Asset Allocation & Risk Management: Family Office Training Manual
Asset Allocation & Risk Management: Family Office Training Manual
This manual guides family office investment teams through aligning portfolios with family objectives and managing risk. Asset allocation – distributing wealth across asset classes – is foundational to returns and risk management. Portfolios should balance growth assets (for long-term wealth creation) with preservation/liquid assets (for near-term needs). For example, many family offices allocate nearly half their portfolios to alternative investments (private equity, real estate, hedge funds), while keeping sufficient cash and high-quality bonds for liquidity. Every strategy must be tailored to the family’s goals, risk tolerance and time horizon.
1. Determining Broad Asset Pools
Align with Objectives & Horizon: First, clarify the family’s financial goals (e.g. wealth preservation vs. growth, philanthropic spending needs, legacy planning) and time frames. A younger dynasty pursuing growth can tolerate more equity or venture allocations, whereas an older generation nearing liquidity needs will favor income and capital preservation. Example: Allocate capital so that cash and short-dated bonds cover expected spending for the next 1–3 years, while equities, private assets and real estate target long-term growth.
Liquid vs. Illiquid Buckets: Define liquidity bands. Liquid assets (cash, money markets, Treasuries, publicly traded stocks/bonds) provide flexibility to meet commitments. Illiquid assets (private equity, direct real estate, infrastructure, collectibles) pursue higher returns but may take years to monetize. A best practice is to hold liquidity buffers – for example, Cambridge Associates suggests keeping 2+ years of cash/fixed income to meet spending and capital calls. Illiquid investments should be sized so calls and lockups fit the family’s cash flows.
Growth vs. Preservation Buckets: Further categorize by risk-return orientation. Growth buckets include equities (public and private), high-yield credit, and venture capital. Preservation buckets include high-quality bonds, cash, inflation-hedges (e.g. TIPS, commodities). Some assets bridge both, e.g. real assets (commercial property, infrastructure) can generate income (preservation) and appreciate (growth). Use a balanced mix: “Diversification is essential…across traditional, alternative, and emerging asset classes (real estate, stocks, private equity) to achieve stable returns and mitigate risk”.
Example Categorization: A working classification might be:
Liquid Growth: Public equities (large-, mid-, small-cap), emerging markets stock, listed REITs.
Liquid Preservation: Government and high-grade corporate bonds, short-duration credit, money markets.
Illiquid Growth: Private equity, venture capital, private credit, direct business holdings.
Illiquid Preservation: Private real estate, infrastructure, natural resources (forestry, agriculture) that yield income.
By clearly mapping investments into these pools aligned with family goals, the office can set a strategic allocation plan. Remember: “asset allocation…involves distributing investments across various asset classes…to balance risk and reward”.
2. Model Portfolio Examples
To illustrate, consider three archetypal family-office objectives. These are hypothetical allocations (by % of total portfolio); actual weights depend on each family’s situation:
Preservation-Focused (Conservative): Priority is capital preservation and income. Typical mix: ~20% public equities, ~50% fixed income (mostly government/IG bonds), ~10% cash/liquidity, ~10% real assets (stable real estate/infrastructure), ~10% alternatives (e.g. hedge funds, private debt). This might be similar to a “Third Generation” multi-generational profile, which Neuberger Berman shows allocating roughly 53% to alternatives, 23% to equities and 25% to bonds (reflecting substantial real assets and insurance-linked alternatives). Fixed income here is tilted toward high-quality sectors, with less emphasis on high yield.
Balanced (Growth-and-Preservation): A moderate approach blending growth with stability. Typical mix: ~30% equities (global), ~30% fixed income, ~20% real assets (real estate, commodities), ~20% alternatives (private equity, credit, hedge funds). For example, NB’s “Second Generation” profile allocates ~51% to alternatives, 28% to equities and 21% to fixed income – essentially equal parts “traditional” and “non-traditional.” This can target long-term ~8–9% returns (using active strategies in private credit and real assets) while limiting volatility.
