Archives

by Marc J. Sharpe & Seth Morton

When you think about starting a family office or implementing a leadership change at your existing family office, the people you hire will determine to a large extent in what direction you go, and how successful you are. Of course, “if you don’t know where you’re going, any road will take you there.” George Harrison’s 1988 paraphrase of a famous exchange between Alice and the Cheshire Cat in Through the Looking Glass (1871) offers a cautionary lesson for any leader that does not have a clear vision for their organization.

Lack of direction can impact the most talented and competent teams, and result in a sub-optimal outcome for everyone. And it’s easy to confuse activity for results when you lack direction or key organizational objectives which determine your priorities. In such situations, mere survival is probably the most you can expect from your team.

Preventing a sub-optimal outcome requires an understanding of your organization’s purpose and the team you’ve built to serve that purpose. The tools you have at your disposal are your existing relationships, your financial resources, and the lens you use to perceive the world. These tools will lead you down a path that may or may not be ideal for what you ultimately want your family office to achieve. In economics and systems theory, the Cheshire Cat’s wisdom is expressed through the language of “path dependency” which describes this phenomenon. Simply put, decisions in the past shape the possible options and outcomes available to you in the future. [1]  Understanding the path dependencies that shape how information is perceived and managed is therefore vital to creating the team that is best designed to accomplish the objectives of your family office. After first considering some of the common path dependencies that shape family office team design, we will offer recommendations on how to manage these potential constraints. We will also provide some thoughts on how to incentivize and retain top talent once you select the right path for your organization to follow.

When it comes to structuring your family office, broadly speaking, there are three common path dependencies that family offices typically follow:

1. Trusted Informal Relationships
2. Trusted Formal Relationships, and
3. Professional Management.

These three paths describe the most common genesis points for any family office; and they typically predict the set of outcomes, strengths, and weaknesses that will define your family office, determine the road you are on, and the direction you are heading.

 

Trusted-Informal Relationships

With any major decision, our close friends and family are often the first people we turn to for help. The decisions that surround the formation of a family office are no exception. Frequently, the first hire at a de novo family office is a “Trusted-Informal Relationship”.  Examples of such relationships include college roommates, in-laws, old friends, and trusted former co-workers. These relationships are based on trust and have often been built over the course of a lifetime. They are precious and often deeply treasured. But are they truly the best people to build or run your family office?

From a path dependency perspective, Trusted-Informal Relationships are the most varied and hard to predict because the individuals themselves represent such different backgrounds. Although their skills may be diverse, what remains consistent is an extremely high level of trust and personal connection to you and your family. In the best situations, Trusted-Informal Relationships have the skills you need to build your family office and can speak candidly and directly, especially when it comes to challenging your ideas in ways that others would not feel comfortable. The highest and best use of their trust is to act as a counterpoint to challenge your own ideas in ways that are helpful and productive. Inversely, these individuals can struggle and fall short when they lack the confidence to speak up or the skills needed to build a high functioning family office team.

 

Trusted Formal Relationships

This category typically includes your trusted CPA, trust and estate attorney, or the company controller from your operating business, as an example, that has faithfully served you for many years in a professional capacity. These are people that have earned your professional trust (although perhaps not the same level of intimacy at the same personal and intimate trust level as those in the prior category).

As it concerns path dependencies, one of the challenges of hiring these people to build and run your family office is that they are often specialists and do not have the breadth of skills needed to build out a multi-faceted single family office. The proverb “if the only tool you have is a hammer, every problem is a nail” comes to mind. This phrase captures the very nature of path dependency relationships and is especially applicable when it comes to the Trusted Formal Relationships that make up a family office leadership team. An individual whose primary strength and expertise is in accounting will typically think about problems and solutions according to the logic of accounting. Similarly, a team that is primarily composed of private equity professionals will most probably apply a range of risk analysis and mitigation strategies to most aspects of the family office business. The ability to bring diverse backgrounds to problems is what generates new and better solutions, but it is easy to either push a team too far from their comfort zone; or worse, to miss out on practical solutions simply because it is outside the comfort zone of your team.

Trusted Formal Relationships can be most successful when they are empowered to engage outside experts to help in areas where they do not have the requisite knowledge and experience. Asking for help should be encouraged and finding ways to meaningfully expand the skill sets of your team will provide long-term value for your family office. In these situations, understanding the limits of your team’s knowledge and expertise is often more valuable than the knowledge itself. In these situations, understanding the limits of your team’s knowledge and expertise is often more valuable than the knowledge itself.

 

Professional Management

Consider the professional backgrounds of your leadership team and how those backgrounds line up with the long-term vision and goals of your family office. Most often, professional family office managers come from the world of wealth management, private banking, and private equity. However, this category extends to a whole host of high-level strategic operations and includes newly emergent professional roles, including Chief of Staff. In addition to a deep understanding of the investment landscape and financial world, the networks, and relationships these professionals bring are often their greatest asset.

While these offices excel in matters of due diligence, structuring, and packaging investments, they sometimes lack the ability to connect their expertise with the long-term vision of the family, especially if compensation packages are not aligned appropriately.  A mis-alignment of incentives can also lead to family offices that are extremely transactional in nature and which operate like privately owned hedge funds or private equity firms. These kind of family offices sometimes appear to be extremely transactional in nature. However, with the right team in place, and the right incentives, it is possible to build a highly effective investment office. Encouraging and incorporating a generalist-specialist approach with special attention to intergenerational transitions, long-term views, and building governance around family mission statements and investment mandates will help.

 

Managing Path Dependencies: The Generalist-Specialist Approach

The various starting points, and the path dependencies that produce an infinite spectrum of family offices (“each one is a snowflake”), is also a function of the breadth of services that a family office can provide.[2] Every family office is going to have its strengths and weaknesses, and every family office will be called upon to undertake projects that are outside the comfort zone of the team. Understanding the path dependencies that shape your family office can help you identify the types of cross-functional roles that will be needed to support and enhance your team’s capabilities.

For many, it’s impractical and unwieldly to hire a slew of full-time experts dedicated to different aspects of the business. And one might argue that the correlation between expert knowledge and success does not always lead to new and better solutions. This common cognitive bias is called “the expert myth.”[4] However, more often than not family offices require cognitively flexible and dynamic individuals that can accommodate a broad and diverse set of challenges. In fact, the entire phenomenon of creative economic disruption is based around the assumption, and historical evidence, that bringing new ways of thinking to old industries creates an economic and organizational net benefit.

The path dependencies of family offices and the bias of the expert myth both point toward the same set of solutions: the best and most resilient family office teams are made up of diverse groups of individuals that all have different backgrounds and areas of expertise. Managing teams like this is especially difficult, because the teams themselves represent so many different styles of thinking and working. As such, the best approach in this context is to take a “generalist-specialist” approach. The generalist-specialist knows a lot about a lot of things; and would be equally comfortable speaking with private equity analysts, trust and estate attorneys, business operators, family office principals, and many more. These types of individuals are often difficult to find through recruiters who are more accustomed to hiring highly defined functional or industry roles (i.e., the proverbial square peg for the square hole).

