At UBS, we spend a considerable amount of time studying global wealth trends and themes. For the last several years, one trend has been clear: there has been incredible growth in the ranks of the ultra-high net worth (UHNW), particularly in North America and Asia. In fact, in China alone, a new person attained billionaire status every week during the first quarter of 2015 .
As a result of this momentous growth, we have seen a rise in the creation of both single and multi-family offices in North America and around the world . At a high level, the growth of single family offices logically follows trends in wealth creation: the institution is ideally suited to families with $150 million or more in private wealth. As a family’s assets grow, it becomes prudent and cost-effective to establish a bespoke organization, governance structure and investment strategy. The evolution of multi-family offices – where offices manage or oversee investments of three or more families – is a newer trend, made attractive as member families can spread administrative costs over a larger pool of assets and may be able to pursue investment options jointly that no one family could on its own.
An offshoot of the wealth-creation trend, intergenerational wealth transfer is another significant driver of family office growth. This is a core purpose for family offices regardless of size, strategy, family business ownership, family complexity or geography. And it may become even more central to the business as, over the next 30 years, the global UHNW population is expected to transfer $16 trillion in assets to future generations .
UBS, in partnership with Campden Wealth Research, recently conducted the largest research study of family offices in history to better understand how client families are being served today as well as the trends shaping family offices for the future. The 2015 Global Family Office Report delivers our findings from studying 224 family offices around the world, 34% of which were based in North America.
SPOTLIGHT ON NORTH AMERICA
For the North American region, we identified three major trends:
• Family offices are taking on more risk, with offices searching for greater investment returns;
• Family offices are keeping it local, continuing to invest their portfolios primarily in domestic markets; and
• Family office costs are rising relative to prior years, which is attributable in large part to the hiring of additional staff to focus on new, specialized investment strategies.
Compared to the rest of the world, North American family offices typically manage a larger pool of assets: the 2015 Global Family Office Report found that average assets under management (AUM) were $926 million in North America versus $806 million globally. These assets tend to be invested more for wealth accumulation than preservation, in part because family offices in this region tend to be led by an entrepreneurial patriarch or matriarch, with a growth mindset. Accordingly, North American family offices’ portfolio mixes tend to differ somewhat from global peers, as described further below.
Historically, North American family offices have had a strong culture of charity, and that orientation continues today. To wit, three quarters of family offices in the region are actively engaged in philanthropy, a much higher proportion than those in Europe (the least likely to involve themselves in charity), Emerging Markets (Latin America, Africa and the Middle East) or Asia-Pacific. Those involved in philanthropy also give a higher percentage of their annual AUM to charity relative to global peers, amounting to approximately $36 million each year. But it doesn’t stop there – North American family offices care deeply about their charitable contributions creating a demonstrable impact, so we have seen an increased desire for measurement tools designed to track social impact.
PORTFOLIO STRUCTURE AND PERFORMANCE
As a result of differing investment objectives, North American family office portfolios do not look like those in other regions – they have a higher allocation to hedge funds (12% versus 9% globally), a much lower fixed income component (11% versus 14% globally), and significantly greater allocations to equities (29% versus 26% globally).
The average North American family office also typically holds 45% of their portfolio in illiquid assets, such as private equity, hedge funds and real estate, a much greater proportion than in the portfolios of high net worth individuals, due to the promising nature of alternative investment returns. Given the greater use of alternatives, North American family offices’ portfolios generally contain more outsourced investments than other regions.
Despite somewhat more aggressive allocations, out of all of the regions surveyed in the 2015 Global Family Office Report, North American family offices experienced the most significant decline in annual investment performance between 2013 and 2014, dropping from a 9.9% average total return to under 6%. Interestingly, family offices in Emerging Markets were the only group to see an improvement in investment performance last year, up to 4.9% versus 4.1% the year prior, beating the performance of developed market family offices in North America, Europe and Asia-Pacific.
The lower returns of North American family offices in 2014 were due, in large part, to weaker performance in equity markets compared to previous years.
