Private banks and investment firms are keen to find out what family offices want. Private banks are keen to win over family offices as clients, and of course asset managers want FOs to use their wares. Almost a decade of rising equity markets, and concerns now in place about when or if the equity bull market runs out of puff, means there is plenty to think about. Readers know that there is plenty of discussion about family offices’ interest in areas such as direct investing, private capital and ESG-themed money management.
In this article, Ahmed Husain, head of family offices for Europe at Lombard Odier Investment Managers, has a look at some of the issues. The comments are his own and not necessarily shared by the editors of this news service; the editors are pleased to share views of outside contributors and invite readers to respond. Email email@example.com
Family offices are in our view some of the smartest and well-connected investors, at the forefront of most investing trends. What they do today, the rest do tomorrow. A family office managing a few billions in dollars has access to the shrewdest advice, the best managers and the ability to source their investments from wherever they choose. At a recent gathering of family offices, we had the opportunity to discuss the investment ideas they are exploring.
At a macro level, family offices prefer asset classes that offer returns away from crowded trades. Geographically, this means opting for Europe and emerging markets over the US. Though it is still growing, the US is a crowded long with less room for alpha creation than Europe and emerging markets, which are seeing rising growth that sets them up for being a multi-year long. A number of family offices already moved in this direction last year, and the rest are reallocating now. Such positioning is also all about weighing value over growth, particularly in the public equity markets. As interest rates rise, future growth gets discounted at higher rates, causing growth stocks to falter, while value stocks like energy and financials benefit from higher rates and late cycle activity.
Even after the recent sell off in rates, quantitative easing has left little room for returns in the credit markets. Family offices are asking questions like: can spreads or rates contract from here, or is the direction of travel towards higher rates and wider spreads? Overall, family offices certainly believe the latter scenario, which means they are looking for alternative sources of fixed income like returns. Where are they finding it? In a more volatile environment with rising rates, event driven hedge funds and macro funds are proving attractive, as is the illiquidity premium offered by private debt.
One of the biggest themes since the global financial crisis has been a preference for private over public markets. After all, if you saw your public portfolio mark down more than 50 per cent in 2008/2009 you would want to do the same. The first move family offices took was to increase their exposure to private equity, and the largest funds were favoured. Then they moved into the smaller specialised funds with a sector or regional focus. The next step is into technology and venture capital. Again, the initial bias has been towards the bigger funds, but slowly family offices are transitioning into the smaller funds, away from the large funds and fund of funds. Some are even building out their own direct investment teams for private equity and venture capital. They are going from being limited partners (LPs) in funds to competing with them.
What comes next?
The search for alpha continues. The advantage family offices have in our view is that they can do what others cannot. Their mandate is to generate returns by finding and investing in the best risk / reward investments. There are no LPs to please and no regulatory guidelines. The goal is to get the best risk adjusted returns.
So which direction and focus do the brave have today?
There is a perception that family offices are looking for 4-6 per cent returns, a return of capital, then a return on capital. Those people would be surprised to discover the number of family offices who have exposure to small Eastern European or Asian countries or Africa. Frontier markets, given their demographics, are a particularly interesting long for them. They are one of the few places where one can source multi-decade growers, with small market caps and high revenue growth.
Another underappreciated and talked about region is Japan, so family offices are looking here. Across the developed economies, Japan has one of the cheapest valuations combined with consistent growth. When you look across the globe and you see how close Japan’s growth is to Asian growth, it is easy to understand why small caps in Japan are attractive.
Family offices are also seeking to capitalise on one of the biggest sources of wealth creation throughout history: innovation. Innovation brings opportunity as well as disruption. The richest men and women in history have created their wealth by having a greater insight and executing that knowledge more effectively than others. Jeff Bezos captured insight about eCommerce, Bill Gates did the same for personal computing, and J.D Rockefeller netted energy demand. That is why family offices today find themselves looking closely at venture capital. They want to collaborate with the best entrepreneurs of today, rather than be run over by them. Most family offices are still learning about venture capital, investing via funds, but some are even finding their own seed and Series A investments.
Another area of interest is commodities. 2018 could be the year that inflation rears its head with a vengeance, but, do higher commodity prices produce inflation or does higher inflation produce higher commodity prices? We think higher commodity prices have the potential to take inflation higher (in addition to other forces). Trade barriers are important here because protectionism leads to inflation. Moreover, trade wars lead to higher risk premium. These are all factors that can bring commodities higher and stocks lower. Due to these risks, some of our clients are starting to buy into commodity hedge funds and oil stocks.
Markets are still focusing on the spectre of a global trade war, triggered by the recent US policy announcements. We have looked at protectionism for a while now given Trump’s comments even before being elected, seeing it as a key investment risk factor alongside inflation in the current environment.
In themselves, the US’s tariffs on steel and aluminum are not significant; however, they have the potential to create a domino effect as other countries react to these measures, which could lead to a negative tit-for-tat spiral. Ultimately though, Trump has more bark than bite and the results are proving much softer that the original demands. We do not completely rule out the potential for a full-blown trade war, and investors should seek downside protection, given that elevated volatility is here to stay.
The one thing no one seems to be positioning for is a big sell off, though a number of clients have begun hedging programs to bring some protection into their books. This sell-off in their minds would come from interest rates rising much faster than the market likes. This would lead to the economy slowing down and / or discount rate on equities rising quickly causing a +20 per cent mark down. While this is not our central scenario, we do think the many risk factors here will create a much higher volatility environment than investors have grown accustomed to.
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