Personal OpinionsON ALTERNATIVE INVESTING FOR FAMILY OFFICES

June 1, 2021

Family Offices have moved farther away from the traditional “60-40 Asset Allocation Model” in recent years. It’s now a trend for investors to diversify the types of equities, the target capitalization size and the geographic focus of equity investments; leaning further towards global and emerging markets.

Hence, many investors have diversified the type and maturity of fixed income securities held in their portfolios.

Studies as far as 2011 have showed that more than 85% of Family Offices investing in hedge funds at that point were highly likely to increase hedge fund allocations and in 2012 McKinsey & Company predicted that allocations to alternatives will increase to 28% of total portfolio assets. The main purpose being to achieve increased diversification and to increase risk-adjusted returns and limit losses in down markets.

So if you want to understand how alternative investments have become a choice option for family offices in this manner, it may be pertinent first to know what types of investments are considered “alternative investments” and why.

ALTERNATIVE INVESTMENTS

Here’s a quick summary to give you an idea of what’s what:

 

HEDGE FUND

A pooled investment vehicle that generally meets the following criteria:

  1. Privately offered and not accessible to the general public
  2. Specifically targeted at high net worth individuals or institutions
  3. Not registered as an investment company under relevant Laws
  4. Its assets are managed by a professional investment management firm that participates in sharing the returns of the investment vehicle depending on investment performance
  5. Provides periodic but limited investor redemption rights.

FUND OF HEDGE FUNDS

This is investment vehicle whose portfolio consists of shares in a number of hedge funds. Its strategy can be applied to any type of investment fund, from a mutual fund to a private equity fund. The fund of funds manages a portfolio of other investment funds instead of investing directly in securities, such as stocks, bonds or commodities.

PRIVATE EQUITY

Ownership interest in a -portion of a- company that is not publicly owned or traded on a stock exchange. But from a strictly investment perspective, a private equity generally refers to equity-related finance that is designed to bring about some sort of change in a private business, such as:

  • Helping to grow a new business
  • Bringing about operational change
  • Taking a public company private
  • Financing an acquisition

 

COMMODITIES

Products such as futures contracts, physical commodities, ETFs etc traded on an authorized commodity exchange. The types of commodities may include agricultural products, metals, petroleum, various types of currencies.

 


 

Now all of the above mentioned types of investments typically are considered “alternatives” being that they are alternative asset classes to the traditional equity and fixed income asset classes.

It is therefore in their best interest for Family Offices to focus on specific “alternative investment” opportunities which not only fit the title but actually have low correlation to the characteristics and performance drivers of traditional markets so that the chosen alternative investments actually provide portfolio diversification and they in turn reach their investment goals of higher expected returns with lower risk as a result of having a truly well-diversified portfolio.

ACKNOWLEDGING KEY CHARACTERISTICS

It is also important for you to understand the distinctive features of each type of alternative investment when deciding an execution strategy in order to achieve the desired impact on overall portfolios.

The chart below shows a summary of the various choices of strategy offered by alternative investments that can be tailored to your family office’s liability stream, cash flow and risk tolerance.

Hedge Funds Equity long/short

Global Macro

Event Driven

Relative Value

Market Neutral

Distressed Credit

Convertible Arbitrage

Geographically focused Strategies

Left-tail risk/Downside Protection

Real Estate Equity

Debt

Industrial

Residential (Single/Multi-Family)

Retail (Shopping Malls)

Mixed Use

Real Estate Investment Trusts

Distressed

Others

Commodities Agricultural
CommoditiesEnergy
Financial
(Futures & options, Foreign Currency etc)
Private Equity Growth Capital

Venture Capital

Mezzanine Capital

Leveraged Buyout

Management Buyout

Distressed

Secondaries

Others

 

 DUE DILLIGENCE: INVESTMENT DUE DILIGENCE

When it comes to “Alternative Investments”, areas of interest to be pursued by Family Offices primarily focus on the allocations among the different alternate investments. Other critical areas to be considered include: asset/liability matching, cash flow needs, risk tolerance, investment time frame etc.

Other areas for investment due diligence for alternatives can involve a firm’s trading capabilities and supporting technologies. Trading capability assessments are central to investment due diligence for most hedge fund strategies and commodities strategies but generally less relevant for most real estate and private equity investment strategies.

 

RISK FACTORS

  • Illiquidity and often lack of transparency like in the case of commodities. This implies that they cannot be easily sold or otherwise converted to cash and cash equivalents.
  • Higher management fees.
  • They are not clearly priced or have lack of open pricing; alternative investments, unlike traditional investments, are not governed by strict disclosure, regulations and protections against fraud. Alternative investments put the onus on you the investor.
  • They have a low correlation to standard traditional asset classes, that is, they do not necessarily move in the same direction as other assets when market conditions change.

YIELDS

  • You would have a proven higher returns potential for at least 5 consecutive years since 2013 with no indication of slowing down.
  • You have a reduced exposure to volatility over the last three years in most categories.
  • There is a growing a sense of direct ownership for your investors on investments and portfolios.
  • Portfolio diversification makes a wider profit margin for your asset managers.
  • The highest yields in passive income for the last 3 consecutive year.
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