The lower returns of North American family offices in 2014 were due, in large part, to weaker performance in equity markets compared to previous years.

APPETITE FOR RISK IS GROWING, BUT FAMILY OFFICES ARE STICKING TO DOMESTIC INVESTMENTS
The 2015 Global Family Office Report also revealed an overall increase in risk tolerance across family offices globally. In North America, specifically, family offices appear to be taking slightly more risk, with cash balances dropping a percentage point between 2013 and 2014.

Two areas where family offices are not taking additional global risk, however are in real estate and equity allocations. Family offices continue to stay on their home turf in both. The average North American family office allocates 11% of their total investment portfolio (typically more than $100 million) to real estate direct investment and tends to invest locally and sometime nationally as investments are typically managed in-house. Foreign real estate investments come with significant added costs and risks – including lack of market familiarity.

Within equity portfolios, North American family offices tend to allocate a greater share of assets to developed markets over emerging markets.  North American offices have the highest allocation to developed market equities of any region (23% versus a global average of 19% and allocations as low as 8% in Emerging Markets-based family offices).  They have the second-lowest allocation to developing markets equities as well, with a 6% allocation versus a 7% global average and 13% among Asia-Pacific-based family offices.

RISING COSTS ARE CREATING A HEAVIER BURDEN
Though operating costs are rising for family offices globally, in large part as a result of added administrative expenses, North American family offices are markedly more efficient relative to their counterparts in other regions of the world. North American family offices paid an average of 74 basis points (bps) of AUM to cover operating costs in 2014, excluding investment manager fees, compared to other global offices that average 99 bps of AUM.

This organization and efficiency is both smart and necessary – as we heard from one single family office in the region, tax policy and regulation in the United States are becoming increasingly complicated, requiring additional staff, resources and costs to understand the rules and ensure compliance. In terms of investment costs, North American family offices are roughly on par with foreign family offices, averaging 43 bps of AUM versus 44 bps globally despite their higher use of outside managers.  North American family offices spend the most on external manager performance fees (22 bps), however.

Recruiting and retaining the right leadership and talent is critical for single and multi-family offices to succeed, and North American family offices put significant funds towards making sure they have it. These regional family office CEOs are paid the highest on average, $446,000 annually, compared to $294,000 in Europe or $150,000 in Emerging Markets, and have an average tenure of nearly 10 years – greater than CEOs in the Asia-Pacific region, but less than in Europe and Emerging Markets.

Staffing and its related costs will become more critical to family offices as the founding principals of North American family offices age.  They typically become more conscientious, relative to their counterparts in other regions, about preparing staff and family office structures for the day when they eventually need to transfer authority to either their relatives or non-family executives.  This professionalism is particularly true of more established family offices that already have been around for multiple generations, compared to younger (newer) family offices.

North American offices also tend to tie CEO compensation more closely to investment performance than other offices do.  One compensation concern for family offices is balancing retention with market pay rates.  Some family office CEOs we spoke with expressed concerns about pay inflation for family office staff as concerns about losing valuable staff members rise.

WHAT IT ALL MEANS AND WHAT TO DO ABOUT IT
Looking ahead, North American family offices have a lot to think about when it comes to effectively managing continually rising costs, risk and return expectations.

In terms of risk management, there have been mixed reviews of the potential for currently high performing asset classes, such as real estate and private equity, to continue their run.  Family offices should be careful to judge future expectations based on past performance and beware of cyclicality. In addition, as some families expand, they have a tendency to transition the focus of their investment strategy from riskier growth to less risky wealth preservation. While this makes sense for some, it’s important to consider the implications of such a shift, including the fact that taking lower risk generally yields lower returns, resulting in a smaller pool of wealth for families that may still be growing.