It is the duty of a family office to access the investment resources needed to achieve its objectives. With assets above $1 billion, a family can generally afford enough professionals and infrastructure to support itself. When the assets are below $1 billion, a family is often better served by outsourcing investment resources to an Outsourced Chief Investment Officer (OCIO), an engagement that delegates duties to an investment management firm. The family can also contract to receive portfolio management advice by using an Outsourced Investment Office (OIO) model, which allows the family to retain decision-making authority. We see highly effective family offices using cost, efficiency, governance, and risk management as determining factors for their investment resourcing.
Motivations for Investment Resourcing
In today’s investment environment, family offices require full investment capabilities to achieve the returns required by wealth owners. The returns that can be realized in the public markets using stocks, bonds, and alternative investments sometimes pale in comparison to the returns the family has gained from a family business. Family wealth creators recognize just how much risk they took to accumulate their wealth and want to preserve it; investing in a broadly diversified portfolio can significantly reduce investment risk over the long term, especially when we know single businesses can face unforeseen events.
So why have a family office at all? There can be several reasons. The family may need a portfolio to hold liquid securities so that when the core family business sees an investment opportunity it can be planned for and funded quickly. In some cases, the second- or third-generation family members may have no desire to continue the core family business and just want investments stable enough to produce market returns to fund their needs in the most cost-effective way. We also often see a philanthropic motive driving the resources within a family office. Setting up family foundations or donor-advised funds are often the vehicles of choice and yet, there needs to be an institutional mindset when it comes to the investment management decisions needed just to meet reasonable objectives over long periods of time.
This mindset understands that the list of decisions an investment team takes on over time runs far beyond choosing the right asset allocation mix and the right investment managers to work with. The family office takes on the role of being an investment manager itself with all the accounting, tax work, legal, investment research and family member reporting needs. Add to this the considerable time spent supervising and controlling the outbound cash flows for tax payments, trust beneficiary income, real property upkeep and service vendors and the family can find themselves easily overwhelmed either due to a lack of subject-matter expertise or the inability to devote the time necessary to stay on top of the many required tasks.
While larger family offices can typically afford to staff investment professionals to manage all of these activities, the time spent on investment management decision-making is never enough. Investment staff must make the specific decisions called for in the investment policy statements related to each of the legal entities within a family office. For any one legal entity, a well-constructed portfolio should be managed for broad diversification that includes global investments, fixed income and comprehensive alternative investments including private equity and debt. While a comprehensive list of all the investment management decisions is beyond the scope of this paper, we want to capture the scale and depth of the responsibilities and decision points across a family office enterprise. Just as we have stated that larger family offices can afford the human and infrastructure resources, we also note that smaller family offices still need to access all the resources to manage their investment portfolios. At lower wealth levels, staffing costs become prohibitive and the wealth owners typically choose to outsource investment management and operational functions.
We note that the management of the family’s investments is best served by a custody provider with the broadest capabilities, preferably through a master-custodial arrangement.
The Costs of Investment Resourcing
To evaluate whether a family office can afford to staff on its own or look to outsource, it is useful to build a cost profile. Key to the success of investment outcomes rests on the shoulders of the Chief Investment Officer or Chief Financial Officer. This role is ultimately responsible for investment decisions and portfolio risk management. In most family offices we work with, we see investment staff dedicated to asset-class assignments: public equities and fixed income, alternative investments along with private equity and debt. Supporting these investment professionals, we see dedicated back office staff that are tasked with broker reconciliation and tax reporting among other duties. One could argue that having support staff organize and assemble the data required by outside vendors like certified public accountants (CPAs) and estate planning attorneys reduces overall costs, as less time is spent with outside professionals.
In addition to the cost of paying salaries, performance incentives and benefits, the family must also invest the time and resources in conducting an effective search to recruit, interview and hire necessary staff. On top of these labor costs, family offices can also expect to pay for the office space and infrastructure needed for daily operations. Technology costs have come down over recent years but the data and security services needed to run an investment operation have expanded because so much more data is needed to support decision-making and cyber threats have many more paths of opportunity into a family office.
How Outsourcing Works
There are different approaches to outsourcing based on the level of discretion desired by the family office investment staff. In an Outsourced Investment Office (OIO) advisory arrangement, the OIO provider offers advice and support around areas such as asset allocation, management selection and reporting, but all decision-making authority remains with the family office investment staff. Over time, the ongoing engagement with an OIO provider can help build the corporate knowledge around the discipline of making investment decisions and the related governance for family office staff.
Alternatively, an Outsourced Chief Investment Officer (OCIO) acting as a fiduciary shifts the investment decisions to the investment advisor. The OCIO works with the family office to establish the proper governance for the family’s portfolios through the investment policy statements (IPS). The governance defined in the IPS provides the guardrails for the investment activities the OCIO then performs. Even with family offices with larger investible assets it can make sense to hire an OCIO to help with estate planning vehicles including trusts and family LLCs. Consolidating the investment decision-making can be the start of the investment buildout or a way to maintain a low-cost profile even with a large scale in investable wealth.
To Build or Outsource?
To evaluate resourcing the investment management roles in a family office, we have built a simple model to identify the approximate cost range where it makes sense to outsource to an investment advisor. The CFA Institute’s 2019 Compensation Study provides aggregate information about total compensation for specific roles we often see in a larger family office.1 Exhibit 1 shows a simple six-person staff headed by a Chief Investment Officer with investment professionals dedicated to various asset classes with support by an accounting-oriented function.
Exhibit 1: Sample Compensation for Six-Person Family Office
The Total Compensation column in the table references the study’s average for each role. Using information from a report by the MIT Sloan School of Management,2 we have scaled the compensation first for an estimate for payroll taxes and benefits and then adjusted the estimates again to include office rent and infrastructure. Because this is a set of averages across the U.S. there will certainly be regional cost differences. However, our model is straightforward enough for a family and their advisors to adjust the analysis to the costs they are facing.
Extending our analysis to compare the build or outsource question, we convert the compensation estimates into a percent relative to a range of asset levels. As one would expect, the costs to build out a family office tend to be lower with higher levels of investable assets as we see in Exhibit 2. The chart also displays an estimated flat fee of 25bps, in order to draw out the concept that there are break-even points when a family office chooses to hire an outsourced investment advisor to fulfill—or support—the investment management decisions. We have included the estimates for both total compensation with payroll tax and benefits with the estimates including rent and infrastructure. For some family offices, they are already running operating businesses with sharable infrastructure in place. Highlighting the left dot in our example, we estimate that with investable assets under $800 million, choosing to hire an OCIO or OIO makes economic sense. The right dot shows the breakeven estimate at $1,400 million for families, perhaps with new wealth from a liquidity event, that require a build-out that is more comprehensive
Exhibit 2: Investment Resourcing Costs by Asset Size
There are several key points a family should consider as they look to resource the investment management roles in their family office. As there are many non-investment activities happening in a family office setting, the build or outsource approach should not only look to save on costs associated with running essentially an in-house investment company but also saving time. Efficiency of decision making is manifested through timely and comprehensive investment reporting aligned with the appropriate governance detailed in the family office’s investment policy statements.
Additionally, investment performance outcomes that meet the family’s objectives are more likely to occur with sound decision-making that takes into consideration risk estimates in a variety of ways. Put another way, risk management should include comprehensive measures like peak-to-trough performance drawdowns, credit risk and liquidity risk, among others.
The decision to outsource some or all investment responsibilities often comes down to time. If more time is spent on family office activities away from investment management, then there is more time for the family to thrive and innovate. In fact, time savings becomes the value proposition for properly resourcing the investment management activities.