What Comes Before Investment Management: Family Offices and Decision-Making

An Integrative Function Connecting the Family, Ownership, Management, and Assets

Summary

The term family office is often understood in connection with investment management and asset administration for wealthy families. However, while investment management is one of its important functions, it is not the whole. Families face a range of interrelated issues involving the business, ownership, assets, succession, and the education of the next generation. Drawing also on my experience as a fund manager working with institutional investors such as pension funds, this article considers why a family must clarify its objectives and decision-making framework before selecting investment products.

How Should We Understand a Family Office?

When people hear the term family office, many may first think of investment management and asset administration for wealthy families.

Asset preservation and investment management are certainly important functions of a family office. How a family should hold not only listed equities and bonds but also real estate, private equity, hedge funds, private companies, and overseas assets; how much risk it should take; and how it should pass those assets to the next generation are all important issues for the family.

However, if a family office is viewed only as an asset management company or an asset administration company, it can be difficult to understand its role fully.

What is required of a family office is not merely to increase financial assets. Its role is to consider the family’s values, business, ownership, assets, succession, education of the next generation, and coordination among professional advisers as an integrated whole over a long time horizon.

In other words, it may be closer to actual practice to think of a family office as an ‘integrative function’ that enables the family to make decisions across generations.

What Must Be Decided Before Selecting Investment Products

In the world of investment management, attention tends to focus on what to invest in. Yet there are matters that should come first.

Why are the assets being invested? What level of return is required? How much loss can be tolerated? How much liquidity must be maintained? What time horizon should be used?

Only after these premises have been established can an appropriate asset allocation and investment strategy be considered.

The same applies to investment management for family assets.

For a family, however, even the initial question of ‘for whom are the assets being invested?’ involves various considerations and does not have a single answer.

Should priority be given to the financial stability of the current generation? Should succession to the next generation come first? Should the family support the growth of the operating company? Should it preserve the family’s assets as a whole over the long term? Or should it allocate a portion of those assets to philanthropy?

These aims are not mutually exclusive, but the desirable asset allocation and approach to risk will vary according to their order of priority.

The selection of investment products comes after these policies have been determined.

What a Comparison with Pension Funds Reveals

As a fund manager, I have explained investment strategies to pension funds and other institutional investors.

Although the circumstances of each pension fund differ, its investment objectives, liability structure, risk tolerance, asset allocation policy, and decision-making process are generally organized with relative clarity.

At the very least, it is usually possible to see the basic framework: for whom the assets are invested, over what time horizon, and under what constraints.

From the perspective of an asset management company, understanding that policy makes it possible to explain where its own investment strategy may be suitable.

By contrast, in investment management for family assets, those underlying premises may not themselves be clear.

Is the priority to grow the assets or to preserve them? How much consideration should be given to the current generation and the next generation, respectively? How should reinvestment in the operating company be balanced against investment in financial assets? How much must be held in highly liquid form? How should philanthropy and the education of the next generation be positioned within the family’s total assets?

A further complication is that family members do not necessarily share the same views.

Unless these premises are adequately organized, it is not easy even for an asset management company to determine which investment products or strategies are appropriate for that family.

This is not simply a matter of preparing an investment policy statement. Before that stage, the family must organize its thinking about what it seeks to achieve and why it holds its assets.

This is one of the roles a family office can perform.

Shares in the Operating Company Are Not Merely Investment Assets

Families that own a family business have a particularly distinctive feature when considering the composition of their assets.

In many cases, shares in the operating company form the core of the family’s assets.

However, these shares differ in character from ordinary financial assets.

Shares in the operating company are assets, but they also confer management control. Responsibility toward employees and business partners, principles inherited from the founder, and relationships with the local community are also deeply connected to the ownership of those shares.

Accordingly, when considering investment management for family assets, it is difficult to treat shares in the operating company and other financial assets as entirely separate.

How much capital should remain in the operating company? To what extent should growth investment be prioritized? How much dividend income should the family seek as a shareholder? How should the risks the family already bears through the business be combined with the risks taken through financial assets?

These issues differ substantially from the investment management concerns of an ordinary individual.

For example, if most of the family’s assets are concentrated in the shares of a single operating company, it is necessary to consider whether it is appropriate for the family to take substantial exposure to the same industry or region through its other financial assets.

