Show V/O:
This is Alternative Allocations by Franklin Templeton, a monthly podcast where we share practical, relatable advice and discuss new investment ideas with leaders in the field. Please subscribe on Apple, Spotify, or wherever you get your podcast to make sure you don't miss an episode. Here is your host, Tony Davidow.
Tony:
Welcome to the latest episode of the Alternative Allocations podcast series. I'm thrilled to be joined by return guest, Aaron Filbeck. Aaron, welcome.
Aaron:
Tony, good to be back.
Tony:
So a lot's happened in CAIA since the last time we got together. Maybe just update us a little bit on some of the changes, your new role. And then we want to delve into a topic that is near and dear to the organization. I know you and John Bowman have been speaking pretty passionately about total portfolio management, but let's kind of start with the beginning. What's new at CAIA? What's new with your role? And then we'll get into that as we get into our discussion here today.
Aaron:
Oh, absolutely. So in terms of what's new at CAIA, we have gone through a bit of a leadership transition at the Association. So very excited about what that will look like over the next several years. And I think really, really trying to focus on member value, building community, making sure that we're engaging with this rapidly growing and evolving industry.
So just very excited from that perspective. And you'll see a lot more from us over the coming months on what that actually means. From my perspective, so my role at CAIA Association, is I sit on our executive leadership team of the Association and am fortunate to serve our 14,000 member community with thought leadership, content development, content strategy.
So really engaging with the industry and creating content in concert with the industry on a day-to-day basis. So I'm really excited about that. Tony, in terms of my background, I know this pretty well, but I started my career in the RIA space working as an analyst and a portfolio manager and focused a lot on manager selection, portfolio construction, engaging with clients both on the high net worth side, as well as our corporate retirement plans that we worked with. So making sure that they understood what was going on in the portfolio, what we were doing in the portfolio, how to align with their goals and so forth.
And then maybe the final thing I'll say, you know, I've been at CAIA for six years and have jumped around in a variety of different roles for a lot of different initiatives, but maybe most relevant to today is I had the privilege of standing up our educational platform for the wealth channel at CAIA Association to educate this brand new group to the world of alternatives to private markets and hopefully raise competence and communication across all the different stakeholders from asset management companies like Franklin Templeton, all the way down to the individual advisors. So it's been a fun ride.
Tony:
And I think that's really helpful, especially talking a little bit about your background, because I know that the CAIA Association and you and John in particular have been very passionate about total portfolio approach, this new approach to allocating capital, something that has been embraced by the institutional community, but still relatively new for the wealth channel.
Maybe if you can, at a high level, describe what TPA is, and then you and I can get in some of the challenges as that translates to the wealth channel.
Aaron:
Yeah, absolutely. And I love the question of “what is TPA” because we're still kind of figuring that out. I think the industry is still somewhat figuring that out, but I think maybe this will be helpful in framing it a little bit more.
So we started doing research on this topic roughly two years ago and the way we did this was just through a series of conversations. We met with a lot of different asset owners, particularly those out in APAC, who have been early adopters of this approach, just to understand the different way that they were looking at managing portfolios.
There's a slightly different approach to a couple of these organizations, which I can list here in a second. And as we were interviewing these different asset owners, we realized that all of these organizations do it a little bit differently and approach things a little bit differently, but there were some common, what we ended up calling dimensions, to some of those different ways of thinking about TPA. So maybe just to list off the organizations that we spoke with – GIC, so the Singapore Sovereign Wealth Fund, CPP, Canada's Pension Plan, the New Zealand Super, so the Sovereign Pension, and then Future Fund, which was Australia's Sovereign Wealth Fund. So as you can imagine, these are large pools of capital, large institutional investors, but really pioneering a different way of thinking about portfolio construction and asset allocation.
Tony:
So maybe if we start to break down the components of it, there are four primary pillars. Walk us through those pillars, and to the extent you can, talk about maybe the differences for a big institution who has a different governance structure versus an RIA, kind of the world that you came from, how might that translate into an RIA thinking about incorporating some of these elements?
Aaron:
So, like I said, these different organizations approach it differently. But when you started to get under the layers of how they think about this, there were four, what we call “dimensions” to TPA and those just listing quickly being governance, culture, a factor-based lens, and then this concept of competition for capital.
