger, referring to the false wealth created by high asset prices. If prices fall, the excessive wealth will quickly fall.

The key takeaway is that credit risk premiums should increase and investors should be paid more to hold risky debt.

John Kenneth Galbraith and the "bezzle" - It is a global issue

The bezzle and markets - Risks could be rising