Roundtable: Lessons from Lehman

Five delegates from Campden's European Family Office Conference sat down to discuss how the global financial crisis affected the way they work

Roundtable panel:

Wolfram Klingler, Executive Director, Silvia Quandt Family Office, Switzerland.

Risto Vayrynen, Managing Director, Sifter Group, a Geneva-based family office.

Khaled Said, Principal, Capital Generation Partners, UK.

Kathrin Eckhart, Director, Dela Verwaltungs, Germany. 

Paddy Walker, Managing Director, J Leon Group, UK.

Have the events of the last 12-18 months changed the way that your family office operates?

Said: Operate is a big word. For me, it's been more about a change in how we view investment opportunities, the issues that people worry about and the risks and how they price them. I think that's slightly different to operating. 

Eckhart: How we operate has not necessarily changed, but how we perceive and control risk certainly has. I have been working in the real estate industry for more then 20 years and the US property crises of the early 1990s meant I had to restructure my business.

But this global financial crisis was unique because I had to find a lawyer and ask him what do I do about certain loans. It was a completely different experience, but it has not changed the way we operate.

Walker: The crisis caught us out on a couple of things. We are a fourth-generation family office and 70% of the work we do is in real estate. The properties that we have tend to be large, institutional buildings on the high street. We don't have any gearing on our balance sheet, which for nine and a half years in any decade can be difficult to justify, but it's obviously a good thing to have at the moment.

However, we have had a bias towards credit strategies in our hedge funds portfolios, which has been somewhat disastrous – we've been gated and we've been suspended, so that was a big issue..

We used to do things that were fantastically complicated but now it's all about simplicity. Transparency is of key importance to us now, while for the first time we are really looking at fees and manager alignments.

We've got about 104 managers across our portfolios and we're really concentrating on structures, reporting, transparency, fee alignment, liquidity across the portfolio and redemptions. We're not trying to beat benchmarks at the moment. 

Klingler: The crisis has actually strengthened the views that we held before – we don't like brand names, we don't like large funds and we don't like business models where managers earn irrespective of their success. Interest alignment has become more important and we've become more selective when looking for opportunities in inefficient markets. We have also started to invest heavily in distressed assets.

Vayrynen: The strategy of our family office is based on sharing risk with other family offices. We were never huge fans of investment banks and there is definitely even less trust towards them than there was a year ago.

Of course everybody uses them, but this is an area that has definitely changed and I think it's going to change for good.

Banks present to a lot of people every week and when their "old" plan doesn't work there is always a "new" plan you have to try – I just don't get the feeling that they are on our side. We don't trust them as we are afraid they'll go bust so we are heavy on bonds but light on funds.

I feel that families are getting much more cautious and looking for people who have similar alignments of interests. 

How would you describe your relationships with the banks now?

Said: I think you have to start by saying you get the service and the product that you deserve in every industry. The problem in the past has been that customers haven't been tough enough in asking for the service that they want and the price they are willing to pay. 

And I think that it's all very well to blame investment banks or private wealth mangers but because customers aren't willing to pay fees for good advice we have ended up with a product driven industry. 

Looking forward, it's important to realise that we have pricing power and negotiating strength. People need to unpick the fees and the incentives and really understand what they're paying for.

Eckhart: Our loan agreements would not be affected if a bank went bust so we've been fine. However, in terms of our liquid assets we found that the asset managers weren't able to provide the returns they had promised. 

They were inflexible and most of them had no idea how to handle such a crisis.

Have you made deliberate moves to find new providers?

Walker: We certainly haven't as we are very diversified, far too diversified in fact, but very happy to be that way. However, as the family moves into the fifth generation I am increasingly worried that we're becoming too passive, relying on a wall of managers. 

