The investment performance of single-family offices is a function of the quality of the money managers and their understanding of the aim of the family. According to Angelo Robles, founder and CEO of Family Office Masterclass, “One of the biggest problems single-family offices have is finding and rewarding talent. Many investment professionals are interested in working at single-family offices, but only a percentage of them are exceptional, and the families want exceptional.”
Once exceptional investment talent has been identified, the wealthy family must ensure they stay around and are highly motivated to excel. There are three ways to compensate in-house investment professionals:
- The employee model: Investment professionals receive a salary and a discretionary bonus.
- The participatory model: Investment professionals are rewarded strictly on performance.
- The hybrid model: This is a combination of the previous two compensation arrangements.
To get the best investment professionals to join and stay with single-family offices increasingly, adopting the participatory or hybrid models is necessary. With the growth in single-family offices, some of the best investment professionals have multiple options. Also, to entice some investment professionals from their current positions at profitable investment firms, the ability to get seriously wealthy is appealing.
At the same time, it is often also necessary to ensure that the interests of the investment professionals and the wealthy family closely align. When this is not the case, there is the potential for some investment professionals to take considerable risks. For example, some investment professionals are given a percentage of the performance past a benchmark and will then choose to make extensive leveraged bets. If they win the bet, they earn enough money to leave the single-family office and retire. If they lose the bet, they are fired. Meanwhile, the wealthy family loses. To avoid these scenarios, all sorts of criteria and parameters are put in place regarding the participatory and hybrid models.
Nonqualified deferred compensation plans and other long-term incentive plans are gaining traction with single-family offices. With these plans, the investment professionals earn compensation from the single-family office but have not yet received the monies. “There are many creative ways to structure nonqualified compensation plans for investment professionals at single-family offices,” says Homer Smith, founder of Konvergent Wealth Partners and co-author of Making Smart Decisions: How Ultra-Wealth Families Get Superior Wealth Planning Results. “One approach proving very effective is to mirror the investment strategy of the investment professionals using customized benchmarks and private placement life insurance. If the investment professionals do not perform, the single-family office does not pay out and can potentially make money on the private placement life insurance.”
Another approach involves creating tranches of compensation that pay out at different times. Additionally, clawback provisions are part of the agreement taking monies from future tranches. This approach works particularly well when the investment professionals are sharing in the profits from alternative investments such as private equity funds and direct investment in private companies.
More and more, in the case of recruiting and rewarding top-of-the-line investment professionals, single-family offices are using participatory and hybrid compensation models. They are also clever about structuring the arrangements by relying on strategies such as highly customized nonqualified deferred compensation plans.
Russ Alan Prince is the executive director of Private Wealth magazine and chief content officer for High-Net-Worth Genius. He consults with family offices, the wealthy, fast-tracking entrepreneurs and select professionals.
