The evolution of family offices

Family Offices are setup with the primary objective of preserving the family fortunes and for other non-financial purposes like philanthropy, tax advising, or anything else that the family may need

Published: May 28, 2018

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Family offices are becoming increasingly popular today. But not many understand the purpose and role of family offices. Let us try and understand what exactly are family offices and what are the factors that one needs to know while considering these.

Family Offices (FOs) are setup with the primary objective of preserving the family fortunes and for other non-financial purposes like philanthropy, tax advising, education, or anything else that the family may need. Globally, these were usually setup by families, having an investible corpus of at least USD 250 million, though in India, one hears of offices which have been setup with amounts starting from Rs100 crores also. As we will explore later in this article, that given the expenses, it would not make sense for considering family offices any amounts lower than these.

Single Family Office and Multiple Family Offices
Family offices can be setup as a Single Family Office (SFO) or Multiple Family Office (MFO).
The SFO is setup to exclusively focus on one family’s needs, that is, they only look after the assets of one family. There are quite a few of these type in India today and these make sense if the funds size are significant to justify these costs.

The infrastructure and resources for the SFO are established based on what role the SFO will play, and what goals (financial and non-financial) the family has in mind. The financial goals would include evaluating avenues for investments, monitoring these investments and the cash flows.

The SFO could be run by a family member or a dedicated professional CEO. The biggest challenge here is that the family members need to have faith in the people behind the family office. This works very well, when the entire family is united in purpose and the SFO reflects that unity of purpose, and its investment and distribution policies. This prevents situations when due to conflict or other reasons, one branch would want to take its investments out of the SFO. These conflicts could arise out of either disagreement on investment choices or as a result of a dispute elsewhere, being reflected in the FO. The risk-return tradeoff is often an area of much debate and concern as these may vary amongst the family members.

Having a family member at the helm of the SFO would probably ensure greater control over these investments, but the question of whether the family member is the best person for this task does arise. One often sees the family member being assisted by a team of professional or a family member supervising a professional. Nowadays, there is an increasing demand for qualified professionals who can run FOs.

Sometimes, the founding family may realise that they can extend their expertise to other families also, and hence they may take on funds of other families to manage, thus leading to a MFO, at a cost. Or this could be setup by professionals or banks usually around one family as the key client. Having multiple families as clients in a MFO increases the investible funds and hence makes it easier to hire more qualified fund managers and staff to handle these funds. But these costs would be lower than those incurred in a SFO. Some international MFOs have the option to “pay on a usage” basis, depending on what activities are expected from the MFO so that various families can customize depending on their needs.

I have seen multiple families use differing options ranging from SFOs to a family member overlooking the funds invested with an external fund manager.

Confidentiality:
This is one of the most important factors in all the families that I have met. The activities of the family office are known within the family but the external world is usually unaware of this.
 
Families like to maintain their privacy, and for obvious reasons, they do not want financial details in the public domain.

There is however, always the challenge of the confidentiality of the investments and the priority one family or family member may get over another, or the role and degree of control of the founding family. This becomes even more complicated, if the MFO is run by a member of the founding family and there could be issues of governance. However, most large MFOs have overcome these challenges by having a team of professionals who have seek to maintain a proven track record, and hence there is an inherent incentive to maintain the strictest confidentiality and professionalism.

On the other hand, there is also the issue of confidentiality between disclosure of the investments between members of the same family. This could lead to heartburn amongst the others like in a case where the patriarch had preferred to keep his investments to himself and not disclosed this to the next gen since he was worried that it may impact their industriousness. When this issue was raised by the family, the patriarch chose to share this information with me, with strict instructions that these were not to be shared with the other members of the family! Having FOs with processes would remove such ambiguity but could keep the confidentiality. For example, another top business family shares the investments portfolio in an annual meeting with the family council. These funds are invested with a couple of fund managers, and other investments which the SFO does directly, are approved by the family council first.

