For the second edition of the Factor InVe(nn)stigator1, we will be evaluating family office portfolios in North America through a risk factor lens. A recent family office report by UBS and Campden Wealth painted a dim market view shared by many of the 360 global family offices surveyed.2 The report explains how family offices are challenged by the lack of investment opportunities in the current environment, and many expect a recession next year. In this blog post, we investigate whether family offices in North America have structured their portfolios appropriately given this dim view.
Figure 2.4 of the report, copied below in Exhibit 1, provides the general portfolio make-up of North American family offices, with each horizontal bar representing the percentage of capital allocated to each asset class.
Exhibit 1: North America Family Office Portfolio Allocations by Asset Class3
Source: The Global Family Office Report by UBS and Campden Wealth, 2019.
The portfolio gives the impression that it is well diversified, as capital is allocated across many asset groups. It also seems to be defensively positioned, given its relatively moderate allocation to equities. With more than a third in public equities, the portfolio is underweight relative to the traditional “60/40” stock/bond portfolio allocation. Further, family offices have reduced their exposure to public equities compared to allocations last year.4 Perhaps this is because the majority of family offices surveyed “expect the global economy to enter a recession by 2020.”
From a risk factor perspective, the allocation may not be ideal for a recession
We loaded this asset allocation into Venn to evaluate how diversified the portfolio is from a risk factor perspective. We used index proxies to represent the various asset classes (e.g., the MSCI ACWI Index represents equities).5 The results show something that may surprise family offices with such an allocation - the portfolio is still dominated by Equity risk.
Exhibit 2: Factor Exposures of the North America Family Office Portfolio
Source: Venn. Time period: December 2010 - March 2019, using monthly data.
Exhibit 3: Factor Contributions to Risk of the North America Family Office Portfolio
Source: Venn. Time period: December 2010 - March 2019, using monthly data.
Exhibits 2 and 3 demonstrate that the portfolio has positive exposure to only three of the fourteen factors in the Two Sigma Factor Lens, with Equity being the most notable.6 The 0.73 Equity beta of the family office portfolio is actually higher than what would be expected of a traditional 60/40 portfolio.7 Further, 81% of the portfolio’s risk is explained by its Equity sensitivity, further demonstrating Equity’s dominance in this portfolio. The other 19% is split across the other two factors and the unexplained, idiosyncratic risk (relative to the factors in the Two Sigma Factor Lens).8
Why might this be, if only a third of the portfolio’s dollars is allocated to the equities asset class? While over half of the 0.73 Equity beta can be attributed to the equities asset class, four of the other asset classes in the portfolio (everything except fixed income and cash) are contributing a combined 46% to that Equity factor exposure. Real estate, private equity, hedge funds, and commodities tend to have some “risk on” component due to their common exposure to shocks in the long-term growth and profitability expectations of companies, as well as overall investor risk aversion.
While their bearish market view may be reflected in their underweight to public equities relative to traditional 60/40 and even past family office portfolio allocations, other asset classes are contributing unexpected Equity beta. Therefore, if equity markets fall and these factor exposures hold up, their portfolios would still be meaningfully exposed to that market decline.
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1 Read the first Factor InVe(nn)stigator, which analyzes the MSCI World Small Cap Index.
2 Source: The Global Family Office Report by UBS and Campden Wealth, 2019.
3 Note: Figures do not sum to 100% due to rounding.
4 Source: Figure 2.3 of The Global Family Office Report by UBS and Campden Wealth, 2019.
5 Fixed Income is proxied by the Bloomberg Barclays Global Aggregate Index. Equities is proxied by the MSCI ACWI Index. Private Equity is proxied by an interpolated series using the Preqin Private Equity Index and the MSCI World Index. Real Estate is proxied by the Dow Jones Total Stock Market US Select REIT Index Total Return. Hedge Funds is proxied by the Credit Suisse Hedge Fund USD Index. Commodities is proxied by the Bloomberg Commodity Index. Cash or Equivalent is proxied by the average 3 month sovereign benchmark yield in the US.
6 The positive Interest Rates factor exposure is not bold in Exhibits 2 and 3 because it is not economically meaningful to the portfolio, as evidenced by its low risk contribution in Exhibit 3.
7 The expected Equity beta for a 60/40 stock/bond portfolio is around 0.6.
8 The positive Interest Rates factor exposure offers a negative (correlation-adjusted) risk contribution because of its diversifying properties relative to the other factors. In fact, the correlation between the Equity and Interest Rates factors over this time period was -0.3.
This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Any statements regarding planned or future development efforts for our existing or new products or services are not intended to be a promise or guarantee of future availability of products, services, or features. Such statements merely reflect our current plans. They are not intended to indicate when or how particular features will be offered or at what price. These planned or future development efforts may change without notice. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. See the end of the document for other important disclaimers and disclosures. Click here for other important disclaimers and disclosures.
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