As some of the earliest examples of family office reach maturity the question of sustainability is coming increasingly to the fore. The likes of the Fleming family, in the UK, and the Rockefeller family, in the US, have already seen their single family offices morph into commercial offerings. Internal factors, like a growing family, and external factors, such as compliance, all represent pressure points for family offices; but when you boil it all down, everything comes back to costs. The recent market turmoil has only sharpened families’ focus on expenditure, according to industry sources.
For the average family office surveyed in the Global Family Office Report 2015 ($806 million AUM), costs rose from 92 basis points (bps) in 2014 to 99 bps in 2015 — this equated to an actual cost increase of 14%. Legal and tax services typically cost $1.5 million annually for the average family office, with financial and tax planning being the costliest service requirements. External manager performance fees accounted for 19bps. The report also flagged up the significant year-on-year rise in administrative costs from 15 to 24bps (see chart page 22). This meant the average family office profiled in the survey saw this expense climb to $1.85 million.
Campden Wealth’s director of research, Stuart Rutherford, says the prime influencer of costs seems to be the desire to either restructure or take on new staff. A quarter of family offices said that in some way their location, number of branches, or size (number of employees) changed in 2014. It’s not possible to split staff or technology costs out separately within the 2015 research, but Rutherford says costs are an area of special focus for the 2016 report.
These cost increases are not just due to families growing in size and complexity, but also the increased demands made on family offices by regulation and compliance plus the family demand to have consolidated and 24/7 reporting. Family offices are taking a serious look at what they can and can’t provide in-house and either taking on staff internally or appointing external advisers.
“Our key philosophy is to do as much as we can in-house. Accordingly, our major cost is staffing and finding the right people,” says Simon Foster, CFO at TY Danjuma Family Office.
Interviews conducted for the Global Family Office Report 2015, whose respondents wished to remain anonymous, echoed this. A US single family office commented that it had brought in a chief investment officer to enhance its ability to manage investments for both return and tax efficiency. And an Asian single family office said that it had brought in more independent directors to manage the family’s increased wealth. It had also outsourced more investment management than previously.
The cost of insourcing specialists is clearly something that family offices feel is worthwhile. Hiring specialist advisers in-house was a trend identified by the report and is expected to increase costs by 1 basis point. Foster says: “Since 2008 the cost of hiring staff has been reasonable – but the market has been depressed so we don’t know what the future will hold. We have sought to have stable staffing levels and to hire people who are specialists to deal with a specific area, as opposed to generalists.”
Bob Goldbaum, vice president for product and market strategy at Backstop Solutions, comments: “Staff costs are on the up as family offices realise that to remain compliant and to be able to cross check everything they need specialist people. In a regulatory context this means having a chief investment officer or, at the least, a couple of analysts who can gather and check data. It’s about having that second set of eyes to know what is going on.”
While family offices have historically operated largely under the radar of regulators, in the post global financial landscape wide-ranging regulations are changing the way family offices must operate in order to be compliant. In particular, the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard are the topics du jour for private client lawyers and advisers, having already started to come into force [see our story on page 16].
If costs from insourcing are on the rise, can they be offset by outsourcing non-core or commoditised activities in areas where the family office can benefit from an external economy of scale?
Outsourcing commoditised services has previously been a challenge. James Holder, head of family office EMEA for Citi Private Bank, explains: “Because every family office is different, it is hard for an outsourced provider to provide something that is bespoke for each and every family. This is very true when it comes to consolidated reporting, for example, a huge area that can take up to 65% of family office resource. It is highly bespoke, high touch and high service and therefore hard to completely outsource”
Foster comments: “The family office is a business just like any other – we need the right tools to do the job and to know what our core competencies are as well to know where it makes no sense to try and do something in-house.”
As Linda Mack, president of Mack International, comments: “Execution and custody are both areas that can be subjected to cost control via an outsourced economy of scale. Effectively the family office is outsourcing a non-core area and benefits from lower costs and operational efficiencies afforded by using the systems and processes of a specialist counterparty.”
She thinks that outsourcing makes sense when a family office has many members to serve. “Technology can be a real enabler in this sense, allowing resources to be freed up in-house. Just from an investment portfolio viewpoint, an increasing number of beneficiaries means that reporting becomes more complicated. Due diligence and compliance is also impacted as the varying investment and risk profiles of family members need consideration. Finally there are varying reporting preferences to think about.”
