Family Office Best Practices

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Family offices globally managed US$5.5 trillion in 2019[1]. The total wealth behind these family offices was close to US$10 trillion. This is a significant economic force, similar in assets under management to all Sovereign Wealth Funds put together. Asia would be home to about 10% of global family offices[2] and their number is growing very fast, especially in Singapore and Hong Kong with the two cities competing to attract both Asian and global family offices. Despite representing such a large pool of capital, family offices are a heterogeneous group, often opaque to the outside world, and incredibly diverse in terms of governance structures, ranging from highly sophisticated professional organisations to smaller emerging structures with limited resources and experience. Partly as a result, family offices have historically been perceived as investment laggards compared with institutional investors. There is seldom smoke without fire: we observe that many family offices have delivered sub-optimal investment returns. Worse, many of the underperformers do not have the right reporting frameworks in place to even know that they have underperformed.

As with any diverse group, there are also some who have delivered stellar performance. How have successful family offices delivered better results? My colleagues Stan Miranda and Raphaël Heynold wrote a white paper on this topic. In this newsletter, we provide a high-level summary and elaborate on the topics most relevant to Asian family offices. (If you want access to the full white paper, please click on this link or send us an email at AsiaIR@partners-cap.com).   

Given the diversity of the space, there is no single template that will ensure growing family wealth while guaranteeing a cohesive process for each family member. Unlike institutional investors, family offices have unique goals and demands that complicate internal investment processes, often forcing trade-offs between financial returns and family needs. While there is no cookie-cutter solution to these problems, we have identified a small number of principles that successful family offices have systematically applied. They include:

• Clear purpose and vision. A clear purpose, vision, and mission reflecting the asset owner's ambitions and impact goals.
• Strategy. An implementation strategy as a logical extension of the family office vision, including five-year plans with key initiatives, deliverables, deadlines, and resources.
• Governance and decision making. Leadership and governance following best practices, including an Operating Agreement guiding decision-making and delegating effectively.
• Investment strategy. An investment strategy starting with distinct capital pools and owner goals, translating into specific investment strategies accounting for target returns, risk budgets, illiquidity budgets, and asset allocation.
• Resourcing and organisation. A team resource plan emerging from the overall family strategy, addressing "make versus buy" decisions based on economic break-even and internal expertise levels.

Clear Purpose and Vision

Our experience shows that long-term inter-generational success needs to be grounded in a clearly defined purpose, vision, and mission. If it sounds obvious, think again. Very few of the Asian family offices we talked to have actually gone through this exercise, syndicated it within the family and embedded it into a clear mission statement. Too many are still focused on perpetuating the vision of a founder without further reflection and codification of how their vision resonates with the next generation that will be expected to continue the execution of the approach. Chart 1 below provides 5 examples of such purposes for family offices.

Chart 1: Five Generic Purposes Typically Defined for Family Office

The purpose outlines the family's goals and motivations, while the vision provides a road map for the future. The mission serves as a rallying cry, encapsulating the organization's drive towards achieving its vision. Amongst Asian family offices we work with, we have found a few interesting archetypes. Philanthropy and impact broadly defined is a common theme, with education, healthcare or the environment featuring amongst the ways the first and second generations often aim to “give back to society”. When well thought through, this can be a very effective way to create a common purpose amongst generations and to implement the type of processes required for longer term success across family assets. New operating businesses offer an opportunity for the next generation(s) to make their mark on the business itself. It can however be very challenging to implement – one of the most common and most challenging archetypes is where the next generation steps away from a traditional business to build a technology orientated business or investment portfolio. It is a remarkably common and difficult shift in operating model to execute and it requires enhanced discipline and governance to ensure it is done successfully and does not endanger the businesses foundational to the family’s success.

Overall Strategy

A family office's strategy outlines how to achieve its vision. It includes long-term goals, near-term milestones, priority actions and projects. It also outlines the capabilities and resources needed to achieve them and assesses whether they should be retained or built in house or through external relationships, partnerships, and networks. Defining success clearly is important and will vary significantly depending on the objectives – e.g., philanthropic impact vs. building new businesses.

A family office’s purpose and vision often starts as the extension of the life and passions of a successful business leader, entrepreneur or investor and thus often mixes business purposes and more personal passions and causes. The strategy however should also address family unity and succession planning, which is often a difficult topic both psychologically and organisationally. It is especially true in the transitions between the first three generations. Many Asian families we work with deeply fear the old Chinese adage that states that “Wealth does not pass three generations”[3]. There are also cultural reasons for which the inter-generational dialogue around strategy tends to be more unidirectional in Asia than in the West. This makes trusted advisers – who need to combine investment sophistication with an in-depth understanding of the family – particularly important for Asian families in order to moderate the dialogue and facilitate the strategy setting process.

