Building an Equity Strategy for Family Offices

Family offices as an investor category cannot be categorized as either institutional or retail investors. Additionally, the size of the family office does not define the complexity of the investment setup. This fluidity is clearly reflected in the listed equity investment strategies that they implement. Over the years we have seen the following bias strategies used by most family offices for their stock allocations.

Majority in direct actions: This strategy is usually supported by family offices who believe they can create a better portfolio compared to third-party managers like mutual funds (MF) and portfolio management services (PMS). This is often due to trust issues with PMS products, usually due to bad past experiences and the classification of MFs as pure retail products. There are many problems with this strategy. The family office does not compare to third-party managers with similar portfolio profiles (capitalization bias). At best, it compares its performance with selected indices, sometimes not even with the Total Return Index (TRI). Sometimes the index comparison is done with the wrong index. The family office does not conduct a proper performance attribution exercise to determine the cause of portfolio returns. However, such an analysis is important so that the cause that led to the return can repeat itself. Finally, family offices only focus on short-term returns, which can be affected by short-term bullish or bearish trends.

Long tail wallet: This strategy is generally based on the assumption that since it is difficult to do fund verification or trust fund managers, it is better to diversify among several managers. It can also be the culmination of many products being sold to the family office by wealth managers with their unique theses/stories. Usually, this happens when there is a lack of fund verification capacity at the family office level and the office relies solely on the sales pitches of wealth managers. This strategy has obvious problems. With over-diversification, the biggest fear is that your overall portfolio will start to look like an index (+/– 2%) when it comes to sector allocations or, in some cases, even equity exposures. So you tend to become an index follower, but with active management fees. Since the number of holdings is large, the tail of the portfolio is long, and many products will not move the needle of the portfolio. The best solution is somewhere in between.

Experienced family offices construct portfolios in these ways:

Asset Allocation: A well accepted and important step understood by all.

Keeping the powder dry: This step uses the flexibility of the portfolio to determine the advised level of cash under prevailing market conditions.

Ceiling bias: The next step is to decide how the equity risk will be allocated between large, mid and small cap stocks.

Choosing the right product categories: This is very important because most product upsells happen at this stage. For example, a combination of passive capitalization weight indices (Nifty 50, Nifty Next 50), strategic indices (alpha, low volatility, etc.) and a few active fund managers who have consistently beaten the Nifty 100 TRI can work well. Direct actions can also be considered to create a quality long-term portfolio. For mid and small cap allocations, PMS is an ideal product category. Active managers in this space tend to beat their benchmarks (mid-cap index) quite regularly.

Selection of the active manager: It is a process that must be analytical enough to not only select managers with consistent performance, but also to determine the unique nuances of each manager to check their suitability against prevailing market conditions such as valuations. , sector rotations, etc.

Cheapest options: It is important to choose the cheapest options for each product category. While direct options for mutual funds are well known, there are direct investment options (at lower fees) even within the PMS product space. Additionally, if you work with an established adviser registered with Sebi under the Investment Advisers Regulations, you also have access to even lower fee structures in PMS and AIF products. When comparing PMS or AIF returns, be sure to look at the figures net of all fees and not the gross performance charts. These expenses can be set-up fees, management fees, operating expenses, carry or profit shares, etc.

Munish Randev is founder and CEO of Matterhorn Family Office & Advisors.

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