Controls:
Family offices (FOs) would either be controlled by outcomes or by processes. Outcomes would mean that their performance would be evaluated against prior agreed benchmarks. This may not be insisted on, if a family member is running the show. In this case, there would be a higher emphasis on the processes, to ensure transparency and inclusiveness. In most FOs, the decisions would be approved in a family council and this process is followed strictly, to ensure trust and transparency. This is a critical factor behind the success of a family office, otherwise trust can quickly disintegrate, if any one family branch member hijacks the investments or these are hidden from the other family members. The presence and strict adherence to processes and transparency is the key in any FO setup.

Goals:
Like I mentioned earlier, the goals for the FOs could be financial and non-financial.

Financial goals include primarily wealth creation and preservation, monitoring of these assets,  ensuring a steady income stream generation for funding the family’s lifestyle and for ensuring their financial independence, all done in a tax efficient manner.

These could include the investing in funds, monitoring dividends from the family’s equity stake in the group company and equity portfolio and its distribution, real estate portfolio (including multiple family holiday homes), other assets, etc. FOs have also started investing in Private equity and venture funds or even startups directly and hence have become an important source of funding. One SFO has a huge investment in residential apartments in the US where the SFO monitors the rentals incomes and manages this real estate portfolio.

Non-financial goals on the other hand, seek to preserve the family values and legacy, maintain the family relationships, build trust, encourage family education and family unity. If the non-financial objectives become the primary focus in the family office, then the family may prefer to invest conservatively, settling for lower returns, in order to maintain their family control and preserve family relationships. This is also sometimes the cause of conflicts as the subsequent generations may desire a higher return or more aggressive alternative investments. I know that for example, Bitcoin investments is a constant discussion point in these meetings!

Increasingly, FOs are getting more involved in philanthropy, to help in realising the family’s desire to give back to society. Most families that I have met, have the genuine desire to give back to society and have been working on contributing to the unserved sections of society, either in education (eg for young girls) or by some long term sustainable means. This is more with the aim of uplifting human lives rather than a direct cash donation. And in most cases, this is done anonymously or away from the media glare, preferring to give their names only if it helps the cause. In fact, most families are very uncomfortable discussing their activities, thus reflecting their desire to be altruistic without taking credit for their contributions.

What are the considerations one needs to consider while setting up the FO?

Purpose of the FO:

The purpose of the FO has to be defined first. Most families desiring to set up a FO usually have not figured out their motivations for having a FO and hence may overlook better suited options due to lack of information. Having a clearly defined objective would make the task easier. And this is something which the entire family has be aligned with.

Size of funds:

The size of the funds would determine the configuration of the FO. The underlying assumption is the that the administrative costs should not be prohibitive to remove any benefits from the FO. For smaller fund sizes, it may be advisable to place these with an investment house fund manager who may be able to do a comparable job. I have seen many families prefer to do this over setting up a FO for solely investing their funds.

The nature of the family including size, generation, aspirations and vision:
These are usually better handled in the first or second generations, where the family may be smaller. As the family size increases, the aspirations of the various members may be different and if the vision is not aligned, then the family office may find it difficult to operate. Having a discussion at the Family council level would help in addressing some of these concerns.

Trust within the family:

This is an extremely important consideration. Family offices work best when the family is aligned, trusts each member and looks at the family office to execute its vision. Lack of trust would make the family office infructuous as decisions could get held up or blocked by the disagreeing members. Additionally, in case of professionally run FOs, the integrity and trust of the person heading the FO is critical as this is a position of great responsibility.

Who will staff the FO?

Staff including the fund manager for the FO is an important task. The role of the FO manager would be critical as he/she would have to balance the needs of each distinct family member and having the skill and ability to handle this would be important. I have seeing family members, especially the younger ones or the next gen members usually express concerns about the governance or lack of information shared by the FO or the risk in allowing an incapable person to handle all the family funds.

Additionally, it is desirable to separate out the FO operations from that of the business as each of these have differing objectives. Having business managers wear dual hats to manage the family office while running the business may lead to governance and ethical issues, besides having a conflict of interest at times. (for example, would the family consider an portfolio investment in a competitor’s group company?)