So if I walk through each of these briefly. Governance, if you think about an institution, they're usually bound by a board of trustees or a board of governors. And the idea behind Governance as one of these dimensions for these organizations was that really delegating the investment capabilities to that CIO office or the investment team to make decisions. Maybe setting the strategies, setting the objective of the portfolio, maybe the risk tolerance of the portfolio, but then you're the CIO, you're the investment team, build a portfolio that's going to have the highest probability of achieving those longer term outcomes.
We talked about factor-based lens as the second pillar. So really decomposing different asset classes or strategies into their component parts. So if you're a factor nerd, you've grown up on this on the equity side, style factors, value, momentum growth, but there's also economic factors. There's sensitivity to GDP, interest rates, commodities, inflation, currencies, and so on.
And so when you're analyzing something like a real estate fund or a private debt fund, they may be different asset classes in terms of the labels, but there's some underlying factors that are very similar in terms of their exposure to the economy, to some of those other sensitivities as well.
Competition for capital – this was really the whole concept of the marginal dollar. So as you're looking at new opportunities to put in a portfolio, rather than thinking about, well, I need to fill this bucket up and I need my 10 percent allocation to equity, every single investment opportunity should be weighed against what's currently in the portfolio and what is the best opportunity at the moment to put that marginal dollar to use.
And then fourth and finally, is that culture. GIC was one of the big champions of this and the concept of long-termism, a one team culture, a one fund culture and so on, so that you are all aligned in managing that portfolio, but you've got incentives, you've got structures in place that will ultimately lead to good outcomes over the long term.
So, Tony, in terms of implementation for an advisor, you know, there are challenges. As you alluded to at the beginning here, institutions are built differently. They have different time horizons. They have different objectives associated with them.
And so I think a couple of challenges that we tend to see, both at the institutional level, but I think it's relevant for the advisor level, is some of that soft stuff. So the culture being one of those things where how do you organize your team when you're a one team culture? How do you build incentives at the institutional level around achieving those different objectives?
And I think that translates to the RIA practice. You know, currently you might have some teams that are generalists, you have some that are much more specialists in terms of asset classes or coverage. You might have the traditional versus the private market analyst or PM or Director. And so breaking those different barriers down, which can be a very challenging thing to do from a cultural perspective because you need expertise in certain areas, but then you need to think broadly about the overall portfolio. So that's kind of softer culture stuff. But then there's the technical stuff as well. So being able to do a factor decomposition at a granular level is challenging for advisors because they may not have access to data. They may not have expertise in thinking through some of those things.
So resources as well is a challenge. If you're a smaller RIA, you may not have an investment team of 20 people. You may have one or two. So those are some examples, but I'll turn it back to you.
Tony:
Yeah, no, and I love that because I think you've kind of tweaked the interest of a lot of folks out there who are thinking intellectually, I understand why total portfolio approach makes sense.
I love the notion of competition for capital, but I think where the rubber meets the road is how, within an organization, do you, in fact, implement it? And going back in my history, I always remember that the equity strategist typically favors equity. The U.S. strategist will favor the U.S. markets. The global strategist will favor the global market.
It's the way that you look at the world, right? You tend to look at it through your lens, which always looks rosy, and the other lens looks less rosy. So I think the last two components of that seem to me where the real rub is, which is we understand that competition for capital, that marginal dollar. Private equity looks attractive today, therefore we should allocate more money to the most attractive asset class.
But it's the implementation that sometimes gets challenging because people have their own horse in the race and they believe that their side of the world is the most interesting. How do institutions grapple with that? Is that something they just memorialize in their IPS? Or is that something that you just hire people who are more team players who accept that at the end of the day, we all win together, or we all lose together? How were they thinking about that? And how then can we bring that back to the advisor practice?
Aaron:
I think it really comes down to on the institutional side, how do you organize and structure both your team, but also what is the guidelines that are put in place from maybe the board or even from the CIO. So one of the things that TPA is trying to solve for is this strategic asset allocation concept or the modern portfolio theory concept where we're building portfolios with a neutral allocation that they're trying to hit. And so you're anchored to that automatically. If you say, I'm going to have 20 percent in large cap growth and 20 percent large cap value, 10 percent to private equity, those are all buckets that you're now trying to fill up. And when you relieve yourself of that, to a large degree, then you can start to make some decisions around that marginal dollar rather than saying, well, this is a really interesting private credit strategy, but I've already got 10 percent private credit and that's my neutral allocation.
