Family Office Threats

Talent troubles, capital needs, profitability problems and competitive threats loom as the biggest concerns for family offices this year.

"Finding and training talented people who want to work in this industry is the No. 1 problem for family offices," says Sara Hamilton, founder and chief executive of Chicago-based Family Office Exchange. "Everyone agrees this is the biggest challenge right now. You either have to develop talent in-house or steal from someone else."

Attracting and retaining both junior and senior advisors is critical, top executives say. "This is a talent business," says Mel Lagomasino, managing partner and chief executive of New York– and Miami-based WE Family Offices. "Your most valuable assets are clients and people. You have to be able to attract people who are fiduciaries and want to work with clients in a certain way. … I can't tell you how many people we see that just don't fit."

Family office executives say competition for talent has been driven in part by last year's strong stock market performance, which unleashed pent-up demand for financial service companies aiming at wealthy families.

"We're under attack," says Michael Casey, president and chief executive of Whittier Trust in Pasadena, Calif., the state's largest independent multifamily office. "More competitors want to come back into the space. They're trying to lure people away, and will pay a premium to do it."

Indeed, demand for qualified talent is expected to drive up costs for family offices and widen "gaps in service differentiation" over the next five years, according to a private wealth management forecast by BMO Financial Group's multifamily office, CTC Consulting/Harris myCFO.

"The talent war is intensifying as boomers are retiring," says CTC/Harris President John Benevides. "We're also seeing a gap in skill positions requiring expertise, in areas like legal, tax and planning. Everyone is going after the same talent pool."

DEVELOPING TALENT

As a result, firms are likely to increasingly hire from nontraditional sources and invest in training programs. But it's not a simple solution.

"There are no specialized courses available, and young people are not patient in learning the practice in-house," Hamilton says. "They think they should be experts in 18 months, and don't respect the time it takes to gain wisdom. They don't want to wait, and firms are not getting deep knowledge."

Many senior-level executives at Pitcairn – a 25-year-old multifamily office in suburban Philadelphia spawned by a 90-year-old single-family office – are retiring at the same time, says Leslie Voth, Pitcairn's president and CEO. As a result, the firm is investing in a personal leadership development program to help smooth the transition.

"The client-facing transition is working well, and we've asked some of the senior people to stay on as independent contractors to be part of the handoff," Voth says. "But it's taking longer than I thought. It's not something you can do in six months."

Single-family offices also face talent problems, especially when it comes to compensation. "Wealthy families are pinching pennies," says Angelo Robles, founder and chief executive of Greenwich, Conn.-based Family Office Association. "They see their single-family offices as an expense, and they haven't shown a willingness to pay what it takes to attract top talent."

The irony, Robles says, is that for the most part these families became wealthy in the first place because they invested wisely in their businesses. "Why are families not looking for top talent the way Fortune 500 companies do?" he asks. "There's not a lack of qualified people out there. … Families are going to have to come to their senses, step it up and pay more money."

PROFIT SQUEEZE

Capital funding, expenses and profitability are another source of strain. "This is a capital-intensive business," says WE Managing Partner Michael Zeuner.

Technology, regulations and operational and talent needs are driving costs upward, eroding profit margins. "Service creep" – the perceived need to offer high-end clients additional services they aren't billed for – poses another challenge. "If your fees are 100% asset-based, it's very difficult to limit service creep," says Tom Livergood, founder and CEO of Wheaton, Ill.-based Family Wealth Alliance.

Meanwhile, pressure on fees puts another squeeze on profits. "There is great tension between [family office] business economics and the client experience," says Jamie McLaughlin, an industry consultant specializing in the ultrahigh-net-worth market. "Firms need to commit capital to staff at appropriate levels to provide advice for families of great wealth and complexity. They also need to have the derring-do to test clients' willingness to pay. Discounting and pricing concessions in this environment is a race to the bottom."

Single-family offices and small multifamily offices will respond to the pressure by seeking to partner or outsource "all but their end-client relationship service," the CTC/Harris myCFO study predicts, while larger multifamily offices are likely to "expand their willingness" to sub-advise and provide private-label service to multi-client family offices and even rivals. "Margins will continue to be pressured in this business across 2014," Benevides says.

CONSOLIDATION AHEAD?

These cost pressures are likely to force multifamily offices with less than $600 million in assets to consolidate or seek partnerships to gain scale and leverage, the report predicts. "Family offices shouldn't be paying more than 60 to 65 basis points to outside managers," says Casey of Whittier Trust. "They can't do that unless they have leverage and greater purchasing power."

As the bull market and rising economy make the ultrahigh-net-worth market more desirable, multifamily offices can expect even more competition from "big institutional players," Livergood says: "They really want to differentiate themselves from the J.P. Morgans of the world."

Multifamily offices can point to virtues such as not selling proprietary products, objectivity, customization, stability and a boutique-like personal touch, Livergood says. Yet their biggest vulnerability is still long-term sustainability. "The question they have to answer is: 'Who will be here in 50 years?'" he says.

Charles Paikert is a senior editor of Financial Planning. Follow him on Twitter at @Paikert.