Bridge over ocean
8 March 2017 Multimedia

Allocation of Family Capital

Taking an Enterprise View

  1. Sara Hamilton

Join Sara Hamilton, founder and CEO of Family Office Exchange, as she discusses how private capital is critical to the global economy and social change, how building a “family enterprise” mindset changes outcomes for families, why family culture preserves the status quo in family decision making, and what fifth- and sixth-generation families do to generate a stronger commitment to the family enterprise.


SARA HAMILTON: What I'm going to try to share with you today is a little bit about the voice of the wealth owner. And I don't know that you would know a lot about Family Office Exchange, but we are a resource for very exceptional families, I would say. We've worked with, and sat down, and interviewed probably over 1200 families now over the last 30 years, and had very deep conversations with them about what impact they wanted to have with the good fortune that they've had, and the hard work that they put together.

So, our client is not someone who-- is someone who not only understands what-- it recognizes that its-- they're not going to use all the wealth they have in their own lifetime, but it won't be used in their children's lifetime, and possibly not in their grandchildren's lifetime. So, it's a conversation about a 100-year impact with the type of family that we work with.

And we work actively with about 360 families today in 20 countries, and about a 120 wealth advisory firms who are focused on understanding the wealth owner better, and trying to move their practice up market to deal with this type of client that has 100-year wealth.

So, I thought what I would do is talk to you a little bit about how we think about these target markets, and how a family like this evolves, because it is an evolution over a number of years before someone reaches this place. I'm going to spend a little bit of time with you on an explanation of what an enterprise family is, what the complexities are that they deal with, and then talk to you about one particular trend that we're really focused on, which has to do with the transition of middle market operating companies and the opportunity that enterprise families have to participate in ownership of those companies, and to be long-term investors in that focus.

And it leads in somewhat into your discussion this afternoon, for those of you who were talking about direct investing. So, let me start by saying many of you deal with hard-driving entrepreneurs, very busy guys who are completely focused on making a difference and having an impact in the business that they're building. As you know, they are typically not all about making money when they're doing this. They're about being successful at what they're up to.

And some of those entrepreneurs over time become very successful business owners. And as they grow, and in their 50s or so start to think about whether or not their kids are going to come into the business, and this-- the family, the whole family, takes on this business-centric focus around-- everything we do centers on what's good for the business and what's good for the family. And a lot of conversations begin to occur, especially after the next generation is brought into the activity.

But at some point, the family has to decide in this stage, whether or not they're going to pass it on and grow-- some of them grow bigger than the business that they're operating in, and we call those enterprise families. And I'm going to give you a thumbnail explanation of a three-day workshop around what an enterprise family really is, and how they operate, and what the dynamics are.

And some families decide they're not going to stay in business, and they become what we call financial families. And financial families are typically the wave of early family offices that we saw here in the States in the late '80s when the leveraged buyout industry came in and cashed out so many family-owned companies with such high market rates that many people sold out, who never intended to sell their companies. And all of a sudden they were financial families, and they had to start this thing called a family office, and they didn't know what it was, or how it was going to work, or what that would be like.

And we've really been on the journey with those families to help them understand how to make the most out of the family office that they have. From that evolution, in many of these families, there's another generation of what we call wealth inheritors who themselves, many times, become the entrepreneurs of tomorrow. And so, the cycle-- we think about the target markets that we work with in a cyclical fashion, that we're growing new entrepreneurs in every enterprise family and every multigenerational family. The big conversation today is about keeping the entrepreneurial spirit alive.

And this is where much of the interest has come from that relates to being involved in direct investing. It's about helping young people in the family who are going to be very wealthy understand how hard it is to run a business. And if they're not exposed, if the family no longer owns an operating company, and they're not exposed to the day-to-day issues that the family is involved with, they really don't have an opportunity to appreciate what it means to be a part of this ever-changing cycle.

And this cycle of investment in middle market companies in our country is at the heart of the solidity of our economic system. And we are facing a lot of big changes coming down the pike that I'm going to talk a little bit about for you here. So, what is an enterprise family? This box at the top. When a family stops feeling business-centric and starts to feel family-centric. They feel like they've outgrown an operating business mentality. That's the beginning of what we call an enterprise family.

