family offices , family businesses, CIO, wealth management
Thoughts & Insights
Advising Family Offices
Advising Family Offices
Managing Family Wealth via a structured Family Office is an exercise which includes almost big institution-like processes but overlaid with very human wishes and expectations of the family members. Unlike brutal investment mechanics at large institutions, the family offices have to include many factors in their planning which may sound very non-finance but are very important for the family. Hence its combination of both EQ & IQ which contribute to this planning process.
In my experience of over 25 years and managing over 50 family offices some facts have become almost common across all families. This article, a first in a series attempts to touch some of these learnings & trends.
Not just one vehicle
Family wealth needs to pass through generations, take on many taxation or regulatory storms and be able to be easily distributed in case of splits. This demands very deep planning on the need for different investment structures or vehicles, in some cases across geographies.
Trusts, LLP, AIFs or even company structures provide a vastly different nuance to the wealth pool. These nuances along with the family wealth & business succession plans and taxation efficiencies are used to draft the family wealth holding policy. This policy is vetted by many legal & taxation experts and is constantly optimized depending on changes in regulation, market realities and family needs.
Not just one portfolio
In professionally managed family offices, a lot of focus is put on “Risk” and the portfolios are structured around it. This is opposite to target return portfolio strategy used by many in the mass affluent and HNI space. By using a Target Risk Strategy, the family offices strive to construct multiple pools of risk with different “Risk-Liquidity-Return-Tenure” specs. These pools answer a different need for a family and are a culmination of numerous consultations between the family members and the family office advisors. These outcomes and decisions are recorded in formal documents usually called investment policy statements or documents etc.
Handholding the families
The above-mentioned discussions also provide an opportunity to the family members to get better understanding of the investment concepts, asset classes and market functioning. In almost all discussions the family members end up reflecting on many past mistakes made while investing in a new product which was pushed by a distributor. Once they understand the mechanics of these products, they actually become more involved in review meetings. The younger members often spend more time with the advisor to get more knowledge of any particular asset class or markets.
While this participation is wished for, in many cases the family members are happy to hand over discretion completely to the advisors as they would like to focus more on the family business.
Portfolio Optimization & Restructuring
Portfolio Optimization for family offices and UHNI portfolios is not about just risk minimization or return maximization. It is a process of continuously ascertaining the risk in the portfolio and whether the return expected to be generated is conducive for the level of risk taken. This risk premium cannot always be depicted in numbers and it has a lot of input from the experience and gutfeel of the Chief Investment Officer.
The “premium” that you expect for taking extra risk is the key to structuring efficient portfolios.
Many families usually already have investments in their portfolios which then must be restructured, re-pooled & optimized basis the new investment policy. This process is executed with a sharp focus on taxation, exit costs and lock-in conditions. In most cases this exercise will take months to complete.
Not necessary to add all new products
New products are only added for the following reasons:-
1. if they provide the necessary minimum risk premium in an asset class
2. if they provide similar returns as generated by current holdings in an asset class but at a lower risk
3. if they provide a higher return for the same kind of risk in an asset class
4. if they provide an uncorrelated return/volatility profile in possibly a newer asset class
5. add liquidity in an asset class which the new product may provide without being much different in the risk-return profile
6. only to increase diversification among managers in an asset class
While the first five reasons are more related to numbers the last point on diversification is usually debated among investment professionals. How much is adequate diversification has many different answers. The investment industry will continue to launch newer products as that is their core business but not every product needs to to be added to a family portfolio. These distributed products will be sold aggressively in the market and many a times played on the premise of “FOMO” or Fear Of Missing Out.
Lastly, most importantly — The ethics of the Advisor
There are many stories about how inferior products have been added to family portfolios, may it be via a single family office or a multifamily office. Advisors must take their fiduciary role very seriously and have to make sure that no conflict of interest arises while advising families. This must be built into the DNA of the advisor.
These conflicts can come in various shapes like getting monetary commissions when investing in a product to non-monetary benefits like getting new business leads, recommendations etc.
In case of monetary benefits usually the advisors will try to push one or two high paying products or transactions into the portfolio which gives them large commission cheques. These products are kept out of the usual Fee-only advisory agreements so that there are no legal issues.
Non-monetary benefits are more difficult to trace but clear pointers can be recognised if the advisor does not sound convincing on why a particular product is being chosen for the portfolio. You may notice over-focus on a particular fund manager (as an individual) and less on his past performance. Sometimes investment banking mandates are taken up by these advisors which then are pushed to the client portfolios.