The generalist-specialist resume and professional background by contrast will typically show a diverse set of experiences. Cognitive flexibility, adaptive communication and empathy, the humility to know when experts are needed, and the confidence to know when and how to push against conventional wisdom are the hallmark traits of a generalist-specialist.

Whether the generalist-specialist you chose to lead the family office has the title of CEO, President or Chief of Staff, the actual responsibilities of the role depend much on the trajectory of the family office itself. Every family office will have its own organizational biases and path dependencies. What’s important is being able to identify the path dependencies that affect your own family office, understand what areas need to be improved based on the current and future objectives of the family office, and to design the most resilient and durable team for your needs.

As you consider how to build out or enhance your family office leadership team, consider the path dependencies that shape your current team’s capabilities. Instead of simply identifying what kind of experts you need to hire, consider cross-functional “generalist-specialists” that will both contribute to the current team and evolve with the myriad needs and desires of your organization going forward. This not only allows you to retain top talent for longer, but it is also often more cost effective and organizationally efficient over time. The road is long, and great talent is hard to find, but identifying highly adaptive leaders that can grow alongside you is well worth the effort.

 

[1] There is a rich body of research around the concept of Path Dependencies in organizational theory, physics, history, and economics. Niklas Luhmann, German sociologist and systems theorist, has emphasized the role of perception as constitutive to our understanding of path dependency. For Luhmann, the dependencies that structure systems are often functions of observation, rather than the other way around. This is good news for any change leaders: paths are not written in stone; they can be changed through a process of analysis and carefully structured decisions. For more on this, consider “The Autopoiesis of Social Systems” in Niklas Luhmann’s Essays on Self-Reference.

[2] In our whitepaper “Family Office Industry: Fact or Fiction,” we discussed this spectrum according to what we describe as “the two laws of family offices.”

[4] David Burkus defines the expert myth as “The belief that a correlation exists between the depth of a person’s knowledge and the quality of work that a person can produce.” Myths of Creativity, 2014, pg. 67.

 

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

by Marc J. Sharpe & Seth Morton

 

John D. Rockefeller retired in 1897, at 56 years old, having accumulated more private wealth than anyone in the history of capitalism. His retirement from for-profit enterprise made way for an equally vigorous career as a philanthropist. As a devout Baptist, he believed that it was his duty to continue working, but now instead of trying to make profit, he sought enterprises that would allow him to give his money away. What we might refer to as “The Rockefeller Model,” divides one’s career into two distinct halves: a career of wealth accumulation and a career of charitable activity. More contemporary philanthropic standards, like The Giving Pledge, and the rise of large foundations sponsored by family wealth, exist within, and expand upon the Rockefeller model.

While that model will continues to this day, with Bill Gates as the obvious modern day analog to John D Rockefeller, a new paradigm is emerging, with a set of practices that are reconfiguring how people think about business, capitalism, wealth accumulation, philanthropy, ethics, investments, returns, and value. Terms like “conscious capitalism,” “double bottom line,” “impact investing,” “environmental, social, & governance investing (ESG),” “sustainability,” “mutual aid,” “shareholder vs stakeholder outcomes” are introducing a new lexicon into the world of philanthropy and investing. The result is that the bright line between for-profit business and mission-driven philanthropy is becoming murkier and murkier every day.

In a generous reading of the situation, entrepreneurs and analysts are asking good-faith questions about the relative efficiency of capital. They ask, is it possible to structure a for-profit business in a way that would relieve the pressure for philanthropic activity altogether? Would that not be a more efficient use of traditional corporate capitalism? In a less generous reading, these activities greenwash (sometimes dubious) investments with marketing designed to pull at the heartstrings and make it appear a little more tolerable to allocate good money into questionable deals[1].

While it’s useful to keep the good faith and bad faith renditions of these arguments in mind, the primary purpose of this whitepaper is focused on understanding the landscape of impact investments, and defining what is often a vague and ill-defined nomenclature, in order to help family office investment teams navigate these murky waters. In the face of a rapidly changing environment, it’s all the more important to understand the ground you’re standing on. In the context of impact investing, that means being able to make distinctions between the major trends in impact investing in order to develop your own methodology for incorporating these ideas into your diligence process. It’s also important to maintain a bright line distinction between for-profit and not-for-profit activity. While the landscape around for-profit business is evolving, that is no excuse to simply collapse mission driven goals together with for-profit activity. At their root, these designations are important tools in your total balance-sheet, especially as you’re looking to optimize tax efficiency.

 

Defining Terms

The four most common terms used to describe these emerging strategies are Impact Investing, ESG (Environment, Sustainability, & Governance), Sustainability, and Conscious Capitalism. These terms overlap in many ways and differ in others. In casual conversation they’re often used confusingly and interchangeably. What these terms share is a commitment to a profitable outcome, measured financially, as well as a commitment to another set of values, measured according to a different set of metrics. Additionally, there is a shared belief across these philosophies that the consideration of non-financial factors should not come at an expense of the ultimate bottom line. To the contrary, the position that these investment philosophies uphold is that a more complete understanding of impact and investment outcomes will ultimately increase the value of the investment.

 

Impact Investing

The term “impact investing” is, in our opinion, the broadest, most all-encompassing, and least meaningful. Looked at from one angle, almost anything can be construed as an “impact investment.” This very article has used the term “impact” because of its capaciousness, not because it carries with it a special meaning. “Impact Investing” is a placeholder term. It shows that the organization using the word is either making a space for further definition or is trying to reframe (or greenwash) an existing investment or strategy in order to make it seem more impactful than it might otherwise be.

The problem with the term is that there are no standards or considerations as to what would make an investment an “impact” investment. As a family office investment analyst, you should engage with the term “impact” with care. If you’re evaluating an “impact investment,” be sure to drill down into the specific ways the sponsor understands and defines the term. In the best-case outcome, pressing this line of questions will reveal a more comprehensive strategy; in the worst case, the term will be revealed as a largely meaningless designator, like the word “unique.” In either case, it falls to you to evaluate of the true investment impact and the extent to which it aligns with your family office goals and values. Be aware that the term impact may not carry the weight you want it to. Expect that an engaged audience will ask you to further define what you mean by impact.

 

Sustainability

Although “sustainability” is a popular concept, in the realm of impact investing it is not much more meaningful than “impact.” A sustainable investment could be focused on a set of environmental outcomes, as in a company that is not degrading or damaging the local community or environment; or it could refer to a capital strategy that is “sustainable” in that the business has a low turnover, efficient with capital, and requires little from outside managers.

Whereas “Impact” is ambivalent and omnidirectional in its provenance, sustainability adds a sense of efficiency. A business might qualify as sustainable if it has a high employee retention rate, efficient capital management, or a low energy or environmental impact. In contrast to “impact,” “sustainability” also imparts a notion of maintaining the status quo. To sustain is not necessarily to change, and this might be the most important difference between it and impact.

