Today’s post is inspired by interactions on twitter over a period of several months. Given the opaque nature of many Family Offices (“FOs”), there are questions by some about why principals bother to build investment teams compared to outsourced solutions. The question has merit.
We will be getting into a few of the potential reasons driving principals to build an investing FO. This list is by no means comprehensive and I don’t claim to be an expert with all of the possibilities presented. Some topics are touched on, but could merit further exploration in the future. From an investment professional perspective, I think an important point to internalize is your opinions of why a FO investment team should or shouldn’t exist really don’t matter or have to align with your view of reality. Principals build investment teams because they want to and they have a variety of motivations for undertaking the venture. Empathy and understanding is something I encourage of people who question the raison d’être of these organizations, not agreement. Investment professionals that understand the drivers of why specific FOs exist could have more success in their interactions with these organizations.
People with large amounts of wealth face an issue that can be hard to appreciate for normal folk; the feeling that most people look at you like a money piñata they want to bust open. There are so many people trying to get a piece of someone who has more that it can hurt your view on humanity. Sorting out the grifters is one of the worst parts of the job, but has high value to the principals. Even financial advisors, private bankers, whatever you want to call them, at large name institutions can be wolves in sheep’s clothing (discussed more later). Principals may feel more comfortable with the relationship dynamic where the employee is solely reliant on the principals for a paycheck. Deeper trust can be forged through the more frequent touch points that come with staff compared to service providers and the comfort knowing the whims of other masters aren’t as prevalent in the relationship.
Conflicts of interests can, and do, exist between principals and FO investment professionals. Compensation structures and forms of aligning incentives such as co-investment can be created to minimize the conflict based on the investment strategy of the FO. Many can have difficulty imagining people who are willing to invest millions each year for trust, but people that are so fabulously wealthy are price insensitive to something they could value so dearly. You also probably don’t have the experience of anyone with PowerPoint and a lust for money trying to get a piece 24/7. 50 BPS of costs for a $1B AUM FO is $5M in annual expenses, a cost many families won’t think twice about paying for the peace of mind that comes with trusting those responsible for stewarding their assets.
Alignment is tied at the hip with control and trust. Conflicts exist to varying degrees with those working with the principals as providers, investment managers, or employees. This topic alone could merit a singular post, but I’ll just use a couple of quick examples to illustrate friction points that can drive principals to prefer their own investing team relative to other options.
Advisors are a tricky bunch to size up. Some are high character individuals trying to do right by their clients. Others are polished, highly educated, and smooth-talking leeches. Anecdotally, I know of stories of theft, fraud, and of trading clients into the ground to make commissions. These terrible outcomes happen. The sad reality is principals can take years to figure out what is happening before the extent of an abusive, or incompetent, advisor relationship is revealed. To be fair, FO investment professionals can be guilty of the same sad conduct. Some advisors treat the assets of clients as a resource of the advisor and make recommendation that can conflict with the client’s best interests. As an example, I know of some advisors that won’t make certain types of investments with their clients because that AUM isn’t easily portable to their likely next firm. Hired guns exist and the reality is some of these clients grow distrustful of the institutions that claim to put the client first.
Here’s shocking news. Not all investment managers make decisions in the best interests of their clients. This reality is part of why FOs with enough resources consider bringing some strategies in house. Here is a generic situation that generates frustration as a family office investor (I know this applies to endowments, foundations, and pensions too). Let’s say a FO invests as a limited partner in a fund with a GP claiming they are long-term focused investors aspiring to compound capital for the long run, a familiar story to all I’m sure. Two or three years into the strategy, the GP comes knocking for the next iteration of the fund. Curiously, the top performers in the portfolio of the prior fund all happen to be for sale at once. A ten-year fund, longer when you consider the GP’s right for extensions, and the GP wants to conveniently blow out of the best holding right around fundraising time. I wonder what is happening here. A principal with enough resources and confidence (or over confidence) could say to hell with it and believe they are better off attempting similar investments in house with a team more aligned with the principal’s investment objectives.
I had the experience of helping a family member allocate some cash in a retirement account to a S&P 500 index fund. The process took almost an hour because they wanted to supervise every step of the process. Now take the personalities of some very wealthy people, especially wealth creators, and imagine how they might feel about controlling their assets. Finding principals that built a FO investing team who didn’t value control would be a rare citing based on my experiences. The desire to be in charge seems pretty straightforward.
