This article belongs to our exclusive single-family office guidebook, where we give guidance on the most relevant topics for newly established and already existing family investment vehicles. It was contributed by Michel Meert, Principal at Barnett-Waddingham, a leading independent UK professional services consultancy.
Given the long-term investment horizon of family offices, the decisions around how to structure portfolios in a low yield environment are crucial for delivering on the investment objectives. Historically, investors have looked towards high quality bonds (namely government bonds and investment grade credit) for income in investment portfolios. Globally, interest rates are currently at very low to even negative levels for many developed economies, leading to challenging decisions for asset allocators in the search for yield. As global levels of debt reach their highest point in history, central banks’ actions suggest that we may be in a lower yield environment for longer. The actions of central banks, inherently, impact how portfolios are built and how sustainable they are in terms of the longevity of investment returns.
Investment objectives, investment beliefs and constraints
The starting point for decision makers should be to review the investment objectives of the family office in terms of risk and return. These will be family office specific and need to be realistic and achievable. Return can be stated in absolute terms or relative to a benchmark (inflation plus x%, for example). Clarifying investment beliefs is also an essential part of the process as these will shape the portfolio. These beliefs will typically include sustainability and impact considerations as well. Any constraints, like for instance liquidity or cash flow requirements, will also have an impact on how the portfolio will be structured.
Overall asset allocation review
Once the objectives, beliefs and constraints have been defined or clarified, an in-depth review of the asset allocation will allow decision makers to align the portfolio with their strategic objectives. Finding an appropriate balance between various sources of return (equity, credit, skill, and illiquidity) is key in order to achieve real diversity in the portfolio. In an environment of low yields it is even more important to model a strategic asset allocation based on a set of forward looking asset class assumptions. Achieving a given investment return objective will depend on the expected returns of the combination of the asset classes being used. In a low yield environment investors will be tempted to take on more risk in order to reach the target return they have decided on. Truly long-term investors like family offices have the ability to use a much wider spectrum of investment opportunities than regulated asset owners like pension funds and insurance companies. That gives them an important advantage compared to the latter. Alternative sources of income-generation should be looked at closely and decision makers should ensure they are comfortable with each component of the portfolio. Non-traditional asset classes, especially within the alternative credit space, but also illiquid assets can play a role in reaching the sought after income and diversification. Real assets such as property, long-term leases and infrastructure can also fulfil this role whilst at the same time providing some protection against rising inflation. Family offices have also the necessary size to structure real estate portfolios to be in line with their specific needs.
Focussing on the fixed income allocation
The role of high quality fixed income assets has, traditionally, been to provide income and diversification benefit to investment portfolios. The diversification benefit needs to be assessed against lower yields to decide whether current strategic allocations to fixed income remain appropriate. Additionally, riskier fixed income assets, like high yield, emerging market debt, securitised credit, loans or private debt, may provide additional yield but this should be weighed up against the additional credit risk that would be taken on. Any allocation to floating rates can also be seen as a welcome diversifier at a moment where the direction of inflation and interest rates is uncertain.
Conclusion
A low-yield environment for longer does represent a challenge but is not all doom and gloom for family offices. Decision makers need to be provided with the necessary tools and guidance to adapt for the new paradigm of lower-for-longer yields and family offices should take advantage of their long term nature to look at the sustainability of the income produced by their investments. The longevity of investment returns is key for family offices and now, more than ever, diversification should be at the heart of strategic investment decisions.
About the contributor: Barnett-Waddingham LLP
Barnett-Waddingham is a leading independent UK professional services consultancy at the forefront of risk, pensions, investment and insurance.
Barnett-Waddingham acts as a trusted partner for a wide range of clients in both the private and public sectors. Being free from any external stakeholders, it takes a long-term view with all its clients and has the freedom to bring fresh ideas to the table, unobstructed.
For family offices, Barnett-Waddingham assists boards, investment committees, Chief Investment Officers and in-house investment teams with a variety of services — from clarifying objectives and investment beliefs, to defining asset allocation and strategy and selecting the right managers and monitoring them. By working in partnership with their clients, Barnett-Waddingham delivers a clear, long-term, bespoke and integrated investment service that allows them to make decisions in an informed and timely manner.
