Skin in the game and the family office boom

There’s one thing all single-family offices have in common – skin in the game. If their investments falter then the person or family who set up the family office suffers.

OK, maybe the SFO’s chief investment office might not suffer financially, but he or she is going to feel the pressure considerably more than someone who manages a mutual fund for hundreds/thousands of investors if things go wrong. In fact, many CIOs and senior investment specialists at SFOs often have co-invested with the families they manage money for – so they also have skin in the game. The families often like having their money managers aligned with their interests by committing their own money – it helps to mitigate against so-called double-agency costs at a family office.

The writer, scholar and statistician Nassim Nicholas Taleb reckons skin in the game is crucial for credibility. He argues for skin in the game as a rational and ethical necessity for all risk-taking. From that perspective, he’d probably admit that SFOs have skin in the game, albeit so much skin in the game that the risk taking for all of them will never lead to really dire outcomes. Nevertheless, the people behind family offices, whether the investor who set it up or those professionals running it, will feel the pain when their investment decisions tank.

Not so for wealth and asset managers. New research has highlighted how few managers of money actually have skin in the game. Done for the Financial Times, the research found that  half of the 15,000 mutual funds in the US are run by portfolio managers who do not invest any of their money in their products. And it appears the bigger fund managers are most guilty of this trend, with Vanguard, State Street, Schroders, BlackRock, and Aberdeen singled out as among the companies with the lowest levels of portfolio manager investment in their funds.

Taleb and his fellow skin in the game advocates probably wouldn’t be too surprised with this research. They’ve argued for some time that much of the financial sector has very little skin in the game, and as such, helps to create the underlying factors that lead to financial crises like the one back in 2008.

Whether their thinking will eventually filter down to the likes of the wealth and asset managers mentioned above remains to be seen. But at the very least it will lead to greater scepticism towards the asset management industry, and for those lucky enough to afford it, greater desire to set up their own independent investment business to gain better control over their investments.

And with ongoing and exciting developments in fintech, the cost of being able to set up a family office will probably fall considerably in the years ahead. That, along with scepticism towards the fund management industry, will be a boom for the growth of the family office sector. It’s a wonder why the big asset managers don’t see the that…or maybe they do, but just don’t see it as an issue.