Long-term success for Single Family Offices

Over the past month, we have looked at a number of pitfalls that Single-Family Offices (SFOs) need to avoid. First, we looked at the mistake of prioritizing individuals over objectives and neglecting to create a mission statement. Then it was the turn of the chief executive and the mistakes that SFO should do their best to avoid. Over the past fortnight, we have looked at the nuts and bolts of IT security and overlapping responsibilities between the Chief Investment Officer (CIO) and the investment committee as well as why shortcuts rarely work. 

In the fifth article in this series, we are looking at why an operation memorandum matters and what Single Family Offices get wrong about asset allocation. 

Misstep #9: Lack of Operating Memorandum

A common oversight in the family office sector is the lack of an operating memorandum. While some offices may possess fragments of such a document, a comprehensive version that consolidates all activities, stakeholders, and processes is often missing. This absence represents a significant gap, as the operating memorandum is an indispensable tool for any single-family office.

The operating memorandum serves several crucial functions:

1. Family Guidance: It provides a clear explanation to family members about the family office’s purpose and mission, as well as the roles and responsibilities within it.

2. Employee Onboarding and Training: The document serves as a manual for both current and new employees, elucidating the office’s operational procedures and collaborative networks.

3. CEO’s Operational Review: It aids the chief executive in the regular assessment of processes and stakeholder relationships within the family office.

4. Risk Mitigation: The memorandum helps to alleviate the risks associated with overreliance on key individuals by documenting essential processes and procedures, thereby preparing the office for potential disruptions or transitions. 

The Family Office Operational Excellence Report 2024 from Campden Wealth and AlTi Tiedemann Global found that 75% of family offices surveyed have at least one form of documentation. Most commonly, this is a mission statement (62%) or strategic investment framework (60%). These two documents are viewed as the minimum for a sustainable family office. The investment framework is very often supplemented by risk management guidelines (37%) and 44% of family offices have an operational handbook. But less than a quarter have a family constitution.

As the Chief Investment Officer of a midsize Single Family Office in Panama said: "Anything the family office can do to promote communication between family members and keep them aligned is, by my definition, value-added. Creating a family constitution, or family council, and supporting the next generation is critically important." 

Ideally, the operating memorandum should undergo an annual review and update. When well-crafted and maintained, it can become a transformative asset for any family office.

Generally, many Single Family Offices suffer from a lack of documented policies and procedures. The absence of an operating memorandum is a significant oversight that directly addresses this issue in a centralized manner. This document not only clarifies roles and responsibilities for family members and staff but also equips the chief executive with a tool for ongoing assessment and improvement. By tackling this misstep and instituting a comprehensive operating memorandum, family offices can significantly enhance their operational efficiency and overall effectiveness.

Misstep #10: Neglecting a Holistic Wealth Perspective in Strategic Asset Allocation 

The asset management industry stands as one of the most competitive sectors globally, with only a select few achieving consistent success over time. Dominated by sovereign funds, pension funds and central banks, individual investors and family offices often find themselves somewhat on the periphery.

In our workshops, we often pose a fundamental question: “Where do you believe performance comes from?” The industry consensus, based on seminal studies, suggests that 75-90% of the variability in a portfolio’s returns can be attributed to strategic asset allocation, while factors like stock selection and market timing contribute to the remaining 10-25% of the variability. 

This leads to a pivotal question: Where should a family office focus its resources?

Investment committees often get entangled in the allure of individual stock stories, or alternative investments fables, frequently peddled by private banks. These narratives may constitute only a small fraction of the portfolio but tend to consume a disproportionate amount of discussion time. While stock selection has its place, the process of determining a family’s strategic asset allocation is often less robust. Risk tolerance questionnaires are commonly employed, but they seldom capture the full complexity of a family’s financial situation.

Many family offices fail to consider the family’s entire wealth spectrum, which often includes not only the family business but also real estate, art, and collectables. This oversight leads to a dislocated approach. While some aspects, such as cash flow and currency considerations, may be well-managed, other crucial factors like interest rate sensitivity and geographical diversification are frequently overlooked. For example, if a family business is burdened with debt and sensitive to interest rate changes, the bond allocation in the strategic asset allocation should be adjusted accordingly.

Family wealth is often a complex blend of various asset classes, each with its unique characteristics and trade-offs. For example, family businesses are not only long-term revenue generators but also sources of pride, family unity, and social capital. However, they are often illiquid, requiring considerable time to sell.

In the investment portfolio, traditional assets like stocks and bonds offer unique advantages in terms of liquidity and divisibility. They can mould to complement other asset classes, such as real estate or collectables, providing essential diversification. Moreover, this adaptation can be achieved quickly.

Much like a master chef carefully selects and blends ingredients, each contributing its unique flavour but reaching culinary excellence only when combined in the right quantities and at the right time, so too does the art of asset allocation lie in finding the right balance among various asset classes. Given these diverse asset characteristics, family offices must adopt a holistic approach to strategic asset allocation. This involves tailoring the investment portfolio to complement the family’s financial ecosystem, thereby maximizing overall wealth. Adopting such a comprehensive approach is not merely best practice; it’s essential for the family’s long-term financial success.