For complex family offices with operating businesses, financial investments, and philanthropic activities, the strategy is more complex and even more critical to success. It should be backed up with rolling updates to agreed five-year strategic plans.

Leadership and Governance

Family office governance is the process by which decisions are made about the management of the family's assets. There are two layers of governance: one for the family office as a whole and one for each of the family's operating businesses, family foundations, and financial assets. The role of the Principal[4], or the creator and beneficial owner of the assets, is critical in family office governance. The Principal should chair the Family Board, setting overall strategic direction but delegating day-to-day decisions related to investment activities to the CIO and their team or, for family offices lacking the scale, to a third party. Whether the Principal should chair the family office Investment Committee should be based almost solely based on competence – would you hire this person as the chair of the IC if she or he was not part of the family? If the answer to this question is “no”, it is probably time to involve a trusted third party with the right level of investment experience.

There is nothing wrong with having family members making investment decisions as long as they have the right experience and expertise. We however observe that family members tend to be more involved on the execution level in Asia – for example, a recent KPMG survey published in 2023 showed that 31% of family offices CEOs were family members in Asia and 23% in Australia. This compares with 10% in the U.S.A. This is not per se an issue but makes it even more important to codify governance and decision making and to provide checks and balance by involving trusted outsiders with deep investment expertise and the right level of independence able to push back where required.

The composition of the Family Board should reflect its primary purpose of managing the family's assets. The board should be composed of family members and a small number of trusted advisers. The Family Board sets the Investment Policy, while the Investment Committee sets the Investment Strategy. The Investment Committee typically consists of those family members who are interested and versed in investment matters, as well as the key employees managing investments within the family office. Especially in Asia, we believe that adding trusted independent advisers to the committee can enhance the quality of governance and decision making significantly. The Chair of the Investment Committee is a critical appointment and should be someone with experience in investment matters. Investment sourcing and investment execution is generally performed by the family office investment team, unless delegated to an outsourced CIO (“OCIO”) or similar adviser.

Clear and well thought through investment decision principles and processes are critically important. One of their objectives is to help in shifting from short-term individual objectives to longer-term inter-generational ones. Another is to act as guardrails for decisions by Principals who may or may not be experienced investors. We have observed many first-generation entrepreneurs in Asia who assumed that what made them successful and wealthy business people would automatically translate through to making them successful investors. Unfortunately, nothing could be further from the truth; the very instincts and behaviours that make successful business-people are often those that can make them fail as investors. Successful business-people in Asian markets tend to manage to tight iterative time frames, tend to take a lot of concentrated risks, vary their risk levels and exposures significantly with the business cycle, tend to make quick decisions relying on one version of the future influenced by their positions and views as business insiders, and tend to lead from the front and make most decisions alone. While these traits often explain how they built successful businesses, they do not translate well in investment decision making. Long-term investments require a long-time horizon, balanced but sustained risk-taking, carefully thought through decisions relying on different possible scenarios and, more often than not, consultation of peers with different views from yours. Having very clear principles, processes, decision making responsibilities is critical in managing this mindset transition successfully and in making it stick through generations. The white paper we highlighted above proposes a decision-making tool to address this issue[5] (see chart 2 below). Another white paper “Investment Committee Best Practice” sheds more light on this critical issue.

Chart 2: RAID Analysis of Family Board Investment Policy and Strategy Decisions

Investment Strategy

The investment strategy of a family office is different from that of an endowment or foundation. Family offices that are grounded in a founder or a broader family’s expertise, differentiated knowledge, or privileged access to resources, can leverage these assets to enhance their investment returns and can justify a specific skew as a result. It is very rare for an institutional investor to have such competitive advantages grounded in experience and expertise. So, especially, within the first generations, the family office’s investment strategy could be different from that of an institution and could derive outsized returns from non-traditional investment approaches. Globally, this is the case with technology entrepreneurs who can derive a privileged access to deal flow. In Asia, this is often the case with families with deep real estate expertise who can leverage it into adjacent businesses (e.g., hospitality or retail).

