At first it was disbelief, then it was horror. Next came resignation, followed in short order by a healthy period of assessment. Now it's time for action. In the wake of the financial meltdown and ensuing mayhem - the Madoff fraud, negligence by counterparties in performing proper due diligence, exposure of gaping holes in the regulatory system and the collapse in the value of assets, family offices around the world have taken a long and forensic look at their business model and are mobilising to combat the crisis. They are using the current climate as an opportunity to slash costs in every form – fees and charges for financial and other services, levels of staffing, leisure assets from yachts to cars and concierge.
Some families are turning away from private banks to like-minded wealth managers. Tosetti Value, a Turin-based multifamily office focusing exclusively on financial management, has reported a sudden increase in business, with funds under management jumping by 25% to €3 billion.
"Six new family clients have joined us since the start of the year," says Marco Toledo, partner and chief operating officer. "They need help and advice in a tough period. Many did not understand the conflicts of interest that private banks have. The crisis has been good for us." But that's Italy where investment strategies are generally lower-risk. As Toledo adds: "The Anglo-Saxon way of approaching markets is much more aggressive." In concrete terms, that means more assets pumped into equities with a consequently higher volatility in the hope of the much-vaunted "alpha" returns. In the US, where many families got burned in higher-risk strategies than those prevailing in Italy and wider Europe, there was a collective bout of "decision paralysis", remembers Leslie C Voth, president and chief operating officer at Philadelphia-based multifamily office Pitcairn.
"Approximately half of the family office client prospects with whom our firm met during 2008 responded to the market angst by postponing strategic decisions," she explains. "That trend is now beginning to reverse. Over the past six months, as the markets have begun to settle somewhat, we are experiencing a steady increase in the number of conversations with trusted advisors and prospective families seeking change." There was a good reason why offices sat on their hands after Black October 2008 –the markets were scarily unstable. But now US-based offices in particular are reacting aggressively, especially those with assets of $100 million or less or those that are burdened with numerous family members. Some are said to be closing down altogether, selling the furniture, letting out the premises and laying off staff in an abrupt return to a relatively frugal, wholly out-sourced lifestyle.
"In 2008, many family offices made a conscious decision not to do anything because the markets were so hostile," explains US-based family office consultant Kathryn McCarthy. "This year there's been a big increase in activity. Most offices are looking at costs and even whether the whole operation is viable in its current form. Some are in a position of dissolution while others are putting more and more of their services outside. Others are bring everything back inside."
For most, the biggest headache is what to do with the investment services that let offices down so badly. Many offices are justifiably aggrieved at the failure of highly-remunerated fund managers to do the most basic of due diligence. "In the light of what happened, they have difficulty in trusting some of the parties," explains Daniel Goldstein, chief executive of Luxembourg-based Dumbarton Associates, specialising in investment and philanthropy for private families. (Several of the offices Campden FO spoke with had rejected approaches from feeder funds acting for the Madoff group of companies.)Do offices completely shut down in-house fund managers or do they boost them with extra resources so they are in a better position to provide the kind of fine-tuned, highly customised advice that family-owned wealth generally requires? Most are still mulling over what to do but in the meantime they are taking a much more sceptical, and probably long overdue, view of their counterparties.
"Offices are putting double and triple measures in place in auditing and verification of reports," says Goldstein. "They're looking at custody, brokerage, legal, accounting and transactional costs. And they're driving a much harder bargain."
It's an ill wind that doesn't blow some good. As Constantin Salameh, chief executive of a Middle East-based family office, reasons, "now is the time to make sure that you are getting the best value for the services that you are in-sourcing or outsourcing and review the selection process, as well as the terms and conditions of your partnerships on a regular basis."
Dirk Jungé, chairman and chief executive of Pitcairn, believes this process should be a virtually endless exercise anyway. "True due diligence is a disciplined, ongoing process of evaluating areas of opportunity and risk," he explains. "It [should] get behind the well-crafted sales pitch and expensive suits."
