Family Offices and Alternative Investments

Author: Paul Erhardt, Managing Member, Investment Business Advisors, LLC and Angelo J. Robles, Family Office Association

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Family Offices and Alternative Investments Abstract

In the midst of a prolonged low-interest rate environment, many mid and large-sized Family Offices are going beyond the traditional 60- 40 equity/fixed income asset allocation framework for their investment portfolios. In search of higher expected returns through portfolio diversification and lower volatility, and seeking to tap true alpha uncorrelated to traditional equity and fixed income markets, many Family Offices are making initial allocations or increased allocations to “alternative investments” including hedge funds, funds of hedge funds, private equity, real estate, and commodities funds.

How can Family Offices effectively and prudently pursue this trend? What are the specific lessons to be learned by Family Offices from the 2008-09 financial crisis regarding alternative investments? What additional lessons need to learn from the Madoff Ponzi scheme and other recent alternative investment frauds and failures? And what lessons can be learned from institutional investors (such as university endowments) whose portfolios have included significant allocations (>50%) to alternatives for many years?

This White Paper posits that, as Family Offices pursue “alternative investments”, it is critical to their success that they undertake broader, deeper, and more robust initial and ongoing due diligence assessment programs for these alternative investments. Traditional alternatives due diligence programs have had two major components: “Investment Due Diligence” and what has been termed “Operational Due Diligence” (“Ops DD”). This White Paper recommends expanding that framework to include 3 additional explicit categories of due diligence assessments regarding: “Alternatives Fund/Account/Investment Vehicle” due diligence, “Alternatives Manager Firm” due diligence and “Investment Business Process” due diligence. And to consider all 5 key areas under a new framework/heading called “Alternatives Investment Business Management Due Diligence.”

Investment research shows that overall asset allocation decisions can be a very important driver of investment performance; explaining as much as 90% of the variability of portfolio returns. Research also shows clearly that “performance dispersion” among alternative investments (the difference between the highest and lowest performing funds/managers in a given alternatives strategy) varies much more widely than the performance dispersion in, e.g., long-only equity strategies. As a result, manager/fund selection is even more important in the alternatives arena than in the long-only world. This heightened importance of alternatives manager/fund selection further reinforces the importance of Family Offices adopting the broader, deeper, and more robust due diligence programs as recommended in this White Paper.

The author also suggests that the use of formally adopted alternatives industry “Best Practices” can guide and give confidence to Family Offices as they pursue alternative investments more extensively. Several sources of formal alternative industry “Best Practices” are highlighted and the author also describes how these “best practices” should be customized to Family Offices based on each Family Office’s distinctive overall investment program characteristics and operating model (mix of internal and outsourced assistance).

Attention is also drawn to a potential distinctive “sweet spot” for Family Offices investing in alternatives; i.e., by seeking to align the typical size of individual alternatives investments made by many Family Offices with the smaller and “younger” alternatives funds/ managers who have outperformed their larger peers.

Family Offices and Alternative Investments Topics Covered

  • Trends: Family Offices and Alternative Investments
  • Types and Characteristics of Alternative Investments
  • Family Offices Take Note of Lessons Learned
  • Past/Present: Traditional Due Diligence
  • Future: Broader & Deeper for Family Offices and Alternative Investments
  • Alternative Industry “Best Practices”
  • Customizing “Best Practices” to Family Offices
  • Family Office Investment Management Models
  • Family Offices and Alternatives Investment “Sweet Spot”
  • Recommendations


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