The smoke is starting to clear from the ashes of many private wealth management plans. At Campden's recent Family Investment Workshop in Geneva, Switzerland, family offices said they had lost, on the average, between 17% and 30% of their assets. Some had lost less, others had lost far, far more.
However, what is emerging is a different world of investment and opportunity for family offices and family office owners. In essence, family offices are no longer relying on the traditional financial investment model; instead, they are developing a more strategic and active focus for the future.
The strategic management of investments occurs when the owner or their team know the industry and the business underlying the investment, understand the asset that is being acquired, identify and manage the risk that exists and actively participate in the investment process with total open-book transparency. It goes to the very definition and calculation of risk and return. It is important not to confuse these terms with financial and strategic partners in private equity investment, although there are similarities.
Critically, family offices are now finding the expertise they need in the form of other family businesses. What develops is a consortium of family expertise investing in the way families prefer to invest, using their own standards and protecting their own interests as investors. This has significant and far-reaching implications for fund and private wealth managers.
Low returns not always low risk
In the past, the investment process for private wealth was behind closed doors and used a black box approach. The owners took a passive, or detached role in the details of investment, trusting that, for significant fees paid, their professionals in banks, funds or management companies were working for them and looking out for their interests. However, the large private wealth and fund managers forgot rule number one; do not lose the client's money.
They intended to avoid risk by investing in funds, or funds of funds, where informed people would make informed decisions and also follow rule number one. Despite having the best of intentions, it didn't work.
The commonly accepted view of the financial investment model is that safe investments (those without risk) yield low returns. Yet, to the strategic investor, that is a dangerous assumption. Returns of 3% per year may sound low and safe. However, the yield is totally wiped out in the long-term by inflation and black swan events, which happen much more frequently than one cares to admit.
Investing in such opportunities actually loses a significant percentage amount of one's investment over time. For family offices, who think in generations, that is an anathema to their investment strategy. A safe investment in the financial world is inherently unsafe. Put another way, in the recent downturn you may have lost 10 years worth of investing in those "safe" investments.
The same goes with major standards used as a benchmark in the investment world. The MSCI index is a benchmark to measure stock market investment performance, and the same is true with the Dow Jones Industrial Average. They are both great benchmarks of performance, however, take a step back, look at the performance of the Dow with a standard other than dollars, and you find that the highest high in 2007 just got back to break-even from years before. In a world of global capital flow and strategic investment management that is the kind of standard that is far more relevant and far more important.
Post Madoff, family office owners and managers are now talking a different language to their counterparties. Strategic investment is a dynamic activity where there is a fundamental understanding of the business behind the investment. Questions no longer surround how many funds you have managed and their track record. The question is: what do you know about the underlying industry where you would like to place the investment? If things go wrong, what can you do? When talking about track records, the metrics of success are based not on one's success in the money industry, but on success in the industry where the money is going.
With a strategic investment opportunity, you need to know about the asset for investment. Why is it unique and how does it create opportunity that the fund or private wealth manager anticipates? What are the risks and how do we manage them? Note it is not about avoiding risks but learning how to deal with them. This is the "things gone wrong" test.
Many family offices are also tracking their cash to the asset – they want to see where the money flows and touch the asset. As they do so, family offices are now also looking very closely at what percentage actually makes it to the asset – "Money down the hole," to use a phrase from the oil industry. It can be amazing how much gets lost along the way.
Further, once invested, what is the real net gain? Funds tout big numbers, but they are always the gross number. Transparency to many funds, banks, wealth advisors and the financial community is limited to a disclosure in the prospectus. That does not work with the new strategic reality.
New investment standards
Change is coming to the wealth management industry from outside forces, driven by family offices and their owners. In fact, a movement is on the way to create an independent standard for investment and performance analysis.
Similar to standards such as ISO, QS 9000 and quality standards from the manufacturing world, these standards will help family offices with their own analysis of investment products and investor related services.
They will provide enormous help to owners in asking the right questions and focusing counterparties on the right issues to be ready with an answer in the future. Meetings with counterparties will change from a few basic questions to a real analysis of their "metrics."
The new "metrics" will replace the outdated performance standards and permit quantitative transparent indicators that meet family office industry investment standards. The black box is a thing of the past and the financial community will be better for it.
Global capital will continue to flow and investments will continue to be made, but with a new transparent, strategic model, a clearer understanding of the investments and better returns for the investor in the long term. Out of the ashes of past plans, comes an exciting, clearer and better solution for family offices and private wealth management in the future.