Said: Managing a portfolio of financial assets is a very complicated and very difficult thing to do well. And I think that 2003-2007 was arguably a very easy time and it lulled people into a false sense of security thinking that you can do it almost as a separate business alongside your core family business and I just think that investment banks fell into that and they would come along and sell you good ideas and you would buy them and they would do well.

I think this has been exposed as well during the Lemans crisis, so we are certainly being more selective than previously.

For those who have made different investments in the last 12 months, who do you trust most when it comes to advice on making those investments?

Klingler: We try not to rely so much on advisers. I've actually found that investment banks, certainly ones I've been dealing with, have become much more service oriented during the crisis and easier to deal with.

Sometimes I feel bad for taking all the advice and connections for free as they're making a great effort and haven't pushed any products.  But that's also because they know that we're not buying ready-made products.

Vayrynen: How we work is that somebody gets an investment idea or does due diligence on a pre-existing deal. They then share the information they glean and how much they are putting in themselves with other members of the group, who then decide whether to co-invest.

Klingler: I think to sum it up for us in what really matters is interest alignment. That's the one governing principle you really want to make sure that people adhere to. If you lose, they lose too. 

Said: Exactly, that's the way we do it too.

Vayrynen: If it hurts you it must hurt them too. 

Let's move on from trust and talk about risk. Family offices that lost significant wealth often didn't have staff dedicated solely to risk management.  Is that the case in your family office?  And are you happy with that? 

Walker: We don't have anyone and we're not intending to have anyone dedicated to risk. We do top level asset allocation, we don't do anything bottom up. We will very rarely do anything that is not a pre-qualified by another family office or endowment.

We try to be very specific on a micro level with all of our managers and we will try to interlace what the managers are doing so we have transparency.

Eckhart: We don't have a special person taking care of risk or doing risk calculations. We try to communicate more with outside managers and see how they are going to handle risk, what their strategies are and how they align the business with the strategy. However, I hope we'll find the time to improve our own reporting systems.

Klingler: The way we approach risk has not changed much. We have a very entrepreneurial mindset whereby risk almost always means opportunities. We try to assess the risk but we don't have much market risk in our portfolio so it's not a major issue.

Generally speaking, we don't trust the traditional statistical ways of measuring risk. 

Vayrynen: We don't have a person who is in charge of risk, and more importantly the whole investment strategy of the family office has been that you can't invest if you don't fully understand or if you don't have access to the manager. This has kept us from investing in hedge funds for example.

Said: We have a small, dedicated portfolio reporting risk allocation team. Ultimately you can't rely on quantifiable measurements but we still do it as good discipline and apply what I think is good common sense.

We do sector analysis drilling down to individual investments and individual equity funds so we can understand how much exposure we have.

We manage managers so, with a few exceptions, we feel that we need to know them incredibly well. Our view is that the fewer managers you have, the better you know them and the more you understand the investments they've made.

The other point I would make is that over the last 5 or 6 years we've created more concentration in the portfolio at manager level with more diversification of over asset class.

The final thing with regard to risk is that we spend a lot of time reference checking and doing investigative research on people. Some people lie on their CVs or have had problems with police so we go back and check everything. Ultimately we are investing in people. 

Have there been any other changes within your family offices as a result of the financial crisis?

Vayrynen: I am setting up a new single family office structure while I'm working in the main family office in Geneva.  I think that the world has changed dramatically because previously everyone seemed to look good no matter what they did.

The breakeven point for how many assets you need to consider setting up a single family office has even gone up.

On the other hand there are products, such as ETFs, that have made the playing field a little bit more even.

I'm not convinced that a single family office in the traditional sense is viable and am leaning more towards a hybrid structure with a custodian and a core portfolio with a couple of managers.

Said: I think the changes that people are making are not structural changes in terms of the operation, but rather a mind set about the type of investment. I think where it's interesting for the asset manager industry is that complexity tends to be a good way for managers to charge higher fees and to hide hidden costs.

So I think what simplification actually does is make it harder in certain asset classes for them to continue to charge very high fees.

