Ashby Monk – Total Portfolio Approach and the Future of Asset Owners (EP.480)

0:00You need to understand the total portfolio. every new investment that comes into the portfolio, you're thinking about the overall risk budget, liquidity needs, all these goals that every pension fund has. TPA begins to think about this not just as an asset allocation project. The word TPA to me feels more like an investor identity project. TPA is the next level of advanced. It implies that you have all of this real-time stuff at your fingertips that you can think about. This piece of knowledge that's being delivered to the investment committee. Is that knowledge better than this other knowledge?

0:38And then you can act on that knowledge. Well, some knowledge is going to be, we've found a manager that does X. Over on the other side, we've got an ETF that does Y. Now it's the CIO's job to recommend which to do. Finding a way of looking at those different opportunities with apples to apples is really valuable.

1:03I'm Ted Seides, and this is Capital Allocators. My guest on today's show is Dr. Ashby Monk, the Executive and Research Director of the Stanford Research Initiative on Long-Term Investing. Over the last two decades, Ashby has worked closely with some of the world's largest sovereign wealth funds and pension funds on governance, organizational design, technology, and investment strategy. He's also a co-founder of KDX Management, a venture capital firm focused on Investec, a co-founder of several startups in the space, and a repeat past guest on the show. His first and most recent appearances are replayed in the feed.

1:44Our conversation explores the increasingly popular total portfolio approach, Ashby's perspective on the role of AI and data in the investment office of the future, including his work with Hoopit AI, a very cool relationship intelligence platform, and examples of innovation at Saudi Arabia's Public Investment Fund and the New Mexico State Investment Council. Before we get going, as we turn the calendar on the new year, past guest Katie Milkman reminds us that it's a wonderful time for a fresh start to form new and improved habits. And start small, like the atomic habits James Clear has made so popular.

2:22I am going to stop responding to emails prolifically while I travel. My team confirmed that I'm both inefficient when doing so and in a rush to get answers that might do more harm than good. So I'll stop, slow down the decision, and write a funny out-of-office reminder instead. In the event you're struggling to find a New Year's resolution, how about telling someone you encounter about the award-winning Capital Allocators podcast. It's true, we've won some awards along the way, but don't worry about that. It sounds really impressive, and you'll sound culturally plugged in for mentioning it. If you do that repeatedly over the next few weeks, you'll form a positive new habit and get in our good graces as we look to expand this year.

3:05So you'll have that going for you, which is nice. Wishing you a very happy new year, happy listening, and a warm thanks for spreading the word. Please enjoy my conversation with Ashby Monk. Ash, great to see you. Great to be here again. How many people are in the four-timer club? We don't keep track of things like that. I have to tell you, even though this is the fourth time, it is scary. You have such a remarkable impact in the world now, my friend. Well, thanks. Let's kick it off with this continued focus you have on the largest asset owners of the world. Why do you think that's so important to do?

3:47They have quietly become the most important organizations in the world. And I don't put a caveat on that one. They are the cornerstone of our modern social welfare state. They are integrated into so much policymaking from Saudi Arabia to United States to Australia. As banks have been regulated out of risk taking, they have become the capital in capitalism. I continue to be focused on these asset owner investors. I talk to so many students that still do not know what pension funds do and sovereign funds do. There's a whole ecosystem of young people that we need to drag along this journey, which is why what you do is so important because a lot of people do listen to your podcast and they'll show up asking me about asset owners because they wanted to learn about investing.

4:44I wish more people knew about this industry that we're passionate about. How's the work that you've done with them evolved over the last few years? If the first decade of my career was about design, governance, process, the second decade or so began to blend data, technology. The last five years has been a pivot for me into data analytics, software technology, tech enablement. You can't do investing without good governance, without culture, without technology. It's which leverage point you're going to go after to drive the change you want to see in the industry. And so for me now, that leverage point is largely tech, but tech touches everything.

