Mohamed has moved, the mountain will follow

Mohamed El-Erian, manager of Harvard University’s $29bn (e23.bn) endowment, has rebalanced the school’s portfolio. This will not go unnoticed, especially in the family office community. Family offices in Europe look to the managers of university endowments – like Harvard and Yale – because they are similar both in size and objective to family offices. Like a family office, an endowment fund must both preserve and grow capital for the benefit of future generations. Consequently, endowments are seen as both a proxy and a model for family strategic asset allocation. Finally, as public entities, endowments are a visible benchmark for the performance of the family office sector. According to Trust Universe Comparison Service, Harvard beat other institutions with $1bn portfolios by 5.9 per cent last year. Harvard’s investment return totalled 16.7 per cent (net of all expenses and fees) and the endowment outperformed its own benchmark by 3.7 per cent. Following this success, the Harvard endowment has been rebalanced. Key changes include:

• Weighting to international and emerging market equities has been increased by four percentage points;
• Forty per cent of all assets are now located outside the US;
• Exposure to absolute return special situations funds has been boosted by five percentage points;
• Meanwhile, fixed income has been reduced by eight percentage points.

Interestingly, recent research by Scorpio Partnership has indicated similar moves are already underway among Europe’s largest family offices. The study looked at the hedge fund allocations of 50 European family offices, controlling some $40bn in assets. The study found that family offices have increased their strategic asset allocation to hedge funds (from 20 per cent to around 30 per cent of AUM since 2002) as portfolios become increasingly alpha orientated. Single manager funds are en vogue, replacing funds of hedge funds in family office portfolios, and there has been a shift from long/short equity strategies towards special situations, emerging markets, global macro players and niche strategies as family offices seek improved returns. Interestingly, it is against this backdrop that the not-so immortal Amaranth Advisors exploded, leaving questions about how widely exposed family offices were to the $9bn multi-strategy fund. Certainly, there have been rumours that some high-profile family investors were exposed to the fund, but the damage appears to have been limited. Heavily invested in natural gas futures, the Amaranth fund represented exactly the sort of play that family offices are increasingly seeking out. The blow-out occurred due to massively leveraged positions by one of the fund’s traders, Brian Hunter, who was banking on supply disruptions, akin to last year’s hurricane season, that would push gas prices high. Instead, prices dropped. His positions are reputed to have represented half of Amaranth’s capital and to be twice as large as the next largest player in the market. To date, the fund is down an estimated 40 per cent-55 per cent. The limited damage among the family offices invested in the fund has been attributed largely to their primitive, but effective, risk management techniques. In the search for higher returns, many families are accepting higher volatility as “par for the course”. To mitigate this risk, family offices are not turning to the structured product sector, but instead are taking smaller, unleveraged positions in a larger number of funds. Some portfolios have in excess of 100 positions in underlying hedge funds. Consequently, it is unlikely that the Amaranth debacle will have a dramatic impact on how family offices are investing into hedge funds. Instead, it is simply an explosive reminder of the importance of due diligence and good, old fashioned diversification. Ted Wilson is a consultant at wealth management strategy think tank Scorpio Partnership