All these cases will add possibly inferior or incorrect products in portfolio and may make the portfolio susceptible to lower returns or higher risk.
Are You Aware Of All Conflicts Of Interest?
Are You Aware Of All Conflicts Of Interest?
Are You Aware Of All Conflicts Of Interest?
Okay, so you have signed up with a fee based “Advisor”. Well, have you? Having a fee agreement DOES NOT make any intermediary an “Advisor”. It needs to be compliant to many SEBI rules and regulations as part of the Investment Advisors Act 2013 and provide essential disclosures.
So, what are the things that a client needs to keep in mind, verify with the advisor on a regular basis and make sure to get all necessary declarations in writing?
Let’s first take a look at some SEBI FAQs on Investment Advisors Act 2013:-
• An investment adviser shall disclose to its client, any consideration by way of remuneration or compensation or in any other form whatsoever, received or receivable by it or any of its associates or subsidiaries for any distribution or execution services in respect of the products or securities for which the investment advice is provided to the client.
• An investment adviser shall act in a fiduciary capacity towards its clients and shall disclose all conflicts of interests as and when they arise. He shall act honestly, fairly and in the best interests of its clients and in the integrity of the market.
• If the client desires to avail the execution services, an investment adviser shall, before recommending such services of a stock broker or other intermediary to a client, disclose any consideration by way of remuneration or compensation or in any other form whatsoever, if any, received or receivable by the investment adviser from such intermediary
These are crucial obligations and call for disclosure of all “conflicts of interest”. What it means is that any fact that may make the advisor biased towards or against selecting an asset class, fund manager, product etc. will have to be clearly disclosed before the investment is made.
Common Conflicts of Interest and Disclosures
If the advisor is receiving any commission/brokerage, referral fee, placement fee etc. of any kind, whether cash or otherwise for selecting a particular product — This is a very common source of conflict of interest. If the intermediary receives any monetary or non-monetary benefit in lieu of choosing a particular product or investment opportunity that has to be disclosed before the investment is made.
1. Monetary benefits may include commission for selling a mutual fund, PMS scheme, Alternate Investment Fund (AIF), startup equity deal, a real estate property etc. In some cases, the payment may be in multiple layers inside the same product, for e.g. setup fee, trail fee and in some cases share from the Carry.
2. Non-monetary benefits may include situations like a particular fund manager acting as a catalyst to give more client referrals to the intermediary in exchange for selling a particular fund to the intermediary’s clients.
Important to mention that these payouts may be over and above the fee charged by the intermediary from the client.
Savvy marketing will aggressively sell a lower advisory fee to attract the client while other payouts as listed above will add to the total earnings for the intermediary. Sometimes the fee charging vehicle and the commission/brokerage receiving vehicles may be sister companies or have a holdco-subsidiary relationship.
The product selected is manufactured by the Asset Management Company (AMC) which partially or fully owns the Advisor (or vice-versa)
The intermediary & the AMC are owned by the same company directly or indirectly (in-house products) — This conflict is very prevalent in large financial services groups. This arises when the intermediary purposefully includes products/deals manufactured/structured by a group entity with an intent to benefit the group.
1. The conflict might lead to a monetary gain of having additional income from management fee/carry from the in-house product over and above the Advisory fee contracted with the client.
2. Another hidden intent might be to shore up the AUM of a group company (possibly for a valuation gain) by adding the products to the client’s portfolio even though the product may not be of adequate quality and performance.
3. In some cases investment banking deals may be distributed to the client as the investment banking arm may be running an important mandate which is crucial to the business. Many a times when the deal is rejected by institutions it is re-packaged to make it seem attractive to unsuspecting clients. With all the buzz around startup investing many relationship managers may push such deals to their clients without proper risk diligence or need in the portfolio.
If any individual in the product manufacturer setup is in any way related to the advisor by way of any personal linkages — This conflict arises due to nepotistic intent to help a family member. As with all conflicts of interest this can also add low quality products or deals into the client portfolio.
The intermediary may be intending to help a relative by choosing his/her managed product or to provide any other monetary benefit in their career or business
Clients must be incredibly careful about these “Facades or Propriety” and insist on all disclosures in writing from the intermediary. The global financial crisis of 2008 clearly showed that large brand names also do not safeguard client’s interest as their priority. While we cannot paint everybody with the same brush it is important for the client to not just go by brand, size, or even fancy awards!