5:32We can't talk about TPA without tech. We've been talking about TPA, Total Portfolio Approach, for a while. Now, it does seem like in the last year, maybe with Steve Gilmore going to CalPERS, that more and more you're starting to hear about this as a thing. I'd love to hear your own description of what TPA is. Dare I say old wine and new bottles? When we came out of the financial crisis, we ended up with this factor-based asset allocation and work by Andrew Ang, but also Dimson and a few others that were going into what are the true nutrients of return. Those nutrients were thought of as factors.

6:17If you were a really forward-thinking investor and you wanted good diversification and not to have all your assets correlated in a crisis, you would think about your diversification across those factors so that when these crises hit, your drawdown wasn't quite as severe. I think of that as the beginnings of what we are now calling TPA. You need to understand the total portfolio, every new investment that comes into the portfolio, you're thinking about the overall risk budget, liquidity needs, all these goals that every pension fund has. TPA begins to think about this not just as an asset allocation project.

6:59The word TPA to me feels more like an investor identity project. We often think of asset allocation as the biggest driver of return. That's the Brinson work. But asset allocation can't just be set in a vacuum. You can't just say we're going to do factor-based asset allocation if you're CalPERS. I can remember having a conversation with the late, great Joe Deer, who was the CIO at CalPERS coming out of the financial crisis. And he explained to me that his goal was to do factor-based asset allocation at CalPERS. And he even talked about how he was going to do it inside an organization that was designed along product categories.

7:45He had this ambition to create a translation committee that would translate a factor-based asset allocation, a total portfolio approach, to a product-based strategic asset allocation with bucket filling. And I think the fact that we're 15 years on from that moment and we're here talking about CalPERS' attempt to do TPA tells me that original project at CalPERS probably didn't go the direction they were hoping because here they are trying another total portfolio approach. It's a very exciting moment. Just as we came out of the financial crisis, we had factor-based asset allocation and we had insourcing, we had the Canadian model taking off.

8:28this is the new model. People have looked at New Zealand, GIC, Canada Pension Plan, and they've said, wow, there's great performance there. How do we replicate that? But it's going to be hard. TPA, to the point of my life's work pivoting from pure governance to almost pure technology, getting TPA right means you have to build this nerve center at the center of the organization. You are aligning everything with an organization's goals. Our risk budget, liquidity, cash flows, capabilities, our people. Everything is thinking about how this portfolio connects to our goals. To do that, you need to know where your portfolio is today.

9:13What are your exposures? What are your assets valued at? The more you have private markets, that's going to be hard. I don't know any plans today that are really good at valuing their private assets. It's incredibly difficult to bring real-time valuation into venture capital, private equity. This whole TPA push is designed for organizations that do less in privates. You can do it. There are places that have big alternative buckets that take a total portfolio view, but you really need to invest in your organizational capabilities. You have these gears. Anytime you shift your asset allocation gear, there's a consequence on your organization and your implementation.

10:04If you're going to go from a strategic asset allocation to a total portfolio approach, that's a shift in asset allocation. Can't do that in a vacuum. You're going to have to completely change your organization and how you're implementing it. And that's the part that we'll need to watch and see how people do. For a pool of capital that's deeply ensconced in strategic asset allocation, where the way they report multiple asset classes are, as you say, these products, but ultimately they need to roll up risk. They need to measure what they have so they understand where they are. How different is it from someone who starts with a sophisticated strategic allocation to say they're now going to use TPA?

10:46It's very different if you're shifting people's incentive compensation to align with a total portfolio approach. You're building analytics that allow you to look across real estate, infrastructure, timber, land, hedge funds, on and on and on, understand where you're going to squeeze that next unit of return out of the risk available to you. It's very difficult. It's the fully advanced level of investing. It's the future. 22 years from now, we'll be like total portfolio approach. That's so funny. We weren't doing that. It's like asset liability management. I'm old enough to remember in 2001 where we were like, wait, we need to link assets and liabilities.

11:25That's the way we'll see TPA. Right now, you need to have a GPS for your portfolio, global positioning system. So let's call it a portfolio positioning system for your portfolio. Where is everything now? Because if you're going to make real-time changes to your asset allocation, you need to know where you are to choose left or right. You then need to know what kind of car are you driving? How are you getting from A to B? Because that's actually going to have an effect whether you choose to invest in hedge funds, private equity, et cetera. That's your identity. Then you have to have this map of the opportunity set.

