Tactical Asset Allocation (TAA)

Has been defined as “a way of describing ‘market timing’ with nine syllables instead of four, making it sound nearly two-and-a-half times more impressive” ¹. That does not, however, make it any more likely to be successful. We place limited value on the merits of TAA. An approach to investing which is built on the expectation that you can forecast how markets are going to perform, and position your portfolio accordingly is, in our belief, questionable at best. Furthermore, when seeking to balance the requirements of multiple family members it does not serve as an appropriate foundation for an investment strategy to be built upon.

Strategic Asset Allocation (SAA)

Should play a central role in a family’s investment strategy. SAA can have multiple interpretations. In its simplest form, it involves determining how much of your capital should be invested in broad categories of asset classes. Importantly, once these decisions have been made you should aim for allocations to remain relatively constant unless there has been a significant change in your family’s circumstances.

The traditional approach for creating an SAA is from a risk perspective. If your family has an ability to take risk, possibly due to the size of your overall wealth; and can withstand the related volatility then your asset allocation should incorporate a higher proportion of risk assets. Essentially, this traditional approach to a SAA suggests that you seek to generate the highest return from the amount of risk that you are willing to take.

Our approach is goals based and focusses on the desired outcomes from your portfolio. If, at the core of your investment strategy, is a set of clearly defined goals, there is much higher probability that these goals will be delivered upon.

‘Traditional’ asset allocation models not fit for purpose

Income Conservative Balanced Growth Equity

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Key Capital Private

Introduction

“Shirtsleeves to shirtsleeves in three generations” is a phrase that we are all familiar with. Around the world there are many variations on this theme, all used to describe the tendency for wealth to dissipate by the third generation – “clogs to clogs”, “rice paddy to rice paddy”. There are many ways that you can seek to avoid this occurring. Creating purpose for your family wealth, along with, keeping family stories and history alive for younger generations is critical to the task. Often overlooked is the importance of developing a shared understanding of the goals that you, as a family, are looking to achieve from your wealth, and the relative priority you place on each of these goals.

Goals may range from maintaining the lifestyle of the current family members to philanthropic pursuits, or provision for future generations. However, if they are not agreed and understood by all family members there is limited prospect of devising a coherent investment strategy. Indeed, if creating wealth for future generations is not a clearly defined objective, with a dedicated plan against which a specific portion of capital is allocated, you can be reasonably confident it will be unlikely to succeed.

Studies show:

Wealthy families across continents lose some 70% of their wealth by the second generation… A stunning 90% by the third

Source: Williams Group Wealth Consultancy

1 “The Devil’s Financial Dictionary”, by Wall Street Journal columnist Jason Zweig.

Equity Risk

Families planning their wealth should consider a goals-based investment framework

Different Approaches To SAA can Lead to Significantly Different Outcomes

How a wealthy family or individual approaches their SAA can result in significantly different outcomes. As discussed, the traditional approach focusses on risk tolerance which may or may not be consistent with a family’s objectives. A goals based approach looks to determine the outcomes that a family is seeking to achieve and construct a portfolio that maximises the probability of these being delivered.

Case Study:

Family Spending

A family’s annual spending equated to approximately 7% of its financial assets or 4% of its total assets if its real estate and art holdings were included.

Goals-Based Investment Framework

A goals-based asset allocation approach would recognise the need for short- to medium-term spending to be protected from potentially excessive equity market fluctuations. This approach would mean that the family would be required to re-evaluate its illiquid portfolio to ensure that it was positioned to generate meaningful capital generation over the longer

term to support the family’s current spending requirements. This may require some difficult decisions about what assets were truly part of the family’s legacy and what could be sold with the capital redeployed into investments optimised to generate return. This would be simply reflecting the reality that a 7% spending rate in today’s environment is difficult to achieve.

Traditional Asset Allocation Framework

The more traditional approach would be to increase the risk profile of the family’s financial assets i.e. increase the allocation to equities with the aim of achieving a sufficient return to match the current level of spending. However, there would be a corresponding risk of an outsized loss in value and sudden requirement for the family to adjust its lifestyle immediately if that added risk did not pay off.

Conclusion

Clearly this case study is somewhat extreme; however, it does illustrate the differentiated outcome that is delivered by using a goals based approach versus the more traditional approach. Obviously an alternative might be to argue that current spending levels are excessive and that constructing a portfolio to achieve this goal, with a high level of certainty, is not consistent with wealth preservation.

Key Capital focusses on the desired outcomes from your portfolio. If at the core of your investment portfolio is the delivery of a clearly defined set of goals, there is much higher probability that these goals will be delivered upon.

Consider Asset Location

Investment Entity

Tax Treatment

Estate Planning

Build Asset Allocation

Investment Policy

Portfolio Construction

Investment Selection

Define Your Investment Goals

Liquidity

Lifestyle

Legacy

Mapping the Goals Pyramid to an Asset Allocation

Our approach aims to assist families in prioritising their goals, mapping these goals to an asset allocation and ultimately to an appropriate portfolio. The central approach is to group investments based on their historic and targeted risk/return profile. Lower risk funds/asset classes /investment strategies with a focus on a stable return profile and protection from equity market drawdowns, are categorised as Pillar I funds. Funds that give exposure to public equity markets are categorised as Pillar II. Pillar III represents illiquid equity risk in the form of private operating businesses, private equity and real estate.

