How HNWIs and Family Offices Allocate Capital
Significant differences in asset allocations as a person or family’s wealth increases.
Public holdings (equities) climb in line with overall wealth while liquid holdings decline in proportion.
Family offices often gather cash to take advantage of future opportunities.
Strategy In broad terms, HNWIs (High Net Worth Investors) tend to seek less volatility for their hard assets.
Balancing the security of the bond market with return benefits of equity markets is as common for family offices as it is for any investor—everyone would prefer higher returns with less risk. But the wealthy can better source the skills, advice and assets that offer a greater promise of such returns.
Regardless of location, family offices generally work within a typical allocation framework. Still, such strategies will be highly customized where the purpose of wealth drives the investment strategy. Objectives of an investment plan will vary widely as they are affected by circumstances, time horizons and so on. Such factors will shape specific KPIs and determine asset allocation.
Family offices and HNWIs generally don’t have a typical strategy nor is it static. Opportunity and speed rate highly because a family office can be ready to write large checks when they spot suitable investments. Such nimbleness is a function of having a direct line of communication with the decision-maker and provides an interesting contrast to investors who are more likely to rely on a structured asset allocation framework, especially if run by external investment professionals.
Diversification, ESG and SRI
Diversification is also important across equities, fixed income, hedge funds and other investments. Core equity holdings for family offices are typically aligned with the family’s business interests and are combined with short-term equity and equity-like investments.
Many FOs are also focused on meeting impact goals as well as returns and invest sustainably across all asset classes including listed equity, fixed income and private equity.
Another commonality is that they often hold a varying number of direct investments that involve more work in terms of due diligence and monitoring but offer a greater chance of higher returns and oftentimes more influence in the direction of the holdings. Additionally, investment frameworks are more determined by the source of wealth rather than geography and that such a sectorial bias will be fairly consistent. It is not unusual for a family whose business is very real-estate heavy to have a continued interest in investing in real estate.
Political Risk Tolerance
One driver that appears more prevalent in the East than in Europe or North America is the issue of political risk. In emerging markets, where such risks are often higher, family office diversification strategies may result in a greater proportion of assets being located outside its home markets in order to mitigate any financial risks that could result from political upheaval.
The differences come in the details of how families define risk. Families are more likely to see collecting assets in the same or adjacent industries as lower risk because they know the markets, understand the dynamics and feel prepared to take advantage of opportunity—a condition that ties back to the fact that founding members of family offices remain the chief investment decision-maker. Where non-family managers are more common, asset diversification rather than industry expertise more often sets the tone for mitigating portfolio risks. However, it’s the family comfort level with either approach that is the determining factor.
Asset allocations typically shift into a greater proportion of public equities as a family’s wealth increases and fortune progress through generations.
Family philosophy about the purpose of wealth is a key driver of investment strategy.
An array of circumstances such as time horizons and growth targets shape specific family office KPIs and determine asset allocation.
Sources of wealth greatly influence asset allocation.
Political risk is a driver of geographic diversification.
Families are more likely to acquire assets in the same or an adjacent industry to that of their original income source.
The length of legacy also has a direct influence on family office investment strategies. The family office of a third-generation family generally doesn’t have the same mandate as a recent entrepreneur. The former will likely be focused on wealth preservation, the latter on wealth creation. With the first-generation wealth creators, how to invest is most important. Also, the longevity of wealth becomes increasingly relevant over time.
Private assets family offices have been at the forefront of the surge in demand for private assets, driven by years of historically low interest rates due to the illiquidity premia and consequent higher returns of these assets. Many offshore families living outside their country of origin look for opportunities in private equity where fewer middlemen are involved and real estate as a tangible asset that people understand. Real estate is still one of the most popular investment strategies for family offices as it is considered the base asset for wealth creation and wealth preservation.
Liquidity remains important for all clients, especially when it comes to the current volatility in markets. However, one recent survey found that family offices are likely to strengthen the weight of private assets, with 59% reporting that if they were to add one additional investment person in the next six months, that person would focus on illiquid investments. It also reported that 13% of total investable assets were direct investments, with 98% of respondents expecting to maintain or increase this exposure over the next three to five years.
As the US Federal Reserve cuts rates and pumps money into the country’s financial system, investors in general have taken advantage. The Wall Street Journal reports that in the second quarter of 2020 private equity-backed companies issued more than US$31bn in junk-bonds, a record that indicates when the Fed buys junk-rated debt, in any fashion, it makes the asset more attractive. It would be fair to assume then that family offices already involved in private debt and equity would follow through with plans based on these developments.
Private equity-style investments are increasingly attractive as they fit particularly well with the long-term horizon of family investment objectives, which often run to 10 or 20 years, and easily fit the maturity profile for a private equity opportunity. A decline in the number of publicly listed US companies—which reduced by almost 50% in the past 15 years—reinforces this belief. Older businesses generally have strong cashflow and lower growth so their related family offices tend to look for higher-growth opportunities in venture capital, private equity, direct investment and the new economy. Such an approach also smooths out concentration risk. Families that have already sold their businesses have a stronger bias towards financial assets while those heading up new high-tech business are looking to invest in other asset classes in other countries to decrease these risks because their businesses are high risk and high return.
Even though many may express that the family office is seeking to invest in sectors and countries that will help to diversify from the main risks that the family businesses themselves are exposed to, in practice they seem to still gravitate towards familiar grounds. This often leads to a significant portion of family office funds being invested domestically and regionally. Families tend to leverage personal business connections and relationships when it comes to new investments. As a result, they can be more open to early-stage businesses, especially if that business is being managed by someone they have an existing relationship with. An additional trend is to choose to have more than one family office—one in their home country and others in strategic offshore locations.