And an enterprise family has-- what distinguishes it is has many dimensions in how they define themselves. And family members have the ability to balance out the importance of the owners, because not only can they participate in the business and working in that activity, but they also have the ability to have a very important role in the family in fostering family unity, in working on philanthropic opportunities that they're doing, in overseeing and looking at the financial capital.

And maybe 2 out of 10 family members that would be in a system have an interest in what's going on with the investments and the financial activities. And a lot of family members have an interest in all these other activities. So, we talk to them about building a house and having a lot of rooms in the house where families can-- members can get involved, because engagement is a big challenge for the family. And the thing that is going to make a big difference for them in their ability to stay together as a family.

There are many different goals that families have. Every enterprise house that I've ever worked on is a little bit different from every other one. If there's a business that's still involved, there are concrete, specific goals that are-- and they're most experienced in being able to articulate what those goals are. But there are family unity goals, and things about helping family members find themselves, become good citizens, have meaningful careers, where there's a lot of activity going on around owner engagement with the families that we work with.

Certainly social responsibility, their philanthropic interests, the way they relate to the community is a main part of how they define their enterprise system. And also, the financial activity that the family has going on at this stage. What's important is that they work together to define clear goals about what matters to them, what's going to make it worthwhile to stay together as a family. It's obviously a lot of work. If you're born into a system that the documents dictate will last for 100 years, and you are a part of a cousin's group, and someone tells you when you're 22 that you're going to need to come sit at quarterly family meetings for the rest of your adult life, it feels very heavy. A very boring type of thing, unless somebody is really able to make it more interesting.

So, we try to work with families to help them make it as exciting as it can possibly be. Family enterprises aren't born overnight, as you can imagine. They start with a founder or a couple that's very committed to the business that they work on. They build a business. Often, they separate the real estate from the family business. They pick up on-- they find an essay planner who helps them realize that they really better put some of this into a structure that's going to protect it from tax, because, as you know, the first generation absolutely hates taxes.

And they begin to look at what they are going to do for play, have a vacation property somewhere, put together a family, begin a family foundation to pass on the values. You've heard the whole story, oversight cycle over time. One of the interesting things about this stage of evolution is the first generation, as you heard this morning, is brutal about wanting to avoid tax. And the second generation is really focused on avoiding complexity.

So, in the world of family enterprises, the second and third generation spend about 10 years on average unraveling a lot of the complexity that the first generation puts into place, because they don't understand it, they don't know where it came from, it wasn't well-documented, it doesn't make sense, the tax laws have changed. A whole variety of drivers.

But many families that aren't well-educated about the structures, and they don't tie the structures to the governance in a way that's meaningful, really are driven to create more simplicity for the family as they go along. As the family is getting bigger, they're wanting the activities they're working on, and the complexity of it, to get smaller.

It keeps evolving over time. The second and third generation is-- might add a second family business. The need to manage all this complexity creates a family office. And a family investment partnership might be a part, so they can pool their assets. And impact investing has started showing up as a topic that the younger generation really wants to talk about.

And it keeps going on to the next stage where it moves out to considerations around private trust companies. We probably have 400 or 500 enterprise families in America today who have chartered their own private trust companies as a mechanism to coordinate the governance process for the family activities, and really for the whole enterprise in most cases. It is very common for them to have a real estate management company.

Those first- and second-generation owners feel really good about physical property. They buy real estate assets. It seems like one of the things that the second and third generation can understand is physical property, and the cash flow formula that goes along with managing real estate effectively. So, they seem to hang on to the real estate. And you'll see this in the asset allocation profiles that I show you.

The next generation of entrepreneurs start to show up somewhere in this system. And possibly, there's a family bank that has been structured that helps fund those new entrepreneurs so that this cycle can actually begin again, and the activity can move ahead. What's important for you to keep in mind here is a message from Jay Hughes, who's an attorney, who's worked in this field for the last 40 years and, maybe, 50 years now, I guess I'd say.

