By Lambert Strether of Corrente.
“We live in capitalism. Its power seems inescapable. So did the divine right of kings. Any human power can be resisted and changed by human beings.” –Ursula Leguin
The United States, it is said, is an oligarchy; it is ruled, by the rich. Hence it behooves us, as a simple matter of self-preservation, to study the habits of our oligarchs, especially those who have achieved dynastic wealth. The International Consortium of Investigative Journalists those habits as follows:
IPS identified six “habits” of highly-entrenched dynasties. These include defeating attempts to raise taxes on the wealthy, not giving away too much to charity, , creating dynasty trusts and loopholes to avoid gift or estate taxation, and using wealth to promote self-serving public policy and weaponizing charitable giving for dynastic interests.
This post will consider family offices. Inequality.org characterizes the purposes of family offices:
Ultra-high-net-worth families — those with $250 million up to the billionaire class — form family offices to bring wealth management services ‘in house.’ Key to their purpose is capital preservation and fostering inherited wealth dynasties. They are major utilizers of dynasty trusts to sequester wealth and avoid estate taxes. In this way, family offices serve to entrench multi-generational wealth inequality. Family offices are an unregulated corner of the financial marketplace with an estimated $6 to $7 trillion in assets under management (compared to $3.4 trillion in global hedge funds).
Like any vertical dealing with the ultra-wealthy, every family office is unique in set-up and structure, with each requiring a different combination of services depending on the wants and needs of their clientele. This makes defining the murky world of family offices incredibly challenging.
And that world is murky indeed. From the Dallas News:
“For each family office people know about, there are two they don’t know about because they keep a low profile,” said Colin Carter, managing director of Tiedemann Advisors’ Dallas office.
One example of a family office that — rather like Hunga Tonga — exploded from obscurity to the headlines almost instantly is Archegos Capital, which was structured as a family office. From Bloomberg:
No individual has lost so much money so quickly. At its peak, [Bill] Hwang’s wealth briefly eclipsed $30 billion. It’s also a peculiar one. Unlike the Wall Street stars and Nobel laureates who ran Long-Term Capital Management, which famously blew up in 1998, Hwang was largely unknown outside a small circle: fellow churchgoers and former hedge fund colleagues, as well as a handful of bankers.
He became the biggest of whales—financial slang for someone with a dominant presence in the market—without ever breaking the surface. By design or by accident, . Hwang used swaps, a type of derivative that gives an investor exposure to the gains or losses in an underlying asset without owning it directly. This concealed both his identity and the size of his positions. Even the firms that financed his investments couldn’t see the big picture. It didn’t matter that he’d been accused of insider trading by U.S. securities regulators or that he pleaded guilty to wire fraud on behalf of Tiger Asia in 2012. he founded to manage his personal wealth, was a lucrative client for the banks, and they were eager to lend Hwang enormous sums.
This will not, however, be a post about Big Banks setting money on fire. Rather, I will look, as best I can, at history and current status of family offices, their appetite for risk, and regulatory issues. I’ll conclude with a few questions.
History and Current Status of Family Offices
So how many family offices are there? (To caveat, recall the estimate that for every one we know about, there are two more we don’t.) The Financial Times estimates 7,000 with $5.9 trillion under management as of 2019, as compared to $3.6tn in the global hedge fund industry. Here, from the Family Office Exchange, is a calculation (a “guesstimate”) that gives a higher number, and for the United States only:
One way to calculate the figure is to understand the threshold for affordability of a single family office, and then consider how many families are likely to have one.
According to the Wall Street Journal, the threshold for single family offices is generally considered to be $100 million due to the costs and challenges of running such an entity. In the United States alone, there are approximately 20,407 individuals with more than $100 million in assets, as reported in the Credit Suisse 2018 Global Wealth Report. Of course, not all these families have separate family offices. Some manage their family wealth management activities within their family business; others use the services of a multi-family office or a wealth advisor.
For our estimate, we’ll assume that half of those individuals with $100-500 million in assets have some form of a family office. For those with assets greater than $500 million, the percentage is probably higher. According to FOX’s biennial Family Office Benchmarking Study, these families typically have more complexity, can afford it, and desire the privacy and control provided by a single family office. For purposes of this analysis, we assume 75% have family offices. This simple reasoning results in more than 10,000 single family offices in the United States.
10,000. “There are not very many of the Shing,” as Ursula Leguin says in City of Illusion. Where are they located? Caveats as above, here is a map:
Family offices used to be a pretty sleepy corner of financial universe. From the Wall Street Journal:
For many years, family offices were a fairly staid part of Wall Street. They often searched for conservative, long-term investments and sometimes invested in partnership with each other, with the goal of maintaining the wealth accumulated by the individuals and families, rather than multiplying it. Back then, it was hedge funds that often embraced riskier tactics, such as borrowing huge amounts of money to amplify their returns, strategies that resulted in the collapse of hedge fund Long-Term Capital Management LLC in 1998. This event forced the Federal Reserve to step in to stabilize the financial system. After the 2008-09 financial crisis, hedge funds adopted more conservative investing approaches, as more of their clients became risk-averse institutions. At the same time, family offices became more aggressive.
