As of April 17, 2021, the reported losses resulting from the collapse of Archegos Capital Management have risen to $20 billion, with Credit Suisse and Nomera Bank losing $4.7 billion and $2 billion respectively. What happened and what impact should this have on family offices?
Archegos is a firm that manages the money of Bill Hwang, a former hedge fund manager who had previously pleaded guilty to securities fraud. Archegos borrowed money from banks and invested the money in the stock of publicly traded companies, such as Viacom, in some cases using swaps that concealed Archegos’ positions. The banks never inquired as to how much leverage Archegos was using, so when the investments lost money, the banks called in the loans to Archegos. Archegos then had to sell large blocks of stock rapidly and at a loss. However, the proceeds of these sales did not cover the loans and so the banks were left holding the bag: yet nothing Archegos did was outright illegal.
Credit Suisse and the other banks that lent Archegos money did not ask enough questions nor did they get the right answers about what Archegos was doing. The Archegos collapse has not led to a more general run on the stock market. Overall, the only ones hurt by this collapse are Hwang and the banks who lent Archegos the money.
Elizabeth Warren has, rightly, blamed the regulators overseeing this sort of speculative investmenting, but others have seen this as a reason to include family offices in the same regulatory scheme as Registered Investment Advisors. These calls are by those who do not know what a family office is, what types of family offices there are; and, in contrast to the private hedge fund of Bill Hwang, what motivates people to form or join a family office.
Motivation for Family Offices
The wealthy are motivated to change the way they manage things due to the problems that arise from the very nature of the sources of their wealth; the resulting complexity of their lives; their desire to keep control of their wealth; the need to access expertise and opportunities; the desire to use their capital in ways that relate to their personality and interests, and their desire to “make a difference”.
Sources of Wealth. Exceptional wealth (that is over $5 million) comes from the ownership of a significant asset (equity in successful firm, real estate, inheritance) rather than from financial speculation, as is the case with Bill Hwang. Despite what entrepreneurial risks they might take to grow their business or real estate portfolio, rarely if ever will the speculate with financial investments and hardly ever will they leverage a financial investment.
Complexity. The amount and nature of their wealth means that exceptionally wealthy have more complexity in their personal and financial lives. Their tax and succession planning tools (wills, trusts, business entities) all work to maintain their freedom of action so with that flexibility comes complications. Money magnifies the eccentricities and animosities present in every family. The desire to “keep the peace,” may override what is the financially best course of action. Managing this intrafamily complexity is a key part of the role of the executive director of the family office.
Control. Control is the main reason families create a family office rather than hiring an institutional trustee. This need for control, and the need to influence the significant events in their lives, extends beyond tax efficiency and perpetuation of wealth to the very way that a fortune is structured, and the way they communicate what they think of themselves to the family and to others. The family office is the legal and cognitive framework within which beneficiaries of the wealth live, and exerts a legal and psychological hold that may create a feeling of ambivalence in the beneficiaries of the wealth.
Connections. Personal and professional connections play a key role in the sourcing of professional services and investment opportunities for the wealthy. They go with a professional they know rather than a firm they do not know. Family offices are a place where the wealthy can expand their connections without threat of undue influence.
Capital. Capital is having the resources to make things happen - both money and what money accomplishes. The use of Capital is the defining element of the wealthy, though capital preservation is often expressed as the first priority. When there is confidence that the future use of capital is protected, the wealthy will use capital based on both personality and how they define themselves, often as the senior executives of the family enterprise.
Make a Difference. The wealthy are not charitable merely because of tax advantages (though this plays a tactical role in charitable decisions) or vanity of seeing their names on buildings, but rather an honest desire to “make the world a better place.” There is, often a desire to follow in the footsteps of such philanthropists as Carnegie and Ford, providing a sense of purpose in making charitable gifts.
Types of Family Offices
Over the last two centuries, family offices have evolved into three types—the single-family office, the multi-family office and the institutional-family office. Although, many factors determine which type of family office is best for a particular family (total assets being one of these), control over the family’s finances and their lives is the driving and decisive force for all families involved with family offices.
Regardless, of the type of family office, all provide coordination of assets, maximization of those assets; a portfolio of lifestyle services with a high level of customization and control; a detailed and comprehensive overview of both financial and non-financial needs and goals; and. a more holistic level of services and a platform to mediate and resolve family conflicts.
Single-Family Offices. The most expensive type of family office, families create a single-family office primarily to maximize the family control over wealth, provide economies of scale in investment management (allowing the family to act as an institutional investor), accessing legal and accounting services for the protection of family members. Single-family offices also work well to educate younger members of the family in the family enterprise, for strategic charitable giving, and for tax efficiency. Single-family offices are only feasible for families with over $100 million in net worth, as the set-up costs can be as high as $2 million, and the annual operating costs a minimum $1 million.
Multi-Family Offices. A multi-family office is a single-family office founded by one family, which is opened up to other wealthy families. They primarily make a profit while allowing the founding family to retain control. Multi-family offices are less expensive. They, however, require that the non-founding member families simplify their wealth (for example some will not manage real estate or art collections), and that they give up control over some aspects of their wealth (e.g. limiting who they can use for investment management). Although, the founding family wealth may be in the billions, multi-family offices are feasible for families with a net wealth of $25 million or more. The set-up costs can be as low as $100,000, and the annual operating costs are, generally, between 0.5% and 1.0% of the net worth of the family.
Institutional-Family Offices. Institutional-family offices are created by elite brokers, investment banks, boutique accounting and law firms, and the investment management arms of institutional banks. The primary motivation for creating an institutional-family office is to make a profit, keep their existing clients and attract new clients. Institutional-family offices are the least expensive alternative, but provide the lowest level of control for the wealthy family, the least access to capital and alternative sources of expertise, and are most likely to focus on investment management over other services. There are usually no set-up costs to the family when joining an institutional-family office which makes the institutional-family office feasible for families with a net worth of $5 million and up. The fees are also based on a percentage of net worth, and can vary depending on the services provided. Private equity investments managed by the institutional-family office may have fees as high as 2.25% annually, while purely custody services may be as low as 0.5% to 0.25%. (Usually, the Institutional-Family Office does not break out the actual fees on specific services). Generally, the blended fees are between 1.5% and .75% annually.
So, how does the collapse of Archegos effect family offices? The real answer is not much. The motivation for most families either creating or using a family office is to preserve the wealth they created in some other business, such as manufacturing or real estate, rather than to create wealth as Bill Hwang did with his leveraged speculative positions. It may be time to tighten regulations at the investment banks and other institutional lenders who are willing to back the Bill Hwang’s of the world, but there is no need for any regulation of family offices overall.
Matthew Erskine is Managing Partner of Erskine & Erskine.