Investing is a major function of family offices, from those with founders in the investment field who are still at the reins to former entrepreneurs figuring out what to do with their windfalls.
When and how to expand investment functions—and whether to do it in-house or look outside for advice and services—is a big question for single- and multi-family offices, especially with opportunities that range from the markets to alternative assets and venture capital. Options range from beefing up internal resources to embracing a hybrid model or using outsourced chief investment officers (OCIOs).
Each approach has pros and cons. Families can have difficulty recruiting talent for in-house operations, not to mention the significant cost of salaries and benefits. But there are advantages such as greater control, more tailored strategies, savings in areas such as manager fees, alignment with family values and long-term goals, as well as enhanced confidentiality and more direct communication.
The challenges of going outside can include a loss of control over investment decisions, possible misalignment of interests as well as reduced transparency and potential conflicts of interest among third-party advisors. Outsourcing, meanwhile, brings access to specialized expertise and investment strategies as well as cost savings, especially for smaller family offices, as well as diversification.
You really have to find individuals or firms that are more of a fit, more of a culture, more of a continuity to the family itself.
Brennan Carson, partner and portfolio manager, Equate Asset Management
Zachary Schwartz, head of client relations and of investment manager research for East West Investment Management, a private investment office in Toronto, notes that the company’s evolution stemmed from a desire to expand its investing functions.
East West was started as a single-family office in 2009 by Richard Phillips to manage his funds after he retired from running capital markets at CIBC. As the company enhanced its external expertise and competencies in the fixed-income alternatives space, Phillips was approached by wealthy families looking to invest alongside him, giving it a broader portfolio management remit using third-party managers. Today it manages investments for affluent families, ultra-high-net-worth investors and single-family offices as well as third-party foundations, with Phillips as CEO.
What were the signs that Phillips needed to look outside for investment advice and management?
Schwartz notes that “one of the most commonly used expressions in portfolio management is, ‘Diversification is the last free lunch.’” This is especially the case with fixed income, where there’s asymmetry and you’re trying to protect your downside risk. “He realized, even with his level of experience, resources and human capital, that he could not achieve the requisite diversification—and by extension the sort of risk-adjusted returns that he was after—internally.”
The benefits of going outside vary depending on a family’s wealth and sophistication, Schwartz says. For example, families might not be able to make the minimum investment in a fund to diversify their fixed-income holdings and can benefit from having their capital pooled with others. On the other hand, the very affluent might be able to afford the research necessary at the macroeconomic and manager-specific level to keep their investing in-house.
On a practical level, going outside can help families and foundations with an area they often struggle with: moderating their relationships with managers, Schwartz points out. “To protect capital from time to time you need to fire a manager, and people are reluctant to do so.”
Steve Ivacko, a partner in Family Office Services with MNP in Vancouver, says that when hiring investment staff internally or outsourcing, the major question is, “What’s the diversification that the family wants and needs?” Many family offices in Vancouver are already heavily invested in real estate, he notes, and while some want to continue in that asset class because they know and trust it, others might look to specialists to branch out into technology startups, say, to “add some octane to their portfolio.”
To protect capital from time to time you need to fire a manager, and people are reluctant to do so.
Zachary Schwartz, head of client relations and investment manager research, East West Investment Management
Ivacko says families occasionally look for introductions to new investment advisors.
“People are always looking for opportunities, something different, something new, something they might be missing,” he notes. The result can be an individual who “puts the puzzle together for you specifically, or a large institution. It really depends on what the family wants and what they’re comfortable with.”
Determining whether to bring the resources in-house means calculating “what kind of returns are you going to get for the costs you’re going to be shelling out,” he says.
Even if family offices have some specialists on staff, “there’s still going to be an external component,” Ivacko adds, even if it’s as simple as investing in GICs through a bank. “It’s very rare that 100 per cent would be completely internal.”
Brennan Carson, partner and portfolio manager at Equate Asset Management, an OCIO based in Toronto, says the challenge in utilizing external resources in a family-office environment is “you really have to find individuals or firms that are more of a fit, more of a culture, more of a continuity to the family itself.”
Single-family offices are often started by entrepreneurial families in industries that shape their investment objectives and risk tolerances, he notes.
“It’s really hard to get an institution that has great alignment with what you’re trying to do as a family and who you are as a family,” he says. Outsourcing a component of your investments means “finding someone who really gets what you’re trying to do,” and can build a unique portfolio that reflects “not just the financial return and risk parameters, but the emotional and personal return and risk objectives.”
Carson says that a family in a multi-family office would typically be looking for an institutional asset manager with a large pool of assets that’s experienced, good at risk management, diversified and can provide access to an asset class or investment strategy the family can’t get itself. Meanwhile, a single-family office looking outside is more likely to opt for a smaller, niche manager “who is more willing to be collaborative in the relationship.”
CIOs of single-family offices will often allocate a small amount of money to a new opportunity because they “like the idea of working with a thoughtful, interesting strategy,” essentially seeding a fund and seeing where it goes. “Someone’s got to pack that first snowball to start rolling it down the hill,” Carson explains.
He’s seen a trend recently where investment professionals who are losing interest in being part of institutional, structured environments with billions of dollars are migrating to working with single-family offices. “They feel the different dynamics,” he says, adding that finding these “entrepreneurial family office-type investment professionals” could help with the family’s investment alignment.
Schwartz notes there are few single-family offices that don’t use some third-party investment managers. “You have to make sure if you are going to go outside for additional support that it’s a fair exchange of value and you’re getting what you’re paying for,” he says.
A mid-sized family office typically might have one or two investment professionals running a portfolio of equities directly for the family internally, while investing in private-equity opportunities through fund managers and co-invests. “It’s a question of what is your capacity in terms of financial and human capital to build a good portfolio?”
One of the biggest challenges of going outside is alignment, he says, as well as the potential for conflict of interest. Some investment groups are effectively placement agents being paid by managers or general partners, with families mistakenly thinking they’re getting “independent or unconflicted advice.”
Outsourced services can be structured in different ways, Schwartz notes, from purely advisory relationships, allowing the investor to retain control, to discretionary arrangements that “tend to work out better for the families, because they’re focused on their operating business or other investments.”
Carson points out that when family offices look outside for investment assistance, it’s important for in-house CIOs to understand their role.
“You really have to check ego and control at the door to be able to create a hybrid model where you respect and understand the limits of what you can do with the team in-house,” he says. “Bringing in those external resources is a complement, an additive; it brings fresh perspective and it allows for an objective opinion, because in a single- or multi-family office there can be groupthink.”
As Canadian family offices grow, they may bring more functions in-house, much like the evolution of the big pension plans over the past 40 years, Carson notes.
He adds that even with size and scale, however, “there’s a limit to how much of the globe you can cover, how much of the different investment strategies, how many different asset classes you can have in-house without having a massive team that erodes the net return.”
Mary Gooderham is a writer, editor and communication advisor based in Ottawa. She leads Cohen Gooderham Communications and has worked as a journalist for more than 40 years at The Globe and Mail, as a recording officer at the International Monetary Fund and as a custom content creator for online and print media. She’s been a contributing writer at Canadian Family Offices for four years, focusing on investment strategy, trusts, philanthropy, women in finance and estate planning.
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