Chairman of Citi Private Capital Group
November 11, 2019Posted InFamily Office
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Effective investment management requires substantial expertise and resources. Family offices must weigh the benefits of building these essentials or buying them from outside sources.
Investment management is often seen by ultra-wealthy families as the main function of their family office or at least one of the most important factors determining family office success. However, many family offices feel they lack the necessary personnel and skills to manage wealth properly. This raises a fundamental question: should family offices try and build the people, expertise, technology, and research they require in order to manage investments or buy access to these resources and capabilities externally? Or should they pursue a hybrid approach?
To answer this question, a family office needs to undertake periodic cost/benefit analyses. The considerations involved are numerous, but include: the availability of experienced investment personnel for hire, the costs of staffing, access to best-of-breed external asset managers, the complexity of new alternative investment opportunities, and the family's desired investment outcomes, processes, and risk appetite.
Family offices often face problems when there are too few resources, or too much resource and cost, or insufficient staff skill and experience to manage large or complex portfolios.
Family office executives should consider the following factors to determine whether they should buy or build their investment management to ensure they can deliver services of the right standard:
Family offices should choose an advisor who:
1. Has a genuine open architecture approach to screening and recommending asset managers rather than favoring certain providers' in-house products and funds. Exceptions to this rule may include cash, core fixed income portfolios, use of passive investments, or when the advisor also acts as discretionary asset manager.
2. Is fully transparent about all fees and conflicts.
3. Has broad experience and substantial staff in such areas as asset allocation, manager research and monitoring, financial reporting, and risk monitoring/management.
4. Has the technical capacity to monitor and help direct all other asset managers or sub-advisors.
5. Has a central focus on family offices' unique needs that is not simply a by-product of advising large endowments and foundations or smaller clients with smaller assets under management (AUM)
6. Can offer technology solutions to the family office, as well as provide training and education for family members and staff.
7. Can effectively support the investment decision-making of the family office.
Third-party provider models
While many outsourcing models and providers exist, family offices most often select from a range of consulting firms, private banks, brokerage houses, trust companies, and multi-family offices (MFOs) to find the solution that makes sense for them. The basic provider models include:
In an American football team, the quarterback plays a pivotal role, directing the team's attack. A 'quarterback' advisor analyzes and monitors all assets, regardless of which firm is managing the underlying accounts or funds. Private banks, certain brokerage firms, trust companies, and select MFOs are often the principal providers.
Benefits: The family has a comprehensive asset allocation, research, monitoring, reporting, and risk framework. This model is often beneficial to families who do not want to hire in-house investment staff and want to invest with a variety of firms.
Drawbacks: Closed architecture firms - those that recommend their own funds - may create potential conflicts. Skill and experience may vary greatly by firm
A consultant focuses largely on manager research and portfolio construction using a defined universe of manager coverage (core, alternative, and specialty funds). Consultants may be small boutique firms or large advisors that serve endowments, foundations, private clients, and corporations.
Benefits: Access to a broad range of manager research, global reach, institutional quality, and well-resourced teams. A family can isolate manager research and selection from all other aspects of asset allocation modelling, reporting, and risk management, which can be provided by other firms or carried out in-house.
Drawbacks: The large consulting firms often cover larger funds to be able to provide access to their sizable client base, generally charge higher fees, potentially react slowly to changing market conditions. There are potential challenges scaling to the personal requirements of a family.
Manager of managers
The manager of managers assembles custom portfolios - for example, asset managers, funds, and separate accounts - often in strategies that are difficult to research, access, or monitor without the benefits of a larger team and purchasing scale. Assets may be managed on a discretionary basis, or advised. Banks, private banks, select mutual fund companies, brokerage houses, and MFOs are the primary providers in this area.
Benefits:Family offices can hire advisory firms with specialized skills and depth in specific asset areas to create one or more customized portfolios.
Drawbacks:There are often higher fees, limited fund selection, potential for conflicts and liquidity management.
This involves allowing outside firms to carry out key parts of the investment process such as fund selection, investment management, and due diligence research. Outsourcing tends to work well for families who have well-defined governance and decision-making practices, regardless of the presence of in-house investment staff.
Benefits: Family offices can use a number of different investment resources, such as sector specialists, asset managers, and technology without being restricted to just one firm or individual.
Drawbacks:It can be difficult to hire a firm that can truly cater to the unique needs of the family office, perceived loss of control, and availability issues if firm is not based within the family office.
Family offices must consider a wide variety of factors and preferences when deciding whether to build or buy their investment management capabilities. There is 'no one size fits all' approach and family offices must assess their own capabilities, scope, priorities, and investment targets to determine which approach would achieve their unique goals, including a hybrid of different approaches.
To read more investment management best practices for family offices, click here to read our white paper.