How I Invest with David Weisburd
E161: The Death of Modern Portfolio Theory? w/John Bowman
Tue, 06 May 2025
John Bowman, CEO of the CAIA Association, joins How I Invest to discuss the most important shift in institutional investing: the move from the traditional bucketed approach to the Total Portfolio Approach (TPA). In this episode, we go deep on how allocators are modernizing portfolio construction, why liquidity might be a hidden danger, and what the future of alternatives will look like as trillions of dollars flow from public to private markets.
Chapter 1: Why is liquidity considered a challenge in investing?
I've listened to interviews with Stan Drunkenmiller. I spoke to Cliff Asness about this, about the difficulty of doing the right action in difficult times. Liquidity is actually not a negative because it tempts you into wrong actions. You sell at the exact wrong time when there's a drawdown just because of human evolutionary purposes. What do you think about that? We certainly have
a fetish with liquidity. The industry, I think we've been conditioned, and look, not just the public and the clients, but the industry, to your point, has probably conditioned individuals to think about liquidity as table stakes, as a starting point, as a required level setting to have further discussion. And that is a I think an unwinding dialogue that's currently going on in the business.
I think you're right. There's some extent in which liquidity or illiquidity, I should say, protects us from the worst parts of ourselves.
Today, I'm excited to welcome John Bowman. John, a seasoned expert in asset allocation and the CEO of Kaya, shares his insights on the evolution of asset management from the traditional bucketed approach to a total portfolio approach.
We'll explore the nuances of optimizing investment strategies around client goals rather than asset buckets, the blurring lines between asset classes themselves, and what the top pension funds, endowments, foundations, and family offices are are doing today that differentiates them from their peers. Without further ado, here's my conversation with John.
So asset allocators are moving from a bucketed portfolio approach to a total portfolio approach. Talk to me about the evolution.
Yeah, as you probably know, David, and as many listeners, I hope, have realized Kai's been doing a lot of work on TPA or total portfolio approach, as you said. I think there's some important context needed here Because all of us have been kind of swimming in the water of modern portfolio theory for our entire careers.
Harry Markowitz, God rest his soul, passed away a couple of years ago, had invented modern portfolio theory. And many of its offspring are apparatus that have been normalized, have been kind of, as I said, the water we swim in. That's things like strategic asset allocation and efficient frontier and the idea of asset class taxonomy. benchmarking at the asset class level.
All of this came out of Markowitz's work. And of course, all of us then were taught this through academia, through credentials like Kaya, through our apprenticeship as we grew up and an entire industry. The consultants grew up around supporting this approach to structuring portfolios, bucketing, as you say, David.
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Chapter 2: What is the Total Portfolio Approach (TPA)?
work in managing up to ensure that mutual expectations are set between the ultimate owner, the family, the individual, and, uh, the CIO office.
So, uh, and we're seeing this in, uh, significantly accelerate, uh, the, the velocity of what was kind of inside baseball family offices that were run by the family or extensions of the family moving into a, a really institutionalized, professionalized outsource CIO, uh, effectively. Um, And that takes a lot of work.
But that is probably one of the biggest themes that we're seeing is the rise, the maturity, the coming of age of the family office today.
Thank you for listening. To join our community and to make sure you do not miss any future episodes, please click the follow button above to subscribe. A couple of views on this. One is there's certain things you shouldn't do. You shouldn't give your money to a large bank and just kind of outsource that for many different reasons. There's a principal agent problem.
You shouldn't try to build a program that's fully mature within a couple of years for a couple of different reasons. And what you should do is you should focus on, just like a great business, where do you have the competitive advantage? Where do you have the right to win? So if you look at the top institutional investors, they're not trying to be a 8 or even 9 out of 10 in a bunch of assets.
They try to be a 9.5, 10 out of 10 on a couple assets, get the average in other assets. The way that they... fundamentally do this is they go direct or maybe even build out a direct investing program and a fund program in a couple areas. And then they might even use a fund to fund in other areas. Where a lot of family offices get wrong is they actually go in the exact opposite.
They start direct investing because they don't have to pay fees, losing millions and millions of dollars in mistakes. And then at some point they go to a fund, also usually adversely selected. It's very difficult in a lot of asset classes to get into the top funds without having decade long relationship with a fund or in the ecosystem.
And then maybe if they concede in year 10, they'll go to a fund of fund. I think they should go the exact opposite direction, which is start with a top fund of fund, learn what good looks like. One of the main things that you have to be able to be a good investor in any space is to know what does excellence look like?
Learn that so that at least you know when you're getting access to a good manager. And then if the fund of fund is a good partner, they'll start introducing you to the funds over time. You start investing into funds.
