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What Can Go Wrong?

BY WILL BONNER


 

Because of our background in financial publishing, we’re probably not the norm when it comes to family offices…

But even so, given my family’s limited experience running an investment committee, I would say that our biggest risks are a lack of professionalism and our lack of serious focus on the family portfolio…

Many family offices have the opposite problem – the biggest risk for many family offices is “doing too much.”

Chasing opportunities you don’t fully understand is a recipe for disaster. This is a common refrain at the family office conferences I attend.

As a family office, you get pitched alluring investment opportunities almost daily… private equity… mezzanine financing… co-investing… hedge funds… you name it. You’ve got money. And other people want it.

Of course, the worst thing that can happen is you take a chance and participate in one of these deals, and by luck, or fortunate timing, you hit a winner. You get a taste of high returns… and you immediately want more…

Joey’s story below about the investment opportunity his brother brought to the family investment committee is a good example of this.

Joey’s family trusted the proposer – and the numbers – and invested. But they were wise enough to see the investment as entirely speculative and limited their investment. Then, when things didn’t work out as expected, they took the loss on the chin. But other families aren’t always so prudent.

These sorts of exciting opportunities are often complicated and outside of the family’s core competency. They can seem so compelling – the numbers look great – but you might not fully understand the risks and what could go wrong…

Once you’ve had some initial success, you think you understand how to do it again. You get confident. Excited by an early win, you go bigger. Before you know it, you’re in over your head.

Knowing Too Little and Trading Too Much

I heard a joke the other day about how Bernie Madoff actually did investors a big favor… by teaching them to be skeptical and to do due diligence…

There are lots of hustlers out there, many of them at the highest levels. Madoff was the former president of the Nasdaq…

If you can’t honestly and simply explain to someone how an investment works, then you have no business participating in it…

The other big danger for family offices is simply trading too much.

According to numerous studies, trading in and out, even in mutual funds, is what causes most individual investors to see poor performance in their portfolios. Driven by emotions, they buy and sell at the worst times. Family offices that “do too much” can fall into this same trap.

Frequent trading activity just leads to high fees… and more risk.

But why even worry about all this… about doing too much or too little?

Wrestling with a group of family members who make up the family investment committee is a lot of work…

Trying to wrangle them into responsibly overseeing the family portfolio can sometimes seem impossible.

Couldn’t you just bypass a lot of pitfalls simply by having professionals manage your money?

Why Not Just Leave It to the Pros?

Being plugged in to the family office publishing world, I’ve noticed that a lot of the published material is not geared toward wealthy families or family offices themselves.

Instead, the bulk of family office publications are directed at the industry surrounding them, the family office professionals…

The family office industry is an offshoot of Wall Street. And, like Wall Street, its ultimate goal is to transfer money from you to them.

These family office publications tell their readers the best ways to get more money under management. They generate more fees by offering new services.

I’m painting with a broad brush. But you can see the problem here.

The goals of these family office professionals are the opposite of yours…

My family office is fiercely independent, as you can imagine. After decades of publishing independent investment research for individual investors, we’re wary of Wall Street and the “professionals.”

We believe no one cares about our financial well-being as much as we do.

We don’t want to hand over our entire portfolio to professional managers. We use professional managers, but they manage relatively small portions of the portfolio.

There are two main reasons we do it this way:

We want to stay close to our investments. We want to keep the responsibility for our family portfolio firmly on our own shoulders, even if we don’t always do the best job of it. But we acknowledge that we need help in certain areas.

We don’t want to lose the ability to manage our own money. That is, when your family relies on someone else to manage your family money, you lose the skills to do it yourself; your investing muscles get weak…

The further you get from your investments, and the less management practice you have, the more your family’s ability to hold on to wealth diminishes…

That’s why multigenerational families so often lose their wealth.

By directly and actively overseeing your family portfolio, your investment committee learns and retains the skills to hold on to wealth. Once you lose those skills, you’re completely reliant on the hired professionals, which puts your wealth in a very vulnerable position. That’s how you land on Wall Street’s “sucker lists.”

The entire purpose of having an investment committee is to remain independent and competent for generations.

But my family’s oversight of our core family investment portfolio is fairly minimal.