One way that “sustainability” becomes more meaningful is through an organization like US SIF, The Forum for Sustainable and Responsible Investment. US SIF takes “sustainability” as their watchword, and underneath that term they build an understanding of environmental, social, and governmental metrics (ESG). The mission statement of US SIF is to “rapidly shift investment practices towards sustainability, focusing on long-term investments and the generation of positive social and environmental impacts.” US SIF expands this mission through its declaration of values; “environmental, social and governance impacts are meaningfully assessed in all investment decisions resulting in a more sustainable and equitable society.”[2] US SIF connects with international advocacy groups; offers education for asset managers, retail investment professionals, financial advisors, and community-based investment platforms; develops policy proposals for investments via the SEC; and acts as a central hub to build a network of investment professionals that are committed to a shared set of standards for sustainable investments.

While the US SIF is a major player in the space, it is not all things to all people. They work with some large family office foundations, however the major focus of their education and advocacy is directed toward retail investors and investment managers. Family offices often have more institutional needs and capabilities, as such these retail-focused offerings should be read through the lens of your particular family office needs, wants, and capabilities. If “sustainability” is the key word that is driving your family offices’ efforts in impact, be sure to carefully define the term according to your target outcomes.

 

Environment, Social, and Governance (ESG)

ESG Investing was one of the first technical approaches to frame this kind of thinking within the context of more traditional securities analysis. The CFA Institute uses ESG in order to mark a set of risk-mitigating protocols and considerations that any securities analyst or marketing firm should utilize in an effort to market or analyze a security.[3] The terms themselves are meant to be somewhat open to interpretation, because the ultimate outcome that the CFA wants to cultivate is one focused on a more comprehensive risk matrix. As such environmental may refer to specific environmental risks associated with an energy plant or with the health and safety concerns within an oil refinery; social risk might refer to strained relationships between management and the labor force; and governance might refer to potential regulatory changes or shareholder activism.

In the rather dry landscape of risk-mitigation, it’s no wonder why an organization like US SIF is compelled to overlay ESG with their concept of sustainability. ESG on its own does not necessarily lead to an “impact” or “sustainable” outcome. While ESG is the most robust framework for analyzing and measuring various forms of risk analysis, it’s also the easiest to “greenwash” investments, because the metrics themselves do not require any special lens in order to qualify as a sound “ESG” measured investment. On their own, ESG considerations are helpful in producing sound analysis, but they are insufficient in underwriting an impact outcome on their own. When evaluating ESG opportunities, pay special attention to the values that are motivating these metrics. Is it coming from a well-grounded theory of sustainability or mission-driven objective, or is it merely a more comprehensive way to risk-mitigate the security or investment? Or something worse, an attempt to greenwash an investment by ticking the boxes on an ESG checklist?

 

Conscious Capitalism

In comparison to the three terms above, conscious capitalism simply introduces a new lexicon to what is an old conception of how capitalism, when done right, should be practiced. The term as its commonly used, refers to a set of practices that aim at achieving a broader and deeper understanding of capitalism as an economic endeavor. The intended result of these practices is twofold: First, the shift of focus moves from strictly maximizing (short-term) shareholder value to include optimizing outcomes for a broader set of stakeholders. These stakeholders may include anyone who is affected by the business’s activity. When decisions are made in light of stakeholder outcomes, then stronger (long-term) alignment emerges between the business, its owners, operators, customers, and the community. Second, the time-horizon expands to consider longer-term outcomes. Consciousness in this sense not only refers to an awareness of how decisions you make today have an impact today, but also how the decisions you make today will impact your stakeholders further out into the future. These two insights are intertwined, but distinctly refer to two different sets of analytical and operational practices.

Organizations such as Conscious Capitalism Inc., a non-profit organization, supports business leaders that want to incorporate these kinds of practices into their business culture. Other such organizations – like Good Business or Certified B Corporation – are similarly aligned non-profit organizations that hope to cultivate a new understanding of business. Their credo is as follows: “We believe that business is good because it creates value, it is ethical because it is based on voluntary exchange, it is noble because it can elevate our existence, and it is heroic because it lifts people out of poverty and creates prosperity. Free enterprise capitalism is the most powerful system for social cooperation and human progress ever conceived. It is one of the most compelling ideas we humans have ever had. But we can aspire to even more.”[4]

From this credo four core themes emerge: Higher purpose, stakeholder orientation, conscious leadership, and conscious culture. Unlike ESG risk analysis, or even the educational tools offered by an organization like US SIF, implementing conscious capitalism in your investing strategy requires a more holistic and philosophical approach. To put it bluntly, it requires that you take seriously the “conscious” part of the equation. The ultimate purpose of conscious capitalism is the development of a prosperous ecosystem, one that encompasses all of the terms discussed above. In some ways this is the highest bar to achieve as a portfolio manager, but it is also the most rewarding.

Conscious capital practitioners believe that private enterprise has an important role as a force for good in the world. If your family office is looking to develop a more sophisticated approach to ‘impact’ investing, we recommend this approach as one worth exploring further. Of course, as with all investment-related endeavors, the more you know about your desired outcomes, the more you can navigate these waters.

 

Final Thoughts

Impact advocates insist that there is moral and financial premium that is earned through impact investing. According to this view, impacting investing is not only good, but it is also more profitable in the long run. In some cases this may be the case, and over time that may be easier to achieve, but more often than not there will be trade-offs and sacrifices that a Chief Investment Officer will have to make in order to achieve a desired impact target. Given the potential trade-offs, it is especially important to define what objectives and concepts are most important to your family office investment plan and to organize your portfolio according to how your current holdings line up with that plan. With that initial knowledge you can start to implement an allocation strategy that slowly incorporates more opportunities that achieve your desired impact outcomes while maintaining overall fund performance.

The world of capital is a lot more complicated than it was for John D. Rockefeller. While there is a temptation to think that the abundance of new terms related to investing with ‘impact’ is merely the clever proliferation of greenwashing tactics, the truth is that these terms point to a vigorous and ongoing secular shift, raising fundamental questions about best practice for a family office’s investment capital. This whitepaper only scratches the surface of a topic that is on the mind of every investment professional and institution today. The sheer breadth of the terms we discussed speaks to the many challenges that will likely cause this subject to remain ongoing and undecided for the foreseeable future. Looking ahead, we hope to see the emergence of more concrete standards and metrics. In the meantime, there is an opportunity for family offices to lead by example by simply initiating these conversations and beginning to implement specific strategies.

 

[1] One might also note that adding a subjective element to investment selection may help the ‘active’ management crowd, who are long suffering when it comes to their performance relative to low cost passive investing strategies.

[2] US SIF Mission and Values, from their 2019 Annual Report.

[3] “Environmental, Social, & Governance Issues in Investing: Guide for Investment Professionals” CFA Institute, 2015

[4] https://www.consciouscapitalism.org/credo

 

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

 

All major faith traditions, ethical systems, and moral codes emphasize the importance of charitable giving. Saint Paul puts it succinctly: “He which soweth sparingly shall reap also sparingly; and he which soweth bountifully shall reap also bountifully.” The stoic philosopher and Roman statesman Seneca offers a complimentary view: “We should give as we would receive, cheerfully, quickly, and without hesitation; for there is no grace in a benefit that sticks to the fingers.”[1]

The highest goal then is to give cheerfully and without hesitation. However, the modern cynic, and probably you and I, for justifiably prudent reasons, would counter that one must also give responsibly. The joy of giving is easily crushed when donations produce little change or, worse, are wasted or stolen. By the same logic, increasing your philanthropic allocation will not proportionally increase your joy. Developing an informed approach is crucial.

