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An increasing number of institutional investors have adopted a total portfolio approach (TPA) as a response to the weaknesses of more traditional strategic asset allocation (SAA)-based methodologies. We believe the current crisis will reinforce this trend, as it is probably marking a paradigm shift in financial markets. This shift could be as important as the change in US monetary policy brought in by Federal Reserve Chairman Paul Volcker at the beginning of the 1980s, which led to a long period of disinflation, lower interest rates and high asset returns.
The frontiers between monetary and budgetary policies are being blurred and ballooning budget policies are likely to lead to some form of debt monetisation later on. As a result, we are probably entering a new regime, one characterised by a higher probability of inflationary scenarios and increased asset volatility. This means investors need to question long-accepted risk and correlation patterns and calls for agility on their part. Moving to TPA as a holistic, essentially goal-based, total return-oriented and flexible approach is one way to adapt the institutional portfolio construction framework to this new environment. Below we develop three arguments in favour of this method.
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