Is it really different this time? Some investors think it might be. While family offices and institutional investors aren’t quite ready to bet their whole portfolios on a new market regime, according to recent data, many are considering significant changes to their strategic asset allocations over the next two to five years.

Family offices are often the first to see and act on shifts in the market. They can move faster and are willing to take on more risk than institutional investors. A recent report from UBS suggests that this process is already underway. According to the UBS Global Family Office Report 2023, families are shifting more dollars to traditional, high–quality, long–duration, fixed–income investments than they have in several years. Of respondents, 38% said they were increasing allocations to traditional fixed income—a notable rise after three years of cutbacks in fixed–income positions.

Allocations to alternatives are changing, too: Family offices are planning bigger allocations to private credit. Additionally, half of all families included in the report invested in hedge funds in 2022, up from 43% a year before.  Over the longer term, many are also looking at targeted allocations to real estate.  

“I think there’s a recognition from families that the overall market regime that we are in is different, and it is likely to stay this way, and we are seeing families making changes in response to shifts in the market, ” says Maximilian Kunkel, CIO of the global family office at UBS and one of the authors of the report.

Institutional investors appear to be thinking along the same lines. The £40 billion BT Pension Scheme—the U.K.’s largest corporate pension scheme— is planning new investments in private credit, hoping to capitalize on private credit funds’ willingness to lend into an otherwise tight liquidity environment. Many of the same opportunities highlighted by family offices in the UBS report are also highlighted for investors of all stripes in this month’s Citi Global Wealth Report and an earlier survey from BlackRock, which showed that institutions plan to increase allocations to private credit.

Despite the uniformity of these findings, the actual opportunity set is less straightforward than headline numbers suggest. Both family offices and institutional investors will have to be cautious about how and when they make changes to their strategic asset allocations.

Private Credit
Investors of all types have remained bullish on private credit for the past several years, and on the heels of recent uncertainty in regional banking, sources say private credit is well–positioned to fill lending gaps. First–quarter data from PitchBook showthat funds raised$42.5 billion across private credit strategies—a pace consistent with Q1 2022 and reflective of the growing interest in private credit as an asset class.

However, global merger-and-acquisition volume shrank to its lowest level in more than a decade during the same time period,  down 48% to $575.1 billion as of March 30, compared to $1.1 trillion during Q1 2022, according to data from Dealogic. Even if private credit is waiting to fill the gaps of the traditional lending and leverage markets, the lack of deal activity could mean that it will take a long time for private credit fund managers to deploy all of their freshly raised billions.

John Zimmerman, president of Ascent Private Capital Management, the family office investment arm of U.S. Bank, works with families on their strategic asset allocations and says that private credit has multiple benefits on which to capitalize in this environment.  Families can exert significant control over where they invest in the capital structure, and they like the diversification benefits. “But I think anytime you see everyone rushing into an asset class, it tends to not be the right time to go rushing into that asset class,” he says. “We’re encouraging much more strategic, targeted investments, rather than a broad significant shift into private credit.”

Still, funds raised this year may have a unique advantage within private credit, despite the slowdown in overall transaction activity. Troy Gayeski, chief market strategist for investment firm FS Investments, says investors are starting to think about private credit investing in terms of vintage years, perhaps as a means of internally benchmarking investment returns to the market environment at the time.

“Folks who invested in middle market private corporate lending have realized that the vast amount of money that was raised over the past three years was put to work at the tightest spreads and at the highest leverage levels in the history of private credit,”Gayeski explains. “So if I had to make a meaningful allocation now, I might want to look at funds that are newer or just launching and don’t have the hangover from legacy loans that were made in 2021 and 2022.”