High-Growth (Aggressive): Goal is above-market returns with higher volatility. Typical mix: ~50–60% equities (including some emerging markets), ~15% fixed income, ~10–20% real assets, ~15–25% alternatives (heavy in private equity/co-investments). NB’s “First Generation” aggressive model, for instance, used ~55% in alternatives (notably private equity and hedge/IL bonds), 30% in equities, and only 15% in bonds. This reflects a focus on private and alternative alpha, accepting short-term drawdowns.
Each model should include clear targets for sub-classes. For instance, an aggressive portfolio might further split equities into 10% U.S. large cap, 5% international developed, 5% emerging, 20% private equity, etc. A balanced portfolio might set max 5–10% in any single strategy or fund to avoid concentration. These examples are illustrative; families must adjust for their unique needs.
3. Asset-Class Benchmark Guidance
When measuring performance and setting expectations, use established benchmarks for each asset class. A benchmark is typically a market index that represents the asset class. Common choices include:
Equities (Public): S&P 500 Index (US large-cap), MSCI ACWI or MSCI All Country World (global equities), MSCI EAFE (developed ex-US), MSCI Emerging Markets, and local indexes (e.g. FTSE All-Share for UK stocks).
Fixed Income: Bloomberg/Barclays U.S. Aggregate Bond Index (broad US investment-grade bonds), Bloomberg Global Aggregate, ICE BofA Global High Yield, and local benchmarks (e.g. iBoxx Sterling Gilts for UK government bonds). For Treasury bills or cash, 3-month Treasury Bill rates or overnight interest benchmarks (SOFR in US, SONIA in UK) serve as cash proxies.
Real Estate: MSCI/INREV Global Property Fund Index (for unlisted real estate), FTSE EPRA/Nareit (listed REITs indices), and NCREIF Open-End Diversified Core Equity (ODCE) for US core real estate. For infrastructure, FTSE Global Infrastructure Index or S&P Global Infrastructure Index.
Private Equity & Venture: Cambridge Associates US Private Equity Index or Preqin Global Private Equity benchmarks (lagging indicators of historical PE returns). These measure the collective performance of pooled private equity portfolios. (Note: Only measured with a delay; use long-term spot check.)
Hedge Funds: HFRI Fund Weighted Composite Index or HFRX Global Hedge Fund Index provide broad hedge fund performance metrics. Some offices also benchmark by strategy (e.g. HFRI Equity Hedge Index for equity hedge funds).
Other Alts: For private debt, benchmarks like S&P/LSTA Leveraged Loan Index or Credit Suisse Leveraged Loan Index; for commodities, Bloomberg Commodity Index.
Cash: Short-term treasury bill yields (e.g., ICE BofA US T-Bill Index) or LIBOR/SOFR-based money market indices.
Using benchmarks lets the family office gauge whether active management is adding value. Remember that benchmarks should match the portfolio’s risk style (e.g. a multi-strategy hedge fund portfolio should not be compared to S&P 500). “A benchmark…tracks a broad asset class”, so pick one that reflects the portfolio’s intended holdings.
4. Rebalancing Strategies
Markets move, so rebalancing keeps the portfolio aligned with targets. Principles: sell “high” assets and buy “low,” locking in gains and resetting risk. Rebalancing is typically done on a calendar basis or threshold basis. Common approaches include:
Periodic Rebalancing: Review allocations semi-annually or annually and trade back to target weights. For example, many offices rebalance annually.
Tolerance Bands: Define ±Δ% bands around targets. E.g., if equities target is 30%, rebalance whenever equity weight drifts above 35% or below 25%. (T. Rowe Price research compares 2–5% bands.) When a band is breached, sell (or trim) the overweight asset back to target.
Hybrid Approach: Combine periodic checks with triggers. For instance, rebalance quarterly if any asset class is ±5% off target; otherwise wait for the annual review. This prevents unchecked drift.