11:59And we need to be much better at forecasting and predicting the future. I can remember the New Zealand Superfund, which is one of the best total portfolio investors having to scrub out all of the individual portfolio links to their compensation. It was total fund, qualitative metrics for compensation. That's hard. A lot of people are still compensated based on their own individual portfolios. So it's hard to tell them not to do deals for a year when their asset class goes out of favor. People have asked me about TPA, the hardest thing to describe is the difference in the unit of work. Strategic asset allocation, we have our buckets.

12:47We're going to go find managers to fill those buckets. If you're now in TPA, how does the individual investment decision differ from that in the strategic asset allocation? The unit of work becomes knowledge work instead of deal work. The unit of work is different. It's not capital deployment. It's not bucket filling. It's something else moving you towards your objective, intelligent understanding of additionality in your portfolio. go. That's why I say TPA is the next level of advanced. It implies that you have all of this real-time stuff at your fingertips that you can think about. This piece of knowledge that's being delivered to the investment committee.

13:33Is that knowledge better than this other knowledge? And then you can act on that knowledge. Well, some knowledge is going to be, we've found a manager that does X. Over on the other side, it's, we've got an ETF that does Y. Now it's the CIO's job to recommend which to do. Finding a way of looking at those different opportunities with apples to apples is really valuable. I have a soft spot for the SAA people that got a board that isn't an expert board. So an SAA is actually useful in keeping us tied to the mast. How much more movement, whether it's turnover or refinements within a TPA approach, is there from their initial reference portfolio or an SAA model?

14:21If it's done well, there's a constant reflection on whether or not this opportunity coming in adds value. So some of it is a bottom-up understanding of deal sourcing and deal opportunities. You would add a deal if it improves the portfolio and you wouldn't if it doesn't. You could imagine where you're quite happy with your portfolio and you're just watching it. That's a very hard thing to do. Sit and do nothing. We're giving you the power to make pretty tactical moves. People don't like saying TAA in relation to TPA because it makes people feel the short-term possibilities of TPA. It is there.

15:03Once you have these systems in place, you could pivot around beliefs, assumptions. It also allows you to be counter-cyclical very quickly. If markets move quickly, you're going to be able to buy low. And if you feel like things are inflated, you can sell high. I am a big fan of counter-cyclical investing for long-term investors. We'll see how a lot of these CIOs like Stephen Gilmore and others implement it. When so much of the long-term drivers of strategic asset allocation returns have been private market investments, venture capital and private equity, and you mentioned that's not really designed to incorporate that.

15:41How does a pool who's trying to implement TPA think about that trade-off of the flexibility versus what's historically been the return driver in these asset owners? There's a couple of hybrid versions where there is basically an underlying commitment to each traditional asset class. 50 % is going to go to the traditional buckets, which looks and feels like bucket filling. And 50 % is that TPA around the reference portfolio. By the way, that's going to help you to recruit and retain human beings. It's hard to recruit and do a TPA. You recruit people into private equity jobs, real estate jobs, because we demand, especially at the senior levels, a certain level of expertise and networks that goes into being successful today.

16:32There's a question about whether or not that's the recipe 10 years from now, but today it's the recipe. Having that hybrid version of TPA would allow you to recruit people and retain people into it. As it relates to the private markets, there is this strong tension. If you're a big private equity infrastructure investor, you're probably a little nervous about the TPA push. It's hard to do TPA when you're making a 15-year commitment. You're planting seeds that are going to take a long time to grow. It's harder to move around that portfolio and add asset allocation alpha. When it's done well, it goes back to this notion of every deal that comes in is judged in relation to everything else in the portfolio.

17:19Doesn't mean that you're not doing private equity. It just means that you're judging your private equity in relation to everything else. And you're thinking about the cost of this illiquidity. And is it better to maintain optionality or is it better to bury this in the ground and generate 22 % returns? I wanna circle back to this thought of your pivot to technology. Everyone's talking about AI. What have you seen in different use cases of AI tools for the asset owner community? A lot of asset owners are thinking in terms of automation. What FTE can we automate? It's a natural place to start because you think about artificial intelligence as replacing human intelligence.

