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31.03.2021

How to define a tailored family office investment strategy

Investments are at the core of single family offices. Whether investment management is performed in-house or outsourced, its success depends on a sound investment strategy. Surprisingly, some families and their family offices still rely on a standard level of wealth managers' services and model portfolios to develop their investment strategy, leading to expected yet unexceptional results. We believe that a bespoke approach delivers more. Especially when it's based on broad considerations and designed to embed unique and lasting strategies in your overall family office governance. Read on for our recommendations when it comes to honing an individualized investment strategy.

The elements of a family office investment strategy

The entire process should clarify the following: the goals, objectives, and vision of your investment strategy and the related investment-decision making and monitoring. These elements not only guide the investment selection and evaluation in detail. They enable the family office's risk management in a consistent due diligence and monitoring process for both service providers and investments.

Where should you start?

If you are a regular reader of our blog posts, the following may sound familiar to you. In our view, shared values, vision, mission, and a family's purpose of wealth are fundamental to every wealth plan, single family office, and wealth management strategy. If these critical pillars do not harmonize, the best place to start is to review them. The comprehensive assessment should reflect the purpose of the family's wealth: it can unify the family, empower its members, and impact the community and result in a common understanding of how the family will manage its wealth over generations. With that, the single family office embeds the family's values and purpose with financial objectives in broad terms. And it's the ideal basis for an individualized investment strategy and to retain control over its execution.

Defining the purpose, goals, and objectives of the family office investment strategy

With the groundwork performed, the first step is to align the family's purpose of wealth with investments. Wealth needs to be preserved in the first place to uphold the family's financial status and standard of living. In contrast, growth ambitions need to be evaluated in light of risk considerations. This should be done for the family wealth as a whole to ensure an appropriate degree of diversification. It must also consider the family's exposure to the different financial risks such as geographical, currency, and asset class exposure.

The family's background has an important impact on the investment strategy's goals and objectives: entrepreneurship, long-term orientation, community interaction, and generational collaboration shape them along with purpose. Shared values and social responsibility provide additional guidance. In particular, the family's business's environmental and social characteristics can set the benchmark for its investment strategy commitments. Conventional investment objective-setting may overlook these factors due to its investment level focus or by considering them only at a later stage of the investment process. However, for families and their family offices, misaligning the investment strategy and the family's overall purpose and strategy causes a severe risk for their future preservation of wealth. It's worth spending time and effort to elaborate on purpose and the origin of motivations and wishes to define the investment process's direction. A single family office is ideally positioned to overcome these shortcomings of traditional investment positioning and to put wealth in context with the family's unique attributes and requirements.

Families focus on building for the future based on their values and vision. Thus, their family office investment strategy should integrate into their overall wealth preservation and growth framework and complete the bigger picture. Still, clear and tangible financial objectives are required to formalize the investment strategy's long-term purpose and goals.

Risk management

It comes as no surprise that the investment strategy's goals and objectives need to align with the risk management strategy. Based on the family's knowledge, experience, financial situation, and ability to bear losses, the assessment should cover risk tolerance, exposure to risk factors, and understanding the investment strategy's overall risk. In other words, it captures the family's understanding of investment risk and the relationship between risk and return on investments and needs to be assessed for each asset class.

This approach is key to enabling investments in line with the family's attitude to risk. It leads to a family office investment strategy where the family can financially bear the related investment risks consistent with its investment objectives. It's also crucial to evaluate the impact of financial instruments and transactions at the family office's investment portfolio level. Further considerations, among other factors, include credit and concentration risks, interest risks, inflation, and custody risks. Extensive stress testing of loss scenarios for both amounts and holding periods to recover will indicate the appropriateness of the defined risk parameters.

Time horizon and liquidity needs

The next step is to specify the investment period. Family office investments will primarily be long-term plans to achieve the desired results, which should be reflected in the minimum investment period. For planning purposes, liquidity needs should be defined in terms of amounts and frequency of withdrawal outflows.

Asset class guidelines

Clear asset class guidelines are required whether the investment strategy implementation is performed by the single family office or outsourced. Classifications should be described with the expected risk and return characteristics. Define the issuer requirements, capitalization requirements, expected risk rewards, management attributes like value or growth for equity, maturity length, and rating standards of fixed income, and criteria for alternative investments' characteristics. This step granularly defines the pool of asset class options for inclusion in the portfolio and needs to be specific on exclusions. A clear assignment to index and peer groups sets the bar for the standard benchmark comparisons in light of the particular risk parameters.

Family offices regularly have specific exposure to alternative investments. In such an event, we recommend developing dedicated in-house capabilities for this asset class and defining core investment options in detail to make a difference. This requires defining the standards for investment ideas and investment opportunities, due diligence, execution, and successful exits. It would be best to have absolute clarity about strategies, sectors, geographies, and maturities to succeed in alternatives.

The asset class guidelines should be specific on inclusions, restrictions, and exclusions on types of schemes and investments. The guidelines further set the standard for responsible, sustainable, and impact investing and its integration into the broader portfolio and asset allocation strategy or definition of separate sustainable and impact investment management parameters.  

Asset allocation

Diversification of investments is an integral part of the investment strategy and assessing how they contribute to the overall portfolio risk and return. Wealth managers widely rely on Modern Portfolio Theory concepts to evaluate and optimize individual investments' potential risk and reward in the portfolio context. The model has its critics due to its downsides in forecasting and emphasizing a single period rather than multiple decision-making periods. Still, diversification and efficiency remain important, and model portfolios can help define minimum weight, target weight, and maximum weight for each asset class. It's more about goals and diversification than optimizing investments, and alternative investments can significantly diversify the portfolio and increase efficiency. The specific asset allocation should ultimately lead to portfolio construction and diversification that targets the defined risk management parameters.

Investment manager selection and monitoring

Your single family office should establish clear guidelines for investment manager selection and monitoring. Each asset class may require different types of investment managers and specific performance parameters and objectives. The manager selection due diligence process should include the manager's regulatory status, correlation to the asset class, performance against its peer group, risk-adjusted performance, minimum track record, assets under management, expense ratio, fees, and team stability.

Regular investment manager reporting and performance reviews are part of the ongoing monitoring process to ensure that the selected investment manager performs according to the selection due diligence criteria. Deviations from the investment strategy guidelines, organizational changes, and regulatory procedures need to be explicitly monitored. If performance is not within the defined parameters, there should be a specific monitoring process, including the monitoring period and criteria for replacing the investment manager.

Controlling, review and monitoring of the investment strategy

Controlling and accounting for the investment expenses will allow for assessing all investment strategy costs and evaluating their appropriateness. The investment strategy needs to be reviewed regularly in light of changes in the objectives and risk profile. If the objectives are not relevant or feasible anymore, the investment strategy needs to be adjusted. Clarity over risks and returns and an adequate understanding of the relationship between them will determine whether the investment strategy achieves its purpose.

Conclusion

The investment strategy is at the core of a single family office to ensure its alignment with the family's purpose of wealth. Ultimately, the financial objectives need to coherently complement the family's values and purpose of wealth in the family office governance framework. There is no standard template for this, and we do not recommend following a common approach that may not be feasible for multi-generational wealth preservation and growth. In our experience, a tailored system with external experts' assistance delivers the best results for a disciplined and structured family office investment process. The target for investment-related decision-making and evaluation is the alignment of goals, objectives, and the strategy's vision with consistent risk parameters in a diversified portfolio. We didn't cover the family office's investment committee to implement its strategy in this post since that will be a specific topic to be covered soon.  

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