Execution: When rebalancing, consider tax implications. In taxable accounts, rebalance mainly in low-gain assets or use new cash inflows. In family offices (often non-taxable entities), tax is less of a constraint, so focus on strategic needs. However, be mindful of trading costs and market impact in illiquid assets.
Adjustments: Rebalancing isn’t automatic – it should reflect changes in family goals or markets. If a family goal shifts (e.g. upcoming liquidity need, or a change in risk tolerance), adjust the strategic targets first, then rebalance to the new targets. Hyzy (Merrill’s CIO) advises frequent reviews to ensure allocations stay aligned. Also, if a major opportunity emerges (e.g. undervalued sector, special investment), one may rebalance early to capitalize, provided it doesn’t jeopardize overall risk limits. Ultimately, rebalancing “ensures that investments remain aligned with the family office’s…goals despite market changes”.
5. Risk Management Considerations
Sound risk management protects the family’s capital. Key elements include:
Diversification: Spread exposures across uncorrelated assets. Hold a mix of equities, bonds, real assets and alternatives as described. Also diversify within asset classes: multiple sectors, geographies and fund managers. Avoid concentration: no single position (including the family’s core business) should dominate the portfolio’s risk. “Diversification…[across] real estate, stocks, and private equity” is essential to mitigate risk. Periodically calculate portfolio correlations and value-at-risk to confirm true diversification.
Liquidity Buffers: Maintain emergency liquidity. Ensure cash and liquid bonds cover at least 1–3 years of spending and commitments. Regularly stress test the portfolio under adverse scenarios (market crash, interest spike, liquidity freeze). Cambridge Associates advises stress-testing for liquidity mismatches so the family can take action before a crisis. An untested plan is risky.
Drawdown and Volatility Limits: Establish risk “budgets” in your Investment Policy Statement. For example, set a maximum portfolio drawdown (e.g. 20–25%) or volatility (standard deviation) that the family is willing to endure. Best practices recommend explicitly defining such limits. Also plan “escalation procedures” – concrete steps if losses approach those limits (e.g. shifting to cash, hedging, or pausing certain strategies).
Stress Testing & Scenario Analysis: Model extreme conditions (e.g. 2008/2020 crises, stagflation, regulatory changes). Use scenario analysis to understand effects on portfolio, cash flows and key holdings. Example: “Hedge fund” strategies may be stress-tested against equity downturns or credit crunches. Include non-market risks too (geopolitical events, regulatory shocks).
Ongoing Monitoring: Implement a risk reporting framework. Use tools to aggregate positions across managers (often via portfolio management software). Track exposures (e.g. interest-rate sensitivity, FX exposures, concentration risk). Have regular risk reviews (monthly/quarterly). Many family offices establish a Risk Committee or use external advisors for independent oversight.
Operational and Legal Risk: Ensure governance structures are in place. Maintain clear mandates for investment staff, conduct due diligence on managers, and have succession plans for key team members. Document all policies in an Investment Policy Statement (IPS) or Risk Management Policy.
By combining broad diversification with strict limits and regular stress tests, the family office can navigate market cycles. Remember: as one practitioner notes, with volatile markets it’s easy to “accumulate too many risks or avoid them and miss out on profitable opportunities” – disciplined governance and rebalancing help stay on track.
6. U.S. and U.K. Regulatory & Tax Considerations
Investments must comply with each jurisdiction’s rules. Key points for U.S. and U.K. family offices include:
U.S. Investment Adviser Exemption: U.S. single-family offices may be exempt from SEC registration under Rule 202(a)(11)(G)-1 if they meet criteria: advise only “family clients,” are wholly family-owned/controlled, and do not publicly solicit clients. Meeting this rule (“Family Office Rule”) means the office avoids most Advisers Act requirements. Offices serving multiple families or outside the family are not exempt and would need to register.
