“To understand things, you only need to consider two things: us, who are doing the understanding, and the things themselves that need to be understood” (René Descartes). Markus Hill spoke for FINANZPLATZ-FRANKFURT-MAIN.DE. with John O’Donnell, founder & partner of VIRIATO GmbH, about the current challenges facing family offices for foundations in the areas of manager selection, risk management, alternative investments, reporting, and controlling. The conversation also covered the importance of fund boutiques, “asset managers & exit,” the business judgment rule, as well as rugby and writing.
Hill: How important is the selection of asset managers for foundations to you?
O’Donnell: In addition to our core competence in reporting and controlling, we also advise our clients on the selection of asset managers. There are many asset managers offering products that are supposedly designed for foundations. If you read the fund descriptions, you will see that they all use buzzwords such as “regular dividends, diversified long-term investment,” etc., which foundations like to hear. However, we find that many of these products operate on a “one-size-fits-all” basis and pursue a “buy and hold” strategy, which means that there is little risk management during periods when the market is falling. In addition, many German foundations have a home-market preference (home bias) in their investment guidelines, which is also followed by asset managers, even though this is definitely not in a foundation’s best interest. A well-positioned portfolio must have geographical and investment style diversification. We pay attention to such details when advising a foundation on the selection of an asset manager. Ultimately, the stability, success, and ability of the foundation to support its projects depend on this.
Hill: Which criteria are particularly important to you?
O’Donnell: In my opinion, the investment process is key. We talk to all the managers we recommend to our clients. First, we observe the fund’s performance over several years, and during this time, we hold regular discussions with the managers. We also attend events where the managers present their approaches. We want to hear consistent messages, which show that the manager has confidence in his approach. For me, the process is slightly more important than performance. If there is a clear process in place, it becomes easier for both the manager and us to communicate, track, and evaluate it. Knowing what to expect from a fund manager is extremely valuable. For example, we work with a fund manager who has a 50/50 mandate. He is currently 80% invested in bonds (which is permitted within the mandate). But he has a clear view, which is reflected in his positioning. We appreciate that. We know that he will underperform the stock market, but we also know that he brings a diversified perspective to the overall portfolio construction. He achieves an acceptable return, so the client does not suffer from his cautious stance. When he sees opportunities in equities, he takes positions.
Hill: Do boutique funds play a special role in your selection of asset managers?
O’Donnell: They don’t play a major role. We have worked successfully with a start-up (bond fund for special situations). We knew the fund manager from his previous company and knew that he was particularly skilled in his investment process, so we were fairly confident that he would be successful with his boutique. Otherwise, we have a good mix of large, established, and well-known asset managers and a few smaller ones. What is important to us is that an asset manager brings diversification to the foundation’s portfolio and covers a theme or style that it does not already have. Then it doesn’t really matter whether it’s a boutique or not. We look closely at the managers; there are some very interesting talents at home and abroad.
Hill: What exactly does your manager selection process look like?
O’Donnell: As mentioned earlier, we follow managers over several years and hold regular discussions with them before recommending that our clients invest in their funds. In addition, we filter the funds ourselves using an Excel format that we have developed. It’s not rocket science, and others probably have similar tools, but we want to see the data ourselves and not rely on the work of others. If we make a mistake, we want it to be our mistake and not have the excuse of saying, “It’s their fault, they used the wrong data.” We are not looking for funds with the best performance, but rather those that can control volatility within the fund when the market is falling. That is rare. The correlation of most stocks with the benchmark increases when the market falls, as everyone sells at the same time. Therefore, it is interesting to find managers who actively control this decline.
Hill: Are there any criteria in the foundation sector that you have to pay particular attention to?
O’Donnell: Aside from the investment side, we are always happy to meet asset managers who know the legal and tax aspects within which foundations must operate. We consider it very important that the cost structure is open and transparent. Many funds appear relatively inexpensive at first glance, and foundations invest in them for this reason without seeing the hidden costs that then reduce performance. Of course, ESG is a very important issue. Many of our clients are state foundations, and there are political aspects that do not allow certain investments or that are simply not in the foundation’s best interests, even if there is a good argument for the investment.
Hill: How do you view the topic of “asset managers & exit” in the management of your mandates?
O’Donnell: It’s part of the job. We have made some changes, but in those cases, we had to replace managers who had been selected by the foundations before our collaboration. There were some behavioral issues that led to the decision. Of course, we talk to the asset managers several times before we decide to end a relationship. We give clear indications of the elements that caused problems, so it’s no surprise when the time comes.
Hill: In your opinion, what role should alternative investments play in foundations?
O’Donnell: That’s a big topic! There is a certain cultural conflict on this issue among our state foundations. First of all, it is a very important topic. Well-chosen alternative investments bring enormous benefits to foundation portfolios. They offer diversification, reduce volatility, and generally generate very good returns. The field of alternative investments is very broad. We have successfully adapted our clients’ investment guidelines to enable them to participate in alternative investments that are in line with the foundation’s purpose without taking unreasonable risks. The foundation reform of July 2023 encourages managers to take reasonable risks under the business judgment rule, provided they have obtained comprehensive information about planned investments. This means either in-house expertise or collaboration with external experts.
The cultural conflict arises from voices within the foundations (whether the supervisory board or other advisors) who view these types of investments as “unnecessary risk.” We completely understand that. For most foundations, this is new territory, and it is healthy and normal for people to be skeptical. However, this should not be the basis for a decision by a foundation that will have a lifespan of hundreds of years. This is where we often encounter financial psychology issues. The foundation is a legal entity, but its management is human beings and has the same problems as any other investor – home market preference, risk aversion, recency bias, etc.
Hill: What exactly is behind the idea of a family office for foundations?
O’Donnell: Partly the point I just made about alternatives – foundation managers are highly educated people who specialize in the field of foundation management and have degrees (science, arts, forestry), but they are not financial experts. Could they learn that? Yes, without a doubt. Is it their job? No, they have to take care of the day-to-day management of a foundation, and from what I see, that work alone takes eight to ten hours a day. Furthermore, even if the manager decided to take on investment management alone (aside from a lack of expertise), they would also have to deal with all the psychological pitfalls that come with managing their own money. And it’s not their money, it’s a foundation’s money. There are many psychological studies that advise against managing your own money. Mr. dos Santos and I worked at a boutique asset manager and had several foundation clients. We saw how hard the management struggled to achieve the necessary returns and—without realizing it—took high risks due to poor portfolio construction habits they had acquired. We decided to start our own company and offer a family office service for foundations. We don’t have any internal products, so we are completely independent and not affiliated with any banks or asset managers. It was a happy coincidence that we met. Paulo’s background is in AIFs, and I come from the banking world and have worked with currencies, bonds, stocks, and their derivatives.
Hill: What do you do when you’re not dealing with foundations?
O’Donnell: At the moment, I’m really enjoying the start of the rugby season again. I follow a team in Ireland called Leinster. I like to read, including sports biographies, and coincidentally, one of Ireland’s best rugby players, Johny Sexton (who retired last year after the World Cup), released a book on October 10. It’s at the top of my list of books I want to read next. Otherwise, I enjoy mountain biking and live outside Frankfurt, which is great because I don’t have to travel far to ride beautiful trails.
Hill: Thank you very much for the interview.
Dialog & Information:
FINANZPLATZ FRANKFURT AM MAIN auf LINKEDIN – KANAL
FINANZPLATZ FRANKFURT AM MAIN auf LINKEDIN – GRUPPE
FONDSBOUTIQUEN auf LINKEDIN – KANAL
Foto: PIXABAY
Quelle: IPE D.A.CH