Family Office – The Investment Process (3)
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.
It is no secret that some asset classes are more tax-efficient than others. Selecting the most efficient combination of assets
for the family may require taking into consideration the ultimate after-tax return that they would expect to receive. For each
asset class, the expected return should be deconstructed to reflect the income yield from interest and dividends versus the return from capital appreciation. Based on the level of turnover typical for each asset class, it is possible to estimate the percentage of asset appreciation that comes from realized versus unrealized capital gains, and also the extent to which
realized capital gains would be treated as short-term as against long-term tax liabilities. Providing asset allocation analysis on an after-tax basis may present a realistic view of the return the family can expect from its portfolio investments, as well as a favorable mix of investments tailored to a family’s specific tax considerations.
Using capital market assumptions
It is important for the asset allocation process to involve capital market assumptions (CMAs) covering as large a number of assets and asset classes as possible. Total return forecasts should balance quantitative forecasts with qualitative
judgments to produce long-term average forecasts of how assets and asset classes will perform. This permits the building
of tailored portfolios guided by how long-run asset returns may look in the future, as opposed to simply using longer-term
historical trends. Nevertheless, cross-checking with the past can also help to put forecasts into context versus the long run.
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