Could Your Family Benefit From An Independent, Outsourced Chief Investment Officer? Part III
When brokers, advisors, friends and acquaintances bring new investment ideas and products to you, are you equipped to determine whether the investment is appropriate for the portfolio given overall investment objectives? Is it a good investment relative to other opportunities? Are fees in-line with the peer group? Is the product structure reasonable?
Brokers or advisors should be able to demonstrate their due diligence process for traditional products being recommended for the family’s portfolio. Typically, manager tenure, performance consistency, fees, style drift, risk, and organizational consistency should all be analyzed and explained.
Sometimes a more challenging situation is when families are approached by friends and acquaintances with new investment opportunities. While there may be some comfort investing alongside people you know well, often these strategies have not been fully vetted and, in particular, the role of the strategy within the family’s overall portfolio might be uncertain. Furthermore, it can be difficult for a family to decline their friends’ recommendations. An independent OCIO can conduct full investment due diligence and provide a third-party perspective on these opportunities. The independent OCIO can also be the one to help communicate the decision as to whether or not the opportunity makes sense for your family.
Alternative Investments. With alternative investments, the process should be even more in-depth. Risks and returns are often less market-driven and more product specific.
Background checks, onsite visits, structure analysis and reference checks are crucial. How and why are returns generated?
Proprietary Products. There may be times when a broker or advisor’s proprietary products are of high quality. Often, however, they are not. The compensation structure at many firms varies and may encourage advisors to recommend their own company’s products. Special scrutiny of these products is essential.
An independent, conflict-free family OCIO that does not offer proprietary products is ideal for conducting this diligence. The OCIO can help you determine whether the recommended products represent the best-of-breed within the asset class.
Case Study
Selling Ideas
Situation: A family office worked with multiple advisors and brokers. The family was skeptical about conflicts of interests and needed an independent OCIO to take control of the asset allocation, product evaluation, and consideration of new products and managers. Additionally, the brokers/advisors were “selling ideas” to the family office that were laden with high fees and commissions. For instance, one manager wanted to “sell access” to a manager for a three percent entry fee!
Independent OCIO Solution: Each broker/manager submitted their best ideas to the family and OCIO, and then the best products were selected based on the family office’s needs. They now use the best products from each broker/advisor at reduced fees.
Attribution analysis can also help explain how the manager’s performance was generated and whether the investment process is sound and repeatable. Institutional investors rely on this information to help make decisions about managers and overall asset allocation. The analysis in the chart to the right provides an example of an attribution analysis that can be performed on investment strategies over short- and long-term time periods.
Product Due Diligence. As managers inherently present their products in the best light, it is essential to obtain an objective opinion as to the progress and success of products, managers and the total portfolio relative to goals. Extensive qualitative and quantitative criteria should be used in the selection and monitoring of managers. The Manager Score Card to the right illustrates a sample rating system in which products are given a yellow or red rating indicating there are minor concerns, or major concerns regarding that manager with an accompanying explanation.
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Case Study
LJM Growth and Preservation Fund – A Morningstar Five-Star Rated Fund
Situation: An investor asked their advisor about whether LJM Growth and Preservation Fund could be a potential investment solution. LJM had generated a consistent track record of high single-digit returns from its inception in 2006 through mid-year 2017. Moreover, whenever the fund had modest negative periods, it snapped back time after time.
Independent OCIO Solution: After extensive due diligence, including a site visit, it was recommended to not invest in the fund. LJM was a classic volatility strategy, using futures and options to essentially bet on the direction and magnitude of the stock market. The strategy itself was not much different than other volatility strategies – it just had more success – for a limited time.
In the matter of a couple days in mid-February 2018, the fund fell approximately 85 percent in value and began liquidating all assets.