At the same time, shares in the operating company should not simply be treated as ‘concentration risk’ and sold solely for the sake of diversification under financial theory. Continuing to hold those shares may itself have meaning for the family.

This is where family assets present issues that are difficult to resolve through conventional portfolio management alone.

From ‘How Should We Invest the Assets?’ to ‘What Do We Seek to Achieve as Owners?’

Some family members work in the operating company, while others are involved only as shareholders. Some have a strong interest in management, while others have a relatively limited connection with the company.

As generations pass, these differences in position generally become more pronounced.

At that point, the important question is not merely, ‘How should we invest the assets?’

How should the family continue to own the company? Under what circumstances may shares be sold? What level of dividends should be sought? How much capital should be reinvested for the company’s growth?

In other words, the family must establish its policy as an owner before developing its investment policy.

The investment policy is therefore positioned within those broader conditions.

For a family that owns an operating company, the starting point of investment management will often be to consider what kind of owner it wishes to be while viewing the business and financial assets as a whole.

The More Professional Advisers Involved, the Greater the Need for an Integrative Function

As the scale of a family’s assets and business grows, the number of professional advisers surrounding the family also increases.

In addition to lawyers handling legal matters and tax accountants serving as tax specialists, financial institutions and asset management companies propose various investment management solutions. Professional advisers also work in real estate, business succession, mergers and acquisitions, overseas relocation, philanthropy, and other fields.

These professional advisers are indispensable. Yet for a family, the greater difficulty may be not the absence of advisers, but the fact that each adviser provides advice from a different perspective.

An approach may be legally sound, yet another option may exist from a tax perspective. An approach may be tax-efficient, yet create concerns about fairness within the family. An investment may be rational in isolation, yet overlap too heavily with risks already borne by the operating company.

Even if each professional adviser’s judgment is correct, simply adding those judgments together does not necessarily produce the best outcome for the family as a whole.

This is why a family office is expected to connect the expertise of professional advisers across disciplines and integrate it into decisions aligned with the family’s objectives.

Clarifying the Family’s Objectives

In this sense, it can be said that the family’s objectives, rather than investment products, should be placed at the center of the family office.

What does the family wish to preserve?

What does it wish to grow?

What values does it wish to pass on to the next generation?

What role should the operating company play in the future?

How much of the assets should be left to the next generation, and how much should be returned to society?

Once the family’s thinking on these questions becomes clear, activities such as investment management, business succession, share ownership, philanthropy, and the education of the next generation can be organized more readily under a common direction.

Conversely, if these objectives remain vague, even a newly established family office may become little more than an organization that administers assets and responds to individual matters.

Establishing a family office is not an end in itself. The family must first determine how it wishes to make decisions and then design the functions required to support those decisions.

A Large Organization Is Not Always Necessary

The term family office may bring to mind a large organization with a dedicated Chief Investment Officer (CIO), lawyers, tax professionals, and investment professionals.

However, not every family needs to establish such a Single Family Office (SFO).

The necessary form will vary with the size of the family, the composition of its assets, its relationship with the business, its international footprint, and the number of next-generation family members.

A small team can perform the family office function by coordinating external professional advisers. The function may also be housed within a holding company or an asset administration company.

What matters is not the organization’s name or size.

Who consolidates the necessary information? Who maintains an overview of the whole? In what forum are matters discussed? Who makes decisions? How are the views of professional advisers organized?

What matters is whether a substantive function exists to make these complex decisions while considering what outcome is best for the family.

Conclusion: The Family Office as a Function Supporting Decision-Making

If a family office is understood as an asset management company, the discussion inevitably turns to questions such as ‘Which product is best?’ and ‘What level of return should we target?’

Yet other questions must come first.

Whose assets are they? What time horizon should be used? How should the business and financial assets be positioned? How should the interests of the current generation and future generations be balanced? And what does the family seek to achieve?

A family office can be positioned as a function that supports the family in making decisions on these questions on a continuing basis.

Investment management is an important part of that function. But it is not the whole.

Connecting the family, ownership, management, assets, succession, and professional advisers, and supporting decision-making across generations, is the integrative function that will become increasingly important as Japan considers the role of family offices in the years ahead.