Although it’s hard to put a figure on it, the number of single-family offices has at least quadrupled in the last 25 years. And that’s probably an underestimation given that the number of billionaires during the same period has almost increased 10 fold to more than 1,200 today.
Back in the 1980s few people outside of the US had even heard of a family office. But today it would appear that they have passed into the vernacular of wealth just as much as the phrase “high net worth”.
However, given their secrecy the mystique around them is still considerable, which makes the risks they collectively face difficult to understand. After talking to a number of family offices and consultants in the US and Europe, Family Capital has come up with a list of what it feels are five of the most pressing risks for single-family offices:
- Expectation of returns. Family office professionals often say that families may not fully appreciate the balance and the relationship between risk and reward. As one family office told Family Capital: “They are bound to hear from their friends about all of their wonderful ‘winners’ whilst of course never hearing anything about losses made on losing positions”.
He added: “It is all too easy to get carried away dreaming of the upside of a risky investment without fully appreciating the downside risks. This is one of the most critical risks and they can only be tempered by patient and regular education of the family”.
- Expectations of staff. Families are often likely to have an unrealistic expectation of the abilities of the staff they hire. As a Swiss-based family office professional says: “Often family office principals will hire a successful Goldman Sachs banker and expect him or her to work their magic for their investments. Quite often they are disappointed.”
There is also often a mismatch of investment horizons among staff and the family office principal. For example, families might have a much more long-term outlook, whereas those running the office might be more short-termist. This is a huge risk and even when addressed often emerges again as an issue in a few years time, say family offices.
Another potential staff risk is the fact that family office principals often surround themselves with yes men. As a UK family office said: “Principals, especially if we are talking about first generational wealth, are often highly entrepreneurial and driven. They like to call the shots and it may at times be difficult to stand in their way. Surrounding oneself with ‘yes men’ can be very dangerous and must be avoided if at all possible”.
- Longevity. Family offices aren’t like family businesses, at least in terms of longevity. If only 10% of family businesses make it through to the third generation, the figure is even lower for family offices, say experts. “If we look backwards in history for a moment at the success rate of the single family office, it does not look balanced,” says Sandy Loder, of AH Loder Advisers. “There are those single family offices with a family business that have survived multiple generations, but I struggle to count on one hand the number of multi-generational single family offices that purely focus on investments.”
- Diversification. Asset managers will always say portfolios need to be as diversified as much as possible to offset risk. That might not make sense for a family offices. “There are countless examples of families making their money in one industry, but then diverting the cash being generated into other, possibly more interesting/sexy, areas instead,” says a London family office professional. “This in most cases is a big mistake. Just because the family may have been great at making money in, say, the tech world, these skills probably won’t translate well into investing in, say, luxury goods.”
- Costs. Almost all family office principals have an unrealistic view on the cost of running a family office – and that expectation is always on the cheap side, say experts. “The family may have run businesses where the cost of hiring senior staff was less than the equivalent position in the financial services sector,” says a family office consultant. “Regardless whether the salary differential is right or wrong, family principals need to appreciate the high salaries of good family office professionals.” They are also likely to underestimate the cost of compliance and technology. Consequently, family office principals will need to realise that costs are likely to be at least 100 basis points of assets under management – many of them don’t, say family office consultants.