1. Before we get into the evolving investment goals of family offices and HNIs in today's environment, can you take us through what it takes to advise family offices? What prerequisites are required for setting up a family or multi- family office? What would be your advice for advisors who are looking to enter the family office space?

The top five points that come to my mind as a prerequisite for setting up a family office are:

To summarise, alignment with the client's interest; transparency and knowledge; expertise on matters of wealth and beyond wealth; investing your time, effort and resources in the process, people, and technology to be future-ready; and continuous and cumulative learning are the five prerequisites to set up, for somebody who wants to enter this segment.

2. Now, we'll get more into the investment side of a family office. When we look at the traditional school of thought, which states that buy and hold for the long term, how are you looking at things in the current evolving space when there is so much volatility that different segments of the markets are performing? How is it evolving with the market dynamics of this buy-and-hold strategy?

Basically, Ravi, buy and hold is required in any case and investing for the long term is equally required. But there is a transition happening from a pure buy and hold. But if you are investing for the long-term, we must understand that time spent in the market is more important than timing the market. However, the more time you spend in the market, the more you understand and see the effects of ever-changing events in the market that keep on affecting the global financial markets, including India. And a lot has happened in the last three years – go back in the last three years from the COVID pandemic; to India and China engaged in border skirmishes; to Mr Biden's inauguration as the President of the United States, Kabul falling following an offensive Taliban attack; supply-side bottlenecks; coming to the current Russia and Ukraine conflict, and needless to say, the multi-decade high inflation which is running across various countries to name a few.

So, when spending time in the market for long-term compounding, you are also getting a lot of these vagaries, which test your strategy and enable a family office to evolve with the market dynamics. With all these things, the investment framework and portfolio-level strategies are changing so that they can consistently handle the vagaries of the market since you are invested for the long term. Earlier, a single investment style preached in the market that growth, value, and play a long-term role, and people used to stick to either. And then, there was buy right to sit tight, which still holds, but it is slowly and steadily transitioning towards a multi-investment style and a core and satellite framework. So, when I'm talking about these frameworks, a buy and hold are applied, but the very nature of the investment framework and strategy is changing.

The advantage of this – or the reason people are transitioning to this multi-investment style and core and satellite - is that it helps remove the definitive source of performance leakage from an inadvertent single investment style, or a buy and hold approach be short, mid, or long term. A core & satellite, along with a multi-investment style framework, helps to keep the portfolio risk and volatility within the targeted levels and allows you to make use of opportunities as and when the market shifts.

3. Can you elaborate more on the strategies and the investment frameworks that family offices are adopting?

Before I move to the frameworks and strategies, let me briefly explain three strategies. I'm sure the people out here definitely know about them, but I'll quickly take a minute to run through it.

The first is a core and satellite. In such a strategy, the core makes up the most significant portion of the portfolio, and it is something which is held for a long-term basis, seldomly churned and is a mainstay of a portfolio. And a smaller allocation is called a satellite, which is carefully picked up and made to sit along with the core to make a complete portfolio. But satellite is more tactical than the core and targeted towards finding opportunities to earn high returns for the portfolio.

The second is barbell investing, which involves investing in the two extremes. For example, you can have a no risk and a high risk at the two extremes. Imagine an iron barbell that we use for weightlifting, which typically has two ends, and there is a rod in between, right? So, you take the two heavyweights on the extreme sides, usually equal weights, and try to stay away from anything in the middle to balance the risk and reward. That's what barbell investing is. But the emergence of various investment styles and ever-changing environments have made it difficult to have a barbell strategy. In addition to growth and value investment styles, now you have a special situation style, contra style, event-driven, turnaround etc. So, with many styles, it’s challenging to pick only two styles and do a barbell anymore.

People are transitioning to bucketing style strategies where the investments are held in two or more investment styles that an investor understands and relates to. So, a framework is usually a standalone core and satellite, barbell, bucketing, or combination. But there is no one-size-fits-all approach, as there are various blends of strategy and styles that one can construct to make a framework.

To give you an example in a straightforward way, having value and growth at the two ends in equal proportion and nothing in between would be a barbell strategy. However, if somebody chooses a value, growth, and momentum as 33%, 33%, and 33% in three buckets would be a bucketing strategy. And, a core and satellite would be where value style is held at 70% and momentum investment style is 30%. Many families are increasingly keeping value and growth together at the core, and satellite usually comprises cyclical and contra.