There is however a risk that such skews, however warranted, may create idiosyncratic, concentrated, and illiquid portfolios. In Asia, we often observe first generation portfolios assembled through personal connections including an eclectic set of both funds and direct deals. While some of these have performed surprisingly well from a returns perspective, they often demonstrate a sole focus on maximising returns investment by investment and scant attention to portfolio construction. As a result, these initial portfolios show poor resilience to market cycles and volatility. In this context, family offices, like institutional investors, still need to answer the following basic questions:

• Risk budget. What is the maximum acceptable drawdown on the assets, and over what period? How should the risk budget defined and measured?
• Illiquidity budget. What proportion of the portfolio is required to be accessed at short notice and what proportion can be held in long-term illiquid investments that may not be realizable for 10 years or more?
• Target Asset Allocation. What is the optimal long-term allocation across asset classes?
• Direct investment vs funds. To what extent should we invest directly into specific assets as opposed to investing through best-of-breed third-party asset managers focused within individual asset classes?

The endowment model, as codified by David Swensen, can be used as a framework for arriving at the best investment strategy for a family office. However, the model needs to be modified to take into account the family office's specific circumstances, such as its tax status and investment time frame. The result of this modification is generally a higher allocation to tax-efficient public equities, more liquidity, and more direct investing activity in areas of differentiated knowledge and access.

One final nuance between family offices and institutions is worth noting. Family offices often manage multiple pools of capital to accommodate varying goals, liquidity needs, and risk appetite of different family members. Managing a single consolidated pool offers investment advantages such as simpler operations, economies of scale, and access to larger investment opportunities. It also offers more flexibility for control of family assets and can make succession simpler. It is as a result the default model from an investment perspective for most investors. However, distinct pools can cater to individual preferences and risk profiles that matter greatly to family offices. A hybrid approach combining a core pool and satellite pools provides a balance between efficiency and customization. This is one of the most complicated decisions family offices need to make and the right answer depends on the level of engagement within the family, trust between family members and between generations, and the need for control of core family assets.

Family Office Resourcing Decision

Family offices often face the decision of whether to build an in-house investment team or outsource the investment management to one or several outside providers. There are benefits and drawbacks to both approaches. Building an in-house investment team can be more cost-effective for the largest family offices and provides more management control. However, it can be challenging to build such a team, and it can be difficult to attract the best investment talent. Outsourcing the investment management can provide access to world-class talent, expertise, and scale, but it requires to build capabilities to manage third parties and it is important to carefully select an outside provider and to ensure that its investment philosophy is aligned with the family's goals.

At the risk of sounding self-serving, we observe that many Asian family offices decide to in-source at insufficient scale. Managing a globally diversified endowment style portfolio cost-effectively requires meeting hundreds of managers every year and managing dozens of capital calls every month. This burden is only justified for assets under management in the billions. In addition, getting access to discounted fees, and in many cases getting access full stop, requires significant scale, which requires most sub-billion family offices to pool capital to invest in the best managers. As a result, a full in-house team can only be justified for the very largest family offices.

A hybrid model, where the family office manages some asset classes in-house and outsources others, can be a good option for family offices that want to balance the benefits of both in-sourcing and outsourcing. In Australia for example, we often manage the international allocation of family offices we work with while they take advantage of their insider understanding of their local markets and businesses to focus on their local markets. Key to success is the concept of partnership: putting the internal family office team in competition with outsiders is seldom fruitful, however theoretically appealing, especially at the early stages of building a family office. Collaboration, sharing information about managers and investment opportunities, within and outside of the mandate of the external adviser, as well as explicit knowledge transfer as the family office grows are much more important in building capabilities over time.

It is always important to review longer-term goals and organisational decisions periodically. Leaders and executives in family offices can take the time to step back and answer the 5 questions raised above. Two final thoughts: make it as complex as needed but as simple as possible and involve people you trust in this dialogue.

[1] Campden Wealth

[2] KPMG

[3] “The first generation builds the wealth; the second generation is inspired to preserve it by witnessing the hard work of their parents; and the third generation, having never witnessed the work that went into the creation of this wealth, squanders it”.

[4] For shorthand, we refer to “The Principal” as the owner(s) of the capital, who we presume is actively involved as the leader of the family office. This may in fact be multiple family members or may be a non-family CEO where family members are not present in the running of the family office.

[5] The RAID decision-making tool is used to define the roles of different participants in investment decisions. The four possible roles are Recommend (R), Approve (A), Input (I), and Decide (D). In a RAID analysis, the R role recommends a decision to the decision-taker, A role has a power to veto the decision, I role provides input and context to the decision and the D role is the most critical as this person makes the final decision.

Important Information

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