The Dallas News describes the change after 2008:
“There was an element of trust lost in 2008, and families wanted to have more control over their assets,” [said Tayyab Mohamed of Agreus Group, a London-based recruitment company that works with family offices worldwide.] said. “Before 2008, it was just meant for the Rockefellers of the world, but right at the start of 2010 we saw families with a couple hundred million starting family offices.” A UBS Securities report looked at 121 of the world’s largest single-family offices and found that 31% had been established between 2000 and 2010, and 38% were created from 2010 to 2020.
So family offices became “more aggressive.” Now let’s turn to their appetite for risk.
Family Offices: Their Appetite for Risk
Recall that family offices aren’t really regulated (more below), as Archegos showed. From the Wall Street Journal:
Family offices don’t have a fiduciary duty to keep their trading limited, and don’t have nervous investors to deal with. This can add to firms’ comfort with risk, say some who work with family offices.
So what kind of investments are family offices “comfortable” with, besides co-working spaces and carbon trading? Here are a few:
SPACs. From the Financial Times:
Family offices have participated in the [SPAC] boom, albeit in smaller numbers than hedge funds and other institutional investors. Among the most prominent names active in the sector are the family offices of tech entrepreneur Michael Dell, billionaire real estate mogul Barry Sternlicht and former hedge fund executive Dan Och. Some billionaires have even set up their own Spacs, with or without family office backing, including former Facebook executive Chamath Palihapitiya and hedge fund manager Bill Ackman. Billionaire financier George Soros’s family office has also begun hunting for Spac opportunities.
Startups. Also from the Financial Times:
Family offices are planning to significantly scale up their start-up investing in the coming year, according to an SVB Capital/Campden Wealth survey published in October, and the effort is being led in many cases by next-generation family members, suggesting it is a trend that will endure.
Crypto. From the Open Markets Institute:
Family offices are also emerging as significant investors in cryptocurrency hedge funds. Assets under managers in cryptocurrency funds reached $36.9 billion in July 2021, while a 2020 report by PwC found that nearly half of all investors in these crypto private funds are family offices. These investments are of particular concern given the high degree of leverage available in the cryptocurrency markets, combined with its extreme volatility
Cash. From Citi Private Capital Group:
There can be no doubt that family offices remain willing to sacrifice medium-term returns to maintain high levels of liquidity. Almost a third of offices report running cash levels at 20% or more, and our own portfolio data analytics show this number is higher. Client conversations suggest that a preference for flexibility, liquidity and the ability to act quickly in the face of opportunity remain the key drivers. Indeed, cash allocations do not reflect a negative investment outlook, with more than 70% of respondents expecting 5% plus returns over the next 12 months. More than a third indicated inflation, the cash crusher, was their most significant near-term concern.
Since I don’t play the ponies, my opinion is virtually worthless — but I’ll give it anyhow. SPACs, startups, and crypto all seem a bit… sporty, as do co-working spaces and carbon trading (more on SPACs). Given a financialized economy, startups are likely to focus on rental extraction. Crypto not only does the same, it’s openly fraudulent — hence its increasing normalization by finance — and actively harmful to the environment. And cash…. Well, if you need to leave the country quickly in your socks, cash is good. Or if you need to buy an island, or a ticket to Mars. So I’ll give them that.
Some have expressed concerns that family offices, aggregated, create systemic risk. From Open Markets:
Family offices owned by tech titans raise particular concerns of systemic risk given their size and concentration of investments. Amazon founder Jeff Bezos’ family office, Bezos Expeditions, is estimated to have over $200 billion in assets— ten times larger than Archegos was at its most leveraged. Microsoft founder Bill Gates’ family office, Cascade Investment, L.L.C., has amassed the largest private ownership of farmland in the United States: 269,000 acres of farmland.
I don’t see leverage, so I don’t see systemic risk. On the other hand, I wouldn’t see leverage, because family offices are opaque. Nobody saw Archegos coming, after all. Certainly not the investors.
Regulating Family Offices
The Archelogos debacle provoked a certain amount of tut-tut-ery. From The National Law Review:
The recent defaults by Archegos caused several large broker-dealers to incur significant losses. Archegos represented that it operated as a single-family office, which made it exempt from many provisions of the federal securities and commodities laws. Questions have arisen about whether Archegos properly qualified for the family office exemption and whether, in any case, the exemption is too broad.