You can now take advantage of that opportunity because it's incrementally going to benefit the overall portfolio. So it's a bit of a mindset shift in terms of how you build that portfolio. Now the benefit of having a neutral allocation or a policy portfolio is that you don't get too far offsides on your overall portfolio.
And so you can imagine, you relieve the constraints and all of a sudden it's like, well, how do I prevent myself from loading up 80 percent on private credit or 80 percent on venture capital? And that's where the risk budget and thinking through potentially a reference portfolio of, here's kind of the risk profile that I'm trying to accomplish, comes into place.
But I think at the very, very high level, it's removing that strategic asset allocation mindset and constraints and thinking more about what am I trying to accomplish at the overall portfolio. And then the conversation becomes, okay, I'm a real estate expert and you're a private credit expert, which one of these asset classes is going to be the best use of our marginal dollar when we're making new commitments.
Tony:
So maybe just to kind of take a little bit of a step back for an advisor who kind of grew up with modern portfolio theory. And then maybe after modern portfolio theory, they started to think about the endowment model, which had larger allocations to alternatives. And then maybe as you and I have espoused over the years, goals-based investing or outcome oriented investing is kind of a logical sort of evolution.
Not to put words in your mouth, but I think you and I have had this discussion. Is TPA the natural evolution of all of those things where we're actually focused on providing outcomes, better outcomes overall, rather than that bucketed sort of approach where we sometimes got caught in a box?
Aaron:
Yeah, particularly on the goals-based investing philosophy, there is an extension of that because at the end of the day, you've got a goal that you're trying to accomplish and institutions, it might be a withdrawal rate or for a client that might be retirement or something along those lines. I think where it differs is that strategic asset allocation, even a lot of goals-based investors take a more modern portfolio theory, you might have many portfolios that are being used to achieve some of those different goals. And so, you could almost think of the goals-based investment philosophy as being the transition agent to TPA, which is again, you're no longer bound by the SAA policy portfolio that's in place.
So it's a yes to your answer, but there's a bit of a nuance that takes place from that perspective. And I think the biggest difference is, are you using SAA or are you not? And then are you transitioning from one to the other?
Tony:
And Aaron, when I was researching TPA for my book, and you were kind enough to review the chapter on TPA, one of the things that struck me, and maybe this is constructive for our audience, is it's not an all or none proposition.
Even those big institutions, many of the big institutions are using elements of it. It's not all in, in one fell swoop. Maybe there's a transition period, and they're starting to, aspirationally, they know where they want to go with their philosophy, but they know there will be steps along the way to get there.
Maybe that's an easier incremental approach for an advisor to think about it rather than changing what they've been doing their whole career with their practice. Walk us through that. How might that evolve? I mean, if you just kind of woke up today, said you wanted to evolve, how could you potentially put a plan in place to maybe transition over a multi-year period of time?
Aaron:
So when you look at the paper that we put out, so Jayne Bok, who's the chair of our board, writes the conclusion. So this is all great stuff. You learned a lot about the four dimensions, but how do you actually do this in the first place? And the first thing that she says is, this is not for the faint of heart. And it's also not going to happen overnight. And so you have a lot of institutional investors who are making incremental change towards TPA over a multi-year time horizon. So for the expectation for an advisor to wake up tomorrow and say, “well, I'm just going to do this,” I think there's a bit of a challenge. But I think there's a couple of things that you can probably do to start off.
When you look at those four dimensions, for example, maybe think about how you organize yourself within your organization, and that will take some time. How do you organize your investment team? How does the investment committee interact with the investment team. I mean, it depends on your organization and there's small RIA’s there’s large RIA’s. But if you have a broader investment committee, are they actively involved in the investment decisions or are they saying here's what we're trying to accomplish for our clients, go investment team, and now that you've got clear direction, build portfolios that are going to do that. That might be a small shift that you can make. You know I think what we were just talking about with the competition for capital. You may not be able to completely abandon SAA overnight, but starting to think about when you get investment opportunities, am I trying to fill up a sleeve of my portfolio, or is this a really good opportunity that I should be thinking about integrating because it leads to a better outcome for the overall portfolio. Maybe back to that goals based investment philosophy.
