The European regulatory environment is fast changing
Historically, family offices tended to fall outside of the scrutiny of the regulator if they did not manage third party money. However, family offices, particularly in Europe, are increasingly coming onto the radar of the regulator. There are a multitude of reasons for this, which can include whether they participate in co-investments, if their clients are politically exposed persons or active in sensitive industries or countries, or where the source of wealth may be difficult to articulate.
It is important to consider whether a family office providing advice to family members is subject to regulatory review, and if so, to ensure that their employees have the correct qualifications. Family offices are now considering their responses to MiFID II, anti-money laundering directives, the Alternative Investment Fund Managers Directive and even data protection legislation. What family offices can be certain of is the increase in costs. Both large and small enterprises will have to decide where to focus their core activities and if necessary, which activities to delegate to third parties in order to manage their risk position.\*
Securing objective advice is key
So, if costs are rising, what are the options to delegate the investment advisory process to external wealth managers? The challenge of delegation is, among other factors, finding an external partner that is objective in selecting investments, agnostic on the choice of any particular manager, asset class, industry sector or geography. While some wealth managers achieve objectivity, many are tied to internal investment solutions or products and have internal sales targets. Reviewing a number of external partners to fulfil this objective delegated advisory role can pay dividends in the long run.
How are my investment managers performing and what are the charges?
If you delegate the investment advisory process externally, that adviser should be equipped to understand the underlying performance of the investment managers and quantifying total expense ratios. Some help is at hand in the form of the imminent MiFID II legislation, which requires a far higher degree of transparency on fees and clear articulation of performance. Nonetheless, the external adviser should conduct a thorough and regular review of the investment managers’ performance, including an assessment of how they generate their returns for every unit of risk taken. It is an important discipline to monitor managers against the mandates they have been given and whether they are meeting their investment objectives.
I need insight and transparency from my reporting
Understandably, family offices diversify across a number of external managers, and can potentially have numerous holdings in private debt and equity investments, as well as non-bankable assets. All of these use varying degrees of leverage. This can lead to the fragmentation of wealth across several custody platforms and reporting systems, which can be difficult to combine and present in one coherent report. In-house investment in bespoke reporting systems create costs that need to be justifiable relative to the assets under management. An alternative is to outsource these systems externally using state of the art consolidated valuation systems, which allow insight and transparency on a ‘whole of wealth’ basis.
The next generation needs education
While the beneficial owner of a family office may be financially literate, they may have children who pursue alternative careers with limited training in financial markets. Investing in financial awareness courses to prepare the younger generation for inheriting significant wealth is an important component to continuing to protect the family’s legacy. In my experience there is, among the next generation, increasing interest in the ethical governance of the portfolio as much as the performance. Therefore, family offices may need to evolve their stewardship to ensure their own commercial operations are matching ethical criteria and are sustainable.
Where do we go from here?
Faced with these challenges, family offices need a clear idea on where to focus their operations and where is most efficient to outsource if necessary. It is essential to have clearly articulated investment guidelines and robust reporting systems to confirm managers and their portfolios are delivering the investment objectives. In my opinion, investing in education and sustainable businesses will help the family to meets its long-term goals and manage the considerable societal responsibilities associated with significant wealth.
The above is commentary from an experienced practitioner where he expresses his personal views based on his own experience.
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