Framework for Investment Office

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The words family office and investment office have been used interchangeably but this blog relates primarily to wealth and investment management. I believe, investment management is the more immediate need of the families, given the significant wealth creation during last decade.

The framework can be either formal or completely informal depending upon the size of the family, interrelationships, and complexity in the decision-making process and number of decision-makers. In my opinion, the answer lies somewhere in between. The framework should be such that it is easy to internalize by all key family members.

Investment office needs to be headed by the family member/s and it is important to agree on the softer aspects of values, aspiration, and culture based on buy-in among the various family members and their advisors before elaborating on the philosophy and process of investment office. The ownership of outcomes must be the responsibility of the family and then it should be managed like a business.

A. Investment Office must be in line with philosophy and objectives of the Family Office 

    The objectives of the family office may be as under:

  • Maintain family harmony, respect, and trust among family members even in situations of realignment among certain members of the family
  • Protect and enhance the family reputation and brand 
  • Protect, grow and ensure a seamless transition of wealth (businesses and assets)

B. Philosophy and Processes of the Investment office

B.1. Investment Philosophy 

At a philosophical level in the initial stages of setting up an investment office, it would be a great idea to focus on safety (capital protection), liquidity (to be able to liquidate assets in a very short period of time, could be 0-30 days) and returns in that order. 

As the family gets to understand the risks resulting from volatility and drawdown attached to the asset class, the allocation can then be increased for riskier assets, as an example, more allocation could then be made towards equity vis-à-vis debt.

Investments should be done in line with the objectives of the investment office and investment philosophy.

B.2. Investment Process 

Broadly the investment process comprises the following activities:

  • Family’s cash flows needs and timelines 
  • Defining investment policy statement 
  • Composition of the investment team 
  • Investments and decision-making process (Invest, Monitor, Exit)
  • Structure considerations 
  • Brand management and reputation
  • MIS, accounts, and frequency of meetings 

a. Family’s Cash Flows Needs and Timelines 

Cash flow needs can be defined under the following buckets along with the timelines of the funds’ requirement, the needs of the family could be as follows:

  • Personal needs to maintain the lifestyle and linked to certain events (Education of children, House, Art, Jewellery, Children Marriage, other personal assets, etc.) 
  • Safety Pot (money required at short notice for emergency for an unforeseen event)
  • Investments required to support existing businesses
  • Investments in new business initiatives with/without control as a JV or otherwise. Define rationale and objectives for investing in a new business
  • Philanthropy and CSR initiatives – The family needs to focus on just a couple of domains and build a deeper understanding of these domains to create maximum impact. The choice of the domain must have a connection with the heart (DilSe). There should be a separate team driving CSR initiatives 

The timelines of cash flow requirement will help in defining the asset allocation and investment horizon, for e.g., funds required in three months must be in liquid assets and funds required after 5 years could preferably be allocated towards equity depending on the risk appetite and implications of drawdown as a result of mark to market during the holding period.

Review of cash flows is an ongoing process and reviews may need to be done on a half-yearly basis or sooner, depending on changing family needs, family dynamics, changing market, and external environment.    

The residual funds that are left, after adjusting for the needs and timelines, may be invested for a longer duration. One must also consider investing in physical assets like commercial real estate or even gold as an asset class. 

b. Defining Investment Policy Statement 

The family office should create an Investment Policy Statement (IPS) after triangulating with Risk, Cash flows, and Investment Philosophy. 

The policy must address investment amongst different asset classes (asset allocation), duration of holding assets and diversification both amongst and within the asset class by defining the maximum permissible limits (cap) at a granular level. This implies capping investments in different verticals, companies, funds (Mutual funds, AIFs), start-ups, inter se asset allocation caps, investment within and outside India etc. While it is important to define the cap, it is equally important to define the minimum ticket size to stay focussed and not get distracted.

As far as possible avoid leverage against assets and minimise asset-liability mismatch. Family should avoid giving personal guarantees or guarantee from Hold Co.

The policy statement must be reviewed every six months or on the happening of certain unforeseen events like the coronavirus pandemic, NBFC crisis, oil price movements, geopolitical events etc. as these events can have a relatively larger impact on certain asset classes.  

There must be a process to approve exceptions to the Policy as also with regards to important parameters. 

c. Composition of Investment team 

The family office domain is still in its infancy in India, except for few family offices that have evolved over the last few years. There is a dearth of right talent.  

The investment office may be headed by an experienced person with strong soft skills of working with family/s and having exposure, not only to investing but also having made successful Exits and minimising NPAs in Debt Investments. 

He could be supported by an Investment Principal and analyst/s (1-3) depending on the size of the investment pool and the width of opportunities being explored. 

The support team may include the following:

  • Legal person responsible for documentation, review of agreements, compliances 
  • Tax management, setting up structures
  • Accounting, MIS 

Some of the activities may be outsourced and /or supported by the specialist advisors depending on the past relationships and comfort of the family 

Most of the families have hired internal talent from within the group for a family office, but not all may have the relevant investment experience. They are retained because of being trusted and confidant of the family. This is a bit of a compromise as this person / s will require to acquire new competencies and skills and may need hand-holding by the family and guidance from an experienced Advisor. 