Tosetti Value echoes that advice. In its fixed-interest department, "the core of our clients' portfolios", explains Toledo, a team of staff constantly conducts due diligence on the issuers, whether sovereign or corporate, and then buys them directly, which is cheaper than through brokers.
Because of the fall-out from the investment community's unbridled appetite for risk, wealth preservation has become the name of the game as offices return to the principles of long-term stewardship and demand much more stability in the investment strategy. Having handed over too much responsibility to fund managers, whether internal or external, they are adopting a distinctly risk-averse attitude.
This amounts to a gravitational shift as the balance of power swings back in favour of the buy side, namely, family offices. High-priced contracts are being torn up and rewritten and professional advisors have no option but to accept much lower remuneration. "Where once advisers asked for and got exorbitant fees, now they're happy to accept any fee to get the business," confirms Goldstein.
This pandemic of economising has been triggered by a sharp fall in wealth – estimated at around 30% on average for most families, but also by a matching decline in revenue from all kinds of assets including commercial real estate. Families in Europe and North America have taken a deep breath and rewritten contracts at much lower rentals than those prevailing before the downturn.
However, as the dust settles, the more sanguine offices see the events of the last two years as something of a blessing in disguise, an opportunity to scrutinise their entire portfolio of services across the delivery chain. As National Holdings' Salameh recommends: "[We should] focus on the services that build on core competencies and outsource the others who can offer a better value proposition. It's a necessary exercise and the meltdown was the ideal catalyst to make it happen."
Pitcairn's Voth could not agree more. After all, the firm has the wisdom of experience. A family office for five generations, it converted itself 20 years ago into a multifamily office and adviser. "The recession helped along a process of strategic reassessment. Some family offices just weren't working properly anyway and others were financially stretched even before the markets deteriorated," she explains. "The successful family offices are run like businesses and, if you think of the size of the challenge we've experienced, a business would do exactly the same thing. They would look at their vision, strategy, redefinition of roles, internal controls, everything to do with the business."
Surprisingly, the downturn could have the unexpected benefit of improving the health and fitness of families. According to Natasha Pearl, founder and president of Aston Pearl, a New York-based advisory firm for wealthy families, they are concentrating as never before on wellness in a bid to reduce stress and, perhaps, in a renewed appreciation of the essential quality of life.
The meltdown has also got the younger generation much more involved than before. "There's a generational transformation going on. It was happening anyway and the downturn has accelerated it," notes Voth. "They want to know more about what's happening. It's a question of strategy over the next five to 10 years. How will the next generation work with that office?" Inevitably, tensions have deepened as the generations differ about the way forward, particularly as the long-serving, broadly conservative strategy of investment diversification proved hopelessly inadequate in the meltdown. Not a little blame has been parcelled out as family members feud over what went wrong. "Like any family, single family offices are not unitary organisations," observes Goldstein drily. "They like to disagree, it's healthy, and I wouldn't have it any other way."
As for concierge services, contrary to general belief, they are not necessarily facing the axe. They are however undergoing the same sort of hard-headed analysis as the rest of the family office business. "There's a general streamlining process, especially on costs," explains Goldstein, citing travel including hotels, cars, yachts and even art. "Some of these are real savings, others might be symbolic gestures intended to let other family members know that a proper sense of responsibility is being applied." Unlikely to be sacrificed are the more personal services such as medical and healthcare.
According to Pearl, this is another area where rationalisation is long overdue. Take domestic services; families with several housekeepers (at starting wages of $50,000) are cutting back to one or two and taking other opportunities to trim the household payroll. "They are using this as a chance to drop the non-performers," she says.
But don't rush into wholesale rationalisation, she warns. For Pearl, who has worked with over 50 families since launching the business six years ago, "the optimal solution seems to be a hybrid where there is a manager/coordinator who fields requests from family members." This human hub – "a crackerjack personal assistant", as Voth describes it – should be able to parcel out requests to appropriate consultants and manage the project.
