Author: Dominic Samuelson, Campden Wealth CEO
29 Dec 2014
The family office is often misrepresented and poorly understood. Although the concept is not new, it is a phenomenon that is changing the wealth management landscape. But what exactly is a family office and how does it operate?
A family office is, in its simplest form, the private office of a family of significant wealth. The number of staff can vary from one to over 20, depending on the type and number of services it provides. The purpose can range from handling key assets and core holdings (tax and accountancy, property and estate management) to more sophisticated wealth management structures, while often providing family members with educational, professional and lifestyle services.
Families should seek to avoid unnecessary involvement in the operations of the office
Generally, family offices manage key areas of family assets, including real estate, direct or indirect investments, tax consolidation and estate management, serving as the central hub for a family’s legacy, governance and succession communication. A typical family office gives structure to the management of family wealth, establishing increased control and oversight of the family wealth strategy and the costs of managing investments. Family offices also consolidate tax, accountancy and wealth reporting under one roof, while providing a confidential decision making framework.
Families with private wealth in excess of $150m are ideal candidates for a family office structure. While it is not uncommon for first-generation entrepreneurs to establish a family office, they more often support families with more complexity in terms of households and generations. This is a key characteristic, and one that offices must account for when designing and executing investment strategies and family governance plans.
For example, a family office serves a family with seven households, spread across three generations. While each household will share some similar needs, from the perspective of the family office each merits specific consideration. Such consideration cannot always be restricted to typical generational needs, such as regular income for retirees, because households themselves have differing liquidity requirements. A common example is the different professional aspirations of equal sibling benefactors.
Of family offices list asset diversification as a motivation for buying art
Multiple nuclear families may opt to consolidate by creating a multi-family office to manage the family’s wealth. Such a structure provides the economies of scale and investment opportunities that formal collaboration and a consolidated management structure afford. Naturally, family complexity factors also arise for multi-family offices, only on another level of magnitude. Here things can get quite messy. As such, traditionally, for a multi-family office to be successful and sustainable, families should share interests and risk appetites or, alternatively, comparable levels of wealth.
What does this all mean? It is vital to consider the raison d’être here. As simple as it sounds, there is no family office without family. Fundamentally, a family office requires families to discuss, determine and define the purpose of family wealth. What is the wealth to be used for? What role will the office play in supporting those objectives? These decisions are critical. A family must also decide and define its risk appetite, distinguishing between long-term/strategic investment planning and the individual asset allocation selections and horizons that will comprise that strategy. These decisions must then be clearly communicated within the family, as well as to the executives, so that the objectives are fulfilled.
Once the structure has been decided and the executives briefed, families should seek to avoid unnecessary involvement in the operations of the office. If beneficiaries are involved, they should be qualified, with the appropriate skillset and professional experience, so they can add value to the office, not distract or detract from its pursuit of the family vision. This requires education, professional development and humility. Stewardship is the watchword for beneficiaries seeking involvement in family office operational, investment or philanthropic initiatives.
Typically, family offices provide three categories of services, either in-house or by delegating tasks to external providers: investment activities, general advisory services and family professional services. Many family offices also have significant art collections, some rivalling museums in breadth and scope. As such, it is important to direct appropriate resources to managing art wealth, just as one would with financial assets. Issues to take into consideration include: estate planning, charitable loans and gifts, tax planning, storage and acquisition/disposal strategies. Due to the scope of services required to manage a collection, most family offices will outsource the majority of activities.
Families generally buy art for personal enjoyment. However, its financial benefits are also recognised. The 2014 Art and Finance report by Deloitte and ArtTactic revealed that 50 percent of family offices list asset diversification as a motivation for buying art. While family offices tend to have a very holistic view of their assets, many do not apply the same resources to art as they might to property or financial portfolios. This is changing though, and, according to the Deloitte report, 88 percent of family offices plan to make estate planning around art and collectibles a strategic focus in the next 12 months.
Family offices in Europe typically manage longer-term assets, such as real estate, private equity and direct investments, in-house. There is a trend toward insourcing investment services, while technical, legal and tax-related services are increasingly outsourced. Short-term assets, hedging instruments and derivatives, which require a high degree of monitoring and execution expertise, are managed through investment and private banks. Portfolios with exotic financial instruments are usually outsourced to asset managers.
Direct family office costs are slightly lower in Europe than the global average of 86 basis points per year. This is a result of the larger average portfolio size of $900m and total assets of $1.5bn per family office. Investment style also contributes to lower costs, as European offices have a higher proportion of conservative mandates, which tend to be cheaper to manage than growth mandates.
Of family offices plan to make estate planning around art and collectibles a strategic focus in the next 12 months
Europe has a relatively mature family office environment, with multiple providers available at each point of the value chain. Hubs in London, Geneva, Zurich, Monaco and Luxembourg have good connectivity with specialist providers and banks in the European time zone.
Costs and issues
Preparing for wealth transfer is the overarching objective of family offices and this is particularly pertinent in Europe, where many offices have a long history and serve multiple generations. Intergenerational issues, especially succession related wealth planning, are of critical importance. While Europe hosts offices with the highest proportions of assets dedicated to philanthropy, a third of offices in the region do not manage their family’s philanthropic involvement (more than the rest of the world’s regions combined).
Families expect strategic asset allocation, asset implementation, risk management and structuring/tax planning expertise. Cost effectiveness is not just a given; it must be proven. The European environment is highly regulated and, in some worst-case scenarios, boundaries are defined by litigation. Therefore, family offices will likely have legal as well as accounting and investment expertise.
The family office space continues to garner increasing interest and is only likely to expand over the next few decades as both entrepreneurial and generational high-net-worth families shape our economy and communities. Family offices are an important source of capital for small and medium sized businesses and investments, which fuel much of the global economy.