Higher priority goals form the foundation of the Goals Pyramid (Minimum Wealth & a portion of Lifestyle Maintenance) and are generally best delivered by Pillar I funds with their lower risk profile and less probability of capital loss. As you move up the Goals Pyramid the ability to take a higher level of risk facilitates increasing exposure to growth assets. Towards the top of the Goals Pyramid the greatest need for capital appreciation sits alongside a willingness to take a longer time horizon, thereby allowing an investor to take illiquid equity risk through operating businesses, private equity and real estate. We believe a meaningful allocation to privately owned companies is a key component of delivering long term capital growth. Furthermore, as a family’s wealth passes through the generations it typically becomes less dependent on the family operating business, which should be complemented by an increase in the allocation to private equity.

Having a clear understanding of the goals that a family is aiming to achieve is critical to the construction of an investment strategy. It should act as the central logic that defines how the portfolio construction is evolved. That is not to imply a rigid inflexible approach that can’t adapt to changing family circumstances. Rather that if the goals change, or the relative priority of the goals alter, then each family member should participate in this process and a formal agreement on the new goals and their relative priority be decided upon.

Implementing a goals-based investment framework

Dynastic

Passive Philanthropy

Active Philanthropy

Family Dividend / Lifestyle Maintenance

Minimum Wealth Threshold

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The Goals Pyramid

The goals pyramid seeks to highlight some of the key goals that are typical across most families.

The priorities that a family attaches to each goal will vary and how the various goals interact with each other will differ. However, in general, most families will be able to relate to these goals.

This document has been issued by Key Capital Private Limited (“Key Capital”). Key Capital Private Limited is regulated by the Central Bank of Ireland. Key Capital is a wholly owned subsidiary of KC II Limited, trading as Key Capital. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. THE VALUE OF INVESTMENTS MAY GO DOWN AS WELL AS UP AND YOU MAY NOT GET BACK YOUR ORIGINAL INVESTMENT. PRIVATE EQUITY FUNDS ARE ILLIQUID PRODUCTS WHERE CAPITAL IS COMMITTED FOR A FIXED TERM OF INVESTMENT. Certain information in this document has been obtained from sources that are believed by Key Capital to be reliable. Key Capital does not accept any responsibility for, or guarantee, its accuracy. This document is provided to you on the understanding that you are a retail investor who will not rely on this document in making any investment decision, and will use it only for the purpose of discussing with Key Capital your preliminary interest in investing in a transaction of the type described herein. THIS DOCUMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY COMPANY’S SECURITIES IN ANY JURISDICTION. ANY SALE OF SECURITIES WILL BE ON THE BASIS OF THE PROSPECTUS, SUPPLEMENT, MEMORANDUM & ARTICLES OF ASSOCIATION AND APPLICATION FORM FOR THE COMPANY AND THE RELEVANT UNDERLYING FUND. All data sourced from Bloomberg & Fund Managers where necessary.

Conclusion A lot more focus should be placed on the discernment of a family’s investment goals and in the formulation of an appropriate investment strategy.

A set of clearly defined goals is as applicable to high net worth individuals as it is families with significant wealth. However, for these families there are added complications given that you are dealing with multiple family members some of whom may have limited or no involvement in the day to day decisions around the family’s wealth. The absence of a well-defined set of investment goals to which all family members fully subscribe to will make it difficult for the CIO or patriarch /matriarch to adopt a coherent investment approach that is designed to meet these goals. Furthermore, in times of market turbulence, those tasked with overseeing investments may receive less support because the investment strategy is not clearly defined. This may create pressure to make significant changes to the asset allocation, thereby allowing market volatility to undermine a family’s investment strategy.

We would welcome the opportunity to engage with you and your family to begin the process of discussing the desired goals and outcomes for your wealth. This, we believe, should form the foundation to the construction of your investment portfolio, placing the values and desired outcomes of your family at its core.

Pillar I Stable Returns

Targeting minimal volatility

Stable Return Profile

Limited equity market correlation

Pillar II Liquid Growth Strategies

Inflation protected growth

Higher year to year volatility of returns

Higher return vs. Pillar I Portfolio

Pillar III Illiquid Growth Strategies

Long-Term Investment Horizon

Illiquidity premium available over listed equity

Investment Selection

Investors often have multiple objectives for their wealthPortfolios should be constructed to achieve these objectives over the appropriate time horizons

Focus on Capital Preservation

Stable Return Profile

Lifestyle Maintenance

Investment Horizon

Legacy / Intergenerational

Key Capital Private, 2nd floor, Huguenot House, St. Stephen’s Green, D02NY63, Ireland.

T +353 (0) 1 638 3850 www.keycapital.ie