Ultra-high net worth (UHNW) families are confused by myriad configurations of advisors and commercial providers and often choose to serve themselves by forming a family office. This article explores where this leads.
The following article explores the many facets of a multi-family office, going into definitions, the reasons why they are founded and the challenges in doing so, as well as how they should be effectively managed and aligned tightly with clients’ needs. These issues are evergreen because the MFO market remains as busy as ever in North America. Indeed, last year’s falls in global equities and the enactment of new tax laws in late 2017 only serve to remind ultra-high net worth families of the value of a good family office model.
Who better to explore this terrain than Jamie McLaughlin, chief executive of J H McLaughlin & Co, a member of FWR's editorial advisory board, and also a founder of the UHNW Institute, the not-for-profit organization which is launching its website and announcing new developments as reported elsewhere on Family Wealth Report.
This article falls into three parts, with the first running today. It was adapted from James H. McLaughlin, “Proscriptions and Prescriptions,” Investments & Wealth Monitor, January/February 2016.
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Serving complex families is, well, complex. And the market that provides these services has likewise become complicated. Ultra-high net worth (UHNW) families are confused by myriad configurations of advisors and commercial providers and often choose to serve themselves by forming a family office.
For most families, a family office cannot be recommended simply given the costs. The number of family offices in the United States is uncertain - some estimates put the number at more than 5,000, but a more helpful guideline is to consider when a family office is economically efficacious. I put that number at $1 billion, which is a rarified level of wealth where Forbes estimates there are 585 families in the United States. (1) This might imply that a very large number of family offices don’t make economic sense, but one needs to understand the complex anthropology of wealthy families to make any judgment on the merits of forming a family-office structure based on the economics alone.
In this context of an abundance of wealth, wealth management firms increasingly assert that they provide a "comprehensive" array of services including a suite of "family office services." Many self-identify as "multi-family offices." The reality is far different as most firms don't or won't recognize their shortcomings and the implied challenges.
Such a service delivery requires a significant investment, particularly in an ensemble staff configuration, an acceptance of lower margins, and, importantly, a different cultural adaptation to client demands from the traditional demands of serving the mass affluent and high net worth (HNW) segments.
Further, over the past decade and accelerated by the market tumult of 2007-2009, the dialogue has changed. UHNW client demand has shifted beyond investment management to include an array of non-investment services (NIS). For the super-wealthy, the dialogue now includes issues related to family systems, family sustainability and the very purpose of the money; an existential discussion for which few traditional advisors are trained or emotionally equipped to facilitate.
In the above context, why do wealth management firms want to compete in the UHNW space? It is neither glamorous nor profitable. With great care and discipline, it is possible to deliver on the implied service promise, but some forbearance is in order for both firms and UHNW families.
In this article, we will cover some of the challenges, opportunities and trends.
A Family Office Ecosystem - Not a Market
Although there may be an ecosystem of families and professionals with some common interests, we fall into an easy trap when we refer to a so-called family-office “market” or “industry.” There is no such monolith and there is no such market, at least not yet.
This ecosystem has some economic aspects of a market, but many other identifiers are entirely unmarket-like; some are even economically perverse. As a result, the configuration and execution of many family offices, across staff models, delivery platforms and processes, varies widely. What is common, however, is a preference for disinterested advice, a desire for sustainability (not simply growth) and sufficient resources to manage risks.
In this environment, many prudent UHNW families conclude that they need outside, supplemental resources to manage a morass of processes and information.
Defining a Multi-Family Office
While many families are confederating formally and informally, this article will focus on commercial MFOs. Models vary widely and cut across regulatory channels. A large majority are organized as registered investment advisors (RIA), and the cohort also includes trust companies and commercial bank private banking lines of business. All generally stand on the presumption of an agency relationship with a family. This relationship is anchored to advisory services rendered in an alignment of interest with the family as distinct from the more transactional models of firms operating as manufacturers and distributors who have some principal/agency conflicts.
The highly fragmented RIA channel is perhaps best positioned to serve families who are looking for an alignment of interests between the firm and client, but they suffer from weak capital structures, indistinct brands, poor organic growth, and deteriorating cost-income ratios—all of which pose challenges. If this isn’t clear to families, contrast the RIA channel with wirehouse brokerages that enjoy national brands, strong organic growth, and an abundance of capital, and which, targeting the UHNW, have shifted largely to a comparable fee-based model.
Clients are Confused
In this narrow context, the MFO submarket is predictably confusing for even the most sophisticated families. MFOs lack brand awareness as individual firms and as a cohort and are best described as heterogeneous with varying types. Some are integrated “whole client” providers; some are more investment-centric/outsourced chief investment officer (CIO) service platforms; others primarily offer non-investment “family office services.” As a result, each has differing staffing models, cost structures, and pricing models.
Demand is Shifting
The good news for MFOs is that we are in the very early stages of a secular global transformation of client demand. Without unduly oversimplifying, the root of the shift lies in the premise that the ultimate economic buyer will favor firms that provide advice largely free of conflict. In tandem, pricing power could shift to advisors in spite of what remains a fragmented industry, which would suggest the opposite effect. Clients, long yearning for advice (and often unsatisfied), will increasingly be willing to pay for impartial and differentiated counsel.
Transactional business models, where firms act as manufacturers and distributors of products and also advise clients on those same products, struggle with an inherent conflict. They will be forced or induced to adapt to a new reality where transparency and disclosure will be increasingly in favor. A sub-theme fueling this demand shift is the client expectation of an improved level of technology that can provide greater data visibility and assimilation.
In summary, a secular trend is underway that portends the disintermediation of an increasingly concentrated group of manufacturers and distributors and favors a more fragmented market of firms and professionals that provide impartial, quality advice.
Further, at the very high end of the market, there is widespread evidence that clients now value the non-investment components of firm service models at least as much as investment performance. However, firms have been slow to use this latent demand to modify their pricing strategies for non-investment-related services.
Part 2 of this series will dive into the demand shift we are seeing from UHNW clients from a strictly product solution to a focus on how solutions are delivered. The design of an effective client experience will ultimately empower firms and advisors to grow and retain clients based on values-based relationship building verses retail product sales.
The UHNW Institute, in partnership with Family Wealth Report, is a non-profit educational initiative serving UHNW families and family offices. The team of industry experts will provide a curriculum in the form of articles, webinars and events throughout the year for their readers which will be highlighted on our site. For more information, please visit www.uhnwinstitute.org
1, Forbes, March 31, 2018.