Rethinking An Investment Model For HNW And Family Office Investors by Brookvine
Abstract
Our distinct impression was that the CIOs and Advisers to HNW/FOs who partipicated in Whiteboarding 1.0 have a fairly realistic sense of what can be controlled, a strong appreciation of the human element involved in their decisions, and a willingness to accept and live with uncertainty.
While much can be learnt from large institutional investors, many CIOs and Advisors to HNW/FOs work in a somewhat (if not entirely) different way. Perhaps the most significant difference is that ‘clients’ are usually more engaged, real and dynamic. This and other differences have a powerful bearing on individual investment approaches, strategies and decision-making.
From their insights and concerns we’ve attempted to infer the current investment model for HNW/FO investors and what its approaches, strategies and opportunities look like. The model (to be compared to the traditional institutional model) tends to have the following characteristics:
1. Advisers/CIOs are educators and influencers, not just allocators. They need to be good advocates and listeners as investment objectives are informed by expectations of both financial and lifestyle values.
2. Less concerned with volatility or tracking error, more concerned with the possibility of not meeting objectives and protection of capital.
3. At times opportunistic, typically with higher conviction, far less diversified by investment opportunity and style. HNW/FO decision-makers tend to be more idiosyncratic in their preferences with less attention paid to industry norms.
4. Limited use of Modern Portfolio Theory including optimisers and other risk management tools. As well, cash is an active component of portfolios, at times held at quite high levels. Transparency is important with a strong desire to eyeball managers.
5. Stronger preference for local managers probably allows for greater transparency (than HNW/FOs might get from offshore managers) and greater understanding through heightened bonding and trust, an aspect of the domestic bias likely to have positive benefits.
6. Broad endorsement for alternative investments, tempered by access, difficulty explaining risks and exposures, and lack of quality independent manager research. Some tolerance for complexity and illiquidity. Greater preparedness to invest in niche opportunities, whether local or offshore.
7. Most favour active managers supported by a strong belief in their ability to identify and access top tier managers. Some HNW/FOs however are strong advocates for index and ETF investing, reflecting their scepticism about active management (in some markets) and the ready availability of specialized ETF opportunities in others. Most have a strong preference for managers with a strong alignment of interest.
8. Very cost conscious but focused more on net-of-fees returns, thus more accommodative of higher cost opportunities where justified by complexity and/or capacity constraints.
9. Limited use of asset consultants, but great value placed on external and independent investment committee members. Finding people with the requisite experience is demanding.
10. Typically flat investment team structure with a high degree of delegation to individual team members and a lack of specialisation by asset class or investment opportunity. Top-down experience across categories of investments matters greatly. Deal with many high touch bespoke issues, and can have a tough job keeping on top of all asset classes and all the things the HNW/FO expects.
Some potentially important stylised similarities and differences between the two types of investors are highlighted in the table below.
Stylized Characteristics of Large Institutional US and Australian Investors and Australian HNW/FOs
Findings
Actions, Reflections, Questions and Provocations
The day’s mood is captured by some participants’ initial comments:
A highly compressed and selective history of the first millennium of investing provided some deep background. The history highlighted influences, including regulatory and legal innovations that led to the current institutional model. An all too common theme was the initial rejection of new ideas and their subsequent slow uptake, typified by the almost half-century lead-time till hedge funds became institutionally acceptable.
A few quotes scattered throughout this report in boxes hint at what some experts do and don’t know.
Discussions
Participants broke into two groups to discuss a broad set of topics. The aim was to develop a few pragmatic approaches, strategies and opportunities appropriate for Australian HNW/FOs. Synopses and summaries of each topic were then presented to both groups for joint discussion.
The discussions centred on:
– Investment objectives, beliefs and approaches
– Risks and uncertainty
– Diversification
– Investment preferences
– Governance and organization
Investment Objectives, Beliefs and Approaches
…. where participants discussed:
– Institutional vs HNW/FO objectives
– Dealing with conflicting objectives
– The need for investment beliefs
Objective setting is seen as crucial in helping clients understand their investment purposes, expectations and preferences. Objectives must address clients’ lifestyles and values which makes prioritising financial vs non-financial purposes challenging. Time, effort and trust are needed to uncover clients’ real objectives which can evolve over generations. Complicating the process and unlike the case in many institutions, objectives can diverge greatly between HNW/FOs and between individuals within them. This can have an enormous bearing on practical decision-making.
While CIOs and Advisors to HNW/FOs spend considerable time with their clients developing and setting investment objectives, only a few seem to have promulgated a set of firm robust investment beliefs about markets. HNW/FO’s small size may account for this as they may not have experienced the benefits institutions have derived from setting beliefs. Nonetheless, most participants agreed it is desirable to develop and circulate underlying beliefs that provide a tool for investment decision-making and a framework for assessing new strategies.
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