Abstract: “Family Offices and Alternative Investments”
Paul A. Ehrhardt
Managing Member, Investment Business Advisors, LLC.
All Rights Reserved
In the midst of a prolonged low interest rate environment, many mid and large sized Family Offices are going beyond the traditional 60-40 equity/fixed income asset allocation framework for their investment portfolios. In search of higher expected returns through portfolio diversification and lower volatility, and seeking to tap true alpha uncorrelated to traditional equity and fixed income markets, many Family Offices are making initial allocations or increased allocations to “alternative investments” including hedge funds, funds of hedge funds, private equity, real estate and commodities funds.
How can Family Offices effectively and prudently pursue this trend? What are the specific lessons to be learned by Family Offices from the 2008-09 financial crisis regarding alternative investments? What additional lessons need to learned from the Madoff Ponzi scheme and other recent alternative investment frauds and failures? And what lessons can be learned from institutional investors (such as university endowments) whose portfolios have included significant allocations (>50%) to alternatives for many years?
This White Paper posits that, as Family Offices pursue “alternative investments”, it is critical to their success that they undertake broader, deeper and more robust initial and ongoing due diligence assessment programs for these alternative investments. Traditional alternatives due diligence programs have had two major components: “Investment Due Diligence” and what has been termed “Operational Due Diligence” (“Ops DD”). This White Paper recommends expanding that framework to include 3 additional explicit categories of due diligence assessments regarding: “Alternatives Fund/Account/Investment Vehicle” due diligence, “Alternatives Manager Firm” due diligence and “Investment Business Process” due diligence. And to consider all 5 key areas under a new framework/heading called “Alternatives Investment Business Management Due Diligence”.
Investment research shows that overall asset allocation decisions can be a very important driver of investment performance; explaining as much as 90% of the variability of portfolio returns. Research also shows clearly that “performance dispersion” among alternative investments (the difference between the highest and lowest performing funds/managers in a given alternatives strategy) varies much more widely than the performance dispersion in, e.g., long-only equity strategies. As a result, manager/fund selection is even more important in the alternatives arena than in the long-only world. This heightened importance of alternatives manager/fund selection further reinforces the importance of Family Offices adopting the broader, deeper and more robust due diligence programs as recommended in this White Paper. .
The author also suggests that use of formally adopted alternatives industry “Best Practices” can guide and give confidence to Family Offices as they pursue alternative investments more extensively. Several sources of formal alternative industry “Best Practices” are highlighted and the author also describes how these “best practices” should be customized to Family Offices based on each Family Office’s distinctive overall investment program characteristics and operating model (mix of internal and outsourced assistance).
Attention is also drawn to a potential distinctive “sweet spot” for Family Offices investing in alternatives; i.e., by seeking to align the typical size of individual alternatives investments made by many Family Offices with the smaller and “younger” alternatives funds/managers who have outperformed their larger peers. .
Following a summary of recommendations, there are 3 Appendices: Appendix A: Bibliography with relevant website addresses; Appendix B Sample Model Due Diligence Questionnaires (DDQs) – one for assessing Hedge Funds and the other for assessing Private Equity investments, and finally, Appendix C: Table of Contents (for 16 different) Alternatives Industry “Best Practices” documents”.
Paul A. Ehrhardt is an executive with 40+ years of experience; public sector (5 years), non-profit (3 years) and financial services experience (36 years). 28+ years of Paul’s experience have been in leadership and management positions in global asset management firms. Most recently Paul served as Managing Director & Chief Operating Officer of Arden Asset Management (fund of hedge funds) and he has experience in the long-only equity and fixed income businesses as well as with a range of “alternative investments” including hedge funds, private equity, real estate and commodities firms. His global asset management experience as Managing Director and Chief Operating Officer includes responsibilities for leadership and management support and regulatory compliance of investment teams located in: London, Tokyo, Hong Kong, Singapore, Melbourne, Sao Paulo, New York and multiple other cities/states in the USA.
In addition to his role at Arden, Paul’s experience also was gained at: Legg Mason International Equities (London & New York), Citigroup Asset Management (London), American Century Investment Management (Kansas City, MO), Aeltus Investment Management, and CIGNA Investment Management (Hartford, CT). Currently Paul is Managing Member of Investment Business Advisors, LLC, registered in Washington, DC and New York.
Paul A. Ehrhardt
Investment Business Advisors, LLC.
This document is for informational purposes only and is not and should not be construed as an offer to sell or a solicitation of an offer to buy any interest in any entity or investment vehicle. Any offer to sell or solicitation of an offer to buy can only be made pursuant to a confidential private offering memorandum of the applicable investment vehicle “Memorandum”). The information in this document is qualified in its entirety and limited by reference to any such Memorandum, and in the event of any inconsistency between this document and such Memorandum, the Memorandum shall control.
Appendix A: Bibliography
Appendix B: Sample Due Diligence Documents
Appendix C: Table of Contents of Alternatives Industry “Best Practices” Documents