 

Increasing Joy Without Decreasing Prudence

If giving should be joyful, then how can one increase joy without sacrificing the crucial role of diligence in order to make prudent and informed decisions?  Looking through the lens of process can help diagnose and understand the overall ecosystem of a family office’s philanthropic work. A family office philanthropy team can enter the space with the best of intentions only to emerge jaded by bad faith actors and overly complicated structures. The result is that they become disenchanted with the potentially rejuvenating and rewarding work of giving, which then reverberates throughout the family office. In this scenario, rather than a source of joy, philanthropy becomes a burden, or just another way to build a tax efficient balance sheet.  The fault doesn’t lie with any individual or organization, but rather emerges from a locus of forces and constraints that make it difficult to do philanthropy well.

The most fundamental force is simply the scale of the problem itself. An unintended consequence of being a global citizen is the inheritance and enormity of global problems. The scale of the problems are often so great that no individual or group of philanthropists alone can solve it. Against such large-scale problems, even large acts of giving appear like a drop in the bucket. But despite the enormity of the problems, and complexity of the system, one can still do philanthropy well. Doing so requires careful design and the ability to mediate a healthy cynicism with a sincere desire to improve the world in a meaningful way.

It’s for these reasons that family offices must proceed with the utmost care and caution — but proceed all the same. The rise of new qualitative metrics like Environmental, Social, and Governance (ESG) and the broader category of “Social Impact” evince the tidal shifts that are underway in public and private markets.[2] The rise of impact investing is in part born out of the realization that the private sector has an immense influence over a host of non-financial outcomes.[3]

Despite these commercial trends, there will always be a need for philanthropic citizens; if for no other reason that not every worthy cause can (or should) be profitable. The division between philanthropy and ‘for-profit’ impact investment is complex and merits further analysis, but for our purposes it’s important to simply note that there are some endeavors that produce desirable social goods but will never themselves be profitable[4].

 

Measuring Giving Practice

To help your assessment of your own family office’s approach to philanthropy, we offer four assessment ‘metrics’ for consideration. These metrics are qualitative in nature and are meant to inspire critical thinking and analysis. Alongside these metrics is a heuristic that offers one way to think about portfolio construction. The most important take away comes from the ancients themselves: giving should be joyful. If you are happy and content with your giving practices, then continue in your path as a joyful giver.

1. Fluidity

The concept of fluidity assesses the overall speed of your giving. How easy is it for you to give? How long does it take you to get comfortable with a new organization? The counterforce to fluidity is drag. These are not moral terms; speed is not a universal good and drag is not a universal bad. Philanthropy is much harder to analyze than investing because the return on philanthropic giving is social, not financial. The nation’s wealthiest individuals have voiced this sentiment. Elon Musk, on January 7, 2021, tweeted that finding impactful ways to donate money is “way harder than it seems.” While Musk is at the beginning of his philanthropic journey, the Bill and Melinda Gates Foundation has 1,600 employees and an endowed trust of $49.8 billion dollars. Even with a large staff and annual contributions from Warren Buffet, the foundation supported grantees with only $5.1 billion in 2019.[5] Based on the Gates Foundation public disclosures, the organization could easily sustain an annual giving budget of about $7.5 billion and still remain within their stated goals and objectives. The need and the resources exist, but the processes and systems increase the drag and slow down the overall impact.

From a macro perspective, the problem of an illiquid philanthropic ecosystem is evinced through the capital held up in donor advised funds (DAF).[6] In 2018 total contributions to DAFs grew by 20% to $37.12 billion. Total charitable assets in DAFs were $121.42 billion in 2018. Despite the increase in funds, the aggregate grant payout rate remains around 20%. While the DAF payout rate is higher than what private foundations are required to give, there is a tremendous amount of capital stuck in DAFs. Unlike an institution like a foundation, the purpose of a DAF is meant to streamline the giving process between making the gift and deploying the gift. Part of the disjointedness emerges because the benefit to giving to a DAF is secured once the gift is made, not when the gift is deployed. In other words, the incentives to make the gift are higher than the incentives to deploy the gift. If DAFs only deployed 20% of their assets in 2018, does that mean that there were only $24.28 billion dollars of worthy organizations? Given the scale of the national and global problems and the amount of human and ecological suffering, it would appear that the problem is not the lack of need, but rather the lack of fluidity.

Your success as a giver is secured through trust and knowledge, both of which require time and patience. As a general principle, the more you trust the individual or organization, and the more you know the details of their organization, as well as their mission, the more quickly and fluidly your giving will be. The conclusion of this paper outlines a few practical strategies that can help increase the overall fluidity of your philanthropic practices without losing the important and necessary work of diligence and building an informed understanding. As a family office philanthropist, reflecting on the fluidity of your own giving practices may help you discover new ways to optimize your overall practice.

2. Transparency

There are two lenses through which one can analyze transparency: authenticity and integrity. Authenticity captures the extent to which claims line up with actions and intentions. Integrity speaks to how the practices of the organization fit within a larger social and economic milieu.

Authenticity is the surest way to establish trust in an organization. Do they do what they say and are their operations open for careful diligence? In extreme cases, inauthentic organizations may be acting fraudulently, however a more common occurrence is simply the marketing claims of the organization not living up to the experience and practices on the ground. Because there is such a strong connection between the story of an organization and their ability to attract donors, sometimes the claims of the organization outgrow the operations. Stakeholder analysis as well as program and financial analysis and track record are critical factors for any analyst here.

The concept of integrity, in this instance, refers to the human, social, and economic stability of the mission of the organization. A clear example of an unstainable practice is found in the practice of donating basic supplies – like clothes – to poor nations. In the case of Haiti, donated T-shirts end up being sold for pennies on public markets. The result disrupts the local economy, puts skilled craftsman like tailors out of work, erodes community-based knowledge, and creates a dependency between the developed and undeveloped world that cannot be easily undone.[7]

There’s no easy way to analyze the sustainability of an organization but empowering your team to investigate the secondary and tertiary consequences of an organization, with the same level of rigor that they bring to private investment opportunities, and working with experts in the space will help build a more sound and thoughtful overall strategy and mission to your philanthropic activity. Becoming a subject-matter expert in a specific region or theme allows you and your team to build a specific knowledge base in order to understand the major players and the best and most effective strategies.

3. Efficiency and Effectiveness

While the concept of fluidity and drag represent one way to understand efficiency, the concept broadly speaks to all the forces that either impede the flow of capital or dilute the use of capital. Drag is both quantitative and qualitative. There are ways to measure the efficiency of the gift, but one must also reflect on the other forces that are causing one to “drag their feet.” Is the gift outside of your comfort zone, do you have reservations about the organization, do you question the larger impact and purpose of the gift, are there competing interests that make an equally strong case for another kind of organization?