Holder comments: “Execution is now done electronically and there are various platforms available to family offices to either do their own execution or collaborate with a third party. This means that margins are lower and there have been huge cost savings in this area.”
Lower execution costs make sense in a world where returns are hard to get. Net returns are under pressure with governments looking to up their tax take combined with the cost of compliance. Alexandra Altinger, chief executive of Sandaire Investment Office, comments: “Governments across the world have been under pressure to collect more tax revenues whether on domestic or overseas income of wealthy families and this has therefore made it ever more important and challenging for those of us managing their investments. The challenges for multi family investment offices have multiplied over the last 20 years requiring greater depth in expertise across asset classes and the employment of a series of sophisticated strategies suited to changing economic cycles. Economies of scale with very wealthy families have enabled us in the industry to bring down fees as much as possible and this, coupled with holding transaction fees to a minimum, can do a lot to help.”
Lying in between that front and back office is the middle office which ranges from overseeing risk management to investment performance management. This is an area where neither outsourcing, nor insourcing is the answer.
Imad Warde, chief executive at HedgeGuard explains: “The middle office has been neglected for so many years and seen just as a cost centre. But the demands of risk management and reporting, both to an end-client and to the regulator, are such that family offices now need processes and data that are accurate and timely.”
He says that technology is the key to this and though an initial upfront investment is required, “having the right system, process, and partners yield clear operational efficiencies and related uplift in front-end service provision.” He thinks that costs could be reduced by half and savings of up to 50 bps are to be made by improving this area – a saving of more than $4 million for the average family office in the Global Family Office Report 2015.
“To comply and prosper operational, excellence is a requirement,” he says. “Family offices need to see this as a positive investment that is not just to be compliant but also to significantly enhance their own operational processes and efficiency.”
Altinger agrees that technology is key to operational efficiency and associated cost savings: “Technology is a key cost. Family offices need something tangible that transcends their investment process, client relations, reporting, and all operational activities. This has seen huge investment in the past few years. However, because the multi family office world is so bespoke to individual families, it can be hard to find technology or software that is a good fit and able to be tweaked and added to. Technology which is well chosen and well used can be a real cost saving as well as a valuable tool in the investment management process.”
The advent of the cloud could potentially solve this problem in the middle office. By attaching a cloud-based service to a family office’s front-end system, a SAAS (software as a service) package takes the pain of installation and service out of the hands of the family office. The office and the service provider are using the same database and data, remotely held in the cloud, allowing for accuracy and efficiency. New technology suppliers, including Way2B1, may help standardise many of the operations required of family offices.
Virtual vaults are another idea to consider. Holder comments: “The ability to hold digital vaults that all relevant people can access can save a huge amount of time when it comes to due diligence and compliance related matters. But it is a large investment with a payback time of about five years.”
However even though many functions can be fully or partly outsourced, retaining some sort of overview functionality in-house is important. This was reflected by the Global Family Office Report 2015. It quoted a multi family office in Asia had incorporated risk management and internal controls technology and processes to monitor investments and fund management.
Goldbaum comments: “A common mistake to make is to totally rely on outsourcing or service providers. Reporting can never be totally outsourced and the responsibility for it lies with the family office itself, not the service provider. Some form of internal check is a must and this means having the right software and people in place to be able to do that.”
Mack adds that an additional advantage of retaining in-house capability is to be able to slice and dice data in a way that each family member wants. There are always parts of every function that it makes more sense to retain in-house. The key is knowing which they are and aren’t,” she says.
Paying for the right people and technology to remain operative and service the family is a necessary cost for family offices, and one that seems to be rising. But being able to see the bigger picture and know that efficiencies and cost savings are a possibility in certain areas is a plus. The key is matching the cultural desires of the office to what is actually possible.
Goldbaum comments: “The role for technology and the value of counterparties as an efficiency and cost-saving play will only increase as the next generation becomes involved in the running of a family office. They are both more technologically savvy, involved, and more open to change.”
Warde agrees: “Cultural acceptance of the gains to be made by engaging with third parties and investing in technology is slow to arrive. But it will eventually gain traction as the need for operational excellence and cost efficiencies eventually reach a tipping point.”