SFOs and External Managers
SFOs and External Managers: Should SFOs Allocate to External Managers or Build Investment Operations Internally?
Upon realizing a liquidity event, an important question for families of significant wealth to consider is how to manage the proceeds of the monetization in regards to SFOs and external managers. There are several issues to consider, but a central question is whether the family should allocate to third-party managers or build an internal investment team. This document frames some of the key issues and provides some guidance on those who wish to build internally.
First Principles of External SFO Managers
At a high level, the question of internal investing versus external allocation is akin to the broader question that all businesses face regarding what activities should be conducted internally and what should be procured externally. Most agree that activities that are strategic in nature should be done internally, while non-strategic activities can be outsourced. As it relates to investment management for families, the prevailing view is that most families should outsource this activity to financial industry experts. This typically implies adopting an asset allocation model, similar to ones popularized by the Yale University endowment, and then finding “best-of-breed” managers that are broadly diversified within each defined asset class. This approach makes sense on the surface, but is it optimal? For starters, since the vast majority of owners of capital are operating in this manner, it stands to reason that going in this direction will result in a family realizing a return on its capital that is more or less consistent with the broader average. This is all the more true if the prevailing allocation model puts undue emphasis on certain attributes such as liquidity or a preference for strategies exhibiting low monthly return volatility. That is, if the majority of investors simultaneously chase highly liquid low-volatility strategies, surely the returns in those strategies
SFOs and External Managers Topics
- Important Considerations to Building Internally
- Team Building
- Trust Development
- Cost Considerations