Melanie Stern is Section Editor of Families in Business magazine.
We asked family offices to tell us what they thought the most interesting alternative investment products for their clients were. Melanie Stern summarises the top four responses
The alternative investment market has seen significant growth in the past couple of years, both in terms of asset inflows and the birth of new products and strategies. It has also had its fair share of column inches, both good and bad, from handsomely compensated 'star' fund managers to the Securities and Exchanges Commission's probe into hedge securities fraud via offshore hedge funds.
Family businesses have long had a relationship with the alternative investment industry through the family office, which mandates external managers – mainly through hedge funds, fund of funds or fund of hedge funds – to produce absolute returns for their wealthy clients. The market provides the kind of diversification from traditional and volatile instruments, risk management and stable, high returns unaffected by the movements in their underlying market that help maximise and protect family wealth.
Families in Business asked a selection of family office directors across the world to tell us what they thought were the most interesting products or strategies in this field for their clients. We picked out the top four responses.
Fund of Funds
The 1794 Commodore Fund of Funds was launched in August 2002, as a joint venture between EURAM Bank, US investment firm York Capital Management and William AM Burden & Co, the New York-based family office for descendents of the Vanderbilt family. Marketed to large, wealthy families, it is based on the investment model already used by the family office and has ten years' data behind it. The investment team describes their FoF as "not an alternative to the equity markets but a non-correlated asset with a higher return alternative to bond markets investments, lower risk-managed interest rate, currency and yield curve exposures."
The FoF's ethos is heavily individual-driven, building a team of managers with a diversity of sectoral experience and analytical talent and through this, being able to react to markets while maintaining stable, absolute returns. A group of 'core' multi-strategy managers, selected for their specific ability to change their asset allocations with market movements and strong track records, control about 50% of the fund's capital. A 'satellite' group of managers with individual product or strategy expertise controls the other half, providing a more tactical approach and alternative way to gain exposure to higher volatility. The fund has added five new managers this year, totalling 20, and EURAM CEO Chris Donegan explains that the level is carefully monitored to ensure that each individual's input makes a difference to the bottom line. "If a manager has a good day, it should have a significant material impact on the overall portfolio performance. Our approach is different to other FoF who might apply a diversification strategy of 30-50 managers because they believe that, if one of them has a bad day, they only hold a small part of the portfolio so it would not make much of a difference," Donegan says. "But if a particular manager only represents 3% of the portfolio, they cannot have any material impact on the performance either."
Traditional FoF models only allow asset re-allocation by liquidating funds before moving them, making the process too cumbersome to respond to the market in real-time. Even though the alternative sector is at centre about steady returns gained by a low correlation to traditional markets, Commodore's approach has turned this on its head to impressive results (see the table below); "Part of the value added when you run an investment programme like this is picking a good manager, and another part of it is constantly making sure the portfolio you have reflects today's reality and not yesterdays," Donegan adds.
Structured finance has grown in popularity in recent years, as it allows companies or investment outfits like family offices to build bespoke financial products to suit specific needs, as opposed to applying a generic product.
Alternative investment giant Man Investments launches a new structured product in the form of a capital guaranteed structured bond, every quarter. The next, Man Multi Strategy Series 6, will be launched in late October 2003.
Man Investment's Chris Grosegger believes that family offices of a size to be compared to large institutional investors would find these structured products attractive for their common goal – controlled exposure to bond market volatility. "For family business and family offices, the importance is to target consistent medium-term annualised growth of around 13-15% for annualised volatility of around 7-8%, for both US$ and € class bonds," Grosegger explains. "Our experience has shown that our principal related products attract interest from the full spectrum of investors."
Exchange Traded Funds (ETF)
An ETF is a single stock that can track an entire index, making it much easier to understand and follow the movements of the overall index while still providing diverse investment and all the benefits of it.
ETF's are a relatively new concept and make good first-time investments for retail players – so they have quickly amassed a wide following. Additionally, they are cheap to trade because rather than paying for a transaction from each individual security on an index, an ETF pays once as a single stock (also making them very tax-efficient), and there are no set investment minimums for these products.
The first ever ETF was the Standard & Poor's Depository Receipts (SPDR or 'Spider'), launched in 1993 to track the S&P 500. Traded on the New York Stock Exchange (NYSE), SPDRs are commonly valued at around one tenth of the total value of the index, and pay a quarterly dividend based on the accumulated dividends of each security on the index. This is paid out through a trust that holds the individual dividends.
Barclays Global Investors launched a selection of its own ETFs in the past few years, i-Shares, covering global markets. They trade on the American Stock Exchange, the Chicago Board Options Exchange and NYSE.
QQQ's are the ETFs offered by Nasdaq tracking its Nasdaq 100 index of leading companies, or the Dow Jones Industrial Average. This gives family offices access to the liquidity and performance of leading companies including eBay, Cisco Systems and Ryanair Holdings in the case of the Nasdaq 100, or an index of companies traded on NYSE indexes including Microsoft, General Electric and 3M.
A popular type of alternative investment folded into a family office portfolio is distressed debt – debt issued by companies in, or expected to soon be in bankruptcy proceedings, so as to avoid insolvency.
The market for debt products has increased in the past few years as corporate scandals and difficult economic conditions have forced companies out of business, and the interest for family offices is to gain exposure to volatile markets for discounted prices. Investment in distressed debt is seen as a medium to long-term investment.