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High Net Worth and Family Office investment practices - what makes them different?


In contrast to the way institutions make investment decisions, family offices and high net worth investors display high levels of engagement and often have their unique non-financial objectives to satisfy.

With tongue partly planted in cheek, George Soros maintains that each day investors should ask how their portfolio would differ if they began investing today. In that spirit and starting with a blank whiteboard, a group of seasoned Chief Investment Officers (CIO) and Advisers to High Net Worths (HNW) and Family Offices (FO) were invited by Brookvine to question the constraints of convention and legacy that underlie their investment practices. It’s a process we call ‘Whiteboarding’.

Constraints of convention and legacy

The exercise was triggered by a suspicion that much of those practices rest on the theories, experiences and characteristics of large institutional US investors. That raises two questions:

Vigorous group discussions led to rich insights and tentative conclusions. Not surprisingly we only managed to scratch the surface of the two main questions; in that sense, we started and finished from scratch. At the very least the differences between the institutional and HNW/FO ‘models’ of investing were highlighted and clarified, differences we intend to explore further at greater depth in future Whiteboardings.

Some of these differences and similarities follow.

Investing models compared

HNW/FO clients are significantly more engaged than their institutional counterparts, a difference with powerful bearings on decision-making and strategy. Because non-financial purposes such as lifestyle and values are important to HNW/FO clients, deep engagement is crucial. Prioritising non-financial objectives is a key decision rarely found in the institutional world. Further complicating that decision, objectives can diverge markedly across individuals, especially across different generations.

Managing competing objectives of near-term dependable income, long-term capital appreciation and capital/inflation protection is also common in the institutional world, though income requirements tend to have higher priority for HNW/FOs. Curiously, and unlike the institutional world, while HNW/FOs spend considerable time with clients setting investment objectives, few have promulgated a set of firm, robust investment beliefs.

This difference likely has two sources. First, Advisers/CIOs to HNW/FOs have a different role; they are more like educators and influencers than just capital allocators. To succeed they need to be good advocates and listeners especially to clients’ expectations, financial goals and lifestyle values. Second, they and their clients tend to have real-life investing experience gained through business building and a greater predilection for personal account investing. These result in a more hands-on and direct approach to investing that favours activity over principles.

Features of HNW/FO portfolios

HNW/FO decision-makers are more opportunistic and more prepared to invest in niche opportunities, such as alternative assets, tempered by access difficulties and the challenge of explaining risks and exposures. A common complaint regarding alternatives is a lack of quality independent manager research. HNW/FO decision-makers also pay less attention to industry preferences and norms. As a result their funds are far less diversified.

Younger generations however tend to be more concerned with diversification (including global investing) as a tool for preserving wealth, than founders who emphasise concentration as a tool for creating wealth. Founders’ resistance to moving away from the sector in which they made their wealth and tax consequences create sizeable barriers to diversifying.

Naturally, tax plays a larger role in the HNW/FO world where decisions are frequently driven by tax considerations.

Two factors seem to lie behind HNW/FO’s limited use of Modern Portfolio Theory including optimisers and other risk management tools. First, HNW/FOs are less concerned with risk described as volatility or tracking error and far more with risk described as (permanent) loss of capital and not meeting objectives. Second, the risks inherent in large holdings of property, founder businesses and legacy equity struggle to fit within the usual parameters of institutional investing. On the other hand, sequencing risk, a hot topic for institutions, is equally important for HNW/FOs because founders do worry about their wealth collapsing late in their life and in that of their family. Yet managing tail and other embedded risks is lower on their agenda in part because they lack the skills and experience some large institutions have in adopting and managing explicit hedges.

Cash holding and active management

Cash is an active component (typically the most active) of portfolios’ tactical asset allocations and at times is held at quite high levels. HNW/FOs revert to cash when faced with potential risks and instability. By way of comparison, institutions tend to see cash as a residual (and occasionally as having option value.)

HNW/FOs have a strong preference for local managers as they are perceived as offering greater transparency and understanding through heightened bonding and trust, a likely benefit of domestic bias. A larger domestic bias to Australia (compared to institutional accounts) is seen as ‘not unreasonable’ and historically valid.

Active managers are strongly supported through a vibrant belief in the ability of Advisors/CIOs to identify and access top tier managers, though a small number remain strong advocates for passive, encouraged by the growing availability of relatively cheap specialised ETFs. Although very cost conscious, HNW/FOs are more focused on net-of-fees returns than their institutional cousins. They are more open to higher cost opportunities where justified by (necessary) complexity and/or capacity constraints.

Governance tends to be based on simple principles executed through high client engagement, which makes decision-making more timely than in the institutional world. As part of that simplicity, investment teams tend to have flat structures with minimal specialisation by asset class or investment opportunity and a high degree of delegation to individuals.

Diversification

Participants were pragmatic about diversification. Having lived and worked through many investment cycles and crises they understand how a naïve reliance on diversification can fail at points of inflection. They also tend to focus on what they think ‘works best’ over time, consistent with their experience, skills and knowledge. What does ‘work best’ varies across HNW/FO organisations to a greater degree than it does across institutional investors.

Sufficiently many rich insights were generated for Brookvine to have already led Whiteboarding 2 that explored this topic, diversification, in greater depth.

About the author
Jack Gray is a Director and Advisor, and Steve Hall is the Chief Executive Officer of investment manager and adviser, Brookvine. See www.brookvine.com.au.
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