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Guest Article: How Family Offices Must Deal With Risk
By Lisa Vizia
Saffery Champness Registered Fiduciaries Guernsey
8 June 2012
In today’s specialist family office sector, managing risk rather than avoiding it is taking an increasingly prominent role, particularly where diverse portfolios are likely to include at least some unusual assets and investments. There are a number of reasons for this development apart from the heightened regulatory focus on risk. Among them are the increased regulation and scrutiny of counterparties that has come about following the credit crisis, but also the relative sophistication and financial literacy of the second and third generations who have come to the fore of wealthy families. Before the credit crisis the awareness of risk around standard investments, such as investment portfolios, was generally well understood. This now has to be more widely and deeply correlated across the total wealth of the family, to include the non-standard assets such as hedge funds, private equity, property and business. By reviewing, understanding and testing all the complex assets and counterparties involved in a family office and by thinking, rather than processing, the private client practitioner can take a more prominent role, becoming a trusted advisor, a “party at the table” and adding value in the form of clarity, efficiency and cost-effectiveness. The appointment of an investment manager, for example, is just the start of the process. That manager’s performance must be monitored and independently reviewed regularly on a risk-adjusted basis. Furthermore, it will be important to be confident that the manager is contracting appropriate counterparties that pass the relevant due diligence checks. Underperformance by an investment manager or failure to meet the benchmarks of a counterparty, such as the auditor or custodian of a hedge fund, cannot be ignored. No choice There is now no choice for the private client practitioner administering or working with an international family office. We may not be the advisors, but we need to be aware of the advice that is being given and that fits with the investments which go beyond cash in the bank and a standard investment portfolio. This approach not only meets the regulatory risk-based requirements and the client’s expectations but also adds value to the relationship. After the credit crisis and sagas such as the Madoff Ponzi scandal and near-collapse of Bear Stearns, and with the increased complexities around tax legislation in the UK, EU and US, it is essential to tackle these elements head on. For example, in relation to FATCA it is highly likely that an international family and their structure will have US “touch points”, be that cash, investments, property for a family member to live in, or through the family members themselves either directly or through other factors such as marriage or schooling. “Leverage” has become a buzzword since 2008 and if there is leverage in a portfolio it will be important to verify how it is structured and what it comprises – is there really a tangible asset in the investment? Taking the example of a big family office, this will typically be for a very large international client family, perhaps from the Middle East, with a significant value of assets under the umbrella of the trust or family office. Spectrum At one end of the spectrum are the “toys” - the planes, boats and private houses which are personal assets for the family’s use. The administrator will need to have the requisite knowledge and experience and obtain the relevant advice to structure and manage these properly. At the other end of the spectrum there are likely to be investments such as hedge fund and private equity portfolios and direct investments in businesses. For instance, if the property portfolio includes developments in Europe, the practitioner will need to ensure that the appropriate expertise on property investments in the relevant jurisdiction is in place. In respect of that particular property market, what are the necessary contracts and legalities and the preferred type of structure for the investment taking into account elements such as tax treaties? Failure to pay attention to these matters could result in a substantial tax liability for the structure that could have been mitigated through proper advice and structuring. Opportunities From a SWOT analysis perspective, I see the capability to understand and manage complex businesses and assets as an opportunity rather than a threat. There are mitigating and limited risks in taking on this work, as long as one is informed and well-advised by effectively having responsibility to understand and manage the risk. This is an intelligent approach, whereas relying solely on processing and systems is not necessarily the “thinking” way. There remains a requirement for structures and processes but, more importantly, to have the right people, the right expertise and communication in place to administer complex structures.