Challenges and Opportunities for Family Offices in the 2020s

David Baker, our Senior Director, Investment Research appears in the March 2021 issue of Cerulli Edge Global, a monthly periodical (subscription-only) from the venerable Cerulli Associates, provider of research and consulting to decision-makers in financial services, including managers of family offices. Cerulli Edge cites a recent UBS Global Family Office report indicating that just 55% of family offices rebalanced portfolios during the spring 2020 market plunge in order to maintain their long-term strategic allocation. But per the same report, two-thirds of family offices took advantage of last spring’s near-term market volatility to trade up to 15% of their portfolio via tactical moves.

One year out from the pandemic rout, markets have more than fully recovered and are at new record highs. That presents a major challenge for managers, says Dave, since most financial assets look expensive in the near term. He and LNWM’s Investment Strategy & Research team expect returns for the next 10 years to be less robust due to current valuations, lower forecast growth after the post-Covid rebound, and uncertainty regarding interest rates and inflation. These trends mean managers should be looking at new ways to diversify and also the possibility of taking on more risk, notes Dave.

He points out that here at LNWM we are looking closely at real assets, on both a near-term and long-term basis, including commodities, Real Estate Investment Trusts (REITs) and infrastructure equities. Commercial real estate remains in limbo as office use is reconsidered/reconfigured, while infrastructure equities lagged in 2020 despite the pandemic having little impact on income statements outside of the energy component.

Dave and his team believe real assets are uniquely positioned to do well in 2021 and 2022 as investors identify them as a pocket of opportunity. Real assets are likely to benefit from higher spending on infrastructure repair and development, and if inflation takes off, offer some natural protection from that shock, as the majority of the businesses in this asset class are able to pass price increases through to customers.

Fixed Income Considerations

Another key concern now is how much to allocate to bonds and other types of fixed income. Dave points out that with the US 10-year Treasury yielding around 1.6% recently, it isn’t surprising that asset allocators are looking for alternatives to bonds for yield, especially if they’re willing to accept more volatility. That said, many may be losing sight of the fact that the primary role fixed income has in a portfolio is to reduce risk, not generate return. Consider the investor making higher allocations to high-yield bonds at the expense of core fixed income. In doing so, they’re boosting the portfolio’s expected yield. But, at the same time, they’re deteriorating the quality of the fixed income as a diversifier.

Dave thinks high-quality fixed income will continue to provide the simplest and cheapest diversification for portfolios that are in aggregate driven by equity risk, even during a period of historically low yields. Portfolios may hold fewer bonds and other debt instruments than they did in the past, but there needs to be a focus on increasing the quality of what remains to ensure it provides value when it’s needed.