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Wealth Trends - September 2011

8th September 2011 Sara Hamilton, Family Office Exchange

Wealthy families are continuing to live in the shadow of uncertainty but strategic issues need addressing.

Wealthy families and their advisors are continuing to live in the shadow of uncertainty. Today’s economic and political environments are as turbulent and uncertain as ever. Anemic global economic growth is a paramount concern. Families and advisors must also contend with the European debt crisis and concerns about pending government policy decisions.

Politics and government policy give today’s uncertainty a markedly different feel than in the recent past. Two years ago, families were primarily focused on their investments and the economy and, as a result, are better equipped today to understand and respond to financial market volatility. Today, however, they must also contend with the impact of revised tax legislation and greater regulatory scrutiny.

Despite the grim news, there are plenty of reasons to feel positively about families’ prospects. The best‐positioned families are maintaining their long‐term focus and adhering to pre‐existing plans rather than responding reflexively to headlines. The focus for these families is developing strategies and structures to manage the strategic deployment of capital.
Wealth Trends
1. Families are staying the course in the midst of current volatility because they adopted more conservative asset allocation and risk profiles as a result of the 2008‐2009 experience. The true test will be how they respond to prolonged uncertainty.
Having weathered the crisis of 2008 and 2009 and witnessed the recovery of the financial markets, families are better equipped to deal with uncertainty and have a more sanguine view of current volatility. Whereas families and their advisers reported numerous flights from risk in 2008, there are few reports of families moving significant assets to cash, but they are diversifying into foreign currencies. Rather than panic, most families are sticking to their existing plans.  
Not only are families psychologically better equipped to handle uncertainty, their investment portfolios are also better fortified. With respect to their investments, families have adopted more conservative approaches, are more diversified, and have better risk management practices in place. Families also have more liquidity and better liquidity management strategies today than they did during the crises of 2008 and 2009.
It is too soon to tell whether stronger nerves and better risk management practices can withstand the real and perceived effects of more bad news. Fears of a double‐dip, concerns about political leadership, dissatisfaction with government policy, and worries about a long‐term decline in U.S. prosperity are negatively impacting sentiment. Should these concerns persist, families may take dramatic measures to reduce risks and to focus on preservation of lifestyle and income needs.
2. Families are more focused on risk control than risk taking and are seeking investments where they have greater control.
Renewed interest in direct private equity and business ownership reflects families’ desires for control, disillusionment with public equity funds, and general distrust of the financial markets. Families that have a history of owning businesses are seeking out reasonably‐priced operating businesses rather than putting money into the financial markets.
Demand for direct private equity investments reflects greater comfort with illiquidity. More families are better structured than they were in 2009 and willing to assume illiquidity risk. Better‐prepared families are asking essential questions about the premium for illiquidity, deal terms, and potential lifestyle implications.
3. Advisers are adding value in new ways by helping families manage economic uncertainty.
Advisers that can articulate a clear view of how to respond to uncertainty have been demonstrating their value proposition to clients who are unsure how to respond to political and economic news. As Greg Curtis of Greycourt notes, investing in the current climate has less to do with investment fundamentals and more to do with unpredictable macro issues such as the actions of politicians and central bankers. In their investment recommendations, many advisors are encouraging a bias toward capital protection over growth. Says Lee Weiss of Family Endowment Partners: “We are giving clients the license to feel good, not guilty, about being cautious. The next six months could be difficult.”
Advisers are also channeling clients’ instinct to react into action plans that do not require a view on the direction of the financial markets or economy.
Eton Advisers, for example, is encouraging clients to adopt the following plan:
  • Reduce or eliminate all asymmetric risks
  • View market prices in a longer‐term historical context
  • Focus less on market direction and more on volatility
  • Re‐examine the mix of passive versus active and hedged versus unhedged strategies
  • Maintain a close watch on portfolio liquidity
Advisors are also working hard to ramp up their communications. At a minimum, most aim to provide reassurance and discourage unwarranted reactions. Some are using flexible reporting platforms and innovative analyses to present portfolios in terms of volatility and liquidity risk. 
4. Families are worried that a wealth backlash and government regulation will introduce new complexity and cost into their lives and planning efforts.
In both the U.S. and abroad there are numerous signs of a looming wealth backlash. Says one observer: “In the current scheme of things, it is no longer politically correct to be wealthy.” Favorable U.S. tax laws and the $5 million estate tax exemption are expected to be short‐lived. Across the U.S. and Europe, the press stirs the debate about the appropriate tax burden for the wealthy. This debate and mounting government debt burdens will have a dramatic future impact on bottom line returns. Governments, globally, are tightening rules about managing assets overseas and beginning to track asset ownership through a multinational network of tax authorities.
Fears of a backlash are elevating families’ interest in wealth transfer structures. Clients that have experience with extended periods of financial market volatility are less familiar with political uncertainty and asking their advisors more frequent questions about estate and tax planning. For their part, trust and estate attorneys and other advisors are prodding clients to act in advance of anticipated regulatory changes and while asset prices remain relatively depressed. Their actions reflect advisors’ expectation that government actions in most venues will change the previously favorable “rules of the game” governing wealth preservation and transfer.
5. Families are strengthening governance structures and decision‐making policies in anticipation of upcoming transitions and continued economic uncertainty.
In 2008 and 2009, frozen capital markets and uncertainty led to paralysis; families deferred critical decisions about business transitions and wealth transfer. Two years later and with better liquidity control measures in place, volatility concerns are no longer deterring families from making plans and taking action. If anything, families that were almost exclusively focused on financial issues are now addressing critical issues affecting their families and businesses. 
Action is being triggered as 
  • More families are reaching the point where aging leadership is forcing transition, 
  • The renewed availability of private equity funding for buy‐outs is allowing family businesses to be sold, and 
  • Families are divesting portions or all of their businesses recognizing the risks of concentrating all of a family’s wealth in an operating business.
The complexity of these issues requires families and their advisors to strengthen governance and decision‐making structures and to address any internal disagreements. Planning for liquidity events, for example, necessitates a complex series of decisions about control, ownership and perpetuation. These high‐stakes decisions, fraught with potential pitfalls, often cause conflict.
Better decision‐making structures are also essential if families are to respond effectively to market volatility. One advisor notes that many family investment committees are notoriously slow in implementing tactical investment decisions: “In a low‐return world, the opportunity cost of slow decision‐making matters a lot. Families cannot afford to sacrifice return because they are slow to implement decisions.” Potential tax laws and new regulations similarly require families to make effective strategic decisions.
6. Families that engage in long‐term strategic planning are best positioned to weather uncertainty and more likely to make good decisions.
A strategic plan for the long‐term deployment of capital is an anchor in periods of uncertainty. The best plans support a family’s goals, perpetuate its identity, help set priorities, and design actionable plans to address risks. The need for effective strategic planning has never been greater given that economic, financial and political uncertainties have implications for all aspects of wealth preservation and transfer.
Unfortunately, many families still do not use a strategic framework to manage their opportunities unless faced with a specific family transition. Absent a transition or similar triggering event, many families fail to embrace long‐term strategic planning as a priority because discussing what could go wrong is disconcerting to many owners.
Maintaining a long‐term, strategic focus can make a decided difference in the future opportunities available to families. The planning process needs to include family leaders and key advisors, and needs to focus on indentifying known transitions, and risks and opportunities. Alternatives have to be evaluated in the context of long‐term family goals and linked to clearly defined measures of success.
Reproduced with permission from Sara Hamilton, Founder and CEO, Family Office Exchange


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