As the cost of keeping an in-house investment team keeps climbing and global markets grow more complex and volatile, family offices have taken a shine to external chief investment officers. Unlike multifamily offices, which pool the resources of several families to add scale and maximize investment acumen, external CIOs only manage money, leaving tax, legal and administrative duties to the clients staff. In response to demand from wealthy families, a diverse contingent of competitors has stepped forward.
We are seeing service models converging, says Robert Casey, director of research at the Family Wealth Alliance, a Wheaton, Illinoisbased research group focused on family offices. Institutional investment consultants, multifamily offices, funds of hedge funds, manager research firms and asset managers are entering the external CIO arena, Casey notes: They each bring their own bag of tricks. Last year his organization surveyed 53 U.S.-based outsourced CIOs advising more than $650 billion in combined assets; it estimates that taxable assets managed by such outfits grew 15 percent in 2012.
With $139 billion under advisement, Cambridge Associates is one of several firms more commonly associated with the institutional marketplace that have emerged as leaders in the external CIO space for family offices. Today private investors comprise roughly 30 percent of our assets managed, says R. Bruce Myers, co-head of CA Capital Management, the Boston-based companys discretionary management unit. Its also one of the fastest-growing parts of our business. According to Myers, unprecedented U.S. wealth creation in recent decades has opened a huge opportunity in the family office market, which remains fragmented and has varied needs. We have learned that we need to be flexible, he says. Some families require more control, so we work with the individual familys wealth creator to make investment decisions rather than managing on a purely discretionary basis.
In 2009, Cambridge added a trust company to its business so it could act as trustee for estate planning. Such adaptation by firms moving into the external CIO business is typical, the Family Wealth Alliances Casey explains. Increasingly, we see them offering new services for instance, consultants that now offer financial planning or an asset manager that now performs manager due diligence, he says. There is a blurring of the lines.
Some outsourced CIOs have been plying their trade for decades. Hirtle Callaghan launched in 1988 to act as an external CIO for wealthy families. While working as a broker at Goldman Sachs Group, co-founder and CEO Jonathan Hirtle noticed that one of his clients, the CIO of a large family office, was consistently outperforming the portfolios that Hirtle managed. He realized that the CIO would always have an advantage for two reasons: the ability to choose top specialist managers from around the world and a strong system for dividing capital among those managers. He was starting with better value-added from bottom-up securities selection and augmenting it with a powerful capital allocation discipline, Hirtle says. That is the power of the CIO model.
Keen to emulate this approach, Hirtle concluded that hed have to go out on his own. With a mandate to act as an independent firm offering a one-stop solution for individual and family investors, West Conshohocken, Pennsylvaniabased Hirtle Callaghan took on institutional customers as clients started asking it to advise nonprofits and endowments they were involved with. Today the firm has 97 investment professionals, who oversee $24 billion on behalf of 250 clients, with families accounting for roughly 55 percent of the latter. It deploys what Hirtle calls a go-anywhere investment approach, allocating globally across all asset classes and strategies.
Demographics are helping fuel the appetite for external CIOs. As more baby boomers reach retirement age, many single-family offices must confront the need to replace key investment personnel, many of whom are family members. We honestly havent really begun to plan for that yet, says Jeffrey Davidowitz, president and CIO of Oldfield Co., a family office based in the Pennsylvania town of Nanticoke. Although Davidowitz hasnt looked at outsourcing for his own firm, he sits on the boards of a college endowment and a nonprofit that have both relinquished their CIO functions to a third party.
Cambridges Myers sees opportunity. This generational transition is an enormous shift, he says. Many wealth creators are aging and realizing that the next generation doesnt have a particularly strong interest in finance.
Firms adding external CIO services should expect fee compression. In the past few years, as families have sought to reduce expenses, multifamily office providers have switched to flat-fee or retainer models rather than fees based on assets, the Family Wealth Alliances Casey notes. While underlying fund fees wont be impacted, I think its inevitable that, as competition increases in the space, ultrawealthy families will be negotiating similar fee arrangements for top-level investment management, he says.