A family office’s central role is as a risk manager, says FOX in a new study, and this idea needs to be formalized to create the right focus for staff and clients.

A family office’s central role is as a risk manager, says FOX in a new study, and this idea needs to be formalized to create the right focus for staff and clients.

“The importance of formalizing or recasting the central role of the family office as a risk manager should not be underestimated,” says the study, Building a Family Enterprise Plan to Deal with Future Uncertainty.

The premise of the study is that to maintain wealth across generations the family and their advisors “have to continuously evaluate the environment to identify and manage risks and seize opportunities.” It defines risk as both threats to wealth preservation and wealth creation opportunities.

Corporate practices

The process of managing risk starts with moving the planning phase “from theory to action,” says the study, which involves finding out which issues keep the family up at night.

Another point the study makes is that practices on risk evaluation and management from the corporate world – which for a long time has viewed risk as something to proactively manage - can be translated into a family context. This involves the use of well-known risk mapping tools, for example.

Soft issues dominate

From looking at risk maps from families, FOX says “it is clear that the most significant threats to long-term wealth are often ‘soft’ or sensitive issues such as dominating personalities, economic inequality, or intra-family conflicts. These issues must be handled with care and may require the experience of a trained professional to address effectively.”

These issues also tend to vary depending on which generation is controlling the wealth, FOX says. For instance, generations one and two have to deal with the original patriarch or matriarch handing over control, which the report acknowledges can be uncomfortable for both parties as the younger generation may also feel uneasy with the responsibility.

“Families in these early generations are often searching for a governance system that will help them formalize their decision-making process and provide everyone with a safety net regarding future control,” says the report.

In later generations, cohesiveness and dealing with shared ownership “must be openly discussed,” says FOX. At this point other challenges surface like maintaining lifestyles through investment returns or business dividends.

Another important aspect is managing the risk to the family office itself: what are the implications of more family members being added? Is it meeting the family’s goals and what are the realistic business model options for the future?

Systemic risk

The report also discusses the importance of “understanding and managing systemic risk,” separately from operational risk. The study recommends using an approach similar to the World Economic Forum, which divides systemic risk into five categories: economic, environmental, geopolitical, societal, technological.

“It is worth stressing that the top perceived systemic risks are all economic in nature: severe income disparity, major systemic financial failure, unforeseen negative consequences of regulation and extreme volatility in energy and agriculture prices,” notes FOX.

While focusing on risk can lead people to thinking first of the downside, gaining a better awareness of micro and macro risk “and maintaining an ongoing review of the changing environment” can actually lead to a more positive, proactive mindset that looks for ways to preserve and grow wealth, says FOX.

For example, as the behavior of financial markets has led many people to question modern portfolio theory in recent years, and revealed that assets can become very correlated under certain circumstances, “it may be instructive to think about risk factors (direct and embedded portfolio risk) rather than traditional asset classes,” the report says. This can help reveal  “imperfect” knowledge and blind spots

A “canvas of opportunity”

Trends such as an aging (in some parts of the world) and expanding population, the rise of emerging markets, the transition to a low-carbon economy and the “digitalization” of the world underlie the systemic threats, says the report.

However, this is as much a positive as a negative: “Viewed against the backdrop of the recent financial crisis, these changes appear bewildering and full of danger for families. The flipside, however, is a vast canvas of opportunity that, seized properly, can yield enormous wealth creation possibilities. The central questions for families are ‘what is your risk appetite?’ and ‘where do you see opportunities?’.”