Principals can still exert a significant amount of control over their investments working with outside advisors, but having a team in house opens up the options further for those who choose to make the investment in building a team. There is freedom not being tied to a platform or a research team designed to service a broader set of clients. G1 wealth creators can have a certain confidence that they will succeed in other ventures due to their history of generating life changing wealth. There are some who believe their skills as an operator will translate into skills as the head of an investment operation, a transition tougher than many expect. They still want to be in charge of something and a FO can be an outlet for that type of individual.
Objectives & Strategy
Another topic with enough depth to shine in a singular post so what is discussed could seem brief. FO mandates are all over the place. Principals can have a vision for what they would like to accomplish that they believe isn’t appropriately addressed by traditional service providers even when trying to coordinate between outsourced groups (accounting, investments, legal, philanthropy, etc.). From the outside looking in (I have no connections to the organization), Laurene Powell Jobs’ Emerson Collective is an example of a FO with a wide scope of objectives that integrates investments into the organization’s larger mandate. I also know of organizations that seek to impact their local communities through a combination of philanthropic giving and investments with intent to help their local economies. The collaboration, idea sharing, and information flow across different arms of an organization can be difficult to replicate by outsourcing to more traditional organizations.
Major financial institutions have their own set of investment products and relationships that are available to clients. Institutions are generally pretty good at creating products to meet their customer’s needs or make money for the firm. Principals that want to have the flexibility of working with a broader set of firms start to get into issues of coordination, research, and portfolio management creating challenges large enough to start putting people on the payroll.
FOs that desire to make direct investments (not advocating here) will get access to a more diverse set of partners in opportunities not available through a singular platform by building a team. I’ll pick on the big banks for a moment, who love to hype up the opportunities available to their clients through their alts platforms. Casper’s Series-D financing? Here is a deck and an hour call with the executive team where you might be able to ask one question if you’re lucky. Thanks, but no thanks. And that could be one of the more interesting direct opportunities presented to clients. I know the organizations like to make these opportunities sound exciting. They’re generally not.
All In The Game Yo
I imagine most of my audience is directly in, or adjacent to, the world of investing. Let’s admit making investments and feeling like you’re out in the world getting things done is addicting. Principals get the same rush. Don’t underestimate how much a family member might like walking downtown and pointing out what buildings they own part of, bragging to their friends about how a startup they funded just raised a Series B with brand name venture capitalists, or discussing on the golf course how one of their portfolio companies is expanding by doing M&A deals. Investments gone wrong are quietly swept under the rug. The pull of the action is real, and principals impacted by the gravity of the game love being in the mix.
There is a subset of principals who seek to be involved with the investments made by the FO beyond just boasting to their social circles. The experience of the principal often frames how they view what is the appropriate level of engagement. Some want to show up for board meetings and pontificate. Other principals get intimately involved with operations and advising management teams in ways that can add value. The builders out there have a switch they just can’t turn ‘off’. They want to get out there and do s***.
Bill Gates Has a Family Office, I Should Too!
Really rich people have conversations with other really rich people that would seem strange to almost anyone else. How do you decide to spend your time between your five homes, security issues, yacht maintenance costs, the harvest for the winery, etc. One might feel left out if their social circles are building investment teams with smart people that are getting all these deals done and making heaps of money. At least that’s what principal’s will tell people. Once the FOMO bug for all these great deals bites, calls to recruiters will be made and teams will be built. For some, the reality is having a FO can be status symbol for separating the fabulously wealthy from people worth mere tens of millions. For those that remember the author’s distant previous post, about 2/3s of FOs were created in the last 20 years. Getting in on the investing action in this form is a relatively new phenomena.
We Gonna Make That Money
Finally we get to the possibility of making bigger piles of cash. The potential for FO structures to achieve superior investing outcomes was an initial appeal for your author to enter the world of FO investing. At this stage in my professional journey, I’m fairly ambivalent about the prospect of fantastic investment returns being why someone would build a FO investment team. Returns wouldn’t even make my top five reasons for myself to build a FO if I somehow found myself possessing a sizable fortune, though I would still hope for that outcome.
The dream of achieving exceptional investment outcomes is evergreen with principals believing their resources, ‘brand name’, decision making, and maybe a little chutzpah will yield a greater fortune. The usual ideas can be bantered around as to how FO’s will do better than alternatives. Longer time horizons, flexible structures, the ability to go anywhere, being better partners, their network, ‘proprietary deal flow’, etc. There is truth to each of these ideas. The execution often leaves much to be desired. Candidly, I rarely talk organizational investment performance with other FOs. My sense is there are few FOs that realize exception investment returns. The dream lives on.