Joe Reilly, president of the Family Office Association, recently sat down with industry consultant Jamie McLaughlin, of JH McLaughlin & Co, to talk about leadership, culture and left-brained wealth advisors.

Joe Reilly, president of the Family Office Association, recently sat down with industry consultant Jamie McLaughlin, of JH McLaughlin & Co, to talk about leadership, culture and left-brained wealth advisors.

Reilly: Great advisors - bred or bought?

McLaughlin:  I’m convinced every firm has the same so-called “talent” issues; they don’t have enough skilled senior client-facing talent, arguably the principal determinant of the client experience and the underlying driver of a firm’s enterprise value. The only way they can find these elusive people is to breed or grow them. 

The pathway to becoming a counselor to families of great wealth and complexity is misaligned. Too often, firms react to whatever the market presents to them; they cannibalize their neighbor’s talent or have a passive response to whatever the market bubbles up, largely products of a higher education system focused on the theoretical. That is, individuals largely focused on degrees or vocational paths heavily tilted to finance and the capital markets where mathematics, analysis, and empiricism is predominant - not the study of the human dimension.

The academy and industry have responded to a degree with programs and credentials (CFA, CFP, CPA-PFS, CIMA, etc.), but these formal training programs are “pulled” by market participants not “pushed” and do not train anyone in the advanced and peculiar needs of families of great wealth and complexity. Without oversimplifying the challenge, most financial firms including wealth management firms are populated by “left-brained” rational, logical, analytical types and, rarely, by “right-brained” “feelers” or intuitive types who possess empathy and to whom others are comfortable revealing themselves.  

Most importantly, there is no early identification methodology. The industry does not effectively identify individuals with the intrinsic talents necessary for a consultative role and, on the professional development continuum, firms have not invested in their people to optimally train and acculturate them into client-facing roles. Ultimately, there is no substitute for applied training where the advisor learns to recognize complexity, can identify and unfurl issues that are often unstated, and can facilitate an integrated dialogue across various needs and solutions - no small task.

Reilly:  How important is culture in an MFO? Does it differ qualitatively from a private bank or trust company?

McLaughlin: Culture is the single most differentiating characteristic of any firm in any industry, even more so in the wealth advisory business where very few firms can differentiate themselves by what they do, but, where every firm can differentiate themselves by who they are. Clients are yearning for a relationship and will naturally select firms with whom they are compatible and where they share common values. Firms are wise to build their brands around these markers – whether using subliminal or overt messaging. 

The so-called MFO is nearly always a closely held partnership organized as a registered investment advisor.  Most private banks and trust companies are divisions of larger commercial banks with nearly all of those being public companies. The introduction of shareholders as “stakeholders” tends to have a dilutive effect on firm culture as return on equity becomes a driver of behavior and skews the client experience, too often placing the firm and client at odds. Further, while scale implies an opportunity for operating leverage, it tends to further dilute the culture and client experience with firms looking for opportunities to replicate processes and clients preferring customized solutions.

Reilly: What are the essential skills for MFO leadership? Can you contrast those skills with the skill sets of traditional and alternative asset managers?

McLaughlin: The essential skills include a combination of leadership and management skills, but far too often MFO leaders lack the critical management skills and experience needed to operate a business. As founder principals their intrinsic talents and interests tend to be either sales and relationship management or an expertise in investment management and capital markets. Few have had previous operating business experience in investment management or any other industry. Firms have been slow to bridge this gap, but this pattern is changing. In the largely undercapitalized MFO model, hiring senior talent for non-revenue bearing operating roles has often been financed through cash flow, dampening margins and/or paid for out of the founder principals’ pockets.

Asset management businesses enjoy stronger capital structures and much better margins and, generally, are a more mature business model where a full generation of founder principals has exited. 

Reilly:  Where do you feel the leading multi-family offices demonstrate strength? Weakness?

McLaughlin: The most successful firms have four interdependent components: capital, a strong and deep leadership team, a strategic vision, and the ability to execute, in that order of importance. Few MFOs have demonstrated success on all four of these dimensions, but the model is evolving. 

·         Capital - MFO capital structures are weak and concentrated. Capital sources are limited and often incompatible with the long-term requirements of the business and the principals’ objectives.

·         Leadership team – as noted, firm leadership often lacks operating skills.

·         Strategy – firms must decide what is a core capability and what is an “adjacency” and then “stick to their knitting.” They need to decide what they will deliver and what they won’t deliver, and in the latter case, how or through whom they’ll deliver certain non-core solutions.

·         Execution – execution requires discipline and discipline requires management.

Reilly: Do you feel the MFO space will consolidate over the next few years or continue to expand? Or do you feel that the paradigm of family office services will shift?

McLaughlin: The nascent wealth management industry is immature – the business economics are extremely challenging and demand is shifting, all at the same time. It’s very dynamic.

The 2007-2009 market convulsion put severe pressure on firms’ business models and has reshaped client demand, particularly at the very high end of the market. Many smaller firms were hit hard and have been unable to get to the next level.  As noted, few have acted strategically and are in position to build or bolster their platforms for the future.

MFO capital structures and income statements remain relatively weak and capital sources are limited. The aging of key principals implies a further diminution of firm valuations.

Remarkably, this extended weak market cycle should portend consolidation and/or roll-up activity as the current low-multiple environment cannot logically persist indefinitely.

While firms have been challenged, demand has shifted. Larger families (>$100 million) are choosing multiple investment advisors and shopping “a la carte” for non-investment needs or choosing an MFO for a completion strategy. 

I’ll go out on a limb with one prediction – a non-investment management “family office services” model will become increasingly in demand as family offices conclude that they cannot rationalize certain internal capabilities such as household financial management and IT/systems development. Firms that can deliver these services and do not provide investment management will capture this market share and will do so at reasonable margins even if using a “time and effort” professional service firm (PSF) revenue model.

Reilly: Staff compensation is a substantial part of an MFO's costs. Are there ways to increase the operational efficiencies of MFO staffing while offering a full suite of services?

McLaughlin: The best long-term strategy is to build a true middle office: one where the senior client-facing personnel are leveraged by next-generation professionals. This can increase capacity utilization (i.e. load management) and provides next-generation personnel a clear professional development track. All non-strategic duties (tactical and administrative) can be cascaded down to middle- and back-office personnel.  Two key performance metrics are a firm’s income/cost ratio and cost of (client) acquisition. As costs are often 65-80 per cent staff related, the middle office needs to be seen as a high return on capital as increased client-facing activities drive client satisfaction, increase income from existing and new clients, and lower unit staff costs. It also has a salutary effect on firm morale.

Secondly, pricing discipline can be improved. Clients are increasingly demanding non-investment services and have been socialized to expect these services will be offered “for free” or as part of a bundled fee where the firm’s pricing power is principally related to the investment delivery. An alternative pricing delivery system, one that avoids this “trap” and does not jeopardize a firm or advisor’s “primacy” with a client, is for firms to either systematically outsource or joint venture the delivery of non-core capabilities or categorically enumerate these discreet services in their annual engagement agreements passing through these true costs. Firms need to stop tip-toeing around their fees and provide regular communication, expectation management, and transparency on their service delivery and value proposition.