But Jay says to families, every generation has to be a first generation. Every generation has to have the opportunity to recraft who they're going to be. To have their own discussion about, why are we staying together? What's holding us together? What do we care about? What's our vision for the future?

So, we use, often, scenario planning to help families think about, where do you want to be 30 years from now when your kids are your age? What is that you want to be there in terms of financial security? What kinds of opportunity do you want to see in place? And so, some of that activity is really helpful to them to think through what might happen in that activity as they go through this.

So, this is picture of a 100-year family. The greatest enemy for these families is status quo. The cultural message that they're given for generations is, don't screw things up, avoid risk. You've got something going really well here. Don't change it. And this is their biggest challenge. They're not comfortable with change, and they don't have a culture built-- since the first generation, built around creating something new.

And this activity at every generational transfer of saying to them, OK, now it's your turn. Where do you want to go with this thing? Feels very foreign to many of these families. So, it takes some real external stimulus, sometimes from the family office team, sometimes from an external advisor, to help them really push the edge, and think about what they want and do with what they have.

The work that we do at Fox is really not focused around helping wealthy people stay wealthy, but it's really focused around helping them realize the capacity they have to have an impact, in whatever manner they want to do that. And when we started back in 1989, we had about 10, maybe a decade, of doing really good work I believe, in creating family office best practice.

And we started surveying members in 1991, and we can tell you any factoid you want to know about how to run a family office. What they cost, how many people it takes, what the goals are. We've got all kinds of data on this. But after about a decade, one of the things we learn is that it didn't matter how good the family office was, or the wealth adviser for that matter. If the family wasn't prepared to be an owner, they weren't committed to take ownership of what they had, no high-quality family office would keep them together.

And so, we actually had to shift our resource allocation and start spending as much time with owners talking about responsible ownership, and getting them comfortable being an owner, getting them understanding this capacity question around, where do you want to go with what you have here? Because it is a very challenging question. I've seen brilliant investors in the markets when they cash out, take years to figure out what they wanted to do with what they now had. And sometimes, they reinvent it along the way.

So, one story that I thought I'd share that happened this week was I had an opportunity to hear Arthur Blank in Atlanta talk about the history of Home Depot, and all the things that he's done since then. Any of you from Atlanta here? That's surprising. So, Arthur as you know, was one of the cofounders of Home Depot in 1979, I think it was. And he left the business in 2001, with some trepidation about what he was going to do with his time, and the rest of his life. And here it is 16 years later, and he has what he calls the Arthur Blank Family of Companies.

They are all centered around play, and they are all committed to using play to develop leadership. And so, he bought the Atlanta Falcons from the Rankin Smith family. And he told us the story about that activity, which I will share with you because I think it's very interesting. He's started a ranch in Montana, he's built a PGA Superstore, and they've just recently launched, when we were in Atlanta, they launched the Atlanta soccer team called Atlanta United. They had 55,000 people opening night for their first soccer game of the league.

The president of the soccer league couldn't even believe they were able to get 55,000 paying ticket holders to come to that. And a lot of it is a result of Arthur's commitment to creating an experience for the client that is customer-focused. His great genius is the customer culture that he's been able to build in what he has done.

But one of the interesting stories he told us is, that when he had his conversation with Rankin Smith about buying the team, the issue with the Smith's was that Rankin had five children. One of the five was involved in the football team, and four of the children were not. And those kids took a vote. One of them definitely wanted to stay involved, and the other four wanted to find other ways to deploy their resources and have a different kind of identity than being the owner of a football team.

So, they ended up selling and becoming a financial family, the Smith family. And Arthur began the journey of becoming a family enterprise. And I wouldn't say in knowing 100s that fit in both categories, that any one group is happier than the other. And I wouldn't say that those who stay together are always happier than those who separate into five branches and go their own way. I don't believe the Smith family has an enterprise structure of any sort still together, but I'm not sure about that.

I think it's-- the element is, it's a family conversation to have about where they want to go with what they have. And it's not an easy conversation. Some of the things you talked about earlier this morning pale in comparison to what do we want to do with a billion dollars? And, how do we want to architect how it's going to impact our children and our grandchildren? And this is-- Arthur said, as someone who has joined the giving pledge, this is the biggest worry that all of those families have who work with-- when they come together and talk about what they're going to do with their philanthropy, there's as much conversation about the wealth and the children as there is about the philanthropic part of it.

