Assets managed by family offices vary drastically. The standard criteria in professional circles for survey purposes require an asset amounts of at least US$200 million. Defined that way, there were more than 10,000 family offices globally in 2015. More than half of them were set up after the year 2000. The total wealth managed by family offices satisfying the US$200 million threshold was estimated to have reached US$5.1 trillion by 2015. With simple extrapolation, the total wealth managed by family offices can be easily in the neighborhood of US$10 trillion by now.  While there is a heavy concentration of family offices in international financial centers such as New York City, London, Zurich, Hong Kong and Singapore, a new trend in the horizon is the surge of family offices in emerging markets, such as Russia, China and countries in the Middle East.   

Collectively, the impact of family offices on asset pricing in the financial market is non-trivial. As such, the subject is definitely worth rigorous academic investigation.  

Family office from an investment perspective

Family offices perform various functions for owners of family businesses. The primary mission of family offices is no doubt to preserve family wealth and achieve growth, so the main function of family offices is investment related. In addition, family offices may also perform services such as philanthropy and other “concierge” services. As a result, investment strategies adopted by family offices may differ from other financial institutions.

How different are actual investment strategies by family offices from other financial institutions and is the difference driven by the fact that family offices need to perform other services for the family businesses? A survey conducted by UBS and Campden Wealth in May 2019 on 360 geographically balanced family offices revealed that average holdings of family offices are 51% in equity (32% public and 19% private), 16% in debt, 8% in cash and equivalent, 18% in real estate, and 7% in other alternatives, including commodities and hedge funds.
 
These family offices, which are 80% so-called single family offices working for a single family business and 20% multiple family offices working for multiple family businesses, have an average asset under management of US$917 million and an average family wealth US$1.2 billion, so they are believed to be quite representative.  Suppose they are, then the pattern revealed above shows a conspicuously bigger focus on private equity and real estate than other financial institutions on average. 

The heavier concentration on private equity and real estate in asset allocations by family offices would not, at first glance, seem consistent with their goals. Empirical evidence suggests that private equity and real estate as asset classes contain high systematic risks. Furthermore, it is well known that private equity and real estate are notoriously illiquid. These features point to the possibilities that family offices’ over concentration on private equity and real estate is inconsistent with the goals of diversifying business risk and increasing asset liquidity. So is this a case of misallocation?

One hypothesis that can reconcile the apparent disparity between the goals and strategies adopted by family offices is that family office executives have information advantage in the areas of private equity and real estate. This may be true, especially for single family offices which evolved from the so-called embedded family offices whose top executives used to be the financial butlers of the families. They followed the family leaders in the development of the family businesses from early stages, went through the dealings of various transactions, and participated in decision-making in many projects. In the process of being groomed to become family office top executives, they accumulated similar knowledge of successful entrepreneurs.  Once they are on the buy-side, they have the flair for identifying promising targets in private equity deals. 

Similarly, the expansion and contraction of businesses inevitably involve transactions featuring real estate properties, so the family office executives have accumulated experience in property evaluation before they became family office executives.  

To conclude, family offices tend to allocate disproportionally more to private equity and real estate because the family office executives have a comparative advantage in these two asset classes. This advantage overweighs the disadvantage posed by the higher risks and lower liquidity of the two asset classes. The hypothesis has several testable implications which can be examined once data becomes available.  Before that, anecdotal evidence from case studies is also helpful.

Family office from corporate finance perspective 

Running a family office is costly. Two potentially large categories of family office expenses are staff compensation (salary and bonus, etc.) and the fees paid for wealth management services of external firms. The ratio of the former to the latter varies substantially across family offices as they adopt different policies regarding the degree of outsourcing, so is the number of internal staff of family office relative to the assets under management. The benefit of outsourcing is that it makes use of more widely available wealth management expertise. The cost of it, beside the fees, includes a loss of confidentiality, effective control of the investment portfolio, and the ability of building up their own in-house expertise with loyalty.

While the pros and cons of outsourcing are understood qualitatively, there is no specific model to provide guidance on this important decision. As the services carried out by family offices are complex, a variety of practices exist. Whether such a variety indicates any sub-optimality to family businesses per se and to the whole society in general is unknown. What makes the matter more complicated than the usual cost-benefit analysis is the potential moral hazard problems between entrepreneur families and family office executives and between family offices and outside wealth management providers. The subject of moral hazard has been well studied for firms between shareholders and managers and for financial institutions such as mutual funds between investors and managers. 

The complexity of family office management offers a new, fruitful ground for corporate finance researchers to study efficient contracting issues with multiple levels, involving features such as loyalty and confidentiality.

A surge of interest

The surge in the number and the assets under management of family offices is generating interest from both practitioners and academics. How decisions are made regarding the establishment of family offices and their management remains largely undocumented and unanalyzed. The task of finding out the truth about family offices is challenging due to the lack of data, but it is also rewarding as the subject is so important. 

At the HKUST Business School, the Center for Investing in the Department of Finance, in collaboration with the Tanoto Center for Asian Family Business and Entrepreneurship Studies, is committed to the research and propagation of the knowledge in family business.  The endeavor of family office research not only can broaden the scope of finance research and deepen the academic sophistication, but also directly benefit the local economic community.
   
References

Bloomberg, 2017. The Future of Family Offices.

Citi Private Capital Group, 2018.  Investment management best practices for family offices 

Credit Suisse, 2014. The Family Office Dynamic: Pathway to Successful Family and Wealth Management, Part II: Process Considerations. (In collaboration with Ernest & Young and University of St. Gallen)

Ernest & Young, updated in 2017. EY Family Office Guide: Pathway to successful family and wealth management. (In collaboration with Credit Swiss and University of St. Gallen)

UBS & Campden Wealth, 2019. The Global Family Office Report, 6th edition