What’s Driving Asset Owners to Adopt a Total Portfolio Approach?

Highlights from the MSCI Institutional Investor Forum

Last week, MSCI hosted its 19th annual?Institutional Investor Forum in partnership with?CalSTRS?and?CalPERS.

Each year, we bring together the most influential global asset owners and investment consultants to discuss and prepare for the future of investing. This year’s theme, "Navigating Total Portfolio Allocations," continued our legacy of tackling today’s most urgent investment challenges.

In discussing what it takes to move toward a total portfolio approach (TPA) from a strategic asset allocation strategy (SAA), attendees spoke about keying off the unique strengths and needs of investment teams and other stakeholders. They discussed the evolving measures of investment performance and risk management to deliver better results. Last, but not least, they surveyed the megatrends creating risks and opportunities and how to address them through a TPA.

Through our discussion, three key insights emerged:

·?????? Culture is the most important factor that drives the success of a TPA.

·?????? Assessing physical risks is critical.

·?????? Successful portfolios will incorporate both public and private assets.

Below are additional perspectives on these insights.

Culture is everything: one TPA does not fit all

While large asset owners around the world have adopted TPAs, governance and investment structures vary widely. Some of the earliest proponents of a TPA did away with asset-class-focused investment teams, eliminated benchmark goals and broke down silos between public and private assets. More recent adoptees are taking a hybrid approach, maintaining asset-class specialists and performance benchmarks for them while also deploying total-return teams to foster discussion among these groups and identify opportunities that might have been missed in an SAA. Whatever approach a CIO takes, fostering collaboration is job No 1. The right structure is the one that meets the portfolio’s unique goals and that leans into “what you’re good at,” as one senior investment leader put it. ???

It’s also essential to explain the shifts in structures and philosophies to governing boards and get their buy-in. Practical tips shared included meeting individually with board members to bring them along on the journey. Clear communication of TPA strategies and anticipated risk/return profiles is especially important in the U.S., where board members often aren’t investment professionals.

TPA is about measuring risk – including physical risk

MSCI Chief Research Officer Ashley Lester shared that TPAs have become more prominent amid greater investment complexity and more risk of “black swan” events.?Specifically, four key forces are pushing pension plans and other asset owners to seek new models and resources to assess risks and pursue opportunities: climate change, geopolitics, the rise of private assets and the rise of AI.?

Models that project physical portfolio risks under different climate-change scenarios are among the most important new tools, Lester added. Multiple participants agreed that assessing physical risks is no longer the sole purview of dedicated sustainable investment teams. For example, real estate investment specialists must consider extreme weather events like hurricanes. Rick Bookstaber, Director of Risk Research at MSCI, said that institutional investors’ risk management should now start with assessing go-forward physical risks before assessing financial risks.

The Holy Grail: bringing together public and private investment opportunities

A total portfolio focus allows asset owners to better identify pockets of opportunity between public and private markets that increasingly interplay with one another as capital seekers continue to diversify their financing across both sectors. While attendees agreed that private markets will offer better opportunities than public equities, they also said they need better benchmarks for private asset performance to capture those opportunities. Irregular valuations and lack of history complicate measuring private asset returns, MSCI’s Lester explained. He also argued that the investment industry needs to move beyond aggregate measures of private markets — a challenge that MSCI is presently trying to solve for by working towards generating indexes and insights at the holding, rather than the fund level.

MSCI will share more from this event, along with key takeaways from our upcoming Canadian Institutional Investor Forum next month, in a Research & Insights report on MSCI.com — where you can always find our latest insights for investors.