Risk versus Return: Most wealthy families are capital preservation-oriented investors. Capital preservation strategies make sense to them because, since they are already rich, the extreme outcomes of aggressive investing are asymmetrical. On the one hand, they might even get richer, which would be nice. On the other hand, they could go broke, which would be catastrophic.
Capital preservation investing begins by thinking first about the risk and only second about return. One reason is that over anyone’s investment lifetime, there are going to be huge market dislocations that destroy capital. In a very sense, the core challenge of managing private capital is to prepare for those dislocations without undermining the long-term returns.
Investment Policy Statement: We start with a description of each family unit or entity. Different family units, individuals, and entities will have different investment objectives. Sometimes there are both long-term objectives and shorter-term investment objectives. Then the asset allocation strategy for that entity is set forth, with targets and ranges.
Asset Allocation: Advisory firms approach the asset allocation challenge in different ways. While there is no one right way to do it, there are many wrong ways, most obviously firms that offer only predesigned portfolios (e.g., a conservative strategy, a moderate strategy, and aggressive strategy). Predesigned portfolios might be necessary in the retail world, but they are completely unacceptable in the world of family wealth management. Every family’s portfolio needs to be custom-designed from ground up.
Manager research: Like the question of asset allocation, there are many ways to go about manager search and monitoring. Family members simply wish to understand how an advisor thinks about the issue and whether the approach resonates with them as a family.
Many advisors like to encourage their clients to have input into the manager selection process. Unfortunately, that blurs the ultimate responsibility for how the managers perform, allowing the advisors to duck culpability. This is wrong in two ways. First, it assumes the client actually knows something about the manager selection, which is unlikely. Second, as noted, it allows the advisor to transfer some of the responsibility for poor manager performance to the client.
Performance reporting: Clients’ takeaways from performance reports should be the following:
- Is my portfolio performing about like I expected it to perform over the longest period available?
- Is the portfolio generating some income I will need for my spending?
- Over shorter periods of time, is my performance against my benchmarks reasonably okay?
- Over longer periods of time, are my managers adding value on a risk-adjusted basis?
- Finally, as the years go by, how happy are you with the way the capital is performing?
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