As was the case with DAFs, analyzing the relationship between the dollars committed vs the dollars deployed is one way to measure overall portfolio efficiency. Another equally important metric is the measurement of operational overhead vs deployed capital. It’s not always the case that low overhead costs mean well managed money. More important is the organizations justification and analysis of their own overhead costs and how those line up with your own ideas. Robust organizations that are looking to build a charitable legacy need to create worthy incentive structures in order to attract and retain top talent. Similar to building a family office team, finding the perfect balance between operational efficiency and rewarding incentives is an ever-evolving dynamic. When it comes to philanthropic activity, the best place to begin is simply with validating the claims of the organization itself. For example, “Food for the Poor”, got into trouble because its marketing claims used cash and noncash donations to appear much more efficient than it actually was. Eventually the state of California issued a cease-and-desist order to “Food for the Poor” and this is a cautionary tale in the importance of careful diligence[8]. Although your gifts will not be measured through an ROI, it is vital to work with experienced professionals that can help identify robust, authentic, and well-designed organizations that will help you achieve the social objectives of your philanthropic gifts. Those that you empower to help steward your capital toward these ends must be as diligent and rigorous as the investment team that structures and negotiates private investment or public securities.

4. Joy

It’s difficult to write about joy in a rigorous way, but it may be the most foundational and important ‘metric’ on this list. Giving should be joyful. When organizations you’ve given to in the past call you, or your philanthropy team reaches out to have a meeting, do you feel joy or dread or nothing at all? If the feelings are negative, then it may be time to undergo a deeper review of your overall strategy and goals. If you already experience joy, then how can you continue to foster and grow that experience for yourself, your team, and your peers? One important relationship is the connection between joy and knowledge. By joy, we’re not referring to the superficial rush one experiences when one makes a large gift. The kind of joy outlined by St Paul and Seneca is sustainable and grounded in knowledge. Making informed choices and knowing that your actions are making a real and significant impact in the world create a foundation for becoming a joyful giver.

 

Putting These Metrics into Practice

Hopefully these four metrics help put your own giving practices into perspective. If that’s the case, then there are some easy-to-implement strategies to improve your giving practice. First: Curate your portfolio. Pick a few organizations to get seriously involved with. Organizing around a specific theme is a great place to start. Second: Become a subject matter expert. Build a knowledge base around the theme, expert writers and thinkers, and major organizations and efforts. Third: Identify opportunities for outsized impact. Large gifts can seem small when given to massive foundations; alternatively, local organizations or more niche strategies may allow you to make a massive difference within a particular area. Extra diligence is required when working with newer organizations, but the opportunity to grow alongside an organization while it builds out its capabilities Finally: Become engaged with the community. Get to know the groups that you’re most active with and look for opportunities to become a board member or advisor.

While these strategies offer a framework for deploying enlightened capital, you can supplement this strategy with a separate pool of funds for more spontaneous gifts, akin to a pipeline for future opportunities and research. From a risk management perspective, 80% of your allocation may be dedicate to your core area, while 20% you keep on reserve for new opportunities.

We hope by putting the above strategies in place it will help you to add more joy to your giving!

 

 

[1] For more of Seneca’s writings on charity, see On Benefits, perhaps the first extended work on the nature, purpose, and value of charity.

[2] For our thoughts on ESG and Impact Investing, see our earlier publication “Impact Investing: What Family Offices Must Consider.” https://tfoatx.com/wp-content/uploads/2021/01/Whitepaper-2.0-Impact-Investing.pdf

[3] According to Charity Navigator, philanthropic dollars represent only 2% of GDP. While that 2% can make a tremendous impact, they must be managed and deployed with utmost care. https://www.charitynavigator.org/index.cfm?bay=content.view&cpid=42

[4] Education is one example: the value of an education is unmistakable, but the gains themselves may not be realized for years or for generations. Hospitals and healthcare are also excellent examples. Hospitals in the 19^th century were largely funded through religious organizations and churches. Their existence was wholly dependent on philanthropic commitments. Today we view hospitals and healthcare as an essential part of our society, not merely as an act of charity.

[5] Gates Foundation Fact Sheet. https://www.gatesfoundation.org/Who-We-Are/General-Information/Foundation-Factsheet

[6] See Mark Schoeff Jr. “A Better Way of Giving,” Investment News, 22 March 2020. https://www.investmentnews.com/a-better-way-of-giving-190446 and the National Philanthropic Trust’s 2018 DAF Report: https://www.nptrust.org/reports/daf-report/

[7] Patrick Moynihan has written about this exact phenomenon, which he witnessed first-hand during his time with The Haitian Project. https://www.catholicnewsagency.com/column/t-shirt-mistakes-2029

[8] Martin Levine, NPQ: Nonprofit Quarterly, “Food for the Poor: Questionable Tactics Threaten its Credibility and Reputation. 6 June 2018 https://nonprofitquarterly.org/food-for-the-poor-questionable-tactics-threaten-its-credibility-and-reputation/

 

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

By Marc J. Sharpe and Seth Morton

“Fear of Missing Out” (aka FOMO) is that anxious feeling of not being included in something with others, such as an interesting or enjoyable activity. The concept was originally used to describe social behavior, a form of self-inflicted peer pressure to participate in social activities. More recently the term has been taken up by the behavioral finance community to describe how investors follow the trades of others in order to “not miss out” on the next big thing. FOMO is a common experience, but in the world of investing it is usually associated with poor decision-making. After all fear rarely provides a solid basis for clear, rational decision making.

The massive breakouts in Bitcoin and other digital assets in the past few years have created many FOMO inducing moments. At The Family Office Association (“TFOA”) members experienced such a moment in late 2017. TFOA often hosts dinners for our family office members to meet with industry experts and learn from leading practitioners about a variety of topics. Over the years we have found that one of the best ways to diligence a manager is during a private dinner where questions and ideas can be openly asked and answered. Our dinner conversations tend to be both candid and fun; and our diverse membership of experienced family office CIOs, CEO’s, Principals and Presidents provide unique and different perspectives.

For this particular dinner we invited the head of a relatively new crypto fund to host a dinner for members in the private room of Pappas Bros. Steak House in Houston, TX. An impressive oak paneled room with wine racks from floor to ceiling offered members the intimacy of a closed door private meeting and the perfect setting for friends and colleagues to visit. The theme of the dinner was “The Facts, not Hype, of Crypto and Blockchain.” At the time the fund’s assets under management were small, around $40M, but the founder was exceptionally knowledgeable about the space and members were keen to learn more about what was really going on and how they should best position themselves. The conversation was fascinating. Many questions were asked, steak eaten, and wine drunk. However, it was perhaps a little early in the evolution of crypto for some of the more skeptical participants to see how this interesting new technology might translate into a viable asset class. Other members saw the potential for asymmetric upside and followed up with the manager after dinner to learn more. The skepticism of those members who chose not to invest wasn’t entirely misplaced as, five years later, digital assets are still perceived by many to be pure risk capital. After all, not many assets maintain a valuation range from zero to infinity, which is what digital assets currently appear to offer. For those that didn’t choose to invest, it is understandable that at that time the opportunity appeared too aspirational and too technical. Five years ago, there was still much to understand about this new asset class. Today, the fund manager who hosted that dinner now overseas an investment business with more than $6.5 billion in assets under management (withmuch of that growth from investment performance). Like we said, the experiencecreated a FOMO inducing moment!