18:09I don't love that framing. I love thinking about how technology unlocks additional basis points of return. It gives permission to pension funds to spend more money, especially on the initial setup cost of getting your data right. There's a big piece here, which is technology enables two things for every investor. One is speed, get to where you're going faster. And the other is insight. for 4 ,000 years, I would argue, most of the tech innovation that went into our industry was speed. You can go back to the Babylonians and look at cuneiform tablets, and you can literally see regressions being done on these cuneiform tablets around the depth and flow of the Euphrates River and commodity prices.

18:56We're still on tablets today. It's just they're digital. That tells me most of that tech advancement has been about speed. But in 2016, we had AlphaGo. We had the beginning of this AI moment. That AlphaGo case study, you see this moment where inhuman intelligence revealed itself for the first time for most of us. The machine did a move that had never been trained on before. It was an inhuman move, move number 37. In fact, all the humans in the room thought the move was a mistake. The move ended up to be the winning move. So all of a sudden we realized, oh, wow, when you define the rules of the game for these machines and you unleash them in these generalized adversarial networks, they create moves that we hadn't even thought of.

19:47That's inhuman intelligence. And so moving from speed to inference and insight is this great unlock. That's what I'm mostly excited about. And that inference is going to benefit the long-term pension fund investors. They're the ones that are managing assets over longer horizons where inference, insight have enough time to get priced. When I'm working with pension funds, a lot of the technology that we're applying AI to are simulations, models, projections of the future, you got to get data clean you got to get it matched you have to have a security master this is what a lot of work that's going on right now in pension funds they're spending a lot of money on their portfolio positioning system their source of truth what you build on top of that source of truth is the insight that allows you to understand where your portfolio is and change it not just automate away a lawyer, which is probably great, but to use the technology to say, gosh, I thought we were in a different position than we are, and now we should change our portfolio.

21:00There's two ways of assessing the data as you've described it. One is looking at what you own and making sure you understand your risk factors. And the other is trying to predict what might happen. How do you think about the possibility of these AI tools going from understanding what you own to helping a CIO make judgments about where they want to head? This is one of my favorite topics because the investment business, we're crystal ball gazers, we're tarot readers, we're living in a world where we're trying to predict the future. human intuition, gut feel. These are the things that most of us are using.

21:45And so the question becomes, what happens when you have really trustworthy, reliable data upon which you can begin to build analytical engines that reveal new knowledge about the world? Right now, where we get knowledge are from podcasts. We get it from books. Other people have gone and done the work, and now they're giving us knowledge. But you can imagine a world where knowledge gets built from the bottom up in your data. You're starting to spot patterns, heuristics, shortcuts. Those are all code words for knowledge, as are algorithms, basically. Code words for knowledge. We're going to build this knowledge on top of clean data.

22:26I often think in terms of navigation, it's a very easy way for people to pull themselves out of the investment industry where we have a bunch of priors and say, well, what's happened over the last 20 years in personal navigation, going from where I am today to my destination, my goal? A lot has changed. When was the last time you pulled out a Rand McNally map? Well, what happened was we got a GPS that told you where you were. Google then went and indexed the world. So we know the universe of destinations. We had all this alternative data coming into this ecosystem to tell us that the possible pathways to take me from where I am to where I'm going.

23:05And the overlay for the investment industry that I think is really important is the type of vehicle you're driving or you're traveling in is incredibly important to connect you from your current location to your destination. We understand your portfolio. We understand your goals, your preferences. That's your destination. Let's maybe stop calling our destination and expected return target on an annual basis, which is again, an intermediate goal rather than a true goal. And we can start to communicate that goal in the cash outflows. Now machines, once they know your current position and your cash inflows, and they know your outflows and all the scenarios around those outflows, machines can start to optimize and really understand the universe of options available to you.

