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The art of family office management
SUCCESSION planning and wealth preservation have always been key priorities for family businesses.
These concerns, coupled with the increasingly global nature of private wealth, are fueling the rise of family offices.
The modern concept of the family office has its roots in the 19th century and since then, organisations and services involved in managing large private fortunes have evolved significantly, especially as the demands of families become increasingly complex and sophisticated.
Managing a family office requires deep knowledge - not just about investing, but also a host of other aspects. To maintain their competitive edge, family offices should have a strategic vision and clear plans for hiring, investing, operations, and brand management.
Attracting and retaining top talent
Talent is one of the most important considerations in running an effective family office. In the face of competition from hedge funds, investments banks and other wealth management firms, family offices often find it tough to retain advisors with the required level of expertise.
This is partly because compensation structures for family office executives tend to be opaque and are often not well understood. In larger institutions, hiring and retention is usually overseen by the human resources department, but family offices cannot rely on such infrastructure. Despite this, families have advantages in attracting talent often because they are able to offer more flexibility in compensation and incentive packages.
Besides money, staff of family offices can be rewarded in other ways, including making use of the family's resources and networks to offer executives opportunities that they might not otherwise have. Compensation could even include, for instance, occasional access to family assets such as vacation homes, aircraft, and yachts.
To outsource or not?
Even the largest family office in terms of assets under management needs to weigh the benefits of outsourcing services against keeping them in-house.
Family offices typically outsource specialised professional functions such as tax strategy, trust and estate planning, custody, and investment management. Increasingly, they are also outsourcing functions such as risk monitoring, bill payment, general ledger, and financial reporting.
Outsourcing certain non-core services can help family offices to be more cost-efficient. For instance, outsourcing high-value professional services brings down costs through economies of scale.
In addition, external providers might be able to offer technology solutions which will benefit the family office. This has become increasingly vital in the aftermath of the global financial crisis, with extensive due diligence and in-depth assessments of top-down portfolio risk now par for the course. This calls for more sophisticated technology platforms to ensure compliance and incorporate stress-testing tools.
On the other hand, keeping key services in-house gives the family greater and more direct control over its wealth.
Conflicts of interest with external providers can also be avoided. It is crucial to obtain the right balance between outsourcing and in-house management. Families should weigh these considerations based on the goal of obtaining the most effective services in an efficient way, while avoiding potential operational risks.
Plugging competency gaps
Closely linked to outsourcing considerations is the issue of knowledge gaps. Family offices often neglect to make a candid assessment of shortfalls in their investment expertise. They should understand their limits and mitigate risks by filling competency gaps.
Family office experience competency risk in different ways. At the extremes, some do not fully understand investment strategies and products, instead opting to delegate the knowledge and responsibilities to third parties, believing their interests will be better served.
Others believe that there are a few limits to their ability to manage investments - skill and experience notwithstanding.
Competency risk can be further increased by investments in hedge fund strategies or direct private equity and venture capital investments, which require even greater depth of experience and skill.
The best way to understand and mitigate competency risk is by candidly and thoroughly identifying the family office's strengths and weaknesses - staff, technology, content and investment practices - relative to the investment demands being made of them. Based on the outcome of this assessment, competency gaps can be identified and filled internally or externally.
Serving the next generation
The new generation of wealth holders is increasingly concerned about building a sustainable legacy and having a positive impact on society.
Millennials are more likely to invest for good, not solely for returns. This means it will become more important for family offices to develop capabilities geared towards assessing social investments. This shift is also closely linked to a family's philanthropic efforts, which are often also managed by the family office.
In addition, the need for intergenerational wealth transfer services is set to rise in tandem with the emergence of millennial wealth owners. This will create an opportunity for family offices to assess the needs of the next generation and devise programs to train them in financial planning for the future. They can also offer estate and tax planning solutions.
Besides investment management, family offices can play a crucial role in the development of next generation family enterprise leadership. One of the top priorities should be encouraging meritocracy in family enterprises. This means no employment or board membership guarantees should be made to family members or relatives including children, cousins or in-laws for example. When family members are employed, compensation should be determined strictly according to role, responsibilities, skill and performance.
There should also be a keen awareness of the negative impact of hiring and promoting unqualified family members especially on other employees. Eliminating any sense of entitlement among family members can help avoid many unfortunate issues from arising.
Clearly, family offices face a range of challenges on multiple fronts that they need to overcome if they want to stay ahead. To create and operate an effective family office, a keen understanding of the family's mission, values and long-term goals is key.
- The writer is head of Trust and Wealth Planning and Family Office - Asia, Citi Private Bank