As I said in last month’s issue of the Investment Committee Series, I don’t think we’ve been serious enough about managing the family portfolio.

My family is in agreement on that point…

Time to Get Serious

What we’re implementing is a hybrid model. We’ll run the family portfolio, as we always have, but with input from a serious professional we trust.

We’ve found someone who shares our worldview. But he also has a very successful long-term track record.

He will create a new model portfolio for Bonner & Partners Family Office by translating our big-picture ideas into simple, safe, long-term investment ideas. Your family will also be able to follow these recommendations. (More details about that to come soon.)

The investment committee will continue to oversee the portfolio and make all the key decisions. But we hope to learn a lot from the outside professional we’re bringing on board… as well as to boost our family wealth by taking advantage of his expertise.

Beyond that, we want to professionalize our family office administrative team. Our investment committee needs more organizational support.

Up to this point, we have operated with a skeleton crew of administrative assistants. They do an excellent job. But they also have responsibilities to the family business, Agora Inc., in addition to what they do for the family office.

We’re working to set up a dedicated administrative team to help us keep up with the responsibilities of the investment committee and other family office business.

Obviously, this will require a greater level of investment than what we are currently paying for administration. But it will draw more of our attention to family office matters.

A more professional team will help hold our investment committee accountable and keep us better informed about what is happening with the family holdings.

This should help our investment committee get more organized and meet more frequently, and provide us with better information than we have currently.

I believe that this higher-level administrative focus and investing support will help keep our investment committee on track.

Family office investing is serious business, and we want a serious, dedicated team to back us up.

Hiring your own team of professionals may or may not be appropriate for your family office.

But the point is, you need to do whatever you can to bolster your investment committee and protect your family wealth.

Don’t take the easy route and hand everything over to professionals. Use the professionals in the context of the family office model.

Remember: The real wealth of your family is the individual skills of its members and their ability to act as a unified group.

Even if some or all of your family wealth is lost, if your family investment committee has the skills to build wealth, your family has a much better chance of getting it back.

Use your family office resources to build up those financial skills through the investment committee. Those skills will be much more valuable than the money family members inherit…

Next, our strategic partner, Joseph McLiney, tells us about an investment that didn’t go to plan and how his family investment committee handled the setback.

 

When Your Investment Committee Stumbles 

BY JOSEPH McLINEY


 

My younger brother is a wizard with numbers. In high school, he was an after-school volunteer math tutor. And while there is nothing particularly unusual about a student teacher, what made my brother unique was his pupils. His class was made up of the school’s math instructors.

When numbers were involved, you simply didn’t question him. His in-head estimates were faster and more accurate than most calculators. As an adult, he put his number-crunching ability to good use. Each of his numerous endeavors proved profitable.

In his early twenties, my brother’s income dwarfed mine. While there was some envy, I mostly felt pride in his ability to turn his gift into profits.

Laying Out the Numbers

There was no arm-twisting when our family’s “walking computer” suggested a particularly attractive investment. My brother reveled in laying out the mind-numbing numbers involved. He also carefully explained the risks and expected hefty rewards. He followed the investment committee’s protocol to the letter.

For the record, had there been an option to skip the excruciatingly detailed investment presentation, our committee may have forgone his presentation and merely handed him a check, trusting his figures implicitly.

The expected return of the first year would be nothing less than 30%. Those funds started rolling in, like clockwork, roughly 45 days after the initial investment, and every month thereafter.

All Went According to Plan, Until…

The first year, we saw investment returns precisely as outlined. Year two proceeded as predictably as the previous 12 months. My only question was how to get more money into this miracle money machine my brother had invented.

And then, as you might expect, we received the phone call and a request to meet for drinks.

Located just a few minutes from our homes is The Peanut. It’s considered the alternate conference room for our investment committee, as well as being No. 31 on the list of America’s top 32 dive bars.

With two tar-colored pints pulled, my brother explained to me that the investment parameters – as well as the regulatory climate and market conditions – had changed, and our funds looked to be “at risk.” His explanation was more involved than the original one presenting the idea.

As before, I would have rather skipped it. But in our family’s investment committee, dissection of a mistake, even one made by a professional, is a requirement, not an option. The reasoning is simple: How can you avoid the same mistake if you’re not even aware of what caused it before?