In hindsight it was an obvious bet, but the fact of the matter is that in 2017 the most common question surrounding crypto was simply “what is crypto?” Today the question is more along the lines of “what is your crypto strategy?” The conversation has moved considerably in five years. Having said that, and despite how much more knowledgeable we all are today, many family offices are still in the process of developing their own approach to digital assets.

According to UBS’ 2021 Global Family Office Report, 13% of family office respondents have already invested in cryptocurrencies, and an additional 15% have it under consideration.[1] Family offices are ahead of institutional investors, who are just now beginning to dip their toes into the space, but the asset class still remains outside a traditional asset allocation. As family offices continue to develop their post covid allocation strategies in parallel with the increasing awareness and adoption of digital assets from a broad spectrum of investors (from retail to institutional), it is more important than ever for families to consider how digital assets may or may not fit into their allocation strategies. To that end we would like to offer some perspectives to help frame how family offices might approach the topic.

Risk Capital

First and foremost, digital assets should be considered pure risk capital. And from a family office perspective, it makes sense to frame a crypto strategy within the overall risk capital budget. Digital assets are new, largely unregulated, and based on technology that is quickly evolving. The lack of regulation has made it exceedingly difficult to invest with conviction for any professional investor or those with a fiduciary responsibility to others. This framework is changing, and institutional investors are beginning to allocate a portion of their risk budget toward digital assets. The continued development of institutional fund strategies is accelerating that process. From a risk calculation perspective, a relatively small allocation can yield tremendous upside.

New coins and tokens can be quickly developed with open source coding, but the resilience of these new coins is largely based on how many people invest, adopt, and remain committed to a particular coin. This means that many emergent coins are very much tied to the success of their marketing campaigns. Therefore, picking coins carries the same kinds of risks as betting on horses at the racetrack – while they look promising, with great form, there’s no guarantee they won’t fall at the first furlong – so finding experts in the space and investing in the underlying technology seems more prudent than simply following Reddit discussion boards or other online communities.

Crypto bears have pointed to China’s recent regulations and the banning of miners while bulls point to El Salvador’s President Bukele who named Bitcoin legal tender for the country in 2021. The more established crypto currencies, like Bitcoin and Ethereum, have established a much larger and stickier share of the market. In the case of Bitcoin, the algorithm is designed to produce a fixed number of total coins, which will be completely mined by around 2140. Although the technology is new, the concept of limited supply serving as a store of value is not. However, if your primary motivation toward Bitcoin is as a store of value, then you must be mindful of how you plan to access that store of value. This is as much a question of privacy and security logistics as it is technology. Physical wallets allow you hold your coins but add an additional layer of risk. If the drive is lost or destroyed, your coins are gone as well. On the other hand, in a situation where you need access to your coins quickly, nothing can beat the speed and efficiency of a digital wallet that you fully control.

Patient Capital

Family offices are uniquely positioned to take advantage of investments over a long time frame. Many have the luxury of being able to deploy capital over generations. While Bitcoin prices may swing wildly on any given day, if your conviction about Bitcoin is based on a belief that it is Gold 2.0 and a better store of value, it’s not unreasonable to conclude that given the limited supply and algorithmic nature of the blockchain, the ultimate value of Bitcoin move higher over the long term.

Currently the IRS treats virtual currencies as property, and they are taxed in accordance with capital gains.However, other government agencies are arguing for different classifications. Not surprisingly, the SEC sees digital assets as securities while the CFTC believes they are commodities. While it is reasonable to assume a “J-Curve” pattern with the asset class in relation to future regulation – the assumption being that regulation will eventually drive down valuations as some investors don’t agree with the regulatory framework, but that over time regulation will make it easier for institutional investors to move in with greater force, thus raising long term valuations far above the initial dip – nobody knows exactly what the time frame for such a development might be. In the meantime, digital assets remain risky by nature but over the long term winners will emerge and there can be no denying that blockchain technologies offer a tantalizing prospect for decentralized finance and smart contracts.

Flexible Capital

In addition to patient capital, families also have access to flexible capital, namely, they can deploy capital with a flexible mandate that does not only require profit maximization, but also take into consideration legacy andimpact. From this perspective, an allocation to digital assets must fit within an impact investing or ESG framework. An investment in digital assets should be flexible in the sense that it may generate positive or negative social or environmental returns, but it should also be tactically flexible given the rapidity of development within the space. Today, each Bitcoin requires energy consumption totaling 1173 kWh/ pertransaction, which in U.S. energy terms would equal about six weeks’ worth of average household electricity.[3] Other coins and new technologies are significantly driving down the energy load for transactions. Questions around energy usage will continue to be a feature in the discussion around digital assets. It is a complex topic. While digital assets appear to use more energy than other forms of currency, the total energy load to mine for gold or run a global fiat banking system is also vast. The relative impact of digital asset energy usage needs to be weighed against the environmental costs of producing other stores of value, like gold mining, which rely on heavy machinery and industry. And digital assets have the ability to utilize forms of energy and electricity that would otherwise be wasted or are currently underutilized. Of course, heavy industry also benefits the economy by creating jobs.Given the complexity of the subject, the many competing narrativesprobably tell you more about personal biases towards crypto currencies than anything else.

For family offices, what is most important is understanding what the question of digital energy means for you, and this question highlights the importance of flexible capital. If a family officecan’t reconcile the energy requirements of certain digital assets against their ESG mandate, there may be other strategies that better align with their goals. For example, Bitcoin mining operations that seek to stabilize and more efficiently utilize the electricity grid may be one such example. Indeed, the speed at which new technologies are coming online to solve these issues is startling, even within the context of a disruptive sector.On the other hand, placing too much faith in technology to solve problems is a common fallacy, so it is prudent to approach new solutions with a certain amount of skepticism[4].

Beyond FOMO

Trains or tulips? As we think about digital assets in the context of the long history of capitalism, examples of transformative industries like the 19^th century railway industry come to mind; followed quickly by the famous17^th century Dutch tulip craze with its ultimate and inevitable flop. Will digital assets prove to be more like the former or the latter?

Perhaps it’s still too early to say, but even if one’s convictions are on side of trains rather than tulips, it’s important to remember the rail industry took many years and saw many failures before stabilizing into a successful system of logistics and travel. History teaches us that family office allocators can’t afford to make decisions based on hype or excitement. Fortunately, in addition to all the FOMO around this asset class, there is also a growing body of knowledge and resources to help develop strategies for prudently allocating to digital assets.