Until the right in house capabilities are built, in the formative years of setting up the investment office, it may be good to have majority investments managed by fund managers (Mutual Funds, PMS, AIF) whether for debt or equity. There needs to be a rigorous process of selecting the best fund managers. 

Delegation of authority for investment, exit, incurring expenses should be defined in such a manner that routine actions including expenses below a certain level and completing compliances are handled by the operating team while other activities may be approved by the family before signing the check. Signatories for different actions and authorities may be agreed in consultation with the family.

d. Investments and decision-making Process (Invest, Monitor, Exit)

The process of investment starts with the sourcing of investments, this service is currently being offered by investment bankerswealth advisors, and multi-family officesfunds, family’s existing ecosystem.

The family office needs to build a network of these service providers and define their expectations. Compensation to advisors should be fair and equitable, as far as possible it should be outcomes-driven. In the recent past, a few family offices have developed a trust deficit as they believe there is a conflict of interest when any advice is offered by the wealth advisors as they try and push products that offer more returns to them while on the other hand wealth advisors believe they are not adequately compensated.

Until the family office ecosystem matures, some of the Families are now contemplating having a trusted advisor, with relevant experience including softer aspects of engaging with the family. This advisor must be aligned with the Philosophy, Values, Risk, etc. and the advisor needs to keep this in mind while making the recommendation for consideration by the family. The advisor needs to be open, candid, and transparent in his communication. 

Investments’ decision should be a two-step process of in-principle approval and then final approval. Once the investment is in alignment with the IPS and philosophy, the in-principle approval is obtained from the Investment Committee (IC). After receiving the approval, the investment team should initiate a process of due diligence (DD) by engaging with external advisors if required. It is important for family members to use their network and ecosystem to get independent feedback on their own as well. The investment team needs to present the final IC note for their final approval, and only then Investment is made. 

The extent of DD, the format of the IC note, and documentation will be different depending on the asset class, the complexity of the underlying asset, size of the investment, strategic vs treasury investment. For instance, a large ticket unlisted equity investment DD would be fairly comprehensive and will typically include the following: business diligence, management presentation by investee companies, legal and accounting, risk and opportunities, synergies, long term business plan, return expectation, etc. On the other hand, the DD for an investment in a shorter duration AAA Debt Mutual fund would be minimal.

Composition of the IC: IC must be headed by the family as all decisions must be owned by the family even while other members are also accountable for the same. The committee could have three members or more, in the beginning, it could be the family Member/s, head of the family office, and a trusted advisor. The final decision in my view should always be of the family.

The investment needs to be monitored regularly, however, periodicity and depth of engagement will be dependent on asset class investment size etc. For example, a strategic investment will need to be monitored much more closely and family may even be more engaged, the family may even hire an external advisor for monitoring performance. As regards the debt portfolio, one can get feedback from CRISIL on the quality of credit rating, and if there is any sensitive exposure in the debt portfolio. 

The family office also needs to be proactive in maintaining, reducing/ increasing exposure or exits and booking full/partial profits or (Loss).

e. Structure Considerations and Ease of Compliances

The family may have inherited a holding structure that may or may not be tax efficient or does not permit ease of transfer etc. Therefore some realignment may need to be done while maintaining the spirit of the law while ensuring seamless transfer including on transmission, ease of sale of an asset, etc. and ease of compliances. Key consideration while setting up an overseas structure for overseas investments is to avoid routing investments through tax havens.

f. Brand Management and Reputation

The family must have a process of managing reputation and manage the trademark, intellectual property, and copyright. It is equally important to manage intangible assets and reputation as this has a rub-off effect vis-à-vis buying or selling assets. 

g. MIS and frequency of meetings 

The purpose of the meeting is to review investments both tangible and intangible. The review may include progress review of certain projects outlined with respect to setting up of a family office, taking appropriate actions based on feedback from the investment team and family, sharing investments returns, ensuring there are no deviations from the IPS and philosophy, tracking the status of compliances and filing of returns, etc. The format of the report is a living document and may go through multiple iterations in the first year of operation of the investment office.

The review meetings must be held if possible, once in 2 weeks in the set-up phase, and then could be once a month but the IC meetings need to be held more frequently and need-based.  

Accounting and compliance review may be done on a quarterly basis 

  • Accounting (including verification of all tangible assets) held by family and investment office 
  • Tax computation of entities including for family members and payment of advance tax
  • Brand compliances 
  • Audit by the third party 

As far as possible the accounting data must be obtained from the books and valuations must be based on data from an external party, for example, listed stocks from exchange data, mutual funds from CAMS, unlisted could be based on the latest round valuation, etc. 

In conclusion, this is a very broad framework of the Investment Office and not a comprehensive framework of the Family office. Family Office shall include a few more areas such as Family members Aspirations, Values, Culture, Succession Planning, Role of Family in Business, Realignment amongst Family, Use of Brand by different Family Members, Governance framework of Family businesses, etc. 

The Investment Office framework can be altered and amended by the Families depending on their needs. This construct will also work for Families with much smaller Investment pool, however, tweaks may have to be done vis a vis the team composition, width of asset allocation, etc.

Further Reading:

Rationale for running Family Office as a business (read more)