4. What is the bucketing strategy? Can you explain further?

Bucketing, in a very simplistic way, means having various investment styles or different maturities always in a portfolio, rather than investing in just one or two styles. For example, 25% value, 25% contra, 25% growth, and 25% cyclical. So, when you make buckets and allocate money to that bucket, that is called a bucketing strategy.

There are more evolved hybrid bucketing strategies like core & satellite with a multi-investment style barbell framework. The core will hold 70% of the allocation, which can be split equally between diversified active and passive funds or growth style and value style oriented. And the remaining 30% will be a satellite, which can be split equally between contra and thematic funds. This is an example of a hybrid framework where the core and satellite is on top, and below that is a barbell strategy. In another variation, a core and satellite can also have a bucketing strategy instead of a barbell where you choose to spread into three to four buckets rather than taking two equally weighted buckets.
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Coming to only specific bucketing – usually, in bonds, it's equivalent to having a laddering approach.

5. What exactly is a laddering approach and what are the benefits?

Basically, you make various time buckets and you allocate a specific portion of the portfolio into every bucket. So, buying bonds with differing maturities in the same portfolio is a laddering approach. Each bucket allocation can be tweaked based on investor objectives. It helps you sort of manage the risk of interest rate fluctuations, keeping you out of the guessing book. So, it attempts not only to mitigate the interest rate risk and improve returns but also gives you reinvestment flexibility because every bucket matures at a different rate. So, in a falling or rising interest rate scenario, you always have something to reinvest and take that risk off, paving the way for more predictable cash flows. The level of liquidity is also maintained throughout.

So, these are the various strategies that can be used in standalone or combination frameworks. The weights can be changed within each framework based on investors' risk appetite. Monitoring and rebalancing are imperative because weights will go on and off with the market vagaries. However, a thorough understanding of the risk and rewards of your investment framework must be supported by back-testing, scenario analysis, and other empirical evidence.

6. Sure. Thanks, Prashant, for that detailed explanation. Apart from the investment risk which comes with specific asset classes, there is another emerging risk which is like a geopolitical risk or country risk, which we are witnessing right now with the Russia-Ukraine war. How do you incorporate such risks while building portfolios?

We have an in-house philosophy - "if return is the yin of wealth, then risk management is the yang of wealth”. Everything is incomplete without risk management and returns would also not hold much sense without understanding the risk taken to deliver those returns.

But coming back to your point, risk management specific to an event is futile because it's very hard to predict events, right? A lot of events have happened in the past, which have affected various asset classes in various ways, and we believe that the same will continue to happen year after year. Sometimes there will be lesser events, sometimes too many events, few will be expected, and as usual, the majority will be unexpected. Whether they will occur in isolation or they will occur simultaneously is anybody's guess. So, the best way to factor risk is to have a robust risk management framework at a broader portfolio level, sub-asset level, and allocation level. And to my mind, we follow five critical points as a family office to ensure that risks are in check.

But before that, let me give you a disclaimer that the family should understand the risk, and should be comfortable with the risk.

7. Sustainable investing is gaining ground globally. There is a myth that ESG can mean sacrificing your returns. How are you incorporating ESG themes in your client's portfolio?

The ESG theme is evolving around the globe, and in India, it is still at a very, very nascent stage. In India, most of the ESG funds will come in around 2020. So, it's too little time to check whether these things will play out. But in fact, when you are talking about sacrificing returns when you go to ESG, the contrary is probably true. In India, the ESG 100 Index has delivered equal or more returns than the broader Nifty indices. Globally also, the ESG indices have done better than their peers on a point-to-point or rolling basis, which we have published in our ESG reports.

Again, if you break it into various parts and see the recency effect, you will figure out that the ESG is holding up well, and we have to understand that the theme is still evolving and maturing. The relatively lesser drawdowns on the ESG, especially in the Indian market, is something to watch out for. So, this space looks promising, and we are still watching and will be investing and building it gradually. But yes, it doesn't mean that we must sacrifice returns.

8. Prashant, thematic investing can deliver outsized returns if you get your entry right, of course. So, how a family office is looking at thematic investing to have exposure to specific sectors like IT, and pharmaceuticals, which did well post-pandemic?

