Business

The pandemic has exposed the lack of portfolio risk management at family offices

Advisers say single-family offices need to make far greater use of risk management tools to deal with this year’s hike in market volatility induced by the coronavirus crisis.

The advisers have services to market, of course. But they are genuinely concerned about the impact of volatility on poorly-supervised portfolios which straddle direct investment in businesses and investment portfolios. 

As well as liquidity issues, family offices are deeply concerned that governments will refuse to offer financial aid to their businesses…

Since February, equities have fallen by a quarter, oil prices have collapsed and the Federal Reserve has been forced to prop up the US bond market. Technology has bounced in anticipation of disruption.  The gold price has risen. This combination of events is virtually unprecedented. It is producing intense stress.

One family office said it had confidence in its private investments and cash resources but conceded that events could have a serious impact on its prospects. If this leads to forced sales, the consequences could be dire. Another family office said better risk controls are needed across the sector. 

As well as liquidity issues, family offices are deeply concerned that governments will refuse to offer financial aid to their businesses, unless they make an enormous contribution to the rescue effort.

Sir Richard Branson of Virgin has offered his holiday island of Necker as partial collateral for a proposed $600 million loan from the UK Government to save his stricken airline. His first loan request was rejected. Branson’s Australian airline has entered bankruptcy following the local government’s refusal to help.

Harvard University reversed its acceptance of state aid worth $8.7 million, after US President Trump slammed the deal, given its endowment is worth $40 billion. Across the board, demands that billionaires put their hands in their pockets are mounting, as was the case at the end of the 19th Century Gilded Age.

Enness Group, the mortgage broker, has confirmed a spike in inquiries from wealthy borrowers keen to take out new loans to cover potential margin calls and meet liquidity needs for their business. Loans secured on art have increased.

Soundings reported by Family Capital last week confirmed risk appetites have evaporated, as family offices question the direct investment model they have followed for a decade. 

Family offices are struggling to understand their overall risk exposures, as they face up to potential liquidity requests and a volatile climate. Craig Pearson, chief executive of data provider Private Wealth Systems says family offices often need to get a grip.

“Family offices have some of the most brilliant minds in business, they are experts in building and scaling businesses, and navigating recessions, yet many principals choose not to engage in the management of their wealth.”

Pearson speaks with feeling, after his family suffered the loss of a fortune due to a lack of centralised manager oversight when a previous generation was in charge.

He believes families should draw on big data which lets them have detailed understanding of the risks embedded in their portfolio, including tactical and hedging exposures.

“A few months ago I spoke with a CIO of a large family office who said he doesn’t need oversight because ‘private investments can’t have negative returns’. A few weeks ago I spoke with another family office who said it’s near impossible to have timely liquidity analysis because of the systems they selected.”

Pearson’s stance has been widely supported on Linkedin, with the majority of commentators agreeing better, more sophisticated, portfolio scrutiny is needed. 

According to a German family office adviser: “Timely and holistic oversight of all your family wealth is of the utmost importance if you want to manage it well.”

Another said the institutional world is better placed to manage risk, working with consultants to manage portfolio risk with the help of overlay programmes.

Over the last decade, family offices have increasingly managed their own affairs, drawing on advice from banks, and others, as needed. 

Family offices have become confident in managing their own affairs in a stable market over the last decade. But now they need more advice from third parties to avoid a panic reaction.

Cara Williams, senior partner at Mercer, the global consultant, told Family Capital last year that family portfolios can be too disparate, or over-focused on ruling passions. Families can also indulge in “magpie” investing, where they back VC assets because they look good as opposed to offering a coherent approach to investment. 

Time and again investors have come unstuck by failing to pay enough attention to neglected parts of their portfolio. Williams accepts that client preferences are paramount but stressed that it is important to structure a portfolio to achieve effective ways to manage risk. 

Mike Faulkner, head of macro strategies at River & Mercantile, uses a range of hedging strategies to offset the risk exposure of family businesses, as outlined in Family Capital last year.

Cara Williams does not believe that family offices will want to review their approach to risk just yet. Right now, they will want to come to terms with more immediate concerns. In six to nine months it could be a different matter as the impact of the current crisis becomes clearer.

In the interim, however, she has seen an uptick of interest in Mercer’s fiduciary management services, where a consultant takes full responsibility for managing all, or part, of a portfolio. 

Consultants can bring other services to the attention of their clients, including access to sustainable investment approaches, manager screening, risk tools and a chance to discuss issues with professional advisers.

Rival consultant Cambridge Associates is renowned for recommending 40% weightings in private assets. It regularly serves up a view of markets which balance out the negative viewpoints which can lead to premature asset sales, at a distressed price.

In his experience, Stephen Martiros of Martiros Strategies is more positive. He believes family offices now recognise the importance of asset allocation, due diligence and portfolio management, using platforms that drill into manager data.

But he concedes: “It’s super hard to understand the underlying nature of a broad number of investment managers across multiple asset classes. There’s going to be a growing need for expertise but it will need to be powered with data not just delivered as trusted advice.”

 

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