Although it's possible to outsource this kind of role, it's generally best handled in-house because families need somebody in the middle, directing the traffic as it were. Similarly, in the management of aircraft, vehicles or boats, families will generally need their own fleet manager, even when outside managers with more specific expertise are engaged. Having said that, the outsourcing trend in concierge is gathering steam during this period of wholesale re-examination. A contributing factor is that families who may previously have got investment professionals to combine their wealth-creating skills with concierge duties are no longer doing so because they don't want them being distracted from the main game. (That's one reason why offices such as Tosetti Value have never done anything other than provide financial advice.) But generally, explains Pearl, "there's a growing understanding of the high cost of error on the lifestyle side and that a high level of expertise is required. This is leading families towards an outsourced solution." And yet again, some family members see the downturn as their own opportunity to get rid of services that are over-used by one particular branch of the clan. Once the services are outsourced, the costs can be individually attributed instead of being borne by the family as a whole. Essentially an accounting measure, it's long been a nagging source of resentment for those family members who don't overburden the system. Nor should families rush into hasty decisions about long-term investment strategy. It's important, suggests Salameh, that "families spend more time in identifying and selecting the most appropriate asset managers with the objective of building a strong partnership based on similar values and performance-based compensation."
Taken together, family offices are in a period of flux, even turmoil, and that in itself requires careful management lest the solutions turn out to be worse than the problems. For Pitcairn's Voth, this kind of forensic analysis should start with the change agent, in management-speak. "Who will co-ordinate the change? You need somebody to step up to the challenge and run it", she says.
Herein lies a problem for many family offices. For long-serving senior staff, this is proving a difficult, even agonising process, especially as they could end up recommending their own redundancy after years of service. This raises the possibility that the entire transformational process could stall before it's really got going. "The head of family offices just may not be as interested in engineering change," explains Voth,
While many offices grapple with the challenges of downsizing, some of the bigger families are running against the trend by turning their backs on outsourcing and boosting their in-house infrastructure by recruiting more, higher-qualified wealth-creation specialists. "They're thinking more tactically and actively, perhaps trading more than they did and relying less on passive investment. Above all, they want to know what's happening," adds Kathryn McCarthy.
But it's a big decision and it shouldn't be rushed, argues Salameh: "The tendency to centralise and increase the control over investment services is a natural reaction in a situation of crisis, irrespective of the size of the family offices. When the dust settles, family offices will redefine the balance between in-sourced and outsourced services based on dimensions such as their unique value proposition, core competencies and governance framework."
The rule of thumb is to focus on the services where an office has a proven track record and outsource the rest. Clearly, the size of the office's assets is a determining factor in this kind of exercise. Or, as McCarthy observes succinctly, "it's a very different situation if one family has $100 million and another $1 billion plus". In the meantime it looks very much as though the major beneficiaries of this orgy of rationalisation will be multifamily offices with their bespoke skills and experience. As Pitcairn's Jungé says, a lot of trust has been lost and the multifamily office could end up as the peace-broker between the offending and aggrieved parties. "It is incumbent on the MFO industry today to provide a bridge of trust to meet the very specific requirements of its client families," he says. And those requirements are not, in the view of Tosetti Value's Toledo, the same as the average investor. "Our clients are already rich people," he says. "They don't need to take much equity risk, especially those who still own companies because they have a lot of equity in them. They don't come to us to make the investment of their lives, they need their wealth to be protected."
The Turin firm's fees reflect this conviction. Its maximum fee is 0.2 % of overall assets and it does not charge performance fees, which are of course based on the kind of high performance that Tosetti Value considers hostile to considerable, accumulated wealth. "It means we are free of any kind of bias towards risk," explains Toledo.
Finally, are we looking at a turning point in family offices, especially single family ones, in a general flight to safety? Dumbarton Association's Goldstein, for one, doesn't think so. "It's not a revolution," he says. "It's just a wake-up call. Everybody needs to regain their commonsense."