While many were thinking of resolutions at the New Year, we asked a series of family office and financial services professionals from around the globe to instead consider what they saw as the biggest challenges and opportunities in the year ahead for the investment division of single family offices.
Investment activities are the single most significant cost for single family offices, according to last year’s Global Family Office Report, released by Campden Wealth and UBS. The average costs for a family office is 99 basis points of assets under management (AUM), with 44bp going towards investment activities.
We kept the question open: If you were the CIO of a single family office, what challenges and opportunities would you be anticipating for 2016? Respondents represented a geographical spread from Europe to the US to Asia.
Most mentioned volatility and instability in the global markets, including the slowing Chinese economy. “An active tactical asset allocation and stock-picking will be key in order to boost returns,” said Christophe Donay and Philippe Dubey, from Pictet Wealth Management, adding that replacing cash in portfolios and achieving diversification to protect against volatility in the equity markets would be other headaches for family office CIOs.
Johnny Hon, who advises high net worth individuals in Asia through his firm Global Group, says despite problems in China’s economy, there are still opportunities to tap into the country’s large middle class, particularly through the entertainment industry.
While global markets were a dominant theme, some respondents highlighted challenges closer to home – or at least the office. Katherine Ellis, group business development director at Boston Multi Family Office in the Isle of Man, says consolidated reporting is currently costly and time consuming and that software solutions to this challenge will be a key theme for the industry in 2016.
Aligning investments with the values and interests of the family will be both an opportunity and a challenge for family office CIOs in 2016, Ellis added, a demand the Isle of Man-based family office is seeing from both existing clients and new business.
Pictet Wealth Management
Christophe Donay, head of asset allocation and macroeconomic research and Philippe Dubey, head of global fiduciary management (Switzerland)
"The biggest challenge for a CIO of a European single family office in 2016 will be to manage instability while coping with an environment of subdued returns. The macroeconomic environment will be lacklustre, with moderate economic growth, but a lack of momentum. Meanwhile the increasing desynchronisation of central bank policies will lead to heightened volatility.
"In this environment, returns on risk assets will effectively be capped. We expect returns on DM equity markets to be limited to around 7% including dividends, which is disappointing by historical standards. An active tactical asset allocation and stock-picking will be key in order to boost returns. For a single family office, that assumes an ability to identify first quartile active managers.
"Another headache will be how to replace cash in portfolios, given continued negative interest rates in EUR and CHF. Investment-grade corporate bonds could offer a tactical play in this respect—returns are not exciting, but are at least not negative.
"Achieving effective diversification, in order to protect portfolios against heightened volatility on equity markets, will also be a major challenge. Core sovereign bonds (US Treasuries and German Bunds) usually offer the best solution, given their decorrelation with equities, but their protection role is fading as interest rates gradually rise.
"Pseudo-diversification may therefore be the best that can be achieved, through low-beta assets. For those willing to enter illiquid and long-term investments, private equity will offer superior returns. Hedge funds should come back into favour. CTA and macro strategies offer downside protection in hedge fund portfolios, while ‘caps and floors’, allowing range-bound trading of equity markets, are another option for equity exposure. Catastrophe bonds are an interesting option. Alternative beta strategies represent another source of diversification (i.e. rule based strategies designed to harvest alternative risk premiums via long-short future positions across various asset classes).
"A successful approach will consist of, on the one hand, identifying new risk premiums and sources of diversification, and, on the other, managing downside risks and introducing strategies with insurance features."
Boston Multi Family Office
Katherine Ellis, group business development director (Isle of Man)
"I foresee two key challenges, which are also the biggest opportunities for those who can meet them.
"The first is access to investment projects that align to the family’s interests. Many families are looking for opportunities that offer better returns than traditional funds and in some cases that are more interesting to them – perhaps projects with beneficial social effects, such as clean tech, for example. Demand from the families we already look after, let alone new business, has already been enough to drive us to set up our own capital introduction service in response to this trend.
"The second is the on-going problem of consolidated reporting for diverse investments and business interests. A typical diversified portfolio may have many asset managers and third parties, each reporting in their own way, and amalgamating their results manually is incredibly time intensive and therefore costly. I believe intelligent, software-driven solutions to this problem will be one of the defining features of our industry in 2016."
Kingsbridge Wealth Management
David J Dunn, president and CIO (Nevada, US)
"I see two distinct challenges and exciting opportunities to be prepared for in 2016.
