Rethinking Investment Philosophy in an Uncertain Climate

Family Office Alpha Report

By Phoebe Outerbridge & Keith Danko

February 8, 2016

The beginning of the new year was not the fresh start that most would have hoped for following the tumultuous fourth quarter of 2015. In fact, the first two weeks of January were the worst start to US equity markets ever, even considering the Great Depression and the Great Recession. With many positive factors influencing investment performance—low unemployment, strong housing fundamentals, and consumer confidence—there are just as many dragging factors (think China, oil) to counter those forces.

While a difficult environment is not pleasant to endure, it can provide the opportunity to shake off any latent complacency and to reflect on overall philosophy going forward.  What additional factors should investors consider as they look to the future and make allocation plans? What changes should or could be made short and long term? What opportunities may be out of the traditional purview or beyond an investor’s typical parameters or criteria? How can timing and control be considered differently, and maximized?

We are not talking about protective reactions or a process of fixing past mistakes.  While those things often must be done, and the attendant pain absorbed, our suggestion is an additional process of re-examining and questioning the underpinnings of one’s overall investment philosophy.

Assess Liquidity and Asset Class Parameters

By stepping back and making an assessment of an individual or institutional investment philosophy, new opportunities may be uncovered. One pragmatic example of this is the opportunity to reexamine risk/return goals as they pertain to liquidity constraints and concerns. Liquidity trades at a premium in uncertain, unsteady times such as these; for investors with liquidity or cash, now could be the time to consider less liquid investments. In this type of market, the capital needs of businesses, managers, developers, and entrepreneurs whose offerings are illiquid or less liquid are even greater, and an investor putting money into an investment such as this will likely receive more favorable economics as a result.

Other areas that warrant a second look are investments that may be off the beaten track, either because the deal size is smaller than an investor’s typical minimum or is outside an investor’s customary asset class. The market has recently made it loud and clear that investing exclusively in the listed equity or bond market is no longer the path of least resistance. Investors can benefit from considering fewer consensus or “name-brand” investments by engaging in deeper research into unique or alternative strategies.  Direct private equity deals with high cash flow or smaller real estate transactions that provide steady yield plus a terminal value are a few examples.

Expand Your Time Horizon

Looking for ways to expand the time horizon on investments can be another facet of a recalibration of strategy or priorities. Thinking beyond the typical three, five or seven-year investment period can usher in fresh opportunities. In recent (and separate) conversations, we asked two large, well-known endowments what investment time horizon their philosophy deemed ideal. One answered that they operate on a 25-year time horizon, while the other said they consider their time horizon “infinity.”  One even explained that they consider investments with an assumption that whatever they do must work for those who come after them as managers, a concept of kicking the can down the road, but with a twist—the can is filled with lots of good things.

While not every investor will have the luxury or freedom to take such a longsighted approach, pushing out or even just considering the effects of such time parameters can be a healthy if not novel practice, and can open up longer opportunities with potentially better returns. Short-term returns, as most know, can be dominated by external elements that in retrospect often have the appearance of randomness. Breaking out of a short-term, reactive mentality and reevaluating calendar constraints will open up new possibilities.

Interest in Control

Another consideration in any reassessment or recalibration of investment strategy: How much control is desired over an investment? If more passive investments like ETFs and index funds have been the preferred mandate for a family office or institutional investor, the benefits and drawbacks that come with this approach should also be recognized and possibly reconsidered. Of course less oversight is needed and higher liquidity can be anticipated with passive investing, but returns may be less attractive going forward.

On the flip side, taking more of a control role in an investment may open up greater opportunities—while simultaneously those may be accompanied by increased concerns, responsibility, and possibly risk. If an investor is in control or partial control and consequently expected to make decisions related to the investment, whether it be a privately owned company, a real estate concern or a hedge fund, the requirements of this more demanding role should be taken into account.

In summary, while these fragile markets can rattle investors and tempt some to take hasty and possibly over-reactive measures, they can also be a catalyst to productive investment soul-searching and brainstorming.  Sizing up and cross-examining current mandates and seriously considering pushing boundaries is a healthy exercise for any investor, and may be productive for the portfolio’s bottom line. Think of it less as a New Year’s resolution and more of a New Year’s evolution.