This is a keynote speech given at the Elite Summit in Montreux, Switzerland, run by Marcus Evans and attended by Family Wealth Report, touching upon a range of issues affecting the family office industry.

Editor's Note: This is a keynote speech given at the Elite Summit in Montreux, Switzerland, run by Marcus Evans and attended by Family Wealth Report.

Good afternoon ladies and gentlemen, and welcome to the Elite Summit. It’s a real pleasure to be here today. My name is Harriet Davies and I am the editor of Family Wealth Report, a publication specializing in the North American wealth management industry. In that role I’m fortunate enough to spend a lot of time talking to some of the top people in the industry, about the challenges they face and how they’re dealing with them. It is some of these insights I hope to share with you today.

When I was asked to talk about the latest emerging trends and best practices in the family office landscape, the hard part was of course narrowing down which points I needed to cover. Because the impact of the financial crisis has been so huge on this industry that its effects are still being felt strongly, and perhaps more so now that we are beginning to see them being worked through.

The main factor might end up being the sea change in sentiment about capitalism broadly and financial services in particular, which has taken hold of the mainstream of our society. This has had two major effects in our industry. Firstly, it has caused an overhaul in regulation of the kind not seen for decades, and secondly, it has caused a change in clients' attitudes. New questions are being asked, and expectations are different.

There is disillusionment with financial services providers, and this is seeing the industry reform itself around ideas of independence and alignment of interests.

Meanwhile, we appear to be reaching a tipping point in terms of the world economy, with relatively wealthier nations becoming relatively poorer, and vice versa. This is affecting the investment landscape, as well as the landscape of business opportunity, prompting everyone to question how they want to position their businesses going forwards.

And wealth management is a business inherently driven by demographics, and so in the US it is grappling with an unprecedented wealth transfer between generations, and the issue of how you retain those clients has become critical.

Finally, technology is advancing at such a rate, providing both the possibility of efficiency gains, but also new and very real challenges, such as how you use new technologies compliantly.

In fact, there seems to be no aspect of this industry that is standing still and that is prompting a huge amount of self-reflection.

What is a family office?

A good place to start this discussion is by asking what a family office is.

In the US, we recently had the first legal definition of a family office under Dodd-Frank. That relates to single-family offices of course, but the defining of a single-family office has spillover effects for multi-family offices, which I will touch upon later. On the other hand multi-family offices are still at a stage where the business model is not quite defined, which creates some confusion, but it is around these edges that the questions are being asked.

On this subject, I spoke recently with a senior executive partner at GenSpring, (view article here), who discussed with me why the firm rebranded a few years ago, and he said that part of the reason was to unify the business and create a really powerful brand in the multi-family office space. This is an interesting concept because you have few powerful brands in the pure advice space, as compared with the household names among banks and asset managers. I think it is symptomatic of confidence in the multi-family office industry in the US, and the fact it is gaining ground and starting to come into its own.

Certainly in the US there is growing awareness about the fee-only model, so where no fees or commissions are made from asset management, and where the onus for the business is to prove that its model puts it “always sitting on the same side of the table as the client.” The debate is really about whether planning services should be wrapped up with asset management, or the costs separated and passed through to the client.

Whether this is something that will truly dominate the family office industry remains to be seen. There are many reasons why it may not. But certainly questions of independence and how fees are earned are being asked, and I think businesses will have to be able to discuss this more transparently with clients in the future, and justify their position either way.

Fees

One challenge for those family offices which are not making any money on investment management is the pressure to get decent margins, and a number of research reports over the summer attacked the pricing in the industry for being too random.

Some of the best practices I’ve heard of are family offices logging how many man hours it has cost to deal with a family's issues over the year, and although they are not billing on an hourly basis, they are logging that, so they can see how much it is costing them to provide those services. And then when it comes to client communications, they are then sitting down with the family to discuss which services have been delivered that year and what they cost, and why they might have to be amended, and in that way having a logical fee structure.

In terms of asset based, or project based or retainer fees, there is anecdotal evidence for a movement towards project/retainer fees, and that family offices want to increase the portion of fees charged in that way. This is perhaps because it aligns better with what it costs to provide those services, as well as providing stability. I’ve heard of some multi-family offices charging a higher fee in the initial year, to reflect the extra services and work. The movement is away from arbitrary fees and towards logical fees, and hopefully therefore sustainable margins.

Now of course charging fees that are profitable is notoriously hard in the high net worth advice space, because free investment advice has proliferated over the years, and this is a client segment that is very cost conscious but expects an impeccable level of service. Also, they may also be paying fees to lawyers and accountants for what they feel is overlapping advice, and might not see the justification for paying again.

Therefore, if operating with a pure advice model, tangible benefits need to be achieved, such as by leveraging investment pools to achieve scale and drive down your asset management costs for your clients, and dealing with product providers and distributors on a level playing field as a finance professional, and thereby bringing in the best providers at the best prices.

Ultimately, it must be a case of saving the customer money somewhere else to justify profitable fees.

The problem with this model in practice course is that finding people with the skills to do that is hard. You need people with the high “EQ” to deal with families and family dynamics, who can also deal with complex investment, estate planning and tax and philanthropy issues, and this is very costly.

One interesting model I've heard suggested is for a multi-family office to offer very specific asset management services in-house to boost its margins, and to make this clear to the client. Perhaps this would work with a fairly undifferentiated asset class, or where the family office has a particularly strong expertise.