Thematic investing is an approach that focuses on predicting long-term trends rather than finding specific companies. The idea is to enable and to have a sense of these structural or one-off shifts that change the entire industry and participate at the opportune time. In India, we have various thematic funds like housing, an international fund, a service fund, FMCG, and consumption. However, selecting the right time to enter them is very difficult because in India at present, you will have at least seven to eight themes.
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At a family office level, we solve this dilemma by not looking at each theme in isolation; we are looking at the entire thematic space as one strategy. We are looking for thematic investing in a very holistic way where we are using bespoke solutions with flavours of megatrends, disruptions, differentiated businesses and impact investing, to name a few in the portfolio. We are not looking at the theme in terms of identifying when the housing, the consumer, or the FMCG is going to outperform. Rather, we are making a holistic basket and looking at them in totality as one strategy. However, the most important thing is that even at the family office, today we are not participating in thematic through stocks. We prefer the fund and PMA structure primarily because of three reasons:

9. Prashant, whatever investment style you mentioned, be it barbell strategy and value investing, growth investing, how do you go about building an all-weather portfolio for your clients?

Building an all-weather portfolio would be a different session. You can go on and on, and there are too many approaches. Everybody wants to build an all-weather portfolio based on their requirements therefore reading about various approaches like Ray Dalio, Swensen Portfolio, and Larry Portfolio will help as everybody wants to add their own flavour. However, I will tell you about the objective of an all-weather portfolio and what one should know.

The objective of an all-weather portfolio is to navigate and withstand the vagaries of economic and business & asset cycles and perform well across all environments. To build an all-weather portfolio, one should understand various asset classes and the market factors which affect these asset classes. The second part is to know the inherent risks of every asset class.

10. Speaking of passives, in the Indian market, we have seen that active funds have outperformed passive funds. How do passive funds benefit portfolios? Is there an appetite among family offices for passive funds?

Yes, there is an appetite for passive funds among family offices, and it's growing. But given the Indian context, there are two reasons for passive funds gaining popularity. One part is the substitution effect and the second part is participating in new themes.
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When talking about the substitution effect, we refer to the active managers being substituted by the large-cap fund indices, Nifty 50, or BSE Sensex. You will see that active large-cap managers have been on and off – it's like hit-and-miss. Sometimes they hit, and sometimes all of them miss outperforming the benchmarks. And again, a handful of active managers have consistently outperformed the Nifty 50 or Sensex over extended time frames like three years or five years on a rolling basis.
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The second part, where passive funds allow investors to participate in new themes, like tracking the BSE 500 Shariah, Nifty 100 Equal Weight index, and a slew of factor-based indices like quality, momentum, low-volatility, which are passively giving a portfolio a flavour and diversification into a different style of investment. Whether these will attract inflow, only time will tell. However, they have been keenly monitored.

Also, important to note is that when I am talking about the substitution effect, it is only specific to large caps in India today. When it comes to small- and mid-cap, we are not going to ETFs; instead, we are sticking to the active funds because we have seen that over a three-years time frame, there are funds which have consistently and significantly outperformed the Mid-cap & Small-cap indices.

11. There are emerging and developed markets and a whole lot of themes like EVs, semiconductors, cryptos, cloud computing, robotics, artificial intelligence, and cyber security. How are family offices looking at the international investing space?

Are family offices looking abroad for potential opportunities? The answer is yes. However, interest has increased in adding global exposures over the last few years. There are two reasons for it. One, the global market offers an opportunity to diversify beyond the local markets and second, to participate in the themes which are not adequately represented in India. There are many themes. Like, you have e-commerce play, which can be very well played globally. You have plays on artificial intelligence. You have plays on cloud computing, which are available globally but not in India. Specifically to us, we are not participating or looking to invest in broader indices like NASDAQ or S&P 500. We are staying away from that completely.

12. Given the kind of headwinds that we are witnessing currently, how would you deploy a lump sum corpus today?

A difficult, tricky question because it depends upon the investment policy statement and the investment mandate designed for the family. It will be difficult to answer as there is no straight-jacket answer for it. However, I will give an asset class-specific answer.

For equity, given the core and satellite style framework, we would deploy the core into value and growth, or a blend and the satellite would have a business cycle investing and a global allocation. From a market capitalization point of view, today, we would be skewed towards large- and mid-cap. However, with every fall, we'll keep adding small caps. As I mentioned earlier, having an adequate portfolio liquidity level is a must. Hence, all our equities run at a certain level of cash to use such opportunities as adding small caps.