So you can kind of do it around the fringes of SAA. Longer term, maybe you abandon SAA, which I know is a different way of approaching things. Maybe from a factor-based investing, you know, partnering with an asset manager that has some insight into factor exposures.
And at least to begin with just understanding what's underlying my portfolio in the first place. Do I have a lot of exposure to equity risk and economic growth, which most portfolios do, just given the run up that we've had. And the public markets, in particular. So I think each of these are not things that you need to do overnight. And we don't see it on the institutional side either. You know, some of the large California pensions are grappling with this as well. And you've seen articles that have come out about, “we're going to adopt TPA,” and this was last year. So that's going to be a long time to go forward and implement it. But on the advisor side, you can do things around the fringes as you start to move to more of that TPA-like philosophy.
Tony:
Yeah. I wonder from a practical perspective too, if this is something aspirationally you want to work towards, whether it would be smart to start to break down some of those walls, so your equity strategist is more aware of how private equity is performing and how they look at it, because ultimately when you get that competition for capital, they should have a vested interest in yielding when their asset class is not the best place to be. And it's more attractive to put more capital to work in the private markets. And maybe just starting that integration process, so they start to feel comfortable with the merits of the other strategies rather than being more silo oriented.
Aaron:
Yeah, definitely. Put your distressed credit and your distressed real estate person next to each other. And I've got this opportunity. You've got this opportunity. If we put both in the portfolio, are we just doubling up on our exposure? So it doesn't need to be a radical shift in the portfolio. And maybe at the end of the day, the portfolio doesn't look all that different and might be more of an evolution than a revolution. But having that thought process when you're building the portfolio of what exposures am I too off sides on or do I not have exposure to at all? So I think those conversations culturally, back to the culture conversation, should just start to happen naturally.
Tony:
So Aaron, I'm going to turn things around a little bit here, go back to your RIA days. And why would you want to do something that appears to be so much harder? And as you point out, there's culture, there's all sorts of dimensions you have to think through.
Why would you want to do something that's harder? There's got to be a hook. And is the hook that we think we’ll have better outcomes for clients? Help us kind of rationalize that for somebody who's hearing this and thinking about all the challenges that it would take to adopt this newer approach.
Aaron:
Yeah. And I think part of the reason why it's harder to think about now is because there's a transition period, which I think is the tough part of doing this. But when you're on the other side of that, and you look at a lot of these organizations that have implemented this thought process and philosophy, there has been a performance differential.
So we published something a year or so ago that looked at these organizations relative to some of the large endowments, for example, and there is a material difference in terms of performance when you make all those adjustments for risk. So tangibly, that's one.
But two, you are shifting to a little bit of a longer-term mindset. You're not as focused on some of the short term gyrations of markets. So having a little bit more patience, both from a psychological perspective, but how you build a portfolio, as well. So maybe you can adopt more illiquid asset classes because you've got this longer time horizon that aligns with the investment product. Whereas maybe today, because of the way that things are set up the way you report, the way you think about this, it's a challenge to get more illiquid exposure. And so being able to take advantage of some of those opportunities changes. But two, I think it does create an alignment across the teams and with your clients around we're building a portfolio that is meant to deliver on a certain goal or a certain objective that you're trying to accomplish. And that means that we're going to build it without SAA in mind, which can be kind of constraining in some instances. I mean, how many times have you sat across from a client and you're thinking about how do I relate retirement or saving for college too? And by the way, we’re building this strategic asset allocation that’s based on modern portfolio theory. It just doesn’t always click in terms of that conversation.
Tony:
And that's why I think it's probably a bit of an easier transition for somebody who's adopted a goals-based approach because hopefully they are already embracing, we're trying to increase the likelihood of achieving an outcome or a goal over the long run. I think it's probably easier for them because TPA seems to be that natural evolution from goals-based investing. I think for a lot of the folks who may be hearing this for the first time, I think you're a hundred percent right. I think the transition feels daunting. Intellectually, I think everyone can embrace the argument that you want the competition for capital. You want the best ideas in the portfolio, regardless of where they fit in a style box or regardless of who's pulling the trigger on where to allocate capital. I think that's an easier sort of thing.