Since the Great Recession, the market size of crypto currencies has swelled from zero to trillions of dollars. That’s a lot considering only a few years ago Bitcoin investors were perceived as fringe actors in a speculative technology with mysterious origins and a uniquely libertarian philosophy. Many of these pioneers are now immensely rich and the future for crypto, decentralized finance, blockchain, and the metaverse, seems boundless and unlimited.

While family offices should proceed with caution, today there is no excuse for not “going down the rabbit hole” to better understand digital assets and develop an approach that fits their strategic asset allocation goals and objectives.

 

[1] Report available at: https://www.ubs.com/global/en/global-family-office/reports/gfo-r-21-4-client.html

[3] According to a report from Money Super Market: https://www.moneysupermarket.com/gas-and-electricity/features/crypto-energy-consumption

[4] Additional information on cryptocurrency energy usage can be found in the New York Times: https://www.nytimes.com/interactive/2021/09/03/climate/bitcoin-carbon-footprint-electricity.html and Harvard Business Review: https://hbr.org/2021/05/how-much-energy-does-bitcoin-actually-consume

 

Marc J. Sharpe is the founder and Chairman of TFOA, an organization formed in 2007 to provide a forum for education and networking and to serve as a resource for single family office principals and professionals to share ideas and best practices, pool buying power, leverage talent and conduct due diligence. Mr. Sharpe is active in the community and has served on the Board of the Holocaust Museum Houston, the HBS Houston Angels, and on the Investment Committee for two Texas based foundations.

Seth Morton, Ph.D. has served family offices in areas of investment diligence, execution, and management; governance; research; communications; and multi-generational, sustainable legacy planning. He seeks to improve team performance by cultivating learning-focused and communications- driven processes that deliver exceptional results. He and his family are currently based in Texas.

 

TFOA is a peer network of Single Family Offices. Our community is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.

 

by Marc J. Sharpe & Seth Morton

 

New and established single family offices are beset on all sides with family office networking opportunities. Most of the self-proclaimed family office networks are run for-profit, with a few  notable ‘non-commercial’ exceptions. Some of the networks look like multi-family offices, or loosely affiliated groups of family offices; others are simply trying to cobble together industry-specific conferences or deal platforms. When it comes to the issue of how best to navigate these networking opportunities, we recommend a Marxist approach. Not Karl, but Groucho: “Refuse to join any club that would have [you] as a member.”

Groucho’s self-deprecating criticism of club culture reminds us to always proceed with skepticism and caution. His humorous refrain raises a question about the core intention of any club that is targeting you as their ideal member. This question should always be at the front of one’s mind when considering joining any  family office network or community or attending any family office conference.

The world of family offices is growing, but it is still relatively small. While multiple reports have put the number of family offices around the world in 2019 at around 7,300 — which represents about a 38% increase over the last two years — we believe the number of true single family offices to be considerably smaller.[1] This small, asset rich, but growing market has seen a precipitous rise over the past five years in the number of networks, clubs, and associations that claim to connect and serve family offices.

Despite the rarity of true single-family offices — especially multi-generational, sustainable family offices, with stewardship across the entire spectrum of a family’s assets and wealth — the family office space has become increasingly filled with ‘everybody and their dog’ claiming to have a family office. Part of the problem is that the term ‘family office’ is used broadly and loosely; and what constitutes a family office for some, may not rise to the same level for others. As a corollary to this increase in the recent preponderance of family offices, there is an associated rise in the number of family office networks, associations, peer groups, and third party service organizations claiming a foothold in the space. The result of all this growth is a feedback loop where more and more high net worth investors claim the status of family office (than probably should) and more and more groups claim to have access to networks of family offices (than probably exist).

When faced with the noisy complexity of this situation, Groucho’s famous quote rings like a bell. Although most wealthy families are used to managing the social and business responsibilities that come with their status, there is a qualitative and quantitative difference with the kinds of groups and organizations that are increasingly clamoring for attention within the single-family office community. Simply put, it is often difficult to differentiate one group from another; and it is becoming increasingly harder to understand the true value proposition for the family offices they claim to serve. At the same time, family offices are increasingly seeking a network of their peers to help them with a host of issues — whether it be a ‘safe’ place to ask questions, to share due diligence, or to pool capital for (no or low fee) co-investment opportunities.

In today’s competitive marketplace, many family offices are looking to deploy their private capital in non-banked, proprietary opportunities; so, the promise of a network of other family offices with whom to co-invest with is highly desirable and very tempting. As family office professionals, it falls to us to understand and evaluate the networks and service providers that are pitching their products, services, and relationship capital. That journey begins with understanding the various business models and alignments (or conflicts) of interest that they entail.

In an effort to provide some clarity, this whitepaper offers an analytical framework to categorize the many groups one might encounter within the family office ecosystem. We suggest that the various business and revenue models they embrace should frame how you think about these groups; more than the service claims they make. With that in mind, we believe three broad business models of family office networks currently exist:[2]

• Member-based Models;
• Commission-based Models;
• Advertising-based Models; and

Similar to any private investment opportunity, our overall methodology is to subject these organizations to a certain amount of diligence. In fact, every family office network or partner group should be evaluated like a private equity opportunity. Good diligence begins with a clear vision of the desired outcomes. Like the development of an investment mandate, the family office should create a strategy or mandate for their objectives with these network opportunities. Having a clear idea of what you’re looking for from the family office community you would like to join will make working with these groups much easier and more productive.

 

Member-based Model (MBM)

Member-based models provide, for a fee, an exclusive network for family office principals (and sometimes also professionals) seeking to learn from one another and stay current on the best-practices in the family office space. When evaluating an organization with a member-based model, one must weigh the exclusivity of the group against the size of the organization. Exclusivity considerations include the quality of the membership, the number of members and how they are organized, and the culture and principles that members abide by. Exclusive membership is fairly easy to evaluate: do they limit membership to single family offices (and perhaps ‘closed’ multi-family offices) only? How do they verify their members? An extremely exclusive group may function more like a small social organization, while a large group with a national presence may function more like a pseudo-industry association. Can they offer the best of both worlds, with local trust and national (or international) reach? Organizations that manage scale and growth through autonomous regional chapters may be able to strike a happy balance between these two ends of the spectrum, so be sure to ask the question!

The issue of group norms, organizational culture, and operating principles speaks to the kind of member participation the group nurtures and encourages. It is important to align your own desired outcomes with the kind of participation the group fosters. The key issue here will turn on matters of privacy, confidentiality, and whether active solicitation is allowed or frowned upon. Organizations can quickly devolve into trading platforms if the main activity becomes simply pitching deals. While this is not necessarily a bad thing — especially if you’re in the market for deals — one consequence of a “deals-focused” association is that the spirit of collaboration and peer-learning usually takes a backseat (and at the extreme the group breaks apart as family office members compete for ‘the best’ deals). In addition, if privacy and confidentiality is not strictly enforced as a core principle of the group, then don’t be surprised if your name and contact details are sold on a list and your family office becomes inundated with calls from a long line of service providers.

