Are family offices unnecessarily nervous?
This article is an opinion piece by Philip Mayer, Head of Family Office, Barclays UK Private Bank. It does not constitute investment advice.
One of the strangest things that I’ve observed working with family offices for more than 20 years is the reluctance of investors to acknowledge empirical evidence and to think they can time markets.
Working with the most fascinating families from around the world brings many challenges. But I’m regularly surprised by a virtually unanimous common trait that has tended to differentiate family office clients from others I’ve interacted with or advised – it’s when they have a pocket of liquidity to deploy into financial markets across multiple asset classes.
Typically, family office clients decide to either delay investing in order to get in at presumed ‘better levels’, or to put in place an averaging-in strategy – drip-feeding investments usually over a period of six to 12 months.
Whichever way you look at the numbers, they show that in nearly 80% of scenarios investors would be better off investing their full amount up front. While past performance is never a guide to future performance, this percentage is worked out using performance data of our balanced discretionary portfolios over a 15-year period, from 2006 to 2020. However, when presented with this insight, the usual response from family offices is a nod of the head and a brushing aside of the evidence – as if this should be applied to others.
An ‘opportunity cost’ worth recognising?
Using 12-month rolling multi-asset returns (please see the chart), it’s only major market shocks – which by definition are unpredictable – that have led to periods where four equal quarterly instalments perform better than investing a lump-sum on day one.
Furthermore, the typical underperformance of this broadly-used averaging-in strategy, is significantly higher than the occasional outperformance. I calculate the average opportunity cost between the two approaches as being 2.1% (using the same 15-year data set). Is that a large number, you may ask? It certainly is when you consider the sums involved and is often in the hundreds of thousands of pounds. Put another way, that’s as much as three to five years’ worth of fees for the typical portfolios we manage for family offices.
Source: Barclays. Figures as of 31 December 2019. The performance shown relates to Moderate Risk – GBP portfolios1. Please note that Barclays composite reflects UK-booked GBP moderate risk portfolios that follow our extended multi-asset class strategy, run by Barclays Private Bank.
What about market pullbacks?
What about the category of family offices who think an equity market correction is due and they will surely be able to get in at ‘better levels’? One of the all-time top three questions at client meetings is: “Are you not worried about current equity valuations?” Equity markets do correct from time to time – but drawdowns are just part of the ebb and flow of markets.
Furthermore, if a multi-asset class portfolio is well constructed, a mild and short-lived pull-back in equity markets should only have a marginal effect on the net asset value, or overall worth of your assets.
Clients have commented that if they saw a pullback of 5%-7% in equity markets, they would feel more comfortable proceeding. The reality is that, when this did occur, it was triggered by some fairly major news – bringing uncertainty to markets and apprehension to investors. Many would then prefer to wait for things to settle, just in case the 5%-7% turned into a 10%-15% pullback. Very few clients of mine over the years have proceeded to invest when faced with this scenario, albeit I appreciate that each client’s circumstances are unique.
8% correction vs. 11% rally…
The other issue with this approach is that, more often than not, anticipated falls occur after a more significant rally. Instead of investing at 100 on day one, a few clients have eventually pulled the trigger after many months of waiting and invested at 102.1. This was indeed following an 8% correction – but only after an initial rally of 11%. It still leaves you 2.1% worse off than the lump-sum approach. Sound familiar?
To make matters worse, many family offices actually end up combining these two misgivings, initially hoping for a pullback and eventually deciding to average-in after that – thereby compounding the issue and underperformance from the outset.
Behavioural finance context
The above begs the question: Why do some of the smartest and most successful people choose a sub-optimal investment strategy? Behavioural finance is a fascinating topic and the subject of innumerable books and academic research. It would be impossible to cover it off with the rigour that it deserves, but I’ve attempted to boil it down to this:
- Over confidence – Because they have enjoyed incredible business success and/or relative privilege, there is a mistaken belief that they can replicate this in financial markets
- Loss aversion – As they have worked so hard to build up their fortunes, they fear making a wrong decision and losing some of that hard-earned cash
- Bargain hunting – Their incredible business acumen has taught them to drive a hard bargain and get a better price, despite goods and services not being comparable to financial markets
- Peace of mind – Delaying a decision or staying in cash can lead to sleeping better at night, in the short term at least. Until they realise the true impact inflation has on maintaining their purchasing power
Whilst family offices might find it easier to fall asleep at night by using delaying tactics, empirical evidence suggests they would sleep tighter – and through the night – if they invested everything on day one.
For more information about this topic, please don’t hesitate to contact your Private Banker.
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