Looking after your family's financial health
The past five years have proved to be a bit of a learning curve for investors, who have been confronted with the true nature of the risk involved in investment management. High-net-worth families have been no exception and the process of wealth management has evolved on several fronts.
Alex Scott, chairman of Sand Aire, says the traditional suppliers of wealth management services have tended to become more product-orientated and more specialised as a consequence of recent challenging markets and changes in ownership structures. In turn, the number of investment choices available to high-net-worth families has exploded and families have become more sophisticated in their demands. He says: “The family office is almost the inevitable consequence of all of these evolutionary pressures.”
Michael Maslinski, director of Maslinski & Co, thinks that the proliferation of new products and services in the investment management industry has led to a complexity of choice beyond the capability of many investment professionals, let alone family members, administrators, lawyers and accountants. He says: “The purchase of investment advice now requires a substantial degree of expertise. The question is where should this expertise reside – in the family itself, its direct employees, in a private bank or in an independent manager selection specialist?”
Family offices in themselves are not new, but this evolution in the market place has made the concept of the family office more familiar to a number of ultra high-net-worth families who are beginning to question whether they should change their approach to managing their assets. In many cases, this new-found interest in taking an integrated approach to wealth management can be traced back to family succession issues.
Ian Partridge, president of Loedstar in Geneva, a company that specialises in training individuals who have or will have responsibility for significant private wealth, explains: “The big theme, although it is not new, is the loss of ownership-control. The early post-war generation that launched family firms in the 1950s and 1960s is handing over to the next generation. There is therefore a sort of ‘baby boom’ bump in the transition of business ownership. Often, it is difficult for families to successfully transition the business and stay in control. In fact, with each transition, less than one-third of families maintain majority ownership. The others perhaps sell their companies to larger firms, undergo public offerings or simply sell most of the shares to non-family owners.”
The desire to retain control of their wealth as well as the growing complexity of investment management is leading families in Europe to reconsider their approach to managing their wealth. As investors have come to recognise the importance of diversification, their investment strategies have changed and the number of asset classes used has grown. Carol Pepper, president of US-based Pepper International, says: “Families are now more aware of the conflicts of interest that can arise in investment management and have become more sophisticated. They are now adopting a ‘best in class’ approach.” Meanwhile, governance and risk measurement have become increasingly important and also need to be factored into the investment process.
Whereas before, the focus was on adding value via active management, now many investors are using indexing as their core investment strategy and are targeting alternatives for their satellite investment strategy. Partridge says: “We have clearly seen a trend towards an increased interest in alternative investments. In the case of families still involved in the business they tend to take a particular interest in private equity.” Francis Heymans, head of business development, institutional asset management, at Belgian bank Petercam, remarks: “Structured products, hedge funds, open architecture products and special vehicles are becoming more popular with private clients and providers are being obliged to professionalise. Private clients are looking to have money managed on a discretionary basis and are more interested in absolute returns than anything else.”
Mass affluent families are already receiving professional advice, although it is not necessarily integrated. Their strategic asset allocation is often carried out with the help of consultants. According to Maslinski, private banks adopted the term family office as a label they could use to market their wealth management services to ultra high-net-worth individuals. He adds: “In a sense, the notion of the family office is being pushed upon the ultra-high-net-worth community by the private banks.” But he admits that it is also a genuine attempt to provide a service that is client-led by banks that recognise that the product/sales approach does not work at the top end of the market.
For some ultra high-net-worth families the growth of the family office is organic. Many family offices have their origins in the administration rather than the direction of family affairs and have only gradually assumed a higher-level role in allocating assets and selecting external professional advisers. Maslinski says: “Many family offices start within family companies, when the founding entrepreneur delegates personal and family matters to his secretary or assistant. At some point, sheer volumes make it necessary to separate personal work from business duties and the more wealthy and more numerous the family, the more complex the administration becomes, eventually requiring considerable technical knowledge.”