I think maybe as an industry, one of the things we'll have to think about is how do we help advisors transition better? Can we help them with roadmaps? Can we do case studies to help them think through the transition period? Can we help them with the dialogue at the back end of it, which is we're increasing the likelihood of achieving your goals over the long run. We're taking away a lot of the noise when markets get volatile and maybe the ability to point to inflection points where it felt like we should have been going left, but clearly the right decision was going right. And all of those things intellectually, we understand, but we need to kind of make that case for the advisor first. And then ultimately, I think for the client. But aspirationally, I'm imagining most people on the call are absolutely nodding their head and agreeing. It makes total sense. It's just how do we get there?
Aaron:
Yeah, and Tony, I'd be curious maybe to turn the table. I can be the host for a second and ask you a question. but you read something like this and you hear conversations that we've had on this. But how does this make you and the way that you talk about investments? Has it changed the way you think about it? Has it changed the way that FT has thought about it? What does that look like from an asset management perspective?
Tony:
Yeah, I think we have always kind of embraced the goals-based investing approach and we want to get past fixating on “did I outperform the market in a rising market, or would I have been better sitting on cash in a falling market?”
So I think we have always tried to help advisors to think through what is the proper combination of asset classes that give you the highest likelihood of achieving goals over the long run. And I find a lot of advisors have kind of morphed into that. Whether they got there intentionally or not, but they definitely have moved beyond just my goal and my value proposition is outperforming the market.
I mean, some clients still are fixated on that, but I think a lot of advisors have understood that that's the journey they need to go on. And that's why I think that group of advisors, it might be an easier sort of transition to TPA. But as you know, just being an advisor, it is always difficult to introduce something new.
So, the easier that we can make it for them to think through, the easier we can make it to communicate the merits. You know, why are we making a change? If we're making a change because it increases the likelihood of achieving a client's goal over the long run and incrementally we've shown historically it's delivered 200 basis points of outperformance or whatever. Those sort of discussions make it a little bit easier than just the intellectual 30,000 foot discussion. Try it because the institutions are doing it. Because I do get pushback from advisors. That's great. I'm not CalSTRS and CalPERS. I think it's instructive to know what they do, but I don't have the resources. I really can't do that. But I think that if we could help the advisor on that journey, I think that would be a really worthwhile endeavor.
Aaron:
If I could even simplify it further. I mean, we've talked a lot about pillars and dimensions and all that, but at the end of the day, a client is coming to you and they have an objective they're trying to accomplish. And maybe they have a risk tolerance. It's that simple. I mean, everything else, we're the ones that are creating the apparatus or the structure around it. And if I've never had a client that said, please build a portfolio based on modern portfolio theory, that's something that we do. So from that perspective, and I hear you on the implementation that can be challenging. But from a client experience perspective, it's already aligned to some degree.
Tony:
Yeah, I think you made a really good point there. I kind of joke sometimes when I'm on stage that we make it more complicated and more confusing for clients and really what they're focused on very simple sort of outcomes. Can I save enough money for retirement? Can I send my kid to college? Can I achieve all my goals, dreams, and aspirations? And we muck it up by introducing all this complexity and industry jargon.
Aaron, this has been fantastic. I'm really interested in seeing how this plays out over the next couple of years, and we'll have to have you come back to revisit this. I thank you for joining us again. One of our repeat guests on the show, which obviously means you've helped us a lot as we think about allocating capital. I would invite everyone, tell us whether you like the episodes or there are other topics that you would like for us to explore in the future. We're solidly into our second season. I think we've got an all-star lineup and we've covered a lot of really interesting topics, many of which come from my travels around the country as advisors come up to me and say, this is really interesting, but I'd like to learn more about retirement or I'd like to learn a little bit about TPA. I hear a lot of noise about it, but I don't exactly know what it means to me.
So I encourage all the folks who are listening, let us know what you like. Rate our shows if you think they're helpful. It helps us in determining what the lineup looks like as we go forward. But I'm thrilled to thank my friend and guest Aaron Filbeck. Great discussion here today, Aaron, and we look forward to revisiting this in the not-too-distant future. Thank you.
Aaron:
Thanks, Tony.
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