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Family Office – The Investment Process (2)

How do family offices invest their principals’ money? Family offices tend to follow their own individual investment policies, because unlike banks and other financial service providers, they are generally subject to the more relaxed regulations applicable to companies, trusts and foundations. However, the degree of freedom enjoyed by family offices is reduced in proportion to the level of services provided by third parties and the number of families served by the family office.

Setting investment goals
For most investment funds, whether sovereign wealth funds, endowments or family offices, the first task is to establish clear
investment objectives and risk profiles. Different investment structures can have varying goals and objectives, and there
is also variety in how these objectives are constructed. For example, some institutional investors work with inflation-related
return objectives, others might not.

An important distinction can also be made at this stage between liquid assets, such as tradable securities; and illiquid assets, such as direct investments, private equity and real estate – the latter being difficult to value and often requiring support in terms of funding. Many CIOs tend to view illiquid assets differently, when it comes to returns and investment horizons, to liquid asset portfolios.
Examining prior investment styles and questionnaires can help to identify the family’s tolerance to risk. In addition, scenario testing that illustrates and draws out important sensitivities to risk and portfolio drawdowns can be useful. In some cases, the discussion of the investment process is led by the CIO. In others, it can entail a more collective discussion involving family members, and cover any desires they have to establish charities or philanthropic initiatives alongside the family office.
Once an asset allocation recommendation has been reviewed, understood and accepted, the family should formalize the investment plan in an investment policy statement. Such a statement is a roadmap and focus for all parties involved, including investment advisers, investment managers and trustees. It also provides a course of action to be followed in times of market dislocation when emotional reactions may result in imprudent courses of action.
Once the specific investment goals – whether they involve growing or preserving wealth – and the risk profile of the family office have been established, the next step is to create an overall portfolio structure and engage the necessary investment tools to drive the investment process. In some cases, historical asset return data is used to give a sense of what future returns might look like. However, as recent stock market history has shown, the past is not a reliable guide to the future.

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