In other cases, family offices come about as a direct result of a catalyst such as a liquidity event, family succession issues or a direct decision from the family itself. The transition from business ownership to liquid wealth is the main factor behind family offices in Europe. But some private banks have argued that many families are not well served by their existing arrangements and that the increasing complexity of wealth management increases the requirement for external, professional help. They claim that many private family offices no longer serve their purpose and that their approach to wealth management is unstructured and unprofessional. Heymans says: “I’m not convinced that family offices are offering a better service to private clients. Family offices are often costly and they are not all as professional as you would expect. Some even create their own products, therefore losing their independence.”
The first step for any family looking to implement an integrated approach to managing their wealth is to engage in an analysis of what they stand for and how they will set out to achieve their goals. Maslinski says: “You have to think through all of the options and line up all the solutions accordingly.” The second step is to engage someone they can relate to. He explains: “The fundamental issue is to pick the person over the institution so that you can engage in a personal and honest analytical exchange. Ask yourself: does the concept fit you? Do you like the people? And trust in the people and their institution usually proves more important than the concept.”
Trust is vital to mass affluent families. Alison Fleming of Aurum Funds, which counts many high-net-worth investors among its clients, says trust is first on the agenda for most families. She adds: “As a consequence of their absolute return mentality, high-net-worth individuals and family offices are less concerned by having full-position transparency, statistical analysis and a quantitative database but trust is paramount because they are investing their own money.”
Many strategic issues need to be addressed before setting up a family office. The family should consider the assets it wants to enhance or preserve as well as the family values it wants to keep, and should clarify which family members are interested in serving in a leadership capacity and how decisions will be made concerning investments. It is also useful to ask what governance structure is appropriate for the family and how the family office will be owned. Thought should also be given to how the office will be organised and managed and what its technology requirements will be. Pepper says: “It is important that the family knows what it wants rather than be steered by service providers. Finding the best service provider for their needs is very challenging. It can be very helpful to talk to other families about their experiences.”
Cost is also a consideration for families deciding what kind of approach to take. Scott says: “The barriers to entry are quite high and establishing a family office requires a significant amount of regulatory capital.” Scott estimates that the costs of setting up a family office and hiring staff of the requisite calibre can amount to as much as $1m (e0.7m). He adds: “You have to think about these expenses in terms of basis points of the overall portfolio, bearing in mind that underlying fees still need to be paid”. Finding the right people to run the family office also remains a challenge. Scott says: “It is quite difficult to find investment professionals with the necessary breadth of experience to assess the opportunities and deploy the assets.”
Partridge adds: “There is no doubt that establishing your own family office can be expensive and concentrates the risk. You need to hire very good people and their back-ups to run the office full-time. Inevitably, this makes it expensive and the fixed costs associated with having your own staff can be high. The cost also depends on the extent of the services provided and what the family is looking for, as well as the asset mix. For instance, hedge funds charge higher fees than other asset classes. This said, asset management fees can be quite competitive as banks are keen to attract ultra-high-net-worth clients.”
But Pepper, who runs a virtual family office, claims that technical innovation has made single-family offices increasingly cost-effective and families are now able to outsource a number of services. Meanwhile, multi-family offices may appeal to those who can’t afford to run a family office and want to create economies of scale by joining up with other families.
According to research carried out by US firm the Family Office Exchange, European families tend to view financial advisers with more distrust than their US counterparts. Maslinski comments: “Families in Europe tend to value their secrecy more than their US counterparts and are less likely to want one person to know everything about their business affairs. But there is a growing recognition that the issues involved are becoming more complex and that there is a need for better communication and organisation.”
Pepper says: “The US has seen a lot of unbundling of services and transparency of fees. As a general rule, the US family has more information to hand than its European equivalent. In Europe, there is a greater degree of privacy and secrecy. Fee structures are less transparent and it can be more difficult to make the right decision. But this has begun to change, no matter where they are from, all families, be they in Europe, the Middle-east or Asia, want a greater degree of transparency and the veils on information are beginning to lift”. For those families in Europe that have sought to manage their own affairs rather than entrust them to a bank, the single-family office has often been the chosen path. Pepper maintains that because families in Europe place a higher value on privacy than US families, those who can afford to run a single-family office will tend to do so.
