Family offices need a plan for equity investing

Besides the often passionate discussions around startups and angel investing, the other most debated topic among family offices is equity investing. While this asset class attracts interest during both bullish rallies and bearish crashes, it is often not planned for optimally. But there are some common mistakes that family offices and ultra-high-net-worth (UHNW) individuals make while structuring an equity portfolio.

Family offices and UHNWs have to think like institutional investors. Most large institutional investors are manager selectors and often do not manage any equities in-house. The exception to that trend are investors who have a strong background in equities and can afford an army of analysts and senior experienced discretionary fund managers. The biggest mistake family offices make is to try to beat the benchmarks using a two- or three-member equity team. The paradox is that while the best full-time equity fund managers are sometimes unable to beat the indices, how can a small in-house team achieve that?

In some instances, family offices often mention that they are actually constructing a long-term buy-and-hold portfolio of well-governed companies and hence they are doing it internally. This is a valid reason to have direct equity holdings, but that surely does not need daily tracking and a small equities team. If the family office CIO lays down basic rules for such a high-quality portfolio, the stocks can be shortlisted using publicly available data.

In some cases, an adviser is hired to run a direct equities portfolio. This has two problems: firstly, if the adviser has a small team, how can it compete with full-time fund managers with much more resources and experience? Secondly, the adviser in most cases avoids giving a comparative performance of the portfolio on a regular basis and the equity advisory just becomes a hook to keep things exciting.

This brings us to the issue around the lack of disciplined assessment of the internally managed portfolio. Assuming it is done on a semi-annual or annual basis, the learnings from that exercise need to be taken seriously. If the portfolio is failing to beat third-party managers, it should surely be a matter of big concern since any underperformance implies the family losing money in the long run.

It is recommended to prepare the younger family members to take over the reins of the family office. What we have seen is that some families push the next gen to either “trade” in equities directly or work with some brokers as trainees. If this is an endeavour to teach them the basics of equity investing, then it’s the wrong place to start. Equity investors make money over a period of time and what they need to learn are the basics of economic cycles, company performance tracking, sectoral cycles and valuations, etc. That is something that trading will not teach the younger minds. A better plan is to have some basic theoretical knowledge and then attempt to understand the thesis behind investments done by experienced fund managers.

Needless to say, with the gradual move towards passive investment strategies using benchmark indices, smart beta or multi-factor investing, etc. the next gen should focus on asset allocation and then identify the best manager for their equity allocations.

When families choose to work with investment advisers, multi-family offices or wealth managers, they need to be sure whether the adviser is not attempting to push his own products or use tie-ups to earn transactional revenues. With Sebi’s strict segregation between advisory and distribution, many wealth managers are using ingenious ways to make that extra money.

Family offices are best served if they have a combination of third-party managers across passive funds, mutual funds, PMS, alternative investment funds and also have a strategic direct equity buy-and-hold portfolio. The onus of creating a professional family office will depend on carefully planning for each asset class and not hurrying to invest without any proper plan.

Originally published in Mint  on 20 May 2021

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    • CIN Number : U74999MH2019PTC324434
    • SEBI Investment Advisor Registration : INA000015385
    • Type of Registration : Corporate
    • Validity : November 2022
    • Principal officer : Mr Rohit Karkera

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