After the postmortem, it was clear that his “at risk” didn’t mean a reduction of the current lofty levels of income. It meant things were blowing up, fast.

The conversation was exceptionally painful, but not for the reasons you might think. Nobody likes to lose money, especially when there were a couple of commas involved.

However, the most difficult part of our conversation was not how much money we had lost. It was watching my brother apologize for losing our investment. His next, identical conversation (and drink) would be with my brother, followed by my father and his outside investors. The thought of him meeting with each individual to explain himself and the situation broke my heart. Knowing how he had been raised, I also understood that there was little choice.

The Investment Committee’s Response

From the investment committee’s point of view, the bad news received a single response. We told my brother that, from the moment he mentioned the oversized returns, we understood that the risks would be equally great. We (the family) and we (the investment committee) were fully aware that this may blow up at some point in time.

The investment committee had done everything correctly and followed our normal procedures:

  1. We had an overly detailed investment plainly spelled out, including expected profits as well as downside potential.
  2. We regularly reviewed the investment’s performance.
  3. We limited our exposure and, while we had funds at risk, a loss would not have been enough to significantly alter any family member’s lifestyle.
  4. And, when things went south, we performed an autopsy, ensuring we did not repeat the error, knowing “experience” may be the only profitable return from this endeavor.

We licked our wounds and went on our way, fully expecting never to see our principal again.

Payback

A check showed up the following month; another followed the month after and each subsequent month. You see, my brother couldn’t stand the thought of losing the investment committee’s money. We never expected to see another dime, and we told our brother as much. Regardless, over the next 60 or so months, the checks kept arriving in the mail until our entire original investment had been returned.

I’m not sure what the lesson from this is, except “Family Investment Committee” begins with “family.” Had this been a private hedge fund that had imploded, we might have received a form letter, and perhaps a few pennies on the dollar of our investment returned. But I doubt it.

As you can imagine, the response from our investment committee could have been entirely different. We could have demanded an audit or become angry with our family member. Had our response not been as united and professional, the family, as a whole, would have suffered. The loss would have been far greater than the monetary beating we sustained.

An Oasis in a World Gone Haywire

A mantra of my dad’s is “Our family is an oasis in a world gone haywire.” We operate following the same format and traditions that have sustained us for multiple generations.

If you take a deeper look into my family, past the investment committee, you’d discover what my wife refers to as our Leave It to Beaver world. More often than not, our family’s structures are the punch lines to jokes.

The entire point of the family investment committee, the family office, the family council, and Bonner & Partners Family Office is to create an oasis of your own.

If you’re the first generation and creator of your family’s wealth, the family office structure is that safe haven you’re building for your kids… and their kids. The investment committee funds, sustains, and financially supports everything for the future generations.

Losses will occur. It’s not an “if” but a “when.” If your family investment committee cannot sustain a mistake caused by a family member, then you need to reexamine the structure and possibly consider hiring a professional to manage it.

A full-time money manager can be helpful. However, it can also be a crutch to avoid facing trouble elsewhere. If you’re hiring a pro to shore up weakness in your investment knowledge, then, by all means, do so. Use one not only to help identify opportunities but, more importantly, to educate yourself and your fellow investment committee members on how to spot and properly evaluate opportunities.

On the other hand, if you’re bringing in an outside expert to avoid making decisions or to avoid sharing the control with your investment committee members, then your oasis will last only as long as the manager is in your good graces.

Your Investment Committee’s Ultimate Responsibility

The ultimate responsibility must rest with the investment committee members. Sustaining and growing the family wealth is always the stated goal of the investment committee. But the real goal of a family investment committee, which typically is not focused on enough, is to support, grow, and shelter the family.

Losing money stinks. How you handle these challenges is everything. Even small losses can tear a family apart. But faced with the proper attitude, family investment committee missteps have the power to weld a family closer together.

There are few joys greater than betting with your family and winning. I can also say that a family that correctly responds to the inevitable stumble will discover a handsome return on a completely unexpected investment of time, professionalism, and a little understanding. This, I say with a certainty only found through experience.

Next month, in the final chapter of the Investment Committee Series, I’ll be looking at how to handle succession issues in your family.

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