Regarding debt, we are looking at credit risk funds and floating rate funds in addition to short-term funds. Across our family office, a meaningful allocation goes towards structured debt deals, majorly into real estate, to generate higher yield or other high-yield funds where the tenure is less than 24 months.

On the real estate side, families usually hold many land banks and commercial properties. However, incremental money is majorly getting deployed into rent-yielding assets like warehousing, and REITs are also finding a way into the family office portfolios now. For the global allocation, as I mentioned, we are participating in themes not adequately represented in India and not looking at investing in broader ETFs like NASDAQ or Dow Jones.

Given today, we would have a gold allocation of 5% and gradually take it to 10% over time.

So, this is what our deployment will look like across various asset classes.

13. Can you also take us through the themes that family offices are looking at in the pre-IPO space or private equity, venture capital, or seed investing space?

Again, it depends, and it varies from one family to another. However, there are certain commonalities which we have observed. When it comes to investing in pre-IPOs, many families allocate a tiny percentage. Since their portfolio sizes are huge, the amount looks quite significant, but allocation-wise they're very small. There is no favourite sector or theme here. Families do not take a blanket approach. Instead, they selectively participate in the companies that they are familiar with, with respect to the businesses they operate, or have a good understanding of the sector there.

For seed and angel investing within families, there are extremes. Either they are too shy and invest in a few, or they have taken a liberal approach by investing in a basket relating to tech. The themes that are getting major allocation are Agri tech, ad tech, hydroponics, drones, defence, and big tech.

With respect to private equity space, most families prefer late-stage investing with no sector bias. Late-stage investing is investing in companies that have moved beyond the start-up phase for development and have rapidly grown sales or have fast growth potential. Typically, late-stage investments are less risky for investors than early-stage ones because funded companies are established in the marketplace and their investments can be converted quickly into cash. Usually, families, while late-stage, prefer not to take the lead.

I hope this fairly gives an idea as to how family offices are looking at investing in this space.

14. Besides the investment, there are other aspects when it comes to family offices, like estate planning, taxation, and succession planning, which are important aspects when it comes to managing the wealth of family office clients. Can you take us through those aspects of managing your clients' wealth?

Estate and succession planning are very important parts of family offices. However, India is still evolving. All the families who have created wealth have their own unique context. The values and belief systems of the generation which created the wealth can be very different from the generation which is acquiring the wealth. The transition of wealth involves a change in the custody of business and estate from one generation to another and takes a few years. So, there are various angles to work upon to have a smooth process.

The first is communication. Now, it is important to connect across generations and have a conversation with them in person to understand their perspective and how they want to further the legacy. On one side, it is important to know how the generation passing the baton wants things to shape up. On the other side, it is imperative to know the next generation who is acquiring, their thoughts on the value and belief systems of earlier generations, the wealth created, and what role they want to play while stepping into the future.

It is quintessential to have an internal alignment first and then move towards external alignment. By external alignment I mean what new roles members would like to assume given their interest in adding to the family legacy, building business or estate. The journey from internal to external alignment involves training and education, which plays a crucial role in preparing the successors and enabling them to step into the roles when needed. And this training and education is not just about investments. It includes governance, philanthropy, and other things which are required to have a holistic view of the family. Everything is facilitated, organized, and done by us.

To summarize, from communication, linkages between the generation who created the wealth, the generation who is managing the wealth, or the generation acquiring the wealth, ensuring internal alignment, moving towards external alignment in a very defined way and then education and training. I think these are the few aspects that must be taken care of to have a smooth transition process.

15. Prashant, any final thoughts which we might have missed out on discussing here related to the family office on how to navigate the current market volatility

We have covered more or less how we are looking at things and how family offices are looking at things. But yes, I think what is more important to understand is that there is no ad hoc way of investing when we are talking about family offices. They have very disciplined, systematic, evolving processes and practices, which help them navigate various cycles and look at long-term compounding. So, having frameworks is crucial, and having that inclination to have a family office is a must. And again, in the end, I would say that it's a wonderful journey to be a part of, and when you get into the family office, you get a holistic view of the family and go beyond to work it out.