Merrill Lynch and Campden’s recent European Single Family Office Survey 2008, Preserving Family Values predicts a decisive shift by single family offices towards more assets being allocated to alternatives.

Merrill Lynch and Campden’s recent European Single Family Office Survey 2008, Preserving Family Values predicts a decisive shift by single family offices towards more assets being allocated to alternatives. The report found family offices are already using alternative investments extensively and are expected to switch their asset allocation even further in favour of alternatives over the next three years from 48 per cent on average today to 55 per cent. The wide-reaching and increasing use of alternatives amongst family offices is no surprise to wealth innovations strategy think tank, Scorpio Partnership. Over two years Scorpio has looked at asset allocation and uptake of hedge funds amongst 50 family offices in the UK and Switzerland on behalf of several clients and say that findings of the Campden research are “conservative” compared to their own: “There are single family offices and family investment vehicles with 100 per cent exposure to alternative assets, often through single managers, not fund of funds,” says Graham Harvey, senior associate at Scorpio. “The key point is not the type of office or its age in terms of generations, but its investment mandate.” Despite SFOs' heavy use of alternatives, the Merrill Lynch/Campden survey found that the majority described their investment objective as balanced (57 per cent), compared to 25 per cent who said that their objective was to preserve and 14 per cent to achieve growth. (For information on how to order this report email WealthBriefing customer services by clicking here.) Gary Dugan, chief investment officer, global wealth management at Merrill Lynch believes that the results “demonstrate clearly how family offices are taking a strategic, long-term view with their investments.” Equities dominate the average single family office portfolio, making up 34 per cent of asset allocation, real estate 16 per cent, hedge funds and funds of hedge funds 14 per cent, fixed income 13 per cent and 11 per cent private equity and funds of private equity funds. The remainder is allocated to cash, commodities and direct or venture capital investments. Whilst family offices have traditionally been considered very conservative investors, Scorpio says that through its research it has detected a long standing high interest in alternative assets amongst ultra high net worth individuals: “Banks think this is new, because it is relatively new to them to be offering such products but the clients have been there for some time. They are comfortable with these allocations typically because of their long investment horizons,” says Sebastian Dovey, managing partner and head of consulting at Scorpio Partnership. Scorpio pinpoints a shift in mind-set from capital preservation to capital growth and says that many families they speak with subscribe to an endowment model and look to US universities as a guide: “David Swensen, at Yale, is held up as a living investment God. He uses some 66 per cent weighting to alternative assets and families utilise his style. Banks will have to reach to this and offer cutting edge product to their largest clients,” says Mr Harvey. This often means plugging single family offices directly into the investment banking desk or bringing institutional product to their largest clients. “They are too demanding for the mere-millionaire desks,” he says. Nick Ring from Northern Trust has also seen a significantly higher proportion of alternatives in portfolios considered “balanced” by family offices than would be the case in the institutional space: “Family offices are driven by entirely different considerations to institutions, the dynamics are different as they start from two different points. Asset liability requirements are not a consideration for a family office, and they tend not to slavishly follow benchmarks. A pension fund, for example, has a very specific set of liability streams and the implication of not being able to meet these is huge, whereas a family is concerned only with managing its own wealth.” He says that families might also define risk differently to the wealth industry because of their experience: “The greater propensity for and interest in alternatives amongst family offices is driven by the fact that many families have come from an entrepreneurial background. They are often very comfortable with private equity for example.” However, Mr Ring does not necessarily believe that a high interest in alternatives means a high risk approach: “Alternatives do not equate 100 per cent with high risk. There are subsets that are, but the use of hedge funds targeting eight per cent per annum is not high risk,” he says. The primary raison d’etre was cited by the majority of SFOs as the control and consolidation of the management of family wealth, with the need to maintain confidentiality a close second. Mr Harvey says that single family offices are often built to provide a high level of service, consolidation and independence from the wider banking market. Around 90 per cent of the SFOs surveyed by Merrill Lynch and Campden provide investment and financial advisory services and most do so in-house. When they seek external