And it's always the elephant in the room with every family group, you know. But one of my wisest advisors in Zurich has said to me, the money is nothing but a magnifier. If things are good, they can get much better. And if things are bad, they can get much worse. And I think that's true whether you have $20 million or $200 million or $2 billion. The relationship with money, and the way we engage with it, is not something that most people are comfortable with.

One of the really interesting things about millennials is they are so much more comfortable with, and demanding of, transparency, a clear understanding of the way things are. They're used to gathering information. They may not be analyzing it quite as deeply as some of us would like to see, but they are aware. And they want-- if you know the phrase FOMO, they have a fear of missing out. And they want to be a part of knowing what is there, because in this day and age, some of their colleagues and neighbors already know everything about them that's been available on the internet. And they want to make sure that they're in command of what's coming down the pike.

So, the conversations are very healthy, we think. And the energy and the younger generation to be engaged and want to know, is really valuable for these families. One of the big challenges for families that were very successful after the war, and cashed out during the leveraged buyout wave, is that the message they gave their children as we were growing up was, don't worry about the money. Get out there, find your own way, pick a career, have a life. Don't be involved in what's going on here. We're taking care of this.

Those individuals who gave out those messages are in their 80s now. Their children are in their late 50s and 60s. They are already ready to check out. They're tired of being involved in what's going on in the system. And it is very difficult to get those young people to come back and be a part of the enterprise, and to learn about it. They're very comfortable, they've settled halfway across the world or across the country. They like their life. They're very busy, they're raising kids.

We're going to have this governance gap here for about 10 or 15 years, where it's difficult to figure out who's overseeing and paying attention to everything that's going on in these families. So, we're working hard to try to build a community of this younger generation who have some curiosity and some amount of time to make sure they get an understanding of what it means to be a trustee or a beneficiary, what it means to be an owner and sit on the governing board, how you pick the leaders for that activity. And to give them a way to practice at being a family leader earlier than just getting it suddenly, because grandfather finally passed away.

It's this organizing of the structures and the bringing in of the third and fourth generation that creates a need for formality in governance, and the way families organize themselves to make decisions, whether or not they trust each other, whether they trust the government system to represent their interests fairly and equitably. And that they feel like they actually own this system. And that a bunch of blue suits don't own that system for them.

And that is the conversation that we have around, what's in the enterprise? What do you want to hold on to? How do you want to organize it? And, how will decisions be made? Who has a right to sit at the owner's table and make a governing decision about that? And it varies as time passes.

In the case of someone like Arthur Blank, he is such a force and has so many creative ideas. He does all these things very early. He's gone at least to the end of the second blue layer. And he's a first generation guy. Grew up with a mom who worked 80 hours a week, and a brother. They were very poor. They had an early start. And he is just full of trying to put something together and that really will be meaningful for the Atlanta community.

So, what is your role in working with-- if you have an opportunity to work with either the whole family as a system, or maybe you're exposed and involved with one of these inheritors who is a part of a bigger system, but has his own money, and has his own ideas about what he wants to do with his money, that he does outside the system. How does that come together for you?

So, I worked on a chart that tried to get you in the mindset of what matters to you as a chief investment officer or a wealth adviser for them. So, we focus on market cycles, having predictable returns, finding alpha, looking for momentum, managing expectations of our clients, and controlling risk. That's our world. That's what we think about.

The first generation guy thinks about a business cycle or a life cycle. His own life, often. They're very focused on themselves. They are looking for a success story. They want results. They're looking for the next good deal. They're all about outcomes and taking big risks, making huge bets on something that goes on.

And the second and third generation is about a generational cycle. Having an impact, getting affirmation about who they are and that they're good enough, and worthy enough to be an owner. They don't have a good relationship with the money, because they didn't make it themselves. So, there's a little bit of guilt connected there, especially in this time of the big wealth gap. Finding purpose and meaning, managing their spending and saving, and taking little risks along the way. To try to understand and get comfortable with risk, is what they are all about.

