FAMILY OFFICES: THE MIDAS TOUCH

As more and more families across the globe become wealthy, family office structures are becoming increasingly popular. Designed to preserve wealth for future generations, they offer a high degree of independence with regards to investment choices. The only downside: their operating model is becoming more and more expensive.

Family offices, essentially dedicated to growing a family’s assets, are not new. However, until the beginning of this century these structures remained remarkably discreet, not only in terms of their assets under management but also in their activities. Despite this changing somewhat, calculating the exact number of family offices remains complicated, not least because the terminology surrounding these firms remains unclear: there is no specific regulatory framework defining the activity, therefore allowing them to operate under a variety of different structures. Each family has a different aspiration, but what is clear, however, is that the family office construct has become the common vector for them to organize their affairs.

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Family offices are the solution to various challenges families are confronted with.

Of the family offices currently operating globally, 30% were created between 2000 and 2010, and 40% have been created in the decade or so that followed, points out Cyril Zastawnik, Head of Global Family Office at UBS Luxembourg. For him, this recent growth is linked to both the more rapid wealth creation and the families desire to professionalise the management of their assets. “Historically family wealth was created step-by-step over generations from an industrial activity. Today, technology has allowed for the creation of unicorns, and billionaires, more rapidly accelerating the creation of family offices.” As a result, while Europe has long hosted the most family office structures, the number of new offices being created in the United States or Asia far outstrips this.

Not all wealthy families can bear the expenditure to set up a dedicated family office. Given that this structure can sometimes have more than ten highly qualified employees, you need a sufficiently large assets base to absorb the costs. For Zastawnik the minimum size necessary to make it an economically viable structure is approximately €300 million, however “this is obviously not a golden rule” he admits.

However, the statistics support this. The UBS Global Family Office report 2021 shows that 40% of respondents have assets in excess of $1 billion and 21% in excess of $500 million (cf.Figure 1). Below a certain threshold, families are more likely to turn to commercial multi-family offices, which despite being an external party supporting a large number of families, stand as a good compromise gathering partly to their requirement.

The key reason why these structures need sufficient assets under management is they are not engaged in commercial activities and are not required to make a profit. “The first objective is to ensure the financial needs of family members, established in advance, by defining the best allocation strategy and then to grow the capital,” explains the head of a large European single-family office, who has asked to remain anonymous to preserve the privacy of the interests they represent. The objective that family offices pursue then implies a certain amount of risk taking, but also of control.

“Being a service provider to the owner of the assets, family offices can be seen as cost centres with these costs are not directly linked to results,” notes Zastawnik, but they are becoming increasingly more important. According to studies carried out by UBS, personnel and IT costs account for 70% of the total budget. Rising costs have largely been linked to the increasing need for technology, as well as the need to reinforce teams in order to respond to the growing complexity and rising regulatory requirements. “Over the last ten years, the regulatory framework has become more volatile and the family office constantly needs to adapt to these new regulations which are not always suitable for our specific structures,” laments the head of the European single-family office. Why, for example, should a single-family office comply with the same AML rules as a large bank, they question.

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Over the last ten years, the regulatory framework has become more volatile and the family office constantly needs to adapt to these new regulations which are not always suitable for our specific structures.

Other new sources of costs concern security in general. Wealthy families have often needed to protect against classic threats, including theft, embezzlement, and kidnapping. Today, given the rise of technology and the increased spotlight on these families, they face a new range of threats stemming from the cyber realm. As such, family offices must now guard against cyber-attacks and develop new solutions to protect data and transactions.

Despite increasing costs, the family office model is not in question. The “Raison d’être” of each family office is unique, stretching from a lack of time required to manage one’s own assets to the desire to separate private assets from an operational economic activity.

The main reason, especially in the case of older money, is the desire to preserve existing assets across generations and to ensure the transition from one to the next. “Family offices are the solution to various challenges families are confronted with,” explains Zastawnik, “such as lack of succession planning, lack of communication between family members, and lack of transparency in decision-making.”

The creation of a family office also makes it possible to entrust the management of the family’s assets to a professional; often ensuring a better return in the face of increasingly sophisticated financial products. “Very often this choice is linked to the growing complexity of the financial world and the lack of expertise within the family unit“, explains a former manager of a large Latin America single-family office, who also requested to remain anonymous.

Within the families themselves, the problem stems from the ramifications that develop over generations. A risk emerges of losing the common heritage and values in subsequent generations with different objectives and initiatives.  “This type of structure makes it possible to bring together the various branches of the family around a common structure to guarantee the continuity of the assets while entrusting the management to a team of independent managers,” continues the former manager of the Latin American family office.

Another core advantage obtained via the creation of a family office is independence in investment choices allowing them to operate as an unconstrained investor. A family office is not accountable to any other shareholders other than the owner family and can therefore plan investments over the long term. It can make its investment choices directly, without having to go through an intermediary. “When you deal with service providers, you become part of a client pool. If you ask for a specific solution, you might not get it immediately, whereas with your own family office you are always the first to be served,” argues Zastawnik.

Finally, there is the question of the FOs’ investment choices. Do they have a preference for certain areas? “Each family makes its own decisions in terms of preferred areas of investments according to their long-term objectives, risk appetite or the level of sophistication it wishes to achieve,” details the former manager of the Latin American family office.

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Today, technology has allowed for the creation of unicorns, and billionaires, more rapidly accelerating the creation of family offices.

Zastawnik, for his part, sees a clear trend emerging; an interest in investing in the real economy. Largely as family office wealth is often intrinsically linked to the real economy and they are often still active in this space themselves. “The entrepreneurial world is in their DNA, and they often have a far better grasp of it than of financial markets. They are therefore often tempted by private equity investments and want to play active roles as shareholders.” However, he warns that it complexifies the family office operations as it does require specific expertise and adequate resources.

Various studies also show a growing interest among family offices for sustainable, impact-led investments as well as pure philanthropy. These choices also depend on the level of involvement of the family within the structure’s operations and the direction in which they wish to take it. However, according to the individuals we consulted, this involvement tends to decline over generations. They do note though that it is rare that the family is not involved in the structure’s strategy at all. To ensure some level of engagement, the family office is often tasked with providing a certain level of financial education to younger generations in order to prepare them to take over.

Family office’s function therefore go far above and beyond the clichéd tasks of holiday booking, managing real estate or acting as an intermediary for the purchase of artworks or vintage cars. “This part of the business does exist,” says the head of the European single-family office “however it is the conciergerie aspect, and it is far from the largest, or most crucial, part of the business.” Therefore, in certain cases, these structures prefer to be considered as investment companies, rather than family offices.

Whatever one calls it, a looming question in Europe is whether the shift in wealth creation, particularly to Asia will reduce the number of these firms operating on the continent. While it could be possible, it seems unlikely, as these investors are, above all else, looking for jurisdictions that provide them with political and fiscal stability, a sound regulatory framework, and access to a global range of investment opportunities. For these reasons, entrepreneurs who made their fortune on other continents still choose locations such as Luxembourg to manage their assets leveraging expertise and “know-how” built over years.