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By Emile Salawi, Head of Family Office Coverage at BNP Paribas Wealth Management and Frédéric Fève, Senior Family Office Overage Banker at BNP Paribas Wealth Management.
The number of family offices globally has increased significantly over the past decade from approximately 4’000 to more than 10’000 according to Wealth-X.
But what exactly do those family offices do? How are they organized? What are the main investment topics they are interested in? What kind of risks are they facing? What type of partner are they looking for?
With the world global wealth reaching new highs every year, the richest with net worth above USD 150M often structure themselves as a family office, either dedicated to managing their own wealth (single family office) or pooled with other net worth individuals (multi-family office).
At the core, smaller family offices usually emerge from the need to oversee the different non investment needs of an Ultra High Net Worth Family. Lifestyle management, Children Education, Transition Planning, Wealth Planning are hence often part of the initial key functions covered. At the same time, for investment aspects, the initial steps can often be to aggregate and efficiently report on the overall family investments and wealth.
At a next stage of development or wealth level, a family office may build up its investment capability by not only overseeing and aggregating assets but by managing them efficiently. This may usually start by building allocation capability for the family into external investment solutions and services.
Finally for the most structured family offices, an increasing part of their chosen allocation buckets can be fully managed in-house. However some families will prefer to outsource their personal life management outside their family office structure and chose to solely focus on investment management.
Family offices come in very different forms. But among this diversity one can still observe some general organisational shapes. These go along with the general patterns of what family offices aim to provide to their owners. Initial structures can encompass a CEO or CFO together with Private Assistant/Lifestyle Management. As structures grow, a CIO will join the team. Depending on the level of entities involved the Operational side will need to start being beefed up. Finally, the most developed entities will further have dedicated teams to invest and deal with the operation of each internally managed strategy of asset class, thereon adding portfolio manager, research and operational teams.
The goal of most family offices being the asset protection and wealth preservation of the family through the generations, they usually deploy a lot of efforts keeping current on all structural subjects that may challenge the wealth of their beneficial owners. This may include tax and legal changes, credit, counterparty and operational risks. The structure of the family wealth, including particularly succession and generational transfers are usually core subjects together with the capability and strength of their counterparts and business partners in order to mitigate those risks.
The flexibility of these offices is supported by the still very present entrepreneurial spirit that often played a key part in the wealth creation of their beneficial owners. This spirit is even so more present when the family members play an active part in their family office and can hence convey to the team their positive experience in being entrepreneurial and probably taking some risks. Due to the often dual objectives of maintaining a wealth preservation portfolio (to sustain the ongoing family cost of life) and wealth creation to build for the next generations, it is quite common to have mostly a liquid allocation very conservative while in the less liquid allocation long term holdings in mix of real estate and private equity investments are held.
The largest family offices (those managing assets in excess of $800M) allocate 20%+ to private equity and close to 15% to real estate, hence replicating the asset allocation of the world's most successful endowments. Direct deals and private equity funds have attracted nearly $15bn from family offices in 2016 according to Campden Research. For instance as returns for Family offices were at historical lows in 2015 and 2016, only those allocating a significant part of their assets to alternative investments managed to reach double digit figures. This includes private equity and real estate which illiquidity premium and longer term investment horizon proved beneficial to generate higher returns.
Besides the hefty returns provided by those asset classes, families appreciate the control and transparency they get on their investments. However sourcing the right deal or the right manager isn't that easy as the market tends to be quite crowded and there's a lot of "dry powder". BNP Paribas thanks to its expertise, strong network and global footprint has been a pioneer in getting its largest clients access to some of the best private equity managers and most sought after direct deals globally, be it real estate or corporate transactions.
As regards more liquid strategies, a number of Family Offices have been rethinking their allocation to hedge funds in the past few years due to the overall challenging performance , the realisation that the 2 and 20 model probably should not apply to some strategies particularly in an interest rate environment that that does not sustain this level anymore. As family offices resize their operations to focus mainly on direct deals, they delegate more and more the liquid part of their portfolios to external managers or private banks who offer tailor-made solutions dedicated to these investors. As an example we at BNP Paribas have established 3 years ago a team of specialized portfolio managers dedicated to managing family offices and smaller institutional investors money with tailor-made portfolios from $20M onwards.
Risks faced by Family Offices are numerous, we divide them in 3 categories:
Counterparty risk: mitigating this risk is Family Offices’ top priority. Solutions include inter alia limited exposure to any given counterparty, synthetic exposure through total return swaps, T-bills, physical gold and segregated accounts. In some ways negative interest rates are a natural answer to counterparty risk as they force investors to diversify.
Operational risk: as transactions become more complex and regulation even more stringent, operating costs have substantially increased for Family Offices representing 76bps of their assets under management according to Campden Research.
Cybersecurity: Family Offices are extremely vulnerable to cybercriminality and underestimate this risk. According to Family Office Exchange they spent on average $500k on IT including data protecting from cybercriminality and are expected to double that amount in the next five years.
Family Offices get solicited from all parts, most deploy money in investments they understand. Being small structures, they rely on few trusted partners to source and execute deals: lawyers, corporate finance boutiques, private equity houses and banks are the usual providers of ideas and intelligence.
Over the years, another source of deal flow has taken more and more importance, that is networking clubs and circles dedicated to ultra high net worth individuals where they can mingle with their peers and seek an alignment of interest in select transactions. BNP Paribas has been a pioneer in establishing a proprietary secured platform dedicated to its 300 largest clients. Branded “The Leaders’ Connection”, this invitation-only application enables its members to network with their peers in other parts of the globe, share ideas, interact together and find co-investors in a secured manner.