So, you have to be able to keep all of these different perspectives on these activities in your head at the same time- what you need to accomplish, what the founders all about, what the granddaughter is saying to the founder about what she thinks ought to be done.

We had a great story at this Owner's Forum that we did from a G2 who said, I have been arguing with my father about the investments that he makes for the last 20 years, and getting pushback and intolerance all this time. She said, but I am finding that my 26-year-old daughter can stand up to him, and say to her grandfather, this is my world that you are messing with. And I need you to understand it's going to affect me and my children, if you don't stop doing some of the things that you're doing in your investment philosophy.

And there's an ability to get through with a message like that, sometimes, that just can't happen in earlier phases of a person's evolution. So, you've got to always be conscious of where they are, and where those opportunities are actually going to be in the process. Another dissection of how we think about this market segment, and this might be more relevant for those of you who are working with $20 million owners who do have children that they're trying to bring into the system, and they're involved in this.

This is an analysis of the impact of producers and consumers. And this is a joke we have in one of my sixth-generation clients, where they have a lot of people living off their wealth and a number of people, a small number of people, who are actually starting to regenerate more wealth. And so, they talk about consumers and producers.

So, when I think about the distinctions in how people invest money, the first thing that I separate is, are they still involved in a core business? Or, are they just involved in preserving financial assets? So, are they creators? Or, preservers? Is kind of the first breakthrough. And the second one relates to this issue of, are they producers around this process? Or, consumers in the process?

And if you're a shareholder in a core business asset that's been successful, you're either in one of two categories. You're living off of the dividends, or you're not living off of the dividends. And you're allowing the family to reinvest the capital. Sometimes the family creator patriarch says, we're not living off of the dividends. And nothing occurs until the breakthrough, and that individual passes on, and the second and third generation maybe revisit that conversation. But it really affects what they're-- in the world of goals-based investing, these are two of the drivers that really affect this.

And with financial assets, when we look at asset allocation among our members, we distinguish between families who are living off of the income, living off of the income and principal, and those who are not living off of either the income or the principal. And the fourth segment, which I almost forgot to put on here, are those family members today who are deciding they're going to distribute it during their lifetime and return it in a philanthropic manner in something meaningful that they want to work on. And they're not-- they either don't have children, or they're not interested in giving their children the burden of being that wealthy.

I can tell you from experience, one of the things the families I work with do not want to do though, is take everything they have, put it in a philanthropic structure, and then ask their non-wealthy children and grandchildren to sit on the board of that philanthropy, and give away billions of dollars. That is a very depressing place to be if you are a third-generation owner.

So, a couple of things about-- there's one trend that I thought I would give you some-- just for you to know that we're working on this, because I think it has a lot of impact in the next decade. We have a great amount of wealth that's been accumulated by these enterprise families since World War II, and they have been now very professional in how they put the money to work.

The allocation of family capital is currently being deployed, more in direct investing than in public markets. Or, not in great proportion, but 30% of an active owner's mentality is being redirected back into private equity funds and direct investments. And we know that in this country, we have a tremendous number of middle market companies that are run by an individual over the age of 60 who does not have a succession plan in place, or doesn't have a next generation in the market segment.

So, we're anticipating about 30,000 solid, well-performing businesses coming to market in this next decade. And one of the opportunities that the enterprise families have, and that we're trying to work with them on, is to have them in the right place to be connected to a business owner who's selling out, who is interested in seeing his business preserved. And not seeing it sold again in seven years to a private equity firm, and recycled back through a whole system of other private equity firms.

So, we have a direct investing network for our members. There are over 140 families involved in wanting to know what other families are working on, and working with another family to learn a new industry, so they can diversify out of the concentration that they're in. And they're very interested in taking long-term bets on family capital, and working with that.

And we find this very appealing to the millennials. I do think the millennials in their purpose-driven mindset will change the nature of what families are looking at, and what they're-- they're becoming a force. And we believe that impact investing is, for a very short time here, an asset class-based overlay. But I think it's going to be, as millennials come into their own, I think it's going to be an overlay across all asset classes. And that that will become a natural part of the conversation about investing is, what is the impact that we're having with what we're doing? Because they're so strong in this message.

