This year, for SFOs Europe-wide, it's a question of risk management and cash alternatives, says Merrill Lynch's Mark Nixon in this exclusive interview with Bruce Love.
The second annual European Single Family Office Report, 'Conserving Family Wealth: Family Offices Adapting to a New Age', hints at some paradigm shifts in the single family office (SFO) market. When the research was conducted in Q3/Q4 of 2008, the effects of the credit crunch and the resulting financial meltdown were apparent, but it wasn't until earlier this year that perhaps many single family offices realised the full extent of the challenges they would be facing. It is for this reason that Merrill Lynch's Mark Nixon thinks 2009 will be a year of retrospect and harsh self analysis for many SFOs.
"Even if you believed your risk management processes held up in 2008, you will be asking yourself whether they are sufficient for the new world we are living in."
"In 2008 the culture of protection replaced the culture of growth," says Nixon, who heads up Merrill Lynch's Family Office Group in EMEA. "The credit crunch sparked a sharp downturn in shares and a contraction in credit markets. SFOs responded to this with a flight to cash. But it is also clear that in 2009 they intend to adopt defensive strategies to weather the storm.''
"SFOs moved away from equities and fixed income to cash and other assets perceived to be safe havens in turbulent times," he says. "This defensive emphasis is hardly surprising given the assumption that many family offices are likely to have sustained even more punishing losses than the average high net worth investor due to their higher exposure to illiquid investments, such as hedge funds and private equity deals. In terms of asset allocation, I predict that in future there will be an increased emphasis on the need for better due diligence within asset allocation."
Nixon points out that whilst many SFOs moved their assets to cash, this is not a sustainable position over the long term. He believes this year family offices will need to look for alternatives to cash, otherwise the families they serve will start wondering what value the office is adding to their wealth.
"For family offices, cash will be a difficult position to sustain over the medium to long term," he says. "With extremely low returns and little management required, families will look more critically at their family offices."
"In terms of asset classes, there will be bigger changes ahead. I think we'll see the fixed income allocation rise. Many SFOs haven't taken reduced liquidity into account when planning for the future. A big challenge for all family offices will be reinvesting the cash they now hold. They will want asset classes that are safe but also offer higher returns than simple cash deposits."
One area that Nixon believes may be of interest to more SFOs will be exchange traded funds (ETFs) and structured products: "ETFs definitely have a role to play in current markets and the five per cent figure in the survey seems very low." He says Education will be the catalyst that increases the allocation family offices make to structured products and ETFs."
"Liquidity will remain extremely important," says Nixon. "The bond number has to go up. The percentage of bonds (10.1% now and predicted to be 9.5% in three years) will be higher than the survey respondents predict. The survey was conducted too early to catch all the changes, but SFOs will readjust their forecasts and targets over the coming 12 months."
But Nixon believes that even more profound, structural changes may be on the cards for many SFOs.
"Families will be asking some serious questions of their family offices," he says. "There is likely to be a period of deep introspection and accountability ahead."
In particular, he points to the role of risk management, which he believes will be one area of sharp reassessment in 2009. Surprisingly, most SFOs have not yet made any significant changes to their risk management systems after last year's events, although many say they are planning to. For the majority, risk management is still just part of one person's role, while 74 per cent of those surveyed said the way they handle risk has not changed.
"Even if you believed your risk management processes held up in 2008, you will be asking yourself whether they are sufficient for the new world we are living in," says Nixon.
"There has been a sea change in attitudes as a result of the credit crunch and subsequent market turmoil in 2008," he says.
"Changes on the risk management front are on the cards soon. A number of SFOs are almost complacent over their risk management systems; some still running them off Excel spreadsheets. This will have to change. Families will demand it eventually."
"The survey highlights that market turbulence has reinforced the view within SFOs that families are best served by organisations devoted to the family's own interests," concludes Nixon. "But this independence will need to be defended. Primary strategies for 2009 and early 2010 will include recruiting and retaining high quality talent, refining investment management, improving governance, reassessing relationships with service providers and upgrading risk management procedures."