In real estate, for example, people are more interested in buying core assets (ie, buildings) as opposed to investing in a REIT. 

Family offices are set up to preserve and grow wealth, but would you agree that over the last few years some have forgotten how to preserve wealth?

Walker: The whole get-rich stay-rich mindset has definitely changed. If you are a steward of a family's wealth then 80-90% of what you do should be focused on staying rich and 10% might be given over to getting rich.

Klingler: It is important to remember that the markets or situations that people shy away from – because they think it's too risky – offer the most interesting opportunities.

We've invested heavily in sub Sahara Africa, for example, because assets there are very cheap. When you buy a company below its liquidation value what's the risk? I think the financial crisis has given us a great opportunity and I think in 10 years from now those who are investing heavily now will see the fruits of it.

We'll also see that holding government bonds in these kinds of years is not the right strategy.

Surely if you are a family that has lost a large amount of money as a result of the crisis, you not going to be particularly eager to dive straight back in?

Klingler: I think that's the wrong conclusion. I think a family office that has lost significant wealth obviously did something wrong and it should analyse these mistakes and move forward. The worst thing it can say is "now we do nothing."

Said: Often families don't work their financial assets in the same way they work their core business – for example, they don't take risks. One of the things I think the financial crisis has taught us is that you have to manage your portfolio.

Actively manage it by directly investing into things that are good value or find someone else who does and let them do it for you. 

Walker: I wouldn't entirely agree with you on that – it depends entirely on what your mandate is. I think one has to be diversified by manager, geography and assets class.

Most of you here are single family offices – has your commitment to the SFO model been strengthened or weakened by the financial crisis?

Said: It comes back to the point that investing in financial assets is a very difficult thing to do. If it was easy then everyone would do it very, very well.

The fees can be very, very large to get the diversification that you might need, and also employing people and having the fixed cost element as just as percentage of your asset management can become very high and it can be hard to incentivise people to do it. 

You need to have expertise and one needs to be realistic about one can do and I think that the single family office model works only when you're at a certain size, because if you're not at a certain size then actually doing the investments directly yourself or even managing the portfolio's directly can be much more difficult then you might imagine it to be.

However, I think the threshold level for having a SFO has risen quite considerably since the financial crisis.

Vayrynen: We only have financial goals in our family office. The family office is separate to the family business and I would agree with everything that Khaled [Said] has said. 

Eckhart: I also believe the threshold is higher. We provide concierge services and manage a real estate business. We would never be able to manage the liquid assets ourselves, it wouldn't be cost effective, so it's completely outsourced. It has to be. 

Walker: Picking up the point what the family office is for, we have a family constitution, a family council, a family forum to communicate with the shareholders and a mission statement. We think the governance is really important, particularly for a family office like ours that is over 100 years old.

I'm sure there have been lots of these cycles during that time so I think it all stems from what you want from a family office.

Vayrynen: The single family office I'm helping to shape in Geneva has a very clear focus on one particular asset class – we will outsource the rest to other family offices and people they trust and are close to. Essentially we feel we've returned to our roots.

To sum up, what is the most important lesson that your family office has learnt over the last 12-18 months?

Walker: Avoid gearing at all costs!

Said: Leverage is a wealth destroyer, it's been proven over history. If you can avoid it, and there are obviously certain asset classes that do require it, then that would be my advice.

Klingler: For me, it's about the alignment of interests, but I agree about leverage. Also, be as strongly focused as possible.

Vayrynen: Alignment of interests is definitely important, so you're not the only party hurting if something goes wrong.

Eckhart: Yes I would agree with all that's been said, but I would add managing your cash flow in the most effective manner.

Said: One more point I'd like to make is that we're learning about human nature. Two managers in two similar funds in very similar situations can behave completely differently.

One might be completely straight and ethical while the one might let you down. People are too quick to forget irresponsible behaviour, so it's something to bear in mind.