As a category of investors, family offices cannot be placed in the institutional category or the retail investor category. Also, the size of the family office does not define the complexity of the investment setup. This liquidity is clearly seen in the listed equity investment strategies used by them. Over the years, we have observed that the following polarizing strategies are used by most of the family offices for their equity allocation.
Majority in Direct Equity: This strategy is typically supported by family offices that think they can build better portfolios than third-party managers such as mutual funds (MFs) and portfolio management services (PMS). This is often due to trust issues with PMS products, usually due to past bad experiences and MFs being bucketed as pure retail products. There are several issues with this strategy. Family Office does not benchmark itself against third-party managers with similar portfolio profiles (capitalization bias). At best, it compares its performance with select indices, sometimes not even the Total Return Index (TRI). Sometimes, the index is compared with the wrong index. The Family Office does not conduct proper return attribution exercises to determine the reasons for portfolio returns. However, such analysis is important so as to reiterate the reason for withdrawal. Finally, family offices focus only on short-term returns, which can be affected by short-term bullish or bearish trends.
Long Tail Portfolio: This strategy is generally based on the assumption that since fund due diligence or trust fund managers are difficult to perform, it is better to diversify into multiple managers. It could also be the culmination of several products being sold to the family office by property managers with their own unique thesis/stories. Typically, this happens when there is a lack of fund due diligence capability at the family office level and the office relies solely on the sales pitches of money managers. There are some obvious problems with this strategy. With over-diversification, the biggest fear is that your overall portfolio may end up looking like an index (+/- 2%) in relation to sector allocation or, in some cases, stock exposure. So, you become an index-hugger but with the fee of an active manager. Since the number of holdings is large, the tail of the portfolio is long and many products will not move the needle for the portfolio. The best solution is somewhere in between.
Experienced family offices build portfolios like this:
Asset Allocation: An acceptable and important step to be understood by all.
Keeping the Powder Dry: This move uses portfolio flexibility to determine what level of liquidity is advisable in current market conditions.
Cap bias: The next step is to decide how equity risk will be allocated among large-, mid- and small-cap stocks.
Choosing the right product categories: This is very important as most of the products are sold at this level. For example, a combination of Passive Cap Weight Index (Nifty 50, Nifty Next 50), Strategic Index (Alpha, Low Volatility, etc.) and a few active fund managers who have actually beaten Nifty 100 TRI regularly, work well. can do. Direct equities can also be considered to build a long-term quality portfolio. For mid- and small-cap allocation, PMS is an ideal product category. Managers operating in this sector regularly outperform their benchmark (mid-cap index).
Active Manager Selection: It is a process that needs to be analytical enough not only to select consistently performing managers, but also to find out the unique nuances of each manager to check their suitability with current market conditions such as valuations, sectoral rotations etc. needed.
Lowest cost option: It is important to choose the lowest cost option for each product category. While direct alternatives to mutual funds are well known, there are direct investment options (at lower fees) in the PMS product segment as well. Moreover, if you work with an established advisor registered with SEBI under the Investment Advisory Regulations, you have access to a lower fee structure in both PMS and AIF products as well. When comparing PMS or AIF returns, make sure you are looking at the net-of-all fee number and not the gross performance table. These expenses can be setup fee, management fee, operation fee, carry or profit share etc.
Munish Randev is the founder and CEO of Cervin Family Office & Advisors.