And so, it's so distinctive to them, brought home by the condition of the world and the environment. And we have concrete examples of this now, in spite of what our president may say. So, how do enterprise families deploy their family capital? I know that people who work with investments really like to know, what does this pattern look like? So, I brought you some data around this topic.

And I'm going to give you-- I'm going to show you what a typical G1, G2 profile looks like. We do an annual survey of our members, and we cut the data in a variety of different ways. So, this a picture of a $500 million family in liquid wealth. 41% of the pool here also have an operating business that is not valued in this liquid portfolio. And this is the typical asset allocation, and I apologize if you can't read the data on that, but it's what you would expect. It's 13% fixed income, 28% domestic equity, 11% international.

The changes we've seen in the last few years are in the alternative areas. It's hedge fund slice is going down, private equity is going up. The overall average in private equity is 13%. In real estate, it's 13%. A first- and second-generation family has a much higher concentration. Although, typically, it's about 15% among the G1s and G2s, and 10% in other.

One of the things that's different is 71% of these families have a CIO today. Since 2010, and the big changes in the market, two critical things happened. They said, wow, we have pulled far too much away from what's really going on in the world. We need someone on staff translating this stuff for us, so we can understand it better, because none of this is making sense to us.

And the second thing that they did was pull back from public markets and begin to deploy back into operating companies, where they feel like they have the ability to make an impact, make a difference, and they have some control over what's happening with the return that they're getting from those direct investments. So, it's as much about wanting to use their expertise to contribute to a business that's producing value in the economy, as much as anything else that they're doing, that is bringing them back to direct investing.

The other activity that's bringing them back to direct is families are finding, when they sit together in a room, if it's 15 people who are G1 to G3, that they can have a really interesting conversation about Matt's Cookies, or some business that they just bought together. And they can get the whole family excited about knowing what's going on with that company. And they cannot get that kind of engagement with an investment portfolio.

So, they lean into the things that draw the family together, and get everybody excited. It's about engagement, as much as anything else. And trying to make sure there's interest. When you look at a kind of G3 and up kind of families, this is a picture of a subset of members from a survey a year ago, that the average liquid wealth happened to be a billion dollars. But it's a coincidence, the age of the family office is about 38 years. So, this is an older generational picture here. And you can see less risk. There's less going on with alternatives. There's more in the traditional markets. There will be more consumers than producers, which affects the nature of what's in the portfolio and how it operates.

With this group, there's only 35% that have an in-house CIO. 81% of them use an investment consultant to guide them on strategy, research, fee negotiation, performance reporting, some of those kinds of activities. So, they haven't-- they're not as active in the process of managing their portfolios, as the G1s and G2s are, and that's just human nature. It's the way it always has been.

This is a picture of-- oh, am I behind on a slide? Sorry about that. This is a picture of an investment family office, where there's definitely a CIO on staff. This happens to be primarily a-- 57% of this pool has an active operating business, probably a big one. They have 700 million that's liquid, in the way they invest the money. And I just got an update on the figures for our CIO group. So, they're been some shifts from this. As I said, this is a year ago, so it's a picture of year-end 2015.

But they are moving a little more towards international. Hedge funds is about the same at 9%. 13% in private equity. This particular profile was 15%. Real estate for a family that has an investment-driven, which probably means they're more centric to first- to third-generation families, are involved in less in real estate in this particular subset.

Now, a little bit of data about this trend around private equity that I thought you might find interesting. What we do when we do a survey of 120 families is, we pull a separate cut on families that are very active in private equity, so, those investing more than 20% of their asset allocation in private equity. And we look at that data as a separate subset, because when you average any of this data, you don't really get the qualitative part that you need.

And what you see here is that G1 and G2 families are doing 36% direct on the left, 53% in funds. And on the right, G3 and up are 67% involved in funds. And there's some data at the bottom that we don't really have time to go into, that tells you a little bit about the level of investment by the generational patterns that are there. But, if you look at this data on the next page, this is really where the story is.