UK Regulation: In the U.K., there is no special “family office” license, but small offices often fall below thresholds for FCA registration. Advisers must ensure they are not unintentionally acting as regulated entities (e.g. collective investment schemes). As a best practice, confirm whether services (investment advice, corporate finance, etc.) require an FCA license or can be provided under an exemption. (Many SFOs operate under corporate entities and may use FCA-regulated third parties for formal advisory services.)
Tax Structures & Funding: In both countries, structuring matters for tax. In the U.S., use of trusts, holding companies and entities will affect estate and gift taxes (top rate ~40% on transfers above exemption). Multi-generational estate planning (e.g. dynasty trusts) can minimize taxes if well-structured. In the U.K., inheritance tax (IHT) can be 40% on large estates (with current nil-rate bands), and trusts are taxed at high rates on gains and income. Non-domiciled individuals can use the remittance basis (tax only UK-source income) but may face charges.
Funding the Family Office: Operating costs should be charged on an arm’s-length basis. UK guidance emphasizes that family office expenses must be funded commercially; non-commercial funding (especially involving offshore trusts) may trigger tax on gains. For example, if an investment company owned by the family pays the FO for services, the charge should reflect market rates so the company can deduct it. Similarly, providing services or borrowing on non-commercial terms can create hidden tax liabilities (e.g. benefits-in-kind or transfer-pricing issues).
International Reporting: U.S. persons (citizens/residents) pay tax on worldwide income, and foreign accounts must be reported (e.g. FATCA/FBAR). U.K. residents are taxed on UK-source income and gains, with specific rules for foreign trusts and offshore structures. Both countries adhere to global standards (FATCA for U.S., CRS for UK/EU) so offshore investments will require disclosure. Ensure compliance with all reporting (annual FBAR, Form 8938 in the U.S.; UK trust/land registries; etc.).
Other Considerations: In the U.S., recent tax law changes (e.g. interest expense deductibility, carried interest rules) may impact investment choices. In the U.K., changes to non-dom and trust taxation (e.g. the 10-yearly trust charge) are being introduced. Offices should consult tax counsel to optimize structures (e.g. whether a Family Investment Company in the UK is appropriate, or use of partnerships). Additionally, both countries impose VAT or GST on some services, and payroll taxes on staff, which must be managed in the budget.
Ultimately, legal and tax advice should be integrated into portfolio planning. A multi-jurisdiction family office must respect each regime’s unique rules while seeking global efficiency. For example, U.S. advisors note that “prior to 2017, the ability to deduct family office fees was a critical factor” in structuring (though many of those rules have since changed), underscoring that tax nuances can alter the cost-benefit of a family office structure.
Key Takeaways for the Family Office Team
Start with Goals: Document the family’s objectives and constraints (liquidity, risk, legacy, values) and have family governance validate them.
Construct the Plan: Define target allocations across liquid/illiquid and growth/preservation pools, balancing current needs and future growth. Use sample models (conservative, balanced, aggressive) as benchmarks, but customize to the family.
Use Benchmarks: For each asset class, pick a relevant index or benchmark, and review manager performance against it regularly.
Review & Rebalance: Implement a rebalancing rule (periodic and/or threshold-based) and stick to it. Adjust targets only when strategic goals change.
Manage Risk Continuously: Enforce diversification, maintain liquidity buffers (e.g. 2–3 years of spending in cash/bonds), and set explicit risk limits (drawdowns, sector caps). Run regular stress tests and adjust the portfolio or strategies if key risks materialize.
Stay Compliant: Verify any regulatory exemptions (e.g. SEC family office rule), register in required jurisdictions, and keep up with tax filings (trust returns, foreign asset reports). Update structures as laws evolve in the US and UK.
By following these guidelines and documenting them in an Investment Policy Statement, family office professionals can ensure that portfolio strategy is aligned with the family’s mission and robust to uncertainty. Regular education (training) sessions and reviews will help keep the team and family informed as markets and regulations change.
Sources: Industry reports and guides (Citi, Goldman Sachs, Neuberger Berman), investment advisors (Cambridge Associates), and family office best-practice publications. These have been synthesized to provide a practical manual.