APPETITE FOR RISK IS GROWING, BUT FAMILY OFFICES ARE STICKING TO DOMESTIC INVESTMENTS
The 2015 Global Family Office Report also revealed an overall increase in risk tolerance across family offices globally. In North America, specifically, family offices appear to be taking slightly more risk, with cash balances dropping a percentage point between 2013 and 2014.
Two areas where family offices are not taking additional global risk, however are in real estate and equity allocations. Family offices continue to stay on their home turf in both. The average North American family office allocates 11% of their total investment portfolio (typically more than $100 million) to real estate direct investment and tends to invest locally and sometime nationally as investments are typically managed in-house. Foreign real estate investments come with significant added costs and risks – including lack of market familiarity.
Within equity portfolios, North American family offices tend to allocate a greater share of assets to developed markets over emerging markets. North American offices have the highest allocation to developed market equities of any region (23% versus a global average of 19% and allocations as low as 8% in Emerging Markets-based family offices). They have the second-lowest allocation to developing markets equities as well, with a 6% allocation versus a 7% global average and 13% among Asia-Pacific-based family offices.
RISING COSTS ARE CREATING A HEAVIER BURDEN
Though operating costs are rising for family offices globally, in large part as a result of added administrative expenses, North American family offices are markedly more efficient relative to their counterparts in other regions of the world. North American family offices paid an average of 74 basis points (bps) of AUM to cover operating costs in 2014, excluding investment manager fees, compared to other global offices that average 99 bps of AUM.
This organization and efficiency is both smart and necessary – as we heard from one single family office in the region, tax policy and regulation in the United States are becoming increasingly complicated, requiring additional staff, resources and costs to understand the rules and ensure compliance. In terms of investment costs, North American family offices are roughly on par with foreign family offices, averaging 43 bps of AUM versus 44 bps globally despite their higher use of outside managers. North American family offices spend the most on external manager performance fees (22 bps), however.
Recruiting and retaining the right leadership and talent is critical for single and multi-family offices to succeed, and North American family offices put significant funds towards making sure they have it. These regional family office CEOs are paid the highest on average, $446,000 annually, compared to $294,000 in Europe or $150,000 in Emerging Markets, and have an average tenure of nearly 10 years – greater than CEOs in the Asia-Pacific region, but less than in Europe and Emerging Markets.
Staffing and its related costs will become more critical to family offices as the founding principals of North American family offices age. They typically become more conscientious, relative to their counterparts in other regions, about preparing staff and family office structures for the day when they eventually need to transfer authority to either their relatives or non-family executives. This professionalism is particularly true of more established family offices that already have been around for multiple generations, compared to younger (newer) family offices.
North American offices also tend to tie CEO compensation more closely to investment performance than other offices do. One compensation concern for family offices is balancing retention with market pay rates. Some family office CEOs we spoke with expressed concerns about pay inflation for family office staff as concerns about losing valuable staff members rise.
WHAT IT ALL MEANS AND WHAT TO DO ABOUT IT
Looking ahead, North American family offices have a lot to think about when it comes to effectively managing continually rising costs, risk and return expectations.
In terms of risk management, there have been mixed reviews of the potential for currently high performing asset classes, such as real estate and private equity, to continue their run. Family offices should be careful to judge future expectations based on past performance and beware of cyclicality. In addition, as some families expand, they have a tendency to transition the focus of their investment strategy from riskier growth to less risky wealth preservation. While this makes sense for some, it’s important to consider the implications of such a shift, including the fact that taking lower risk generally yields lower returns, resulting in a smaller pool of wealth for families that may still be growing.
On cost, because we do not expect cost pressures to go away anytime soon, it is important for family offices to constantly monitor asset and manager allocations, question the benefits of services provided, and evaluate the efficiency of insourcing versus outsourcing various tasks. In addition, family office CEOs should ensure their costs are aligned with the family’s or families’ financial management needs and that they are getting the best value for what they are paying.
As wealthy families grow with each generation, financial regulations evolve and global markets experience peaks and valleys, family offices will have to become smarter and more efficient to keep up with the times and accommodate changes in size. Putting the right organization, structure, people and plan in place now – and periodically re-evaluating it – will put them on the path to success.
Charlie Buckley is Americas head of global family office coverage at UBS.
