CAIA L2 - 4.5 - Family Offices and the Family Office Model Flashcards
Contrast
First-Generation Wealth
vs
Second-Generation
(Concerns, Goals)
4.5 - Family Offices and the Family Office Model
First-generation wealth or new money
* usually concerned with wealth preservation
* Portfolio key goal: offset the risk of a concentrated position
Subsequent generations (old money):
* usually concerned use of the wealth
* Portfolio key goal: wealth generation and growth (PE is commonly added)
* Important constraint: Tax considerations
4.5 - Family Offices and the Family Office Model
Complete
Ultra-high-net-worth families
usually have at least $ ____ m
4.5 - Family Offices and the Family Office Model
Ultra-high-net-worth families
usually have at least $ 30 m
4.5 - Family Offices and the Family Office Model
Define
function of a
completion portfolio
of a family office
4.5 - Family Offices and the Family Office Model
is designed to
own assets uncorrelated with their concentrated positions.
For example, the family office of a health care executive would be ill advised to buy more health care stocks within the completion portfolio, but energy or consumer durables may be good diversifiers.
4.5 - Family Offices and the Family Office Model
Describe
How FO
increase tax efficiency
with hedge funds
4.5 - Family Offices and the Family Office Model
- Reviewing the information on a hedge fund’s K-1 form, which is a tax document that includes an itemization of short-term gains, long-term gains, and dividends (among other things)
- Using strategies that favor long-term investing, such as long/short and event-driven funds
- Looking for specialized HFs in futures contracts
4.5 - Family Offices and the Family Office Model
Describe
How Section 1256 contracts
can benefit investors
4.5 - Family Offices and the Family Office Model
Futures = classified as Section 1256 contracts - U.S. tax code
Taxed in a hybrid form:
* 60% at the lower long-term capital gains tax rate (~20%)
* 40% at the higher short-term rate (~37%)
4.5 - Family Offices and the Family Office Model
Contrast
Arguments
for and against
the inclusion of art
as an asset class
4.5 - Family Offices and the Family Office Model
For:
* rare item that is usually held over an extended period and will likely generate a capital gain during that time based on how an objective third party values the art in the future
Against:
* No systematic risk premium that would allow it to be included in an asset class.
* No cash flow productions - on an ongoing basis, which makes discounted cash flow valuation irrelevant.
* Uniqueness - Unlike homogeneous asset classes like stocks and bonds, every piece of artwork is unique, so the uniqueness precludes its inclusion in an asset class.
* Personal enjoyment - many ultra-high-net-worth individuals purchase art solely for the personal enjoyment they derive from owning it and are not motivated by any future potential capital gains.
4.5 - Family Offices and the Family Office Model
List
Four primary factors
work against wealth
lasting over multiple generations
4.5 - Family Offices and the Family Office Model
- A growing number of descendants dilutes the wealth into smaller portions.
- Succeeding generations may lack the skill or inclination to operate the dynastic business.
- Succeeding generations may be unprepared to be productive members of the family office.
- The family office might have a philanthropic focus that redirects family assets to benefit society as a whole.
4.5 - Family Offices and the Family Office Model
Contrast
Charity
x
Philanthropy
4.5 - Family Offices and the Family Office Model
Charity
giving of money or time in an attempt to meet an immediate need, without holding its recipients accountable
“giving a man a fish”
Philanthropy
giving of money or time with the intention of making a lasting change
“teaching a man to fish”
4.5 - Family Offices and the Family Office Model
Contrast
Impact-first investing
x
Finance-first investing
4.5 - Family Offices and the Family Office Model
Impact-first investing
seeks to accomplish a social good, with investment returns as a secondary objective
Finance-first investing
focused on investment returns, but in a way that is believed to advance social good
4.5 - Family Offices and the Family Office Model
Define
impact alpha
4.5 - Family Offices and the Family Office Model
Expectation that ethical companies will eventually earn excess returns relative to their peers
Ex: natural resources industry.
One firm invests in environmentally friendly exploration and production techniques. That pursuit will be more costly in the short run. Yet, in the long run, it may prove to be more cost effective as public opinion shifts consumers to their products,
less-responsible peers may have substantial environmental cleanup costs.
4.5 - Family Offices and the Family Office Model
List and describe
Ten natural advantages
of family offices
4.5 - Family Offices and the Family Office Model
- High risk tolerances, which enable an aggressive asset allocation - for the ones focused on wealth generation.
- Can capture liquidity premiums by investing in illiquid investments.
- Access to deals. FOs usually not activist investors (as PE typically is). For the family office, a direct investment also means that they do not need to pay the typically high fees associated with private equity, and they gain transparency into the investment target’s books. Another benefit is that direct investors usually get a slight discount to the company’s fair enterprise value, while private equity firms pay a premium. A better entry point produces a better return on investment.
- Deploy capital quickly. Pensions and endowments = slower.
- Minimized conflicts of interest - providing confidentiality and advice tailored to each individual family member.
- Better alignment of interests
- Lower costs by negotiating fees - economies of scale = higher returns
- Centralized Risk management, including risk reporting and performance attribution, may be performed more efficiently by centralizing it in a family office.
- Confidentiality - Because ultra-high-net-worth individuals generally prefer confidentiality in their financial dealings, it is also beneficial to centralize services such as estate planning, tax management, and philanthropy.
- Lifestyle assets in a portfolio perspective within the context of a family office
4.5 - Family Offices and the Family Office Model
List and describe
generalized planning framework
that they use for wealthy families
4.5 - Family Offices and the Family Office Model
- Develop a financial plan. Assessing a client’s previous experiences, their objectives and needs, time horizon, risk appetite, return expectations, and cash flow needs.
- Review trust and estate issues. This includes assessing asset holdings, determining charitable gifting goals, and evaluating strategies designed to reduce the client’s tax burden.
- Develop an asset allocation strategy. Long-term strategic asset allocation is critical, as the asset classes chosen should align with the client’s risk and return objectives.
- Implement portfolio construction. This involves choosing the investments that will be used to gain exposure to various asset classes.
- Monitor progress relative to goals. Measuring progress towards meeting client objectives, which may or may not involve utilizing benchmarks, is critical.
- Become a behavioral coach. An advisor must be able to serve as a behavioral coach, which will help clients with their inherent behavioral biases and will minimize emotional responses to market events.
4.5 - Family Offices and the Family Office Model
Differentiate
Client service models
of private wealth management
4.5 - Family Offices and the Family Office Model
Digital Advice and Roboadvisors
* <100k investable
* Software-based of customized and automated investment advice
* Fee: 0.25%–0.50%
* ETFs
Financial Planning and Investment Management
* $100k - $1M - Mass-affluent investors
* Phone-based FA accessible through digital channels to deliver personal advice
* Fee: 0.30%–0.90%
* ETFs, stocks
* turnkey asset management program (TAMP) is an outsourcing service providing investment management services for smaller wealth management firms that lack in-house investment professionals
Comprehensive Wealth Management
* >$100k - $1M
* Face-to-face advice mainly through branch network offering comprehensive wealth management
* Fee 0.75%–1.5% (Decreasing: 1.0% for a $1 million base, 0.9% for a $2 million base, etc)
* Stocks, bonds, ETFs, mutual funds, options, alternative investments, commodities, structured products
4.5 - Family Offices and the Family Office Model
benefits of family offices
LO 4.5.2
conflict-free advice
centralization of portfolio management
understanding of the unique needs of different family members
