The terms family office and investment office are often used interchangeably. However, in this context, we are focusing primarily on wealth and investment management, which I believe is an immediate and pressing need for families, particularly given the significant wealth creation over the last decade.
The framework for an investment office can vary from highly formalized to entirely informal, depending on the size of the family, the complexity of family relationships, and the number of decision-makers involved. In my view, the most effective approach lies somewhere in between. The framework should be structured yet flexible enough to be internalized by all key family members given the agility required to take quick decisions as markets don’t wait.
The investment office should be headed by a family member(s), and before diving into the philosophy and processes of the office, it is crucial to align on softer aspects like values, aspirations, and culture. Achieving buy-in among family members and their advisors is key. Importantly, the family must take full ownership of the outcomes, and once set, the investment office should be managed like a business.
A. Alignment with Family Office Philosophy and Objectives
An investment office should always align with the overarching objectives of the family office, which typically include:
- Maintaining family harmony, respect, and trust, even during potential realignments among family members.
- Protecting and enhancing the family’s reputation and brand both in business and society.
- Preserving, growing, and ensuring the seamless transition of wealth—this includes both businesses and other assets.
These objectives must guide all decisions made by the investment office, ensuring they align with the broader goals of the family.
B. Philosophy and Processes of the Investment Office
The investment office must follow a clear philosophy and process to manage wealth effectively.
B.1. Investment Philosophy
At the outset, it’s advisable to focus on three priorities in this order:
- Capital protection (Safety)
- Liquidity (the ability to liquidate assets quickly, within 0-30 days)
- Returns (gains over time)
As the family becomes more familiar with the risks associated with different asset classes, they can adjust allocations based on their risk appetite. For example, as the family grows comfortable with the volatility in equities, they may choose to increase their allocation to equity from debt. The investment philosophy should always align with the objectives and long-term vision of the family office. It is extremely important to keep in mind the fact that the family members must be able to sleep well even during times of stress in the market and their tolerance on drawdown (even though the losses are not booked but on a mark to market basis there may be a paper loss)
B.2. Investment Process
The investment process in an investment office encompasses the following core activities:
- Assessing the family’s cash flow needs and timelines
- Defining the Investment Policy Statement (IPS)
- Establishing the composition of the investment team
- Managing the investment decision-making process (Invest, Monitor, Exit)
- Considering structure and compliance issues
- Brand management and reputation
- MIS, accounts, and frequency of meetings
Each of these activities is critical in ensuring the office operates efficiently and aligns with family goals. Let’s break down each component.
a. Family’s Cash Flow Needs and Timelines
Cash flow needs should be categorized based on family priorities and timelines. Some key areas include:
- Personal needs (e.g., lifestyle maintenance, education, real estate, art, jewelry, and major life events like weddings).
- Safety pot (emergency funds set aside for unforeseen events).
- Investments in existing businesses (supporting current operations).
- New business investments, with or without control, such as joint ventures.
- Philanthropy and CSR initiatives should focus on a few key domains that resonate deeply with the family’s values (DilSe). These should be managed by a separate team.
Cash flow needs will define the asset allocation strategy. For example, funds needed within three months should be in liquid assets, while funds not required for five years could be allocated to equities, depending on the family’s risk appetite. Reviewing cash flows is an ongoing process and should be revisited at least every six months or when family or market conditions change.
b. Defining the Investment Policy Statement (IPS)
An IPS should triangulate the family’s risk tolerance, cash flow needs, and investment philosophy. The IPS must:
- Define asset allocation across different asset classes (e.g., equities, debt, real estate, commodities , gold …) and diversification strategies within those classes.
- Set caps on investments in various sectors, companies, and geographies, including minimum ticket sizes.
- Avoid leverage against assets and minimize any asset-liability mismatch.
- Avoid personal guarantees from the family or holding company.
The IPS should be reviewed every six months or after significant market disruptions, such as the COVID-19 pandemic, NBFC crisis, or geopolitical events.
c. Composition of the Investment Team
The domain of family offices is still in its infancy in India, and there is a shortage of experienced talent. Ideally, the investment office should be headed by a professional with extensive investment experience and soft skills for working with families. They should also have experience making successful exits and minimizing NPAs in debt investments. The head of the investment office should be supported by an Investment Principal and analysts, depending on the size of the investment pool.
The team may include:
- Legal experts for documentation and compliance
- Tax experts for setting up structures
- MIS and accounting personnel
Some tasks may be outsourced to specialist advisors, depending on the family’s comfort and relationships.
d. Investment and Decision-Making Process (Invest, Monitor, Exit)
The investment process begins with sourcing potential investments, often facilitated by investment bankers, wealth advisors, multi-family offices, and funds. The family office must cultivate a network of service providers and define clear expectations. Compensation for advisors should be equitable and preferably outcomes driven.
The investment decision-making process should consist of two stages:
- In-principle approval from the Investment Committee (IC) based on alignment with the IPS.
- Final approval after due diligence, which may involve external advisors, depending on the complexity of the investment.
Monitoring investments should be ongoing. The depth of monitoring depends on the asset class and size of the investment. For strategic investments, closer engagement and monitoring are essential, while for debt portfolios, regular updates from agencies like CRISIL may suffice.
e. Structure Considerations and Compliance
Over time, families may need to realign their holding structures to ensure tax efficiency and compliance with the spirit of the law. This includes seamless transfer of assets, ease of sale, and avoidance of tax havens in overseas investments.
f. Brand Management and Reputation
Families must have processes in place to manage their reputation and protect intellectual property (trademarks, copyrights, etc.). This is essential as it impacts not only the family’s public image but also business dealings.
g. MIS and Frequency of Meetings
Regular meetings are essential to review tangible and intangible investments, share progress reports, track compliance, and ensure that the investment office adheres to the IPS and broader family goals.
- Initial phase: Meetings should occur every two weeks, gradually transitioning to monthly as the investment office matures.
- IC meetings: These should be held more frequently, as needed.
- Accounting and compliance reviews: These should be conducted quarterly.
Reports should draw on external data (e.g., stock exchanges, CAMS for mutual funds, recent round valuations for unlisted companies).
Conclusion:
This framework provides a broad structure for an investment office, distinct from the more comprehensive framework of a family office. A family office encompasses many additional aspects, such as succession planning, family governance, and realignment among family members. The investment office framework can and should be adapted to suit the specific needs of each family, whether they have a large or small investment pool. Tweaks to team composition and asset allocation will ensure that the framework remains practical and effective for each unique family context.
Amended, October 2024