"Volatility is back and likely to stay with us throughout 2016. With the Chinese economy slowing there is very little for people to point to as a growth leader for world economy. Without a shining star to focus on, many investors will question what they are invested in and why. Global economic uncertainty will contribute to market volatility and the less committed investors will abruptly exit the markets on dips only to come back in during market run ups.
"Liquidity will become an outsized area of focus again in 2016. Investors will give up return potential for the perceived ability to quickly exit an investment. This short term focus and lack of fortitude is the hall mark of investment pools with inappropriate structures and investors without a true understanding of the risks and potential rewards.
"Family office capital is uniquely positioned to take advantage of longer term investment opportunities. Because family offices control the entire allocation - cash, bonds, equities, alternatives - they can set aside liquidity reserves and multiple layers of assets to sell before needing to access their long term capital. In other words, they'll have enough liquidity in cash and short term bonds to not need to sell longer term assets. The premium paid for illiquidity should increase as illiquid assets like venture capital and private equity are re-priced lower. I believe the re-pricing of illiquidity will be excellent risk adjusted return opportunity for the right capital."
Johnny Hon, chairman (Hong Kong)
"Following volatility in the Chinese markets in 2015 – and the developments of early 2016 suggest the same trends are still in play – China’s entertainment industry provides a wide range of alternative opportunities for savvy investors this year. China’s exponential growth over the past decade has created an expansive middle class with disposable income. Their skyrocketing demand for quality entertainment offers opens up some fantastic investment options.
"In 2015, US$ 6.3 billion was spent in Chinese cinemas and cinema spending in China is set to surpass the USA (currently the biggest global market) in 2016-2017. The potential of this market has led to increased investment and joint ventures between Hollywood entertainment companies and Chinese companies, such as the collaboration between Warner Bros and China Media Capital to produce local Chinese language films. Joint ventures of this type provide a lower risk and more accessible ways for international investors to take advantage of the opportunities in the Chinese entertainment market.
Beware of piracy or investing in theatre production
"However, film piracy in China is still a widespread issue and real risk to return on investment. As such, the savvy CIO wishing to invest in the entertainment industry may look to established theatre production companies expanding into China. Although theatre is a much smaller market than film, it is a growing sector in China. In fact, in the first half of 2015, over half a million people attended the theatre in China. Furthermore, the huge brand value associated with established productions and live nature of theatre entertainment almost nullifies the risk of piracy. The ongoing co-production of War Horse by the UK National Theatre and the National Theatre of China demonstrate the clear appetite for quality productions from consumers in China. As this sector grows, there is a huge opportunity for investors to take advantage of a growth story in the making."
Societe Generale Private Banking Hambros
Eric Verleyen, global CIO, London
"As widely expected, the Fed decided to raise the target range for the Federal funds rate by 25 basis points, on the back of strong economic fundamentals. Despite the hike, monetary conditions remain very accommodative and the Fed made clear that the economic outlook warranted only gradual monetary tightening.
"Most economies worldwide are faring better, especially in the developed world. In contrast, in emerging space, the recent acceleration in the commodity plunge is weighing increasingly on fundamentals, especially in the countries most dependent on commodity exports.
"In the current context, we continue to favour equities with a strong preference for developed markets over emerging markets. Our preferred regions are 1/ the eurozone, where positive economic surprises continue to pour in and 2/ Japan, where we expect a pick-up in consumption.
"On the fixed-income side, we remain positive on corporates although we have been gradually reducing our high yield exposure in both the US and the eurozone.
"At this stage, you could be tempted to ask me what’s new for 2016 and the coming quarters? Well, now that the Fed normalisation has officially started, we expect absolute return strategies to outperform traditional asset classes, despite the rather disappointing performances they have shown over the last years. In the new environment, we expect more dispersion and less correlation, which should benefit Macro and Long/Short managers. As such, we are increasing our exposure in some those vehicles which should outperform with lower beta. Of course, investors should remember that the selection and ongoing due diligence process is essential here to obtain the expected outcome.
"While currency movements have been widely played in the market especially in anticipation of a weaker Euro and Japanese Yen, we now anticipate a stabilisation of those currencies. As every investor knows, it is very difficult to time the exact point of reversal and as such, we would start to get exposure in those two currencies at current levels. In 2016, sterling could face headwinds, ahead of the referendum, and as such we would advise euro investors to take some of their profits and conversely sterling investors to diversify their currency exposure."