Operating businesses are often the lifeblood of family offices and most offices can trace their wealth back to a successful enterprise. So one lesser-lauded finding from the Global Family Office Report 2015 that caught my attention was the number of family offices that still had an interest in an operating business.
Globally it was 70%, and in Asia-Pacific, three quarters of offices had an interest in a family business. Typically these offices have just over half their wealth still tied into the operating business. The continuing importance of operating businesses wasn’t among this year’s star findings, but the consequences for family offices are worth exploring. How does this symbiotic relationship affect the nature of family offices? And what differences are there in having an operating business, to those without one?
One thing that doesn’t change is the purpose of the family office. Intergenerational wealth management remains the primary motivation, followed by the consolidation of accounting, tax and estate affairs. However having an operating business does mean lower costs and significantly different portfolios.
Firstly, costs. The logic goes that if the family office has an operating business, it can use the resources (often staff) that already exist or leverage this to achieve better efficiencies and scale benefits. This would seem to be the case. Excluding external manager fees, family offices with an operating business are up to eight basis points cheaper, a swing from 87 to 79 basis points (bps), than those without.
Portfolios too feel the effects. Family offices with operating businesses invest six percentage points more into private equity and two percentage points more into real estate direct investment than those without. Family offices with no operating business put more into developed-market equities and hedge funds. The distinction is logical, family offices with operating businesses may have more experience in private equity activity, conducting M&A activities and knowing how other businesses operate. Understandably, these distinctions in portfolios make an impact on costs, with external manager performance fees being higher for family offices without an operating business (expected to be 23 bps in 2015, compared with 18 bps for offices with an operating business). Investing in hedge funds and developed-market equities relative to private equity and real estate means that these family offices are more likely to outsource a larger proportion of their portfolio management.
It’s worth noting too that for some family offices, the distinction between the family office and the operating business can be slim, particularly in emerging markets where the family business will often provide the services that family offices normally offer.
In Asia-Pacific I spoke to one family member who said: “In the US or Europe, most family offices already have the chief investment officer or somebody to look purely at the family office investments.
In Asia, the staff member is often the same person also running the business. This staff member would not be spending all their time with the investments, so to him or her [the family office investments] may be seen as a side project that they don’t look at much.”
The benefits of this close tie between family office and operating business include everyone understanding the culture and ideals of the family. But it could also put a brake on ideas or ingenuity within the family office, limit the time spent by beneficiaries, and offices may not always be aware of best practice. Better understanding the impact of this symbiotic relationship between business and office can benefit both.