Family office as a business & framework for investment office

Before I share my thoughts on the above topics, it is important to understand my experience and depth of engagement with some of the large business families. While my experience has been limited to North Indian families, but I do believe at a philosophical level there may not be much difference in the construct of the family office even if the families are from different parts of India.

I have had the opportunity to work with family managed businesses for close to 36 years, 28 of which were spent in Senior Management roles, the longest stint of 24 years was with Hero family, and 4 years with Ranbaxy. It has been an amazing journey and I learned a lot about the complexities involved in engaging with large and small families. I worked with family members across three generations.

The role at Hero was predominantly working with the family members, except for a couple of years during which I led a Business with P&L responsibility, while the role at Ranbaxy was primarily engaged with Treasury function of the company and some time was also spent in offering advice and execution with regards to private investment of promoters.

The experience spanned across realignment amongst families, the realignment with business partners (Japan, Germany, and UK), expansion into new business opportunities including diversification away from automotive and cycle business, managing treasury and investments, fundraise, corporate finance and M&A, long term strategy and execution, creating Frameworks for project executions, leading a business, managing wealth and heading family office. During this journey, I built a great Network with Ecosystem partners spanning across different operating roles.

The reason for achieving great outcomes for the families I worked with is a result of my deep engagement with the promoters in the decision-making process more like an extension of the family and not just engaging at the peripheral level.

I have divided this article into two separate Essays:

Essay 1- Rationale for running a Family Office as a business
Essay 2- Framework of the Investment office

Essay 1

The rationale for running a Family Office as a business

While both Essays will require me to write a book, but I will just share a few relevant and key learnings based on my experience.

The family members must be engaged and enjoy the journey in leading the family offices and take responsibility for their decisions, which is what Promoters do when they are engaged in running an operating business. While I do understand that running a business is important for a family member as their identity is because of their business, but not focussing on the family/investment office can have some unknown and negative consequences.

In any case, there are much lesser moving parts in the family office construct and it is only in the initial days of setting up, that there is a much higher involvement of the family member/s in order to define the objectives, values, goals, and policies but over time the engagement tends to taper off depending on family members’ other commitments. The role of the family member/s should be that of the Executive Chairman and the Professional Manager could be the CEO of the family office.

It is my personal view, if the family members’ engagement is as deep as in operating business, they will make informed decisions with high conviction. If decision making is based on goals, objectives, investment policy, etc., it is very likely that one may actually choose to increase investment and not reduce exposure, despite a market fall, so long as the fundamentals of business continue to remain strong and the price drop is a result of a change in market sentiment or some external events.

The investment journey, like any operating business, will always have ups and downs. We easily accept the downturns in operating business because of our deeper engagement with the business and business trends. Similarly, if the family office is run like a business it will be easy to absorb such shocks and decisions are taken, not just based on what people think about the investment, but understanding on why the family took the decision and if some factors have changed that require altering the decision. A couple of examples to substantiate this point:

Example 1: Family may have been interested in buying/investing in a company but the valuation may not have been right as a result of which the decision got deferred. However, as a result of certain external factors (which could be because of over-leveraged promoter) the price of the company came down, the family can move fast enough in buying the business. The decision process in a family office can be much more nimble and flexible both in terms of process and boundary conditions because of the deeper engagement of the family

Example 2: While conducting a review of all direct investments made by the family office it took less than an hour to arrive at certain decisions, however for a similar size of investments through mutual funds it took a few days and yet the conviction around direct investments was very high despite spending much lesser time compared to investment in funds.

Most large Indian families understand the DNA of other promoters through their network and ecosystem, this I would say is an unfair advantage that a family has in their decision-making process vis-à-vis the funds. The information arbitrage has nothing to do with insider trading but just knowing the belief systems of the promoter of the business, whose stock is being bought or debt being provided, helps the family to take an entrepreneurial call with this additional data point. Another advantage that a family enjoys vis-à-vis the funds is that the family is neither under time pressure to invest nor it has peer pressure, unlike a fund that has peer pressure and has no option but to invest the funds received, as they are expected to retain only small cash. While funds have the best research and experience but due to the above factors, it is likely that direct investments may, at certain times, outperform the investment through funds.

In conclusion, deeper engagement leads to better decision making as it is not driven by emotions or unwanted advice from external advisors but after giving due consideration to both the soft aspects and business logic.

Most of us whether business owners or professionals are more passionate about our operating engagement (P&L) and tend not to focus on our personal wealth (Balance Sheet) even though the adverse impact on our balance sheet may be relatively large. We tend to spend disproportionate time on the operating role (given that this gives us our identity) even though risk and reward may not warrant this. My personal example, while I made fantastic returns for both promoters and company, but I lost wealth as I did not pay any attention to my balance sheet in large part of my career

The success of family office to some extent is also dependent upon the CEO/advisor of a family office, therefore in order to create success; the family must recruit the CEO not just because he has been with them for long, which is contrary to the accepted norm of hiring the best talent for the role. It is therefore important that family should run a similar process for hiring, as in operating business i.e hiring the right person who has the requisite soft skills and investment experience. The professional must win the trust and respect of the family members. Family members should as far as possible be able to share information and expectations without using any filters. In fact, the family may need to share much more information than they would be sharing with the professional CEO of the operating business.

Connect amongst the promoter and advisor/professional needs to be both from the heart and the mind, and this may imply the advisor becomes the extension of a family or Dost (friend). The advisor should not just be independent but also be able to speak his mind and needs to be seen like that. He should be the Go-To Man for family and help them think trade-offs both vis-à-vis the family or business situations.

Family office construct is much more elaborate than currently perceived by most of the families/advisors as a family office and investment office are used interchangeably as the family office construct is a very recent phenomenon. Some of the factors that may lead to the creation of family office where investment will be a subsection are wealth creation/monetization of assets in recent times, changing aspirations of some family members and realignments amongst families in the recent past, some of which have been very acrimonious resulting in huge destruction of wealth and reputation.

There are however some large and evolved families that have been able to adapt and implement a comprehensive family office framework including dealing with the issues of succession, the role of the family in the business, realignment process, etc.

In conclusion there are inherent advantages of running a family office as a business , this helps in making the right choices and taking right decisions at right time with conviction while staying focused on values and keeping in mind softer aspects of family dynamics

Essay 2

The framework of the Investment office

Having understood the rationale behind the deeper engagement of the family and the need to manage the family office as a business, I will now share my thoughts on the family office construct defining the objectives and process of setting up an investment office. The scope of this article is focussed around investments, as this I believe, is the need of the families and not a comprehensive family office framework. The words family office and investment office have been used interchangeably but they largely relate to the investment office in this section.

A. Objectives of Setting up Family Office

The objectives of the family office may be as under:

Maintain family harmony, respect, and trust amongst family members even in situations of realignment amongst 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)

Investment office needs to be headed by family member/s and it is important to agree on the softer aspects of values, aspiration, and culture based on buy-in amongst the various family members and their advisors before elaborating on the philosophy and process of investment office.

The document elaborating “Objectives” framework can be either formal or completely informal depending upon the size of the family, interrelationships, and complexity in the decision 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

B. Philosophy and Processes of the Investment office

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.

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 bankers, wealth advisors, and multi-family offices, funds, 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 few of 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.

May 2020

Rationale for Running a Family Office as a Business & Framework of Investments office