Ultra-high net worth families are confused by myriad configurations of advisors and commercial providers and often choose to serve themselves by forming a family office. This article continues to explore 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.
In the second part of this feature, (see part 1 here) 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, a not-for-profit organization, examines the themes. The article was adapted from James H McLaughlin, “Proscriptions and Prescriptions,” Investments & Wealth Monitor, January/February 2016. (Part three has been published, see here.)
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The market leaders in wealth management understand that there is a pronounced demand shift and have moved from delivering products and solutions to a focus on how solutions are provided. In this post-product era, we have entered a design period where firms differentiate themselves by designing a client experience. Designing the experience can improve the level of diagnostics and discovery, and affords opportunities for a firm and advisor to become more deeply connected with a client.
Such experiences, first conceived in consumer and retail product sales, are applicable equally to wealth management. Names such as Tiffany, Lexus and Ritz-Carlton come to mind. Design discipline requires input from employees, clients, and, potentially, other alliance partners and professionals, on how they want complex products and services delivered. It includes a careful review of all interactions such as work flow and work process and their effect on the ultimate delivery to the client.
The process can take time and is often iterative as firms explore and determine client preferences, rationalizing what matters most.
The client experience
In this post-product setting, some clients are yearning for something more existential, even impactful, best described as an experience. “Existential” is not so abstract as to be transcendent; rather, it’s an experience that goes beyond a discussion of a family’s prosaic financial affairs to a deeper level. Unfortunately, most clients have little reference for other possibilities that lie beyond their customary relationship with their advisors and they have only modest or low expectations.
The most successful firms understand this need to create a client experience and will be led by owner/principals and executives who have had client-facing duties and know what drives this client experience.
What is this experience?
-- First and foremost - a compatibility in values and culture;
-- An alignment of interests - true disinterest and impartiality;
-- A relationship with an advisor and team where no one “owns” the client relationship;
-- Solutions not products - access to the best thinking (contemporaneous information and advice) whether in-sourced or out-sourced;
-- Privacy and security; and
-- Data assimilation - simplicity in the face of increasing information complexity.
MFO business economics
The post-2008 period has been challenging for all wealth-management firms, particularly the smaller, less well-capitalized MFOs. Like many emerging industries, the relatively brief history of the MFO is one where the business economics remain extremely challenging. Costs are high, and few firms have any scale and, therefore, few firms enjoy any operating leverage.
Further, and perhaps most importantly, no firm has any meaningful market share or brand. Consequently, pricing power remains with the client/buyer. If there is pricing power it has been with the investment component of the MFO delivery and not with the non-investment components, principally, planning-related services and the administration of household financial management. Unless firms are very disciplined and “stick to their knitting,” delivering on the non-investment components has tended to systematically erode their operating margins.
If the historical context is not challenging enough, the effect of the 2008 market collapse put pressure on MFO economics with an ugly combination of asset-based fee compression, lost business, negligible new business with less money in motion, increased service requirements, and increased costs, primarily for staff, compliance, and technology. Although the promise of the MFO remains noble, woefully few MFOs have succeeded in scaling their businesses or achieving any operating leverage in this extremely challenging market cycle.
Despite inherent weakness, outside capital shows
With few exceptions, MFO capital structures are weak and concentrated and, until recently, capital sources have been limited. While firm valuations (i.e., multiples) have expanded during the current, extended business cycle, the continued aging of principals, delayed succession planning and tepid organic growth have combined to have a dampening effect on potential UHNW firms’ valuations compared with firms who serve the mass affluent and high net worth segments.
Leadership also must adjust - MFOs are often led by two general archetypes - either dynamic, externally oriented principals and/or investment or capital markets mavens. Firms will need a new generation of internally-focused business operators to develop a more sustainable, institutional character.
In spite of these weaknesses, capital sources and the low-interest-rate environment have spawned increased interest in the MFO segment and portend continued merger activity, recapitalizations, consolidation and internal equity transitions.
The sales paradox
Given their strict conflict-free agency mission and service cultures, MFOs continue to wrestle with an affirmative approach to sales, preferring to use the more benign term “client acquisition.” Organic growth rates (i.e., compound annual growth rates) in the low single digits are common, but there is hope as MFOs increasingly understand and are implementing client-acquisition strategies (i.e., client-to-client propagation rates, development of external referral channels, and improved onboarding processes) that can drive both margin expansion and firm enterprise value.
In the third and final part of our series, we will explore the elements of a successful MFO in the context of business economics and pricing, the latter one of the most challenging and complex topics facing not only MFOs, but all wealth management firms today. We will explore the great tension between serving the economics of the firm while delivering the elements of a successful client experience highlighting four key factors necessary to obtain success in both of these areas.