Capital trends for the ultra-wealthy
By Harold Pine
Increasingly, the ultra-wealthy – those with a net worth of $30 million or more – are taking a closer look at how they handle their financial affairs due to the low returns and high fluctuations experienced in 2000-2002, 2008-2009, 2011 and now early 2016.
Have you noticed that you have not gained much ground in the last 15 years? Why is this? The main reason is that valuations have been mostly elevated since late 1998, with the exception of 2002 and 2009. Interest rates have declined steadily since then, giving a boost to your fixed income portfolio. But how much lower can they go?
With valuations still elevated in some areas, the prognosis for returns is less than promising in the public space. Private equity and debt do not appear to offer much more opportunity as the flood of liquidity has worked its way here, and valuations are also elevated in selective areas.
Unveiling hidden costs
After a long period of low returns and occasional high volatility, the wealthy are now focusing on their costs. Unveiling hidden costs through transparency has become paramount.
There are significant expenses associated with investing, including management fees, commissions, taxes and sub-manager fees, as well as performance fees in some instances. This is drastically changing now that families are demanding transparency.
The cost of the management fee for, say, a $50 million portfolio is around one-third of 1 percent, or 33 basis points.
If the manager is tax efficient, you would expect to pay around 50 basis points in taxes.
If they are using outside managers, you can expect around another 50 basis points.
Summing that up, it comes to 1.33 percent. In a low-return environment, that can be significant.
This makes portfolio customization and consolidation more important.
Wealthy families are more interested in customization, which large investment firms cannot offer. Why not?
Large firms look for scalability, which is more profitable. Imagine going to a large firm and asking them to take a look at a special investment, or telling them you would like them to monitor all three of your investment managers and produce a consolidated portfolio accounting report on a monthly basis.
The desire for such services has spurred the wealthy to begin seeking performance, customization, consolidation and oversight all in one place.
Rise of family offices
Increasingly, ultra-wealthy families are turning to family or multifamily offices that offer a cohesive, cost-efficient and collaborative platform. It puts investments, financial planning and estate guidance under one roof.
Family investment offices can yield the highest returns and the best overall experience for families who need guidance in investing, managing and transferring their capital as well as planning for future generations. This can all be done for a cost that is comparable to the investment management fees of well-recognized investment firms.
Privacy is difficult, if not impossible, to safeguard in a large firm. The employee turnover rate alone is almost a guarantee that your information will be distributed among many people.
Family investment offices, in contrast, can offer the personal oversight and stability to ensure that a family’s financial information will not be spread to others.
Large organizations have many resources, but also many clients, and the pressure from senior management to bring in new business is unrelenting.
The conversation around the table is about the new client pipeline, not about how well the organization is doing for its clients. Large firms can do an adequate job with traditional and model portfolios by and large, but they are unable to meet the complex needs of individual families. They try, but it is just not a highly profitable business.
So where do you begin? First, take a look at your situation. Do you have a complex financial picture? Are you interested in multigenerational planning? Would you like to explore non-traditional investment opportunities with due diligence? Are you looking to collaborate with families who have similar situations?
If you answered yes to all, then a single or multifamily office may work you.
How do you determine which one? The cost of setting up a proper family office starts at around $1 million. To make that cost efficient, your total net worth needs to be in excess of $350 million.
For a multifamily office to make sense, you would like to keep your total costs around 50 basis points of one-half of 1 percent. This means you probably need at least $50 million to make it competitive with other services. This, of course, is if cost is your only driver. Some of the benefits may be worth more to you than 50 basis points.
Where do you find a suitable family firm?
There are a couple of places such as The Family Wealth Alliance or Family Office Exchange that can direct you to some potential candidates. Ask your legal or accounting office if they have some recommendations as well.
If they reply by saying they offer that service, suggest that you would like a third-party recommendation. There are, of course, other sources, but asking around and interviewing potential candidates will give you the best chance of the right fit.
Investigating your options thoroughly can be time-consuming and the commitment is sizable, not just from a monetary standpoint, but from a family perspective as well.
As you assess your current set of advisors, review your cost structure in detail. This includes investment management, administrative support and surrounding professionals.
LOOK CLOSELY at what services for which you and your family really are searching. Make a list of things you are doing now and things that concern you in both the medium term and long term. Finding the right solution for your circumstances is a process, but a worthwhile one.