Cost pressures

There are other changes resulting from this cost pressure being felt. One is the development by family offices of “á la carte” services. Whereas it used to be the case that families would come and take the whole package, as it were, increasingly firms are pricing individual services and allowing potential customers to customize their offering. This is helpful in two senses. Firstly, at a time when some families may not be able to afford a full family office offering, this widens the industry's potential client-base. It also is very useful for families, for instance, who have very specific needs, such as a huge business interest but few liquid assets.

This movement also ties in with the aforementioned Dodd-Frank act, and the fact single-family offices may need to outsource certain services. As the family office exemption defines a single-family office very narrowly, more will perhaps be looking to outsource certain services to MFOs and also to work with them in new arrangements.

So far, the key factor is that there remains lots of uncertainty. In the latest Family Wealth Alliance survey on single-family offices, around half still did not know the full impact Dodd-Frank will have upon them. Best guesses at the moment are that most will qualify with some restructuring, according to Robert Casey, research director at the Alliance. He also told me this effect shouldn't be underestimated, as it's a radical change for a group of previously unregulated entities.

There are also significant costs for those not required to register with the SEC, such as record-keeping to prove eligibility. Therefore there may be knock on effects as more singly-family offices become unsustainable and join the MFO space.

Another model which is often discussed is the idea of an "equity family office." This is where the family takes an equity stake in the multi-family office and therefore makes it more similar to an SFO in structure. The basic idea is that it might provide the “ultimate” alignment of interest for families and the firms which are supposed to represent them. However, it also brings some of the difficulties of SFOs to the MFO space, such as questioning what role those family members may then want to take actively in the company.

Investing

Of course as well as regulation what has prompted such a level of introspection has been the tough investment landscape, as it has really highlighted the issues of fees. It has always been the case that costs are a drag on returns, but with “risk-free” yields at rock bottom this issue has been put under a spotlight.

Again, best practices I have seen to deal with this challenge include some of the following.

Firstly, clients’ expectations need to be managed, and they need to be better informed. The priority now has to be communicating with clients and getting them to understand what they hold and why. With such political and economic volatility, a client should be able to turn on the news and if there has been another development in the European debt saga, for instance, they should have some understanding of the implications.

Being proactive in that can save a lot of time with clients, and as mentioned before, that precious employee time is the biggest driver of cost.

In the US a movement towards goals-based investing is supporting that trend. This has been in the works quite a while. The idea is to portion out clients' funds in terms of their regular living costs and lump-sum costs, as well as legacy goals, and allow the ultimate use of an asset to determine how it will be deployed until such time it is needed, so that its liquidity, risk level and timeframe tie in with its intended purpose.

Family dynamics

Another trend that has really gathered pace in the industry is the attention paid to family dynamics. The basis of this is that family unity may be just as important for multi-generational wealth preservation as good investments and tax planning, for example.

In a book entitled Preparing Heirs, Roy Williams and Vic Preisser found that from interviews with 3,000 wealthy families who had failed to successfully transfer and preserve wealth, the primary reason was a breakdown in family communications.

In terms of managing conflict, some wealth managers look to transfer tactics developed in fields such as corporate team building, and a number of the large family offices have either these kinds of strategists, or fully trained psychologists, in house. There is an increasing awareness that financial plans need to take into account some of the emotional realities of the family.

There is also an issue of trust, as a recent Barclays Wealth Insights survey found there was a significant breakdown in trust between parents and children over how the children would manage their inheritance in countries such as the US and UK. Allaying these concerns for your clients can be a way of delivering value to them.

Meanwhile, families become more spread out over time, and perhaps more diverse in terms of values and beliefs. Developments such as family portals, and sites designed like social media sites but for the family only, and with various levels of security for different members, are new ways they are finding to communicate.

This unfortunately brings us back though to the question of fees as it’s not clear yet how to charge for this, although most include it in the percentage of assets under management fee.

However, even smaller firms are starting to advertise their family governance abilities, and in the US there is tough competition on the talent management side for the top people in this special area.

Technology

There is, I believe, still a big opportunity for a technology provider to supply the family office market with a solution to its unique requirements. One of the main complaints I’ve heard is the need for better reporting across multiple asset managers, brokerage providers and custodians, often in multi-currency environments and across several tax entities.

Wealth and philanthropy

Lastly, I want to touch on the wider issue of wealth in our society. This year has been marked with civil unrest which is symptomatic of dissatisfaction, and inequalities in our society are running, in the US for example, near 30-year highs. We have, in the West, benefited greatly from decades of domestic stability, which is also one of the most powerful predictors of economic growth.

Wealthy individuals and financial services firms, as the perceived winners in our society, have a great interest in protecting this stability and I think, as an industry, to protect its image it should engage with this debate as much as possible.

Given this, it is heartening to see the way philanthropy as an industry is taking off, and that private client demand for philanthropic advice and services has remained strong despite the downturn.

One of the newest trends in this space is "venture philanthropy" or "mission investing," where charitable foundations also use their principal to invest in such a way as to further their charitable goals while gaining a return. This aligns the investment and distribution side and should increase the overall impact of the foundation.

One reason I think this is so important is because it can also help advisors broaden their relationships within families. For example, a colleague in the industry told me about the difficulty of engaging with the younger generation, and how misguided efforts can be by adults. However he found that engaging children in the family foundation was an excellent way to get them to think about money, responsibilities and values. Many studies show these are some of the things clients really worry about passing onto their children, and that this can help family unity.

So I think it is all the more important now to make this kind of advice clearly available to clients, as it can help play a part in bridging gaps with clients, their children, and perhaps the general public.