23:57The important part is to say, because we understand you, Ted, and we know your resources, your people, your process, your information, we can see where you are on the map, your portfolio. We can layer, just like Google Maps does, the different risk factors. We can see the satellite view. We can see the traffic view. We can see all these things on your portfolio. When the AI starts to optimize between your destination and your location today, it will give you very unique guidance. So I often get asked, won't AI just tell everybody to buy the same stock? That's a very short-sighted moment of AI, which is, yeah, if we're applying AI to the outside world of investable opportunities, maybe it's going to tell everybody to buy the same stock.

24:51But that's not the way we're going to apply AI in our world. It's going to be more like when you pull up your Google Maps and say, give me directions to In-N-Out Burger. It's going to tell me, hey, Ashby's in Los Gatos. The nearest In-N-Out Burger is at San Jose Airport. But the line is too long at San Jose Airport. So it's going to direct me to Palo Alto because there's no line. because Google knows that my destination is the hamburger. It's not the back of the line of in and out burger. Think about how powerful that is. That's where the human beings in these organizations will become the co-pilot to the AI rather than the AI being the co-pilot to the human beings because they're going to have all the data and they're going to have that customization available.

25:40As we take this from the conceptual stage of what allocators in general are doing to some of the ones that you've seen and worked with that are doing interesting things, we'd love to hear some examples of what you see as some of the most interesting things happening in the allocator world. Because innovation is hard in this industry, we don't often see R &D teams inside pensions. The really interesting pension funds, sovereign funds are those that are trying new things, new models. The way that best practices are transmitted around the industry is when a new model drives high performance, then everybody else looks around and says, oh, hey, how did they do that?

26:27And could we do that? Is our organizational identity similar enough to do that? That's what's happening right now with TPA. People have seen the high performance of New Zealand Superfund over 20 years, and they're saying, how do we get a little bit of that? You literally have CalPERS hiring the CIO of New Zealand. Well, where can I find places that are taking on big grand challenges and trying to build new models? The most interesting sovereign funds feel like they have a development angle right now. The two that I would flag are PIF in Saudi and New Mexico's State Investment Council. Not all that similar when we dig into it.

27:09The PIF, trillion-dollar-ish organization, started over 100 companies. This is a sovereign fund. Think about how different that is. This sovereign fund has started over 100 companies. Even more than that, the crown prince of Saudi Arabia has said that he wants Saudi Arabia to be net zero by 2060. Saudi Arabia, that is synonymous with fossil fuels. For the crown prince to say, we're going to go to net zero by 2060 and then point at the PIF and say, this is my lever for change. We can all get excited about that opportunity to watch and see, can PIF take this place that is the global epicenter of fossil fuels and helped turn it into a net zero economy.

28:02Really fun project there that if they need help, we should all be interested in seeing that through because if you can get Saudi to net zero, haven't we sort of by definition avoided climate change? The next one is the State Investment Council in New Mexico. Similar idea. It's a sovereign fund. A lot of the wealth comes from the subsoil assets, a lot of it coming out of the fracking boom. The exciting thing about New Mexico is that the goal is education. They are taking the assets under the ground, and through this investment vehicle, they are creating a generation of educated humans. That's the difference from a pension fund, where you're taking all of this wealth and you're creating retirement security.

28:46They just made this announcement that they're going to do universal childcare from zero to four. That's only possible if they manage to invest this capital well. That's, first of all, the cornerstone of the modern social welfare state. What a neat illustration of how these organizations can have a tangible impact on people. You're going to see that in New Mexico. Because of the scale of that organization, they're going to add$20 to$30 billion. They will soon be the biggest sovereign fund in America, passing Alaska. There's an opportunity to say the model that was working there for the last 10 years probably needs to change.

29:29So the door's opening because of the scale coming into that organization to think about what's next. I love those moments where the board says, hey, we probably need to change because of some dynamic. In this case, it's inflows are coming so fast, they're going to need to change. The other piece that's fun about New Mexico is they are maybe the biggest developmental investor in America, not because they are mandated to, but because they see it as an opportunity to connect the investment fund to the local population and drive positive impact. They also see it as an opportunity to drive alpha. That's where I get excited because that's when things can be repeatable role models.