In 2011, when we looked at families committed to private equity, what we found is they were 14% engaged in funds, and 12% involved in direct ownership of companies. And when we looked at this again three years later, the direct active operating company investment was 22%, and the equity funds are 13%. In families who are big believers in direct ownership, do invest in private equity funds because they're interested in the market research and the perspectives that other people have on their industry. And so, it's really a mechanism for them to stay current and to find out when everybody else is doing.

That's a large part of what we do for them is trying to help them understand what other families doing direct are doing, and how they're doing it. So, in our network of 140 families, we have probably a good 60% of that group that wants to move from being concentrated in one industry like health care, to wanting to be a second chair investor with another family, but in a different industry, so they can come to the table and learn what they don't know about-- and teach that, and pass it on to their kids, so they can start to have a diversified portfolio of different kind of businesses they own.

The nature of what families invested in and made their money in dramatically affects the way they think about money, the way they think about return, and how they relate to their family office. The kind of investment they make in the family office. And also, in educating their kids, interestingly enough.

In this subset also what's important to note is 83% of these families have an operating business. So, they probably have an M&A component in that operating business that's looking for add-on strategies and other activities they want to bring to the fore. So, they are attuned in, in the earlier generations. As long as they own an operating business, they've got a team to help them do this well. And one of the biggest challenges for families who no longer have an operating business is, not understanding the complexities of private equity, not setting up a large enough resource team, not getting the governance in place in the family to understand how much money they're going to deploy, who's going to make the decision, who's on the investment committee, how quickly we can get to the table to win the deal.

So, the families, I would tell you, have not been that successful to date since the interest started to crop up in 2010, because they aren't organized effectively yet to do it well. But I think they will get there. I think it's a trend that we will continue to see through this decade. I am respectful of Don Putnam's commentary about private equity, if you know him from Putnam Level. He's been an investor for at least 50 years, and is the only 70-year-old I know who moved from Boston to San Francisco, because he wanted to know what was going on out there.

But Don says, private equity moves in 40-year cycles. So, people do funds, they get really committed to funds, so they do it for 20 years. They look at the data, and they say we're not making any money in funds. Let's go back into direct. So, the pendulum starts to swing back in the other direction, families get excited and organized around direct investing. They go up the learning curve, they find out how hard it is to do it. They do it for 10 years. They spend $5, $6 million a year trying to do it well. They get to the end of the cycle and they go, we're not making enough money for all this effort that we're putting out. Let's go back to funds.

So, I haven't been through it long enough to see the whole cycle, but human nature is human nature. So, we'll see how that goes for that. So, I think that is the end of my-- oh, I have just one more, there's one more chart, that shows you specifically a little bit more about this shift of families that are doing 22% in equity. And again, this data is a year old. So, our new survey just got closed out, and the data is being crunched right now. And I don't have the most current information about this right now. But it gets families talking, and interested, and excited about-- and it can create a lot of conflict around risk and risk taking. And that's my story, and I'm sticking with it.


SPEAKER 1: Questions seem to center around, what is the potential role for the advisors in this room? It seems that it could be really two things. Not talking about the particular family member, but the overall family, that of either an investment consultant, or that of an outsourced chief investment officer. Could you define the nuances between the two? And also, the differing compensation arrangements, what's typical? What's not?

SARA HAMILTON: Oh, OK. So, one of the most valuable things you can do is sort out, early in your exposure to somebody who comes from these kinds of families, is, what's their mindset about where they sit? Because it's a very wide spectrum about, I don't care about it, it frightens me, the other branch is in charge, bitterness and frustration, all the way to, wow, this is really exciting. I think this is something I'd like to get to know about. And it really varies. So, be the questioner on this. What have you been told about the history of your family and its wealth and how decisions are made?

And let them talk. And help them reflect on where they sit. They don't understand where they sit in the system. And think about the age that they're at. When we're asking 20-somethings this question, they're in the, who am I, and where's my place on the world, stage of life. And asking them to talk about where they sit in the family enterprise system is just not something that most of them have the capacity for. It's often when they first-- when they have their first children of their own, and they go, oh, I see this generational thing. This is starting to make sense. I wonder how my grandfather did that, when he did this-- and the scope of looking forward, which is what they've all been doing in their 20s. And now they start to begin to look back, and to think about where it came from. So, help them understand where they're looking in this family dynamic, I think is really valuable.