Member-based models typically finance their operations through membership fees. Besides keeping the lights on, a reasonable level for dues shows commitment and some skin in the game to the network from members. However, some member-based family office groups charge fees in the tens of thousands of dollars. They aim to be exclusive, but often experience significant turnover as their value quickly diminishes, and family offices are unable to justify the expense. If possible, examine how other peer groups interface with the network. Is there a sizable contingent of family offices that regularly participate in events, or do family offices come and go with limited engagement?

Peer-networks are a special class of member-based groups and deserve particular attention. A true peer network allows family office principals and professionals to interface directly with each other in order to learn from one another and build bonds of friendship and trust. The true test of a peer-network is the peer-group itself. The best peer-groups provide opportunities for principals (and professionals) of family offices to meet in a commercial-free environment. In the best cases, the digital platform, annual or semi-annual meetings, and overall engagement with the network all point to a community with diverse interests and a shared purpose. While there are many peer networks forming, there are only a special few who have survived the test of time and continually add value to their members in a safe and trusted environment.

 

Commission-based model

Commission-based networks are ‘for-profit’ enterprises that generate income through commissions associated with executing commercial transactions. Like any for-profit business, profit motive determines action, and these groups are incented to sell investments or deals, preferably in volume. In the strictest sense, these groups aren’t reallyfamily-office networks, but rather they are sell-side focused businesses or deal platforms. However, it’s important to consider these groups because they often claim to associate with family offices and represent large networks of family office investors. Occasionally, these groups emerge from a profitable family office investment practice. If a family office investment team is growing and building a profitable base, they may seek to register themselves as a broker-dealer and become their own business. While these businesses may offer ancillary services, because of their close connection with family offices, the fundamental relationship they offer is deal-focused and commercial. As their primary interest is in generating transaction or commission-based revenue, it’s best to let your dedicated family office investment team evaluate the viability of the commercial offering before fully committing to any network opportunities.[3]

One variety of a fee-based model to consider is the multi-family office (MFO), operating as a Registered Investment Advisor (RIA), which typically charges a fee based on assets under management (AUM) and occasionally assets under supervision (AUS). One important distinction to understand and evaluate is whether these groups operate as an ‘open’ or a ‘closed’ MFO. Open MFOs have a core group of family office clients but offer a set of services to any potential client who is willing to pay them a fee. Closed MFOs have a finite set of families that agree to share overhead and pool buying power; and are generally not soliciting for or open to new clients.

Within the spectrum of open/closed MFOs, there is a variety of different kinds of service and/or collaboration models. At one end of the spectrum, an open MFO looks very much like an RIA, perhaps with a few large family office clients that anchor the business. On the other end of the spectrum, a closed MFO may look like a single-family office with a complex structure of sub-organizations, estates, and trusts. From the perspective of evaluating potential partnerships with groups like these, the naming conventions are not as important as the working relationships. One important question to ask yourself when evaluating these groups for your own objectives is whether or not you will be treated as a client or a peer. If the answer is the former, then you’re likely speaking with an open MFO that faces the same incentives and challenges as a typical RIA. If it’s the latter, then you may be dealing with a closed MFO, which has a different set of challenges (which will require a future whitepaper from us at a later time to explore in depth!).

 

Advertising-based model

Viewed in the context of fee-based models, the advertising-based model appears at first to solve for the issue of mis-aligned profit-motives by generating profits for the family office network, club, or organization through the sale of advertising relevant to the family office ecosystem. As a result, these networks often organize events and engagements that require little financial commitment from a family office. Typically, these family office networking organizations rely on a diverse array of advertisers and sponsors to cover the costs. In the case of large institutions looking to promote a specific area of their business, the organization itself will be its own sponsor — like a private bank or insurance company, for example, hosting an industry-specific conference.

 

However, to borrow a concept from digital marketing and the tech industry, it’s important to keep in mind that “when the product is free, you are the product”. In other words, these organizations invert the commercial-based model by creating a context where your family office will be “sold” to any commercial interest willing to pay for the lead. We don’t present these relationships in stark terms in order to offer critique, but simply to lay out the fundamental business dynamics that are at work here. Indeed, this model is one of the most common and can produce “win-win” scenarios: single family office professionals gain valuable insights into best practices and new industries, new relationships are forged, and advertisers / service providers may gain important new clients. As in the discussion above, it is always important to understand the motives of the involved parties: what is the objective of the organizers, advertisers, and your fellow participants? And, how do these objectives line up with the objectives of your family office? Special attention should be paid to any data that your family office provides. As we have seen in digital marketing trends, the data generated by users is often more valuable than the product itself.

 

Final Thoughts

While the number of family offices and family office networks appears complex, our advice for building a peer-network of like-minded single family offices is simple: begin with local and regional groups, consider the underlying business models that drive either profitability (in the case of your commercial enterprise) or mission (in the case of a peer network), and align your organization with groups that share your objectives. When evaluating the merits of any individual organization, seek a diverse array of researched and practiced experts. Ultimately the network that you build is a reflection of your own organization and the mission that is driving your family office. The relationships and goodwill that are forged through these groups can last a lifetime. The task may be daunting, but the rewards can be plentiful. Caveat emptor!

 

 

[1] Mordor Intelligence LLP, https://www.mordorintelligence.com/industry-reports/global-family-offices-industry (2020)Campden Research Report, http://www.campdenwealth.com/article/global-family-office-report-2019 (2019).

[2] Some groups blend these different organizational and revenue-based strategies, but for the sake of simplicity we will limit our discussion to a hypothetically pure version of each network. Of course, when undertaking your own diligence, you should consider the ways in which the family office organization(s) under consideration blend these different approaches and tailor your diligence accordingly.

[3] If their model involves selling securities, a thorough review of the relevant SEC and FINRA documents is in order, especially as it relates to their model and their role as (or relationship to) a licensed broker dealer.

 

TFOA is an affinity group dedicated primarily to the interests of Single Family Offices. TFOA is intended to provide members with educational information and a forum in which to exchange information of mutual interest. TFOA does not participate in the offer, sale or distribution of any securities nor does it provide investment advice. Further, TFOA does not provide tax, legal or financial advice. Materials distributed by TFOA are provided for informational purposes only and shall not be construed to be a recommendation to buy or sell securities or a recommendation to retain the services of any investment adviser or other professional adviser. The identification or listing of products, services, links, or other information does not constitute or imply any warranty, endorsement, guaranty, sponsorship, affiliation, or recommendation by TFOA. Any investment decisions you may make based on any information provided by TFOA is your sole responsibility. The TFOA logo and all related product and service names, designs, and slogans are the trademarks or service marks of The Family Office Association. All other product and service marks on materials provided by TFOA are the trademarks of their respective owners. All of the intellectual property rights of TFOA or its contributors remain the property of TFOA or such contributor, as the case may be, such rights may be protected by United States and international laws and none of such rights are transferred to you as a result of such material appearing on the TFOA web site. The information presented by TFOA has been obtained by TFOA from sources it believes are reliable. However, TFOA does not guarantee the accuracy or completeness of any such information. All such information has been prepared and provided solely for general informational purposes and is not intended as user specific advice.