According to Partridge, in Europe, most families with the potential to set up an integrated family office have not yet done so. The majority still do not have an integrated approach to managing their wealth, while a significant minority uses third-party integration via a bank or multi-family offices and only a very small minority have their own family offices. Even at the top end of the market, the majority of very wealthy families in Europe do not have their own family office. Partridge says: “It is surprising how few families have been through the process of defining a wealth strategy and implementing it. Quite often, families’ goals are ill-defined because they haven’t thought about them. Most families have to reach a trigger point in order to change the status quo. Many families see their liquid assets as non-core to their future family wealth. They see it as a safety net, in case the family wants to stay in business.”
In fact, there are only a few hundred family offices in Europe. According to the Family Office Exchange, over 3,500 US families have dedicated family offices, while just over 200 European families have formal family offices (although many more are informally structured). Partridge adds: “Compared with the US, a far smaller proportion of ultra high-net-worth families have a family office, even in the case of billionaire families. European families that have gone through a liquidation are often happy to maintain the status quo whereas in the US, they are more likely to adopt a consolidated approach. This is also due in part to a stronger tradition of offshore private banking in Europe.”
Partridge says: “In Europe, we are seeing a steady growth in the number of single family offices. But we are only catching up very slowly compared to North America. There is faster growth among multi-family offices. But, even without having a family office, ultra high-net-worth families are increasingly using independent consultants to help them with strategic asset allocation or top law firms to help with structuring.”
It is clear that the way that families manage their wealth has undergone a significant change and there has been a big shift in the decision-making dynamics in favour of the client. Pepper says: “Family offices have put the client back in the driving seat after years of dependency upon private banks.”
It appears that, in Europe, family offices are becoming increasingly popular. Many families are studying this model and are taking a family-centred, integrated approach to managing their wealth. But we can expect to see a gradual evolution of family offices rather an explosion. Scott says: “The service orientation of family offices makes acquiring clients and capital a longer process that either requires deep pockets or a significant input of capital.”
Pepper adds: “Families are keen to look for unconflicted business models. In the future, it will be harder for banks to sit on the fence. They will have to provide either objective advice or a product range. Private banks will have to become more competitive, hopefully this will raise the game, which is beneficial for everyone.”
According to Maslinski not all families are rushing to deal with banks. He says: “Banks still have quite a lot to prove and need to show that they are more than just product suppliers. At the moment, few banks offer an integrated strategic approach. Most have teams that deal with high-net-worth individuals but they are still more focused on products than on strategic advice. The real challenge for the banks is to know how to tread the line between sales and advice – they haven’t succeeded yet.”
Yet it is unlikely that, given the size of the private wealth market, banks will stop trying to provide integrated wealth management services to high-net-worth families. In fact, many banks globally are interested in developing operations in this part of the market. Partridge says: “In the short-term, we are not likely to see significant growth in the number of banks offering full-service family offices with some degree of independence. We will, however, continue to see strong growth in banks providing dedicated services for ultra-high-net-worth families. These will be based upon a greater degree of consulting and advice but will not be completely objective. By definition, they cannot be objective as banks make most of their revenues from in-house products.”
In fact, it is likely that mass affluent families will use the services of both family offices and private banks to their advantage. Partridge says: “Ultra high-net-worth families are looking for both professionalism and an appropriate level of objectivity. They understand that private banks are trying to sell them products. Families will often look to consultants for objective advice but will use private bankers and asset managers to provide asset management and financial products. The challenge is finding both good advice and strong product performance.” Scott adds: “I doubt whether private banks will see the emergence of family offices as a threat. If anything, they are likely to see them as an attractive source of distribution for their products.”
But whatever happens, it is clear that mass affluent families in Europe are taking more responsibility for the preservation and enhancement of their wealth. This new approach to wealth management will have many different guises and will not necessarily follow the US model of a family office. The question of who it is that will perform the role of selecting, overseeing and co-ordinating professional advisers is one that only the family itself can answer. Mass affluent families will entrust the management of their wealth to banks, to boutiques or will establish their own in-house affair according to their own individual needs.