Here is ginormous global law and lobbying firm Squire Patton Boggs on the “family office exemption,” and its origin in Dodd-Frank:
In the course of managing the finances and investments of a family, a family office frequently provides advice related to the family’s investments in securities. This activity would ordinarily subject the family office to regulation under the Investment Advisers Act of 1940 (Advisers Act). The Advisers Act defines an “investment adviser” as anyone who provides advice regarding securities, is engaged in the business of providing such services and does so for compensation. As it clearly falls within this particularly broad definition of “investment adviser,” the family office would be required to register with the Securities and Exchange Commission (SEC) unless it can find an exemption. In 2011, pursuant to a directive in the Dodd-Frank Act,1 the SEC adopted a rule, codified as the Advisers Act Rule 202(a)(11)(G)-1, more commonly referred to as the “Family Office Rule,” which effectively excludes family offices from the broad definition of “investment adviser.” The adoption of the Family Office Rule was largely driven by the fact that families who have set up family offices to manage their wealth are financially sophisticated and less in need of the protections that the Advisers Act was intended to provide to typical investors.
(Yes, it’s their sophistication that causes them to invest in crypto. NFTs, too.)
So far as I can tell — and I do feel like I’m juggling chainsaws here, since I am no expert in SEC regulation — nothing has come of the tut-tuttery, and the family office exemption remains intact. From the National Law Review once more, in June 2021:
Review of the family office exemption could be addressed in several ways. First, Congress could repeal or limit the family office exemption. No legislation has been introduced to accomplish this, and it appears that any possible legislative action is not imminent. Rather, it is more likely that the SEC and/or the CFTC will change their regulations to redefine the family office exemption. Existing legislation appears to grant the Commissions broad statutory authority to redefine the family office exemption more restrictively — or even, in the case of the CFTC, to eliminate it completely. Significant changes to current regulations could significantly restrict the availability of the exemption for many family offices.
(AOC did introduce legislation, which passed the House and died in the Senate. From Dentons, another ginormous law firm:
On July 22, 2021, New York Congresswoman Alexandria Ocasio-Cortez, a Member of the House Financial Services Committee, introduced HR 4620, the Family Office Regulation Act of 2021. HR 4620 would limit the use of the family office exclusion from the definition of “investment adviser” under the Investment Advisers Act of 1940 (the “Advisers Act”) to certain “covered family offices” — i.e., family offices with $750 million or less in assets under management (AUM) that are not barred or subject to final orders for conduct constituting fraud, manipulation or deceit. Family offices with more than $750 million in AUM would be exempt from registering as investment advisers with the SEC under a new exemption, but would have to file reports with the SEC as “exempt reporting advisers” (ERAs). The bill would also repeal a grandfathering clause in section 409 of the Dodd-Frank Act that permitted family offices whose clients include persons that are not members of the family to qualify for the family office exclusion. Finally, the bill would authorize the SEC to further define a “covered family office” to exclude family offices that are below the $750 million threshold if they are highly leveraged or engage in high-risk activities.
The Congressional Research Service provided a list of possible policy solutions, including subjecting family offices to the Investment Advisers Act and enhancing 13F and 13D requirements (“But family funds don’t need to file a 13F, so their portfolio positions remain hidden.”) To my knowledge, not of these have been adopted either.
In fact, the argument can be made — see the opening discussion of family offices as an institutions — that regulating them is not possible. From Forbes:
Even if family offices become subject to regulation, there is no standardized version of the family office – so how will they be regulated?
In a significant number of cases, family offices have succeeded in their goal of preserving generational wealth. From a UBS annual report on family offices:
Almost all (95%) of the family offices support just one or two generations. However, almost half (48%) of those family offices supporting one generation no longer include the founder or business owner. Almost a quarter (24%) of the single-generation offices support the second generation, with the balance supporting the third, fourth and fifth.
Whether ephemeral or more permanent, family offices have a disportionate effect on the state of the world. From Forbes:
[Bill Woodson Head of Strategic Wealth Planning and Family Enterprise Services for Boston Private] explains that a select few families control the majority of the world’s wealth, and how their wealth is utilized and managed has significant implications for society. Therefore, the family offices representing these UHNWIs play a critical role and have a unique opportunity to determine how wealth is channeled for good.
(“Of all the works of Sauron, the only fair.”) It’s pretty to think so, but I’m dubious about the overlap between “wealth channeled for good” and, at least, crypto and startups. In any case, I think oligarchs would reject Woodson’s view out of hand, except for public relations purposes. From the Financial Times:
“If it’s their money, they can do what they want,” says Angelo Robles, founder and chief executive of the Family Office Association. “Just like the average person, why should they be disclosing things?”
Well, one answer would be to defang the aristocracy of inherited wealth. From the New Republic:
“Tradition,” wrote G.K. Chesterton, “means giving votes to the most obscure of all classes, our ancestors. It is the democracy of the dead.” Substitute “money” for “tradition,” and you have the situation created in the U.S. by an accumulation of laws protecting people’s money after they depart this vale of tears. Except the end point isn’t democracy, it’s oligarchy.
An end point at which we have arrived. What about a serious attempt at confiscating inherited wealth?