Investment

Family office asset allocation – and why venture exposure is a lot less than expected

Family office allocations to venture capital can be smaller than you might expect, according to a survey by the Family Office Association.

VC allocations average 7% against the 20% recommended by consultant Cambridge Associates last year. It appears family office risk appetites have been constrained by their own cash requirements, plus uncertainty over the demanding ratings of bonds and large growth stocks in their portfolios.

Many woefully underestimate true inflation for the exceptionally wealthy

FOA chief executive Angelo Robles favours a 25% allocation to venture capital moonshots, given the contribution they can make to long-term wealth preservation. He points out the 7% VC average conceals a wide dispersion of allocations. Some SFOs are keen to invest large sums in technology capable of outperforming the old economy. Others prefer not to take the risk.

Robles says: “The 7% number was astoundingly low. I was surprised. But families say they don’t know enough to be a direct investor so they need to invest through VC funds dominated by institutional shareholders.”

These funds can charge hefty fees. Investments can be illiquid. Early investors can also see their returns diluted by subsequent subscriptions on better terms. Robles says family offices can do better by negotiating separate accounts with VC firms where they, and no one else, invest as limited partners, co-investing with the general partner.

BlackRock surveyed family office opinion in August. It has discovered a growing taste for co-investment across the private equity sector. BlackRock also found interest in new opportunities, with two-thirds of respondents open to investing in first vintage funds.   

Robles says large family offices have also succeeded by developing in-house VC expertise, capable of moving deep into cutting-edge technologies such as biotech, cryptocurrencies, quantum computers and space travel. 

They can also afford to wait for the 12 to 15 years it takes VC deals to deliver a return, even if they fail to generate much income. SFO respondents to the FOA survey are relatively keen on private assets, backed by private equity firms, where allocations average 11%.  

Private asset allocations in the FOA survey totals 18%, including VC, roughly in line with BlackRock. Robles thinks SFOs can face a disconnect because their executives tend to look at returns over five years, while families contemplate 20 to 40 years. 

He believes greater efforts should be made to agree strategic asset allocations through investment policy statements and investment committee discussions. 

This needs to involve discussions about the resilience of family estates and their ability to withstand costs and levels of inflation which easily outstrip official data. 

He says: “Many woefully underestimate true inflation for the exceptionally wealthy.”  This would relate to the servicing of healthcare, education, lifestyles, allowances, lawsuits, art, sports teams and mansions in upmarket locations. 

Low interest rates also make it impossible to service estate costs out of interest received on cash and bonds. Anxiety over outgoings would explain why family offices often limit their investment risk exposures. Robles says: “Sometimes family offices become very conservative when they are trying not to lose what they have.”

The FOA survey showed the average portfolio allocations to cash was larger than you might expect at 7%. Family offices can find liquidity comfortable. BlackRock says 35% of family offices are nervous over dealing with illiquid investments and capital calls during a liquidity crisis. They are keeping a very close eye on their cash flow.

On 7 January, Family Capital warned family offices with real estate and hospitality interests were forced into laying off members of staff during the pandemic. 

The FOA survey suggests family offices are, on average,  favourably disposed to listed equities: their average weighting comes top with allocations of 34%.

But Robles says interest in passive funds is waning, out of concern that performance has been too dependent for too long on large internet stocks. According to BlackRock, a UK respondent was nervous of the “narrow breadth of performing equities” within indexed funds. 

“SFOs are tactically, and directly, investing in concentrated public equity positions,” says Robles.  They are opting for active separate managed accounts split between different managers and long/short. 

According to BlackRock, 80% of family offices select long/short hedge funds as a preferred strategies. Interest in ESG is on the rise. It reports growing interest in equities outside the US, particularly in China. 

Quant products, at 2%, do not attract much of a following due a difficult 2020 for systematic hedge funds such as Bridgewater, Renaissance, AQR and Winton due to the failure of their algorithms to navigate the pandemic by using backward looking data. Interest in emerging markets and commodities (3%) also remained low, even though they could benefit from US reflation.

Government and corporate bonds comprise 16% of portfolios, with high yield and loans accounting for 5%. Many families say bonds still provide them with portfolio stability. But many family offices are growing wary. 

According to a Swiss family office: “Something like 60% of sovereign bonds in the developed world are trading at negative yields. Fixed income is going to give you nothing. In fact, it is most likely to lose you money.”

Rob Kyprianou, former head of global fixed income at Axa, recently said: “Over my whole career in asset management I have not seen a time when fixed income offered so little value to private investors.”

According to other family offices: “Treasury bonds will have higher future volatility, in our opinion, thus fewer are needed to meet a risk budget.” Another said: “We are migrating risk budgets away from fixed income and supplementing with direct credit, distressed lending and equity yield.” 

BlackRock says concern over inflation is rising, leading to growing interest in real assets like real estate and infrastructure.  

But with real estate averaging 9% of FOA allocations this commitment throws up mixed views due to uncertainty over retail and office space. Property has been a mainstay for many families over the years and this will buy for recovery. Relative newcomers are less convinced.

BlackRock says 40% of families are keen to increase their allocation to real estate with a stress on multi-family, logistics and data centres in line with research by Family Capital on 26 November.

Infrastructure does not figure in the FOA survey, but BlackRock says allocations of up to 5%, with 62% of family offices inclined to increase exposures, partly due to the protection their income can offer some protection against inflation.

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