The squeeze on profit margins across the wealth
management industry is raising questions about the economics of
running family offices. Paul Golden finds that spiking operational
costs are driving the development of creative arrangements in
family office operations.
Go deeper with GlobalData
Cost/income ratios for private
banks are at their highest rate for the past 10 years. The reduced
returns on investment portfolios and increasing compliance demands
are raising questions about the true cost of operating a family
office.
Rising costs are forcing high net
worth (HNW) investors in single and multi-family offices to
carefully reconsider if it is worth operating their stand-alone
entities. This is providing private banks with the opportunity to
poach HNW clients by showing their ability to provide top quality
investment advice and absorb the prohibitive costs of compliance
and technology.
The numbers are not
comforting. A McKinsey European private banking survey found the
industry’s operating profit pool in 2009 was 25% below 2008 levels.
Profit margins went down from 26 to 20 basis points of assets under
management and the cost-income ratio jumped from 71% to 76% in the
same period.
James McLaughlin is former chief
executive of Geller Family Office Services, a New York-based
multi-family office. He says the past two years have been a wake-up
call, challenging the sustainability of the family office concept.
Most family office clients are less demanding and more realistic
about their expectations since the global financial downturn, he
adds.
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By GlobalDataMcLaughlin says staff can account
for up to 80% of a family office’s operational costs. Outsourced
professional advisers and technology systems have increased
significantly over the past four to five years, he adds.
Key trend: non-commercial
pairing up
The development of arrangements
between independent family offices in a non multi-family office,
non-commercial pairing up consortium or purchasing group is a key
trend in the drive to keep costs down, says McLaughlin.
“Continuing demand for lower costs
from clients across all generations is inevitable as costs need to
be borne by an increasingly larger number of clients and
households,” he adds. “In the near-term, the focus has been on
operational efficiency for staff alignment, financial controls and
systems/technology leverage.”
Nailing down the precise
operational costs of a family office is not easy. Single family
offices (SFO) have significant administrative functions arising
from serving one family only.
Anyone setting up an SFO will have
to dedicate significant resources to finding good people to manage
it. Legal and regulatory advice is also important and a single
family office still has to pay fees to investment managers and
bankers.
Joseph Reilly, president of the
US-based Family Office Association, says there is a new-found
awareness of the costs of running a family office. Wealthy family
members are realising that they must pay out of their own pocket
for something that used to be covered by positive returns.
“Client demand is not driven by
macro issues. It is almost always generated in the sphere of
family,” he says. “Transitions from one generation to the next,
family members who choose to change advisers or families who start
or dismantle a family office are the sources of change in the
industry.”
Technology
solutions?
The rise of technology solutions
for trust administration and data aggregation was, and continues to
be, the great hope of family offices in regards to cutting costs,
says Reilly.
“The technology is vastly improved
compared to 10 or 15 years ago, but the concept of the virtual
family office with low costs and push-button maintenance is still a
way off,” he says.
Andrew Rodger, director of
Stonehage Group, says the costs associated with
multi-family offices, or what he calls family investment offices,
are like any investment advisory boutique.
Multi-family offices have to invest
in bespoke systems that allow them to manage the affairs of their
clients and multi-disciplinary expertise, including lawyers,
investments experts, bankers and accountants.
Mitigating
risk
“Counterparty risk – the need for
intensive due diligence and monitoring of all counterparties,
including hitherto ‘safe’ institutions – has increased,” says
Rodger.
“The sense that the markets are
less predictable than usual has inclined families to seek more
independent advice. Furthermore, risk appetites have come down,
meaning that portfolios are generating less income, which makes
costs more painful in comparative terms.”
Rodger points out that clients have
seen risks such as counterparty risk in banking institutions
materialise with devastating effect. These risks were viewed as
more or less theoretical before the downturn.
“More people than ever want to see
systems put in place to ensure that their affairs are attended to
in a way that manages all risk effectively across disciplines,” he
notes.
Regulation drives
cost
Simon Paul, director of wealth
management at London-based multi-family office Sand Aire, says
increased regulation has pushed up costs, which his organisation
has sought to mitigate in a number of ways, including implementing
a new portfolio administration system.
Regulation has had less impact on
US family offices, although the Dodd-Frank financial regulatory
reform bill is expected to add some additional costs for
compliance, according to McLaughlin.
There is always pressure from
clients for greater value for money, especially in the family
office segment of the market, adds Paul.
“With little return coming from cash and lower returns expected
from risky assets, the costs associated with managing money are
under greater scrutiny,” he concludes.