When you see big conflict in a family that's multigenerational, often it's because some of the family, let's say it's a third-generation owner, the conflict occurs because some of the family members are standing on the first- to third-generation bridge and feeling like they've finally arrived, and some of them have already moved to the second- to fourth-generation bridge, thinking about, where are we going next? And some of them are looking forward to the future, and some of them are looking back, keeping score, and feeling bad about what has happened in the past.

So, getting a real feel for where they are, and what matters to them individually. You can be a great resource, even if you've never met the family office team that works with the whole family system. You can be a tremendous resource to an individual who is a wealth inheritor, who has his own challenges of forming his own nuclear family, figuring out how together they fit into the bigger system, where they want to go, how much inclusiveness they want to have. Tremendous amount of complexities there.

When it comes to the compensation question, I'm assuming this is around what is someone paid to work in this type of--

AUDIENCE: You know, what are the-- what's the difference between the investment consulting function and the outsourced chief investment officer function? And is are difference in pay scale? And, how is it done? It's probably a retainer or a fixed fee?

SARA HAMILTON: Yeah. So, and you know, the role the investment consultant is changing dramatically in the industry. And with access to more product without needing to use a consultant, and everything about how we invest money and what we charge for it, is changing. And we see it first with multifamily offices, and you'll begin to see it down in the wealth advisory space also. But it's going to be a very big decade for a transition, I think, in pricing.

In terms of what families pay for the kind of strategic advice that they get, a few metrics about family offices. Overall, the average family office today probably pays about 52 basis points for the set up of the office. The office spends a third of its time counting what the family owns, just as you have a lot of bookkeepers who help your clients, maybe not as many of the family enterprise would.

A third of their time they spend engaging with all the outside advisers that help the family. So, if you have 12 family members, you've got a lot of different advisors you're working with. Typically 48 would be an average number. And a third of the time, engaging directly with the client. So, it's a very challenging, and also can be a very rewarding, role.

When you look at compensation for family office executives, the dots are all over the page. We pull comp data every year. The average CIO in that office profile that I showed you, the base and short-term incentive was about 350. Typically, a good chief investment officer wants to see $800 to a billion dollars in liquid wealth to work with, before they are really attracted to come into a family office setting.

So, when you see data about a family that has $400,000 and they have someone called a CIO, it's not a strategic CIO. And that family may also have an investment consultant who is the partner with that individual who might have had experience with portfolio management, and be able to run the committee that they're working with and the investment committee, but they're not the strategist in the same way that you would get in an MFO or a larger organization.

SPEAKER 1: We only have about 30 seconds left. Could you talk a little bit more, very briefly, about the civil family office's as potential buyers of middle market companies? Are they willing to take minority stakes?


SPEAKER 1: You said longer term.

SARA HAMILTON: The biggest shift, with my 15 seconds, the biggest shift we've seen is 30 years ago, families who did direct, insisted on having a 100% ownership, majority control. Now, everyone sees the value of being a 40% partner, or a 20% partner, with somebody else who really knows what they're doing. And we hear a lot about collaboration and the ability to work together to manage these things. We don't actually-- we haven't seen a lot of transactions in that direction, but I do believe that we will see some.

Families finding strategic partners that they want to own businesses with it's a tough call. And a lot of conversations won't really end up going anywhere, but I think there's a tremendous interest. And, who knows where the millennials may take this? They're much more open about this. So, I think I'm past my--

SPEAKER 1: Well, thank you for your insight.

SARA HAMILTON: Thank you very much.

SPEAKER 1: We appreciate you being here.

SPEAKER 2: Copyright 2017 CFA Institute. All rights reserved. This program is designed to give accurate and authoritative information in regards to the subject matter covered. It is distributed with the understanding that CFA Institute is not engaged in rendering legal, accounting, tax, investment, or other expert advice. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

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