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Chapter 3: How is Modern Portfolio Theory being challenged?
When I talk about some of the massaging, real estate is underreported if you just look at funds, drawdown funds, but significant real estate occurs through direct investing of these big asset owners. So that's almost as big as hedge funds now. And then you get a long tail of private credit, which is now 2 trillion, which is shocking, infrastructure, natural resources.
That's kind of the long form flow. Now, the only other thing I'd say is We all remember from our statistics classes, danger of the mean or the average, right? I mentioned that 21% is the average. If you look at a typical endowment or sovereign, it could be up at 40, 50, 60% alternatives. Whereas the high net worth investor, which is about half of that total 120 trillion is two to 3%.
So you get this kind of mushy, very flawed signal that the average is 21% when in reality, it kind of It exists in more of a barbell approach, depending on the type of asset ownership you're talking about.
It reminds me of the saying, the future is already here. It's just not evenly distributed. There you go. I've had people on this podcast like Lawrence Calcano, founder and CEO of iCapital, and kind of democratization of alternatives is a big trend. How do we get that alternatives number higher in the high net worth, ultra high net worth? And what are the main frictions to that today? Yeah.
So I alluded to this earlier, but just to punctuate it a bit. Again, the average institution is 40, 50% alternatives. The average wealthy family, I'm talking high net worth and ultra high net worth even. Over 10 million, over 100 million, you're talking two to 3% on average. Just to do some quick math,
folks to get a sense for the tsunami or tectonic shift you're talking about in dollar terms before I get to your question. If you simply just take 2% to 3% and modestly extrapolate, so let's just say this thing doubles or gets to 10% over the next 10 years, right? If it's already $70 trillion, meaning the high net worth AUM is already $70 trillion, just do that math.
You're talking several trillion dollars. of money moving from kind of traditional, let's call it ETFs or mutual funds to alternatives. And so to your point with Lawrence, and we work very closely with iCapital, this democratization thing is happening at very fast paces. The demand is voracious.
I think most investors generally, particularly high net worth investors, realize they've been kind of late to the game, missed the game over the last two, three decades as private capital in particular has come of age. And it's not that they're all just trying to juice the portfolio. This is not a return pursuit. This is about a diversification pursuit. This is about access to the global economy.
As you know, David, 90% of US companies are private. Something like 82% of companies that have over 100 million of revenues are private. So this is, I like to challenge folks that talk about return chasings. with private capital, you know, the illiquidity premium debate that we often have. Is it two? Is it three? Is it five?
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Chapter 4: What are the benefits of a Total Portfolio Approach?
And I think that is a flawed approach. It's been the way that we've thought about investments historically, but it's been a flawed approach because again, the world has changed. Systems thinking is
the ability to understand and put together and see connections across asset classes, across geographies, now the introduction of geopolitics, structurally higher interest rates and inflation, parallel trading and supply world that are now coming into fruition. All of these things play a massive role on how to think about an individual valuing a specific asset. And so even
as a junior level associate valuing a piece of real estate property, just to kind of illustrate your question. You need to understand the LP that's walking in the door to consider your strategy, even if you're not the head of IR, even if you're not the head portfolio manager, that they're thinking about the total portfolio and its inclusion, as we've talked about at length,
in delivering on an investment outcome. I think the days where you're parading through a bunch of real estate GPs and it's a beauty contest, who's got the best return capability to fit a certain bucket because I've got a certain need. Those are largely over.
And if GPs, I say this all the time to GPs, if you're still approaching the LP that way, you're not speaking their language because they're thinking about a whole lot of other different dynamics. So again, I go back to, it doesn't change the fact that you need to learn, again, this illustration, real estate valuation in an apprenticeship model.
bumping shoulders, rubbing elbows with all of the senior folks to learn your craft. But understanding the ecosystem, the GPS illustration, I think is critical for the future investment professional.
It's not mutually exclusive. You want to be the best real estate GP. And also you want to have a strategic view on the industry. If you want to be in a leadership position, either on the LP or GP side, you have to understand the ecosystem. I talk to venture capital funds all the time.
You're not only competing against other venture capital funds, you're competing against private equity, you're competing against S&P 500. Whether you know it or not, you have to understand the risks and rewards of each asset classes and the pros and cons of investing so that you could sell against your competition. How do you sell against your competition if you don't know who your competition is?
We didn't talk about it much, but the M&A, even within the GP world, where the traditional folks, the T-Row prices, pick your poster child of 90s, 60, 40 asset management, right? Maybe it's T. Rowe Price, maybe it's Franklin Templeton, BlackRock. These folks are aggressively moving into private capital.
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