The Family Office CIO – Planning for Disruptions
The Family Office CIO – Planning for Disruptions
“Chief Investment Officers will have to continuously change their thesis as they move across the highly competitive and disruptive spaces. Today’s CIOs do not have the luxury of buying something and sitting back as last generation professionals could afford to do. This means that they must be continuously adapting, absorbing and recreating their investment models. Strategic vision has to be somewhat flexible as disruption in many industries is expected and is already visible”
While the concept of asset allocation will continue to guide the planners, the individual asset classes may see changes or additions. This will keep the CIOs on their feet in identifying suitable new opportunities and then investing and learning along with the maturity of the product/asset class. For e.g., till 10 years back (or even 7) venture capital or private equity were not part of the core asset allocation of many large investors including family offices. Now this asset class is growing the fastest but also comes with its own risk issues. More on this a bit later.
Continuously Changing Bluechips
There were times when holding large bluechip company’s shares was considered to be essential. Their moats and the concept of industry entry hurdles were considered as key parameters to continued growth of those companies and hence their inclusion in core portfolios. Times have changed…a lot.
Challengers are erupting from all sides due to tech ideas, newer infrastructure, regulation and even changing consumer sensitivities to environmental and social impact of their buying decisions.
“Disruption today is a reality in most sectors and we have to accept that so called heavy-weight companies or even core sector definitions might change”
What’s Changing — Shortening Gestation & New Capital Backing
Earlier disruptors had longer gestation periods and hence they could be adjusted to by the industry leaders. But now the gestation cycles are becoming shorter.
Another factor was the availability of capital to back the disruptors; this was a huge problem in earlier times as not many capital owners looked at it very seriously. The risk was not digestible. The advent of private equity players and subsequently family offices & private capital into the playzone did change the rules of the game. Further-on these venture capital institutions are being joined by crowd sourcing or group investing platforms which are attempting to make available the piece of this pie to smaller investors.
All these new entrants find their own space in the lifecycle of a new entity/idea; some want to back at the early stage with smaller cheques while some want to help companies grow after the business has achieved some maturity.
Besides availability of capital the necessary infrastructure and support has come via incubators, accelerators and availability of Stacks or the necessary tools to support the Startup development.
Many industries may witness disruption or a restructuring in the coming decade as entrepreneurs continue to find intelligent solutions to consumer needs/problems. Some may use technology while some may just try to make a better product for a specific need of the end consumer. On the other hand, some entrepreneurs may also help large corporate entities to remain competitive by providing better tool or processes etc.
Let us see some cases…
The increase in the share of Electric vehicles is going to become a certainty now with various countries pushing for the change, for reasons around the environmental benefits, cost of costly fuel imports etc. Even in India we have somewhat taken the first steps towards a more electrified transportation market. But we have a long way to go. While we first try to first provide full electrification (with continuous supply of electricity and not just poles and wires), some cities and towns are improving in the availability of power. These may be the first areas which can adopt an electric vehicle. Needless of say the running cost, Kms on a single charge, cost of the vehicle, tax benefits etc. will play an important role in the buying decision.
Let us see with the coming of these vehicles how does the industry changes –
• The established players will have to design & manufacture this category of vehicles as the demand increases and the regulatory pressure start.
• These vehicles have fewer moving parts and hence the need for maintenance and instances of breakdown are fewer. This will completely change the whole ancillary industry which thrives upon spare parts, breakdown repair, servicing centres etc. Needless to say, the people employed will need to be re-skilled and reallocated.
• EV companies may not need a vast service network if the cases of breakdowns are lesser and the servicing requirements are not that frequent. What this means is that even for a newer EV company a good product may pull in consumers who earlier brought a brand (or two) just because they had a good service network. The focus may shift from just the network to the quality of the vehicle. Needless to say, that new player will have to build trust to start with.
• Need for charging centres will increase across both the city limits and the highways. This may lead to special “green stations” which may also have the usual hooks for eating and shopping zones. What if the accompanying shops and eateries are built around organic foods and socially impacting products?
Looking from a CIO’s lens, this requires a bit of adjusting their thesis on the Auto sector both from a point of the vehicle manufacturers and the Auto component space. Adaptability of the companies to newer demands and entry of new players will decide the ultimate winners in this space.