It is better, especially for large sized dynamic or complex portfolios, to consider a separate individual responsible for the FO. Of course, this would depend on a case to case basis. I know a family which has a 200+ crore portfolio handled by an active family member along with his role in the family business, whereas another 80+ crore FO needs a full time professional manager, to handle the family’s various members and investment complexity.

Additionally, the time commitment of the FO head will have to be considered. A family member who is actively involved in the family business may not have the necessary time to devote to the FO and this may cause challenges. Or due to his role and power in the business, he does pretty much what he wants, thus the rest of the family being in the dark. This is similar to the traditional joint family system where the family patriarch invested on behalf of the family and decided how to allocate distributions.

External Advisors:
This is an important factor which most people overlook. Advisors could be of various types. There are financial advisors which include the investment advisors to advise on the investments, depending on the investment types (eg equities, real estate, art, etc.). There are
Tax advisors and Legal advisors who bring their expertise in the respective areas. These are well understood and are a part of the normal panel of advisors that most families already have.

Then there are family advisors. These advisors may be external members of the family council and advise the family. They play an important role in helping the family reach a decision on what is for the overall benefit of the family. Having a trusted external person as a family advisor, to advise the FO is very important as this brings an independent external perspective. This also helps in keeping issues within the family and resolutions are made quickly in a pre-determined manner. I have seen many times, that having an independent trusted opinion does help resolve lot of tricky situations in times where the family may be at an impasse.

What is the future of FOs?
I know that the most families are currently grappling with the challenges of setting up a FO to be worried about the future of FOs, but I have tried to forecast what the future challenges could be:

Ability to operate in and expertise of multiple global geographies:
Given that most families increasingly are present in multiple countries, family offices would have to offer the possibilities for offering their services in each of these geographies.  I know a FO who is equipped to advise the family in Indian along with the US jurisdiction as the family has multiple interests there.

Ability to handle complex newer investments:
The investment opportunities keep on increasing and becoming more complex. These have moved away from the traditional family’s equity holdings in the group company and fixed deposits to mutual funds, real estate, private equity funds and today in Bitcoins and crypto currencies. These avenues will keep on coming up and the family needs to have the professional expertise of a qualified adviser to guide the family across these. For example, If the family wants to invest in startups (maybe promoted by a family member) then the capability to evaluate ventures is also desirable.

Technology:
This is an increasingly important factor. FOs need to be aware of the technology which can be used for the benefit of the family. There are some investment advisors who are using robo-advisors on a trial basis, and these will become increasingly significant, whereas a couple of FOs that I know, insist on a personal meeting on a periodic basis. Given that the FO also plays the role of educating the family members, they have to be aware of how technology would impact the family, especially with AI and financial technologies constantly evolving.

Another role that FOs may have to play is the data and online security of the family members. For example, I had helped set up an internet policy for a family, defining what the members could or could not post or use social media, to protect this media shy family.

Philanthropy:
Families are looking to contribute to the society and have taken up causes that are dear to them, to do this. They are looking for deliverable and realistic outcomes, which they can play a part in, and hence family offices will need to have the expertise and experience to enable the family to do this. There are increasingly large number of initiatives that a family can choose to associate itself with, and this will be an area where family offices will play a bigger role.

I know a next gen member who spearheaded a new initiative, wanting to impact a cause that she did not find anyone addressing. FOs will have to work with the family members for delivering these objectives.

Family offices are coming into the limelight in India, and family who set these up can expect challenges in the initial stages. If FOs are to serve the needs and aspirations of the business family, they will have to extend their roles from a mere extension of an investment arm for the family to being a vehicle for enabling the family’s aspirations. For this, knowing what needs to be done is a constant learning process and FOs will have to constantly keep on working on this.

But then again, anything connected with families, needs that. Doesn’t it?

The author is a Professor of Family Business at SPJIMR and a Family Business Advisor
 
 

[This article has been reproduced with permission from SP Jain Institute of Management & Research, Mumbai. Views expressed by authors are personal.]

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