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Why Family Offices May Struggle to Invest in Simple Index Fund Portfolios

Neckar worked in two family offices before and he shares with us why family offices invest the way they invest.

I was originally drawn by the question of why we won’t see family offices invest in passive index ETF portfolios.

Here is a short summary of why.

A family office has a few very appealing advantages:

  1. The timeframe for the pool of capital is long-term compounding. There is less pressure to outperform in the short term.
  2. You have the flexibility in how you deploy the money due to the size and the flexible mandate.
  3. You do not have to be bothered by the often challenging part of running a fund such as investors asking you why are you doing things this way, quarterly letters, unwanted publicity about your returns.

But Neckar explains that there is one problem: The client can fire you at will and this could be due to your lack of performance, loss of trust or they do not like you anymore.

Newsflash: This is the same for us folks with less money as well!

Neckar observed an interesting thing in both family offices:

  1. They want their money to be managed by talented employees that they can trust.
  2. But talented people are typically ambitious and they seek both challenging work.
  3. And ambitious people also want to get wealthy!

These employees also know that they have career risks. In the article, Neckar presents a German family office case study JAB, taking us through how the family business started and the eventual pivot.

JAB’s performance is currently less than the S&P 500 but Neckar feels that given that the capital is deployed into a private equity strategy, a more appropriate benchmark should be a market index plus an illiquidity premium (this would most likely mean that JAB underperformed even more.)

If you are ambitious and have career risks, what would you do?

  1. Create complexity. Make the need more complex than necessary and packaged it well. Explain the need for hand-holding, specialized training required, complex tax and legal work. All these increase the switching cost.
  2. Turn the office into a platform. Instead of just managing for one family, turn it into an entity that can manage for a group of families!
  3. Invest in operating businesses. This makes everyone lives more interesting because you have seats on the board, need to provide input and make the managers, and indirectly the owner feel like this is their personal projects

The more complex things are, the more they make you realize they have to rely on having a group of employees.

I think that is an interesting take and upon reflection, this happens for the people in the lower net worth rung as well.

Some of us have the belief that building wealth, having protection, manage our retirement income is very complex.

The industry encourages that perception as well.

Complexity equals areas to give advice and consultation equals justification for higher fees.

Some things are really more complex and they have to be paid for. However, you should ask the question whether things are really that complex or that people are trying to hoodwink you by layering complexity that does not help you and may erode your wealth.

Tactical allocation, fresh investment ideas are some key phrases that you should be more careful of.

Recently, I have been hearing about the needs of the rich a fair bit. They have 3-4 houses that span the different countries and paper assets in different managed accounts, some individual and some joint.

Sometimes, I wonder if they really like living that kind of life with a spawn of threaded investment things to think about.

We sometimes get new clients looking us up because they wanted to “settle” their estate and create a trust.

Very often, when we ask them “What do you REALLY want to do with these assets? Who should get these assets?”

Some of them paused for a long while.

Nothing came to them. They spend their time accumulating a bunch of stuff of value, that requires many threaded investment considerations, but vaguely know what they are for.

Keeping things simple, doing a KonMari seemed so right but many of us find it challenging to believe that things could be so simple.

Neckar also has something to say about trust.

The very wealthy faces an uneasiness about the authenticity of their relationships unknown to the rest of us.

  • They wonder if a person stepping into their world has ulterior motives.
  • Do the person like what they represent?
  • Is the person trying to gain money and status for themselves?

This is why they value the relationships built before they became wealthy.

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Sinkie

Sunday 30th of January 2022

Sounds very much like large Uni endowment funds or pension funds or sovereign wealth funds.

The more an investment business transforms itself to be more "business-like", the more it devolves into a banker-client relationship with high fees & structural complexity.

Looking at the 10-20 years' performance of our own SWFs, it does seem a lot of money is being paid to achieve index fund performance.

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