The real estate market has taken a few blows from the demonetization exercise, the new RERA rules, focus on benami (not owned directly by the ultimate capital provider) etc. While the intent of the regulations is to ensure that the customer’s interests are protected and legitimate transactions happen in the market, the cash ban pulled out a lot of unaccounted money fuelling the bubbles in many markets.
The disruptions are happening in various ways –
• The younger consumers are opting for shared workspaces and that too which come pre-furnished and ready to plug-in. Many co-working space providers are coming up trying to attract both the newer age professionals & established companies who need more flexible sized offices. In time all these spaces will compete for a client by providing various facilities, member benefits like access to advisors/mentors and across the network usage of spaces. The process of identifying a space, comparing facilities & benefits and even negotiating/bidding is becoming more software app based. This means two things; firstly, the commercial real estate broking industry is up for a disruption and secondly the concept of a landlord will change.
• Unsophisticated commercial property owners who do not have the capability will use specialist property managers who can convert the space into co-working offices along with key member facilities.
• With the share of co-working spaces rising, there will be a situation when finding an office will be done via an app and standardized agreements will make sure that lengthy negotiations are avoided.
• This will lead to a somewhat better demand projection for the industry in general.
• This trend may be witnessed in the co-living space as well
• Another entrant has been the student housing industry. With booming student numbers traversing the country there is a massive shortage of hostel accommodation (both on-campus & off-campus). These new players either execute build-to suite projects or take over exiting real estate options and bring them under their own umbrella.
The investment opportunities in this space will accordingly change with the changing realities. With regulation getting clearer and the players in the space getting more professional there will be many new opportunities cropping up. From building build-to suite projects for the co-working industry, investing in co-working operators to getting ready for app based co-living concept.
The Food & Eating-out industry is seeing massive changes. The food delivery startups are changing the complete structure of the industry. This industry spans across from giving sustenance to experiential dining.
The disruptive changes are evident in –
• Essential food can now be delivered at your doorstep in realistic timelines. Earlier the choice was limited to a few pizza outlets and some restaurants having their own neighbourhood delivery people. This is pushing families to order-in more rather than cooking at home.
• With access to food from even some costlier outlets the usual family eating out trips are getting somewhat affected. Adding to this the traffic woes on weekends accompanied by long waiting periods. The walk-ins to many restaurants have visibly dropped as per many studies.
• There has been a flood of delivery only business models; some good and some not so hygienic ones as many reports have shown. So, it does promote entrepreneurship but there are some questionable entrants as well.
• Order-in parties are a reality these days with each party member ordering a particular dish to be added to the party menu!
• High footfall restaurant owners are also happy as their real estate is limited and the delivery service allows them to make almost the same margins as from in-outlet dinners. This increases the efficiency of the kitchen costs as well.
Asset Ownership is being redefined by the millennials, or at least the trends show this currently. The understanding of which owned items are assets and which are liabilities is dawning upon a lot of people.
Let us look at some changes here –
• Today you need not be stuck with the same furniture as you move around (or even if you do not). There are many players who will rent out the furniture, from a single bed to a whole room set. You can choose from basic furniture to even specially designed flexible products more demanded by the younger clients.
• Car ownership is not only getting affected by the traffic and parking issues but also by the sheer depreciation that a car goes thru. Add to that the cost of fuel and maintenance and it adds up to a lot. You can already rent self-drive cars for a few hours to months! On any weekend drive to your favorite holiday spot you will already find a few of these being driven around. Time will be a good judge on the sustainability of the model but the EV onslaught may make these ventures even better.
• You can already get app-based cabs and many car owners have been relegated to only weekend drivers.
• Even household durables like washing machines etc can now be rented. This may affect the durables market in the future as the manufacturers may want to sell more to these new B2B buyers. Will the customer be very keen to rent only from a particular brand?
• Mobile phones & computers are next in line to be available on rent. This helps the clients to change these more frequently. Also, older models can then be refurbished and rented out at a lower cost.
• Costly designer Clothing & jewellery has always been a social designation. The renting model has already started percolating in this industry making it much cheaper to hire a designer evening gown with matching jewels. You can now also give your own pricey wear to be given out on rent if you do not have much attachment to it.
There will be even more such shifts in this space and can have a lot of impact on the consumption industry. The investment experts will have to relook at many companies in the consumer space. Needless to say, all this also has an impact on the consumer finance industry. Will the customers be willing to ‘borrow money to own’ or just ‘pay rent to use’? Or maybe you will be borrowing to pay rentals?