The family office trends that will continue shaping 2018 and beyond will be determined by economics, demographics, and generational differences in values among very high-net-worth individuals and heirs to their fortunes.
Establishing a family office is an excellent way to ensure family wealth is properly managed and eventually distributed to successive generations. There are opportunities not only to preserve assets, but also to grow them.
However, there are always threats (and our previous blog highlighted the risks investment management operations face in uncertain climates). Positioning and preparing your organization accordingly will ensure a smooth operations.
Wealth Management and Family Office Trends
According to Bloomberg:
- There are an estimated 10,000 single family offices worldwide. Roughly half of them were established after the year 2000.
- As of 2016, there were 187,500 ultra-high-net-worth (UHNW) families, defined as controlling more than $30 million in assets. By 2025, that number is expected to grow to 263,500.
- UHNW families hold a total of more than $5 trillion in assets.
- Asia and Europe will see a 66% and 27% rise in the number of millionaires, respectively.
- India will see a 109% increase in UHNW families through 2024.
- The Middle East will see 59% UHNW growth through 2025.
As the number of super wealthy families grows, so will the number of single- and multi-family offices. The global rise in ultra-high-net-worth families from emerging markets has not only developed financial hubs in their respective countries, but their wealth is also flowing into the United States and Western Europe.
Why UHNW Families from Emerging Markets Move Their Assets Abroad
Safety is a major motivating factor why wealthy families in emerging markets move their assets to the US and Western Europe, as these destinations are perceived as favorable for legal, political, and economic reasons.
Bloomberg also states:
- UHNW Chinese families prefer having wealth and investments in the US as a “safety hatch”, if necessary.
- UHNW Russians have viewed the United States as a “safe haven”, citing recognition of attorney-client privilege.
- UHNW Brazilians “have the wherewithal to find expertise abroad”, fearing currency, economic, and governmental crises.
- UHNW families from Colombia, Venezuela, and Panama move their assets to the United States because they feel their personal financial information is better protected and less vulnerable to data breaches and legally mandated disclosures in their home countries, and it may arouse suspicion from local jurisdictions.
- London is a favorable destination because “clients value the UK rule of law, access to (their) courts, and transparency and fairness of treatment”.
- How Family Offices Invest: New Trends
From Hedge Funds to Private Equities
Family office allocation of assets to hedge funds are becoming a smaller proportion of holdings, as a Campden Wealth report revealed average FO allocation to funds dropped 9% to 8.1% in 2016. Poor performance, high fees and taxes are contributing factors to the move away from hedge funds. The “winner” in this shift are private equities, showing a 2.3 percentage point increase in PE holdings to 22.1%.
Philip Higson, at Vice Chairman at UBS, stated “Most family offices can trace their roots back to the growth and success of a single business, and as a consequence you will often find an emotional desire to back entrepreneurs and ideas they believe in. Strong performance from private equity over the last five years has only served to strengthen this natural affiliation.”
Growing Popularity in Impact Investing
Not only have the demographics of global wealth evolved, but so have high-net-worth families’ approaches to investments. The super-wealthy are increasingly conscious of how they are perceived by the public and how their investments affect society and the environment, so impact investing has become a popular way to contribute to a greater societal good.
According to UBS and Campden, 61% of family offices are active in or expect to be active in impacting investing, and 47% say impact investing is a better use of funds and will have a greater social impact than philanthropy.
Helping drive this trend are the millennials, who are coming of age to have a say in managing of the family’s assets. A generation that is less concerned with material items like yachts and airplanes, millennials are described by the The Family Office Exchange (FOX) as “sophisticated, highly educated, and well-traveled”, and they shave shown a preference to investing in environmental, social and governance (ESG) projects.
Campden reports thats the percentage of family offices pursuing a ‘growth’ strategy has increased from 29% to 36%, but among asset allocations across markets, the results are varied.
US family offices have shown the most appetite for pursuing ‘growth’ strategies, as their assets have performed better than those in other regions. Likewise, a growing number of emerging market FOs have reduced their ‘preservation’ allocations, shaking off fears due to weak performance in 2015. Europe, in contrast, has seen more if its family offices cut ‘growth’ allocations in favor of ‘preservation’.
In light of the optimism for growth strategies, wealth preservation will remain appealing as family offices prepare for succession plans and inter-generational wealth transfers. In Asia, for example, it is “evolving from one of wealth accumulation to wealth preservation and so issues such as succession planning and intergenerational wealth transfer through structures such as foundations and trusts are moving higher up the agenda,” according to Dominic Gamble, CEO of WealthinAsia.com.
Challenges Facing Family Offices
In light of the optimism for growth strategies and the opportunity for family offices in mature and emerging markets, challenges loom on the horizon.
Setting up succession plans for family offices in emerging markets, particularly for Gulf Cooperation Council (GCC), is a concern. According to an Invesco study, “In the GCC, most wealth is first generation so new inheritance structures need to be developed for large families within local legal frameworks.” Finding appropriate service providers for managing this wealth is often in mature markets in the United States and Western Europe, where legal and financial frameworks are better suited for these families’ situations.
If not the local laws being ill-equipped to handle wealth distribution among family members, then the challenge lies within a succession plan itself. Setting up such a plan over the course of 12-24 months is a top priority, and 69% plan for an inter-generational wealth transfer within 15 years, according to Campden.
General transitions don’t always go smoothly:
- A lack of interest or qualification in running a family office among the younger generations
- An unwillingness to give up control among the older generations
- Generational disagreements over investment strategies after the transition
- Distrust in how the family office will be run
Rising Investment and Operational Costs
Rising costs and low returns threaten profit margins, and outsourcing for family offices is a great way to reduce costs and attain operational efficiency.
According to Rick Flynn, a managing partner of Flynn Family Office, “More successful family businesses are today relying on outsourced family office services providers to achieve greater control and cost savings while managing toward defined family wealth objectives.”
Just as costs have risen, the other issue has been insufficient talent. A World Economic Forum report revealed that nearly one-third of family offices lack in-house expertise. In addition to outsourcing back -office functions like reconciliation, family offices can outsource some of their investment management tasks, streamlining operations.
The Future for Family Offices
The number of ultra-high-net-worth families will continue to rise for the foreseeable future as emerging markets, primarily led by Asia, continue their economic ascendence. With that comes a demand for family offices, ensuring that wealth is properly transferred to future generations.
The United States and Western European markets may not experience the same rate of growth in the emerging markets, but they are still in a position to benefit from the flow of capital, as UHNW families from emerging markets seek access to legal, political, and financial systems that better serve their needs.
Investment patterns will change, as more FOs increase their allocations into private equities and impact investing, and to the extent that the markets offer good returns, more firms will have a ‘growth’ strategy.
Challenges lie ahead, as complications with succession planning and rising costs threaten the effectiveness of a family office, and middle- and back-office outsourcing will be one way to mitigate those risks.
Overall, the future is bright for family offices, and running the organization effectively will make all the difference.