Stuart Katz, CIO at wealth management firm Robertson Stephens, which caters to family offices, adds that to the extent that investors have their own resources to engage in direct lending, it might make sense to pursue limited direct opportunities. “There are diverse opportunities in private credit that can work for families, institutions, foundations, endowments,” he says. “We’ve seen interest in corporate lending, real estate lending and, to some degree, lending to high-quality, venture-backed businesses. There are also, increasingly, loans that will mature and need to be refinanced, both in corporates and real estate.  We could also see limited distressed opportunities emerge there. ”

Hedge Funds
According to the UBS Global Family Office Report, family offices believe the current environment is well–suited for active management. Of respondents, 73% expect hedge funds to meet or exceed their targets in the next 12 months. Global macro, multi-strategy and long/short equity are the top strategies in which family offices with hedge fund investments are planning to investduring 2023.

“What the data says to me is that families recognize that conditions could be good for some hedge funds, but there is still a preference for liquidity, based on the strategies they prefer,” says Charles Otton, head of global family and institutional wealth for the Americas and chairman of the global industries group in global banking at UBS.

The report data is somewhat mixed on whether families believe hedge funds provide enough value for their fee dollars, but strategies that tend to be more liquid are easier to get out of if conditions change.

Institutions appear to be doing similar math. Kevin Lyons, a senior investment manager at Scottish asset manager abrdn, says institutions are “broadly constructive on macro strategies. There are lot of dislocations and dispersions between asset classes right now. We also think that inflation and interest rates are going to stay higher for longer, and macro tends to do well in these types of environments.”

Specifically, Lyons says, he believes institutions are positive on discretionary macro and neutral on systematic macro strategies. Lyons is also positive on corporate credit, relative value and structured credit, while he takes a more neutral stance on long/short equity.

“Valuations are still pretty high—relative to history. I think we’ve all also read those stories about eight to 10 stocks driving most of the headline returns right now, ” he says.  “A lot of the beta equity hedge managers rely on is really tough to predict right now. ”

If family offices are interested in hedge funds, managers may welcome the interest. Even if market conditions are poised to bolster returns in some strategies, that may not be enough to overcome structural issues in institutional portfolios.

“We are seeing that the denominator effect is a real issue, ” Lyons says.  “Some institutional investors may see hedge funds as an ATM because [the investors] probably outperformed their long-only equity and fixed–income allocations. And, they have commitments to private equity and venture, which are less liquid. So that could impact the fundraising environment for hedge funds over the near–to–medium term.”

Real Estate
The cautious but growing interest in real estate is probably the most counterintuitive bit of data to come from investors recently, given growing concerns over commercial real estate and even residential in some areas.

Family offices tend to run real estate–heavy portfolios, regardless of market environment, and UBS’ Kunkel points out that families will invest into a market downturn if they can find well-priced opportunities.

“We aren’t at a place where people are flocking to this asset class again, but families are looking closely for opportunities, ” Kunkel says.  “I think there is a sense from the data that families think we are at the end of the interest–rate–hiking cycle. So if you’re looking into the future, new opportunities may emerge.”

Ascent’s Zimmerman says he hears similar things from the families with whom he works.  “People are creating a game plan,” he says.  “Real estate is such a broad category, [that] it’s hard to say there is one specific time when you shouldn’t invest in real estate. Energy real estate has been an interesting topic for some of our families recently. We have families in the Permian Basin [in Texas and New Mexico] that have generated a lot of net–worth increase over the past three years,  and they are looking at what to do next. ”

FS Investments’ Gayeski adds that it will be important for investors to be diligent about not just opportunities, but also investment partners in real estate, specifically, over the next few years.

“If you’re a fund taking marks on your existing properties for the next few years and you’re in a redemption cycle, how much can you really raise to offset that and buy properties at lower prices? ” he asks.  “Investors should be patient and do their homework. Sophisticated investors are going to do well to look for partners that have new, clean funds and can deploy [fresh capital] into any downturn.”

Tags: abrdn, Ascent Private Capital Management, BT Pension Scheme, Charles Otton, Family Offices, FS Investments, John Zimmerman, Kevin Lyons, Maximilian Kunkel, Private Credit, Robertson Stephens, Stuart Katz, Troy Gayeski, U.S. Bank, UBS