financial services providers, they place the greatest emphasis on investment track-record and confidentiality. According to the head of a UK based family office quoted in the survey: “There are three things to look for when selecting a financial services provider, and they are … performance, performance, performance.” Scorpio agrees that families are looking for results, but, says that crucially, this does not just mean performance: “Our assessment clearly indicates it to mean three main things: better control over the assets; enhanced engagement levels with the financial institutions through a professional interface of the office; and ownership of the advisors,” says Mr Harvey. The report also highlights cooperation between Europe’s SFOs on investments. Around 60 per cent of those surveyed said that they occasionally collaborated with other family offices on investment opportunities, and 11 per cent said they did so frequently. The report deduced that this might lead to the emergence of multi-family offices to compete with financial services providers for the business of other single family offices. Whilst Scorpio believes that there will be growth in the SFO space as long as there continues to be more liquidity events, it agrees that there will be consolidation: “Then, as the industry matures, portfolios become more disparate (as people have children or take their assets out of the family structure), staff start to move between family offices, both single-family offices and multi-family office, there will be consolidation and the single family offices that are not pursuing capital growth become less sustainable cost centres,” says Mr Harvey. Mr Ring also believes that single family offices will remain popular: “Individuals make money regardless of investment cycles. The current economic environment is good for exporters for example. As more families are hitting a level of wealth, they are setting up single family offices.” A key driver for possible consolidation in the family office space is cost. Almost a third of respondents to the survey argued that a single family office needs assets under management of at least €250 million ($350,000) to €300 million to support a wealth management operation. The annual management fee excluding set-up costs and investment performance fees was found to be around 89bps for the smaller offices with assets of up to €250 million and as low as 48bps for offices over €1 billion due to economies of scale. However, this does not necessarily mean that single family offices are prohibitively expensive for those with less than €250 million and that this will lead to further consolidation in the industry. Scorpio believes that it may be realistic to say that a true family office will require 9-figure wealth by 2020, however, this will not stop UHNW individuals setting up entities that they call “family offices”. It believes that families will start to pool aspects of their family activities (such as investment) while separating other aspects (such as governance). Scorpio says that the key change in the family office space in recent years has been the adoption of the term by so many different market participants: “In our view what was a relatively simple and clear concept has now become ‘owned’ by more than half a dozen different business models. Interestingly, family offices are now also becoming status symbols - put somewhat glibly they are the replacement to the hedge fund or the dot com company,” says Mr Dovey. The consultancy says costs are dependent on a huge range of factors including office structure, jurisdiction, asset classes and beneficiary requirements. Mr Ring believes that whilst there will inevitably be some consolidation in the family office space, it will not necessarily be driven by clear-cut, commercial decisions: “Families look at costs and benefits differently than commercial enterprises and softer issues come into play. They might well be willing to spend a few more basis points to retain the covenience, confidentialty and personal service afforded to them by their own dedicated single family office.” The Merrill Lynch/Campden survey found that 75 per cent of single family offices use external asset managers, 43 per cent investment banks and 36 per cent private banks. According to Mr Ring families like to hire professionals and build their own investment office in-house, in order to better control their families’ financial destiny. He says that investment banks and private banks have to be commercially scaleable in order to effect this, and will have, to some degree, put clients in “buckets”. However, he acknowledges that very few family offices pick stocks and bonds themselves and they are outsourcing a lot more than in the past: “There is definitely consolidation in terms of investment managements platforms, performance analysis and reporting which is benefitting companies like ours,” he says. Amir Sadr, Merrill’s head of the family office group EMEA, says that he believes that multi-family offices will increasingly provide services tailored to other family offices, but consolidation will be restricted by concerns around secrecy: “Whilst we can see the potential for increased collaboration on the investment side, confidentiality is seen as so important that I would be surprised if the single family office was a dying breed,” he says.