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Family office design

How would I design a family investment office?

I’ve received that question many times. I tend to answer it with a few questions of my own – what are your goals? Risk appetite? Capital base? That said, here are a few archetypes:

1) Low-cost beta.

Build a globally diversified portfolio with ETFs and rules-based funds (e.g., from DFA, AQR). No direct investments. Just don’t do it. You can also slowly build a small allocation (<10-15%) to small specialist managers for exposure to less efficient, less correlated areas (e.g., litigation finance).

Investment team = CIO + midlevel analyst. Minimum size = $200-250 million (investable). Less than that – to invest – doesn’t justify the cost of an internal team (and please don’t try to hire talent on the cheap)*.

2) Deep specialization.

Build a dedicated investment team with deep specialization in a narrow asset class or niche sector. The same team should not do LBO, VC, public, fund selection, etc. They should focus on one thing. Doing one thing well (well = equal / better than the competition**) is hard enough.

For example, direct LBO requires at least 6-7 dedicated investment professionals. And at least $400-500 million behind the LBO effort to attract and keep high-quality people and stay in the game longer-term.

3) Low-cost beta + concentrated active.

Mostly low-cost beta exposure with ETFs/funds plus a gradually increasing allocation to top flight active managers (if/as you get access to them). IF you can get access to top early-stage VC managers (and only early stage), allocate there. Each active investment must be expected to add value vs. its fees (risk, etc.). The active portfolio – of managers that can generate excess returns (net of fees, risk, etc.) – takes 7-10+ years to build. No direct investments.

You can probably do this with a three-person investment team.

Most family offices have small investment teams that try to do too many things. Or they often shift priorities, chasing the flavor of the month. And many are casual participants in directs. They’d benefit from thinking hard about their edge. As I wrote here, almost everyone “in the game” has a large network, lots of money, and many are long-term. Those traits are table stakes; they don’t make for a real edge.

Other family offices tend to have large allocations to active managers (private equity, hedge funds, etc.). But do these strategies justify their high fees? By owning many funds, have you inadvertently created a high-fee, high-tax index fund? Some hedge funds hedge, others offer expensive long equity exposure. Some PE firms add value, others don’t. How can you tell the difference without deep expertise?

Lastly, best-in-class managers are capacity-limited and have plenty of money from the Yales, UTIMCOs, etc. of the world. They have to have a compelling reason to let a family office invest with them.

That said, there’s no right answer. At the end of the day, it is the family’s money. But don’t draw the wrong conclusions from the last 11-12 years when almost anything you bought went up a lot.

*you’d be better off hiring an OCIO; there are decent ones IF you know what to look for.

**equal is a low bar; if you want to have a chance at excess returns, you’ll need to do better.

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