By Stephan Schilken, Director of AIFM and Head of Delivery, Luxembourg
The family office space continues to evolve with pace around the world. Part of that evolution is a convergence of focus between family wealth preservation and succession and institution-like governance.
The recent disruption and reflection caused by COVID-19 has added further impetus to this convergence, particularly in the context of risk management. Family offices across the globe are realising the importance of understanding all risks that they face and ensuring a proper risk mitigation framework is in place to cover any eventuality.
With this in mind, the timing seems right to share and discuss a holistic, multi-step risk management approach that family offices may wish to consider as part of their overall wealth stewardship role.
Step 1: define long-term goals
The first step towards ensuring sound risk management is to define the family’s long-term goals. (Indeed, this step is key to all areas of family wealth oversight.) The fundamental question to be considered is, “What do you want to accomplish with your wealth?” Answers to this question will vary, but will become a part of the family’s, and therefore family office’s, collective voice and ethos.
Step 2: identify the risk spectrum
With purpose and ethos established, the second step in the risk management process is to identify the broad range of risks that might prevent the family and family office from achieving those goals.
This lays the foundation for risk mitigation and may in fact be the most difficult stage in the process. While certain risks are more general, foreseeable and may already have been addressed, other risks might be unique to the specific family or region and must be resolved in line with individual circumstances and preferences.
As a guide, the classic portfolio risk management approach, derived in most part from the institutional asset management world, consists of the following risk monitoring categories:
- Risk appetite / investment guidelines
- Concentration risk
- Market risk
- Liquidity risk
- Credit risk
- Operational risk
- Limit monitoring
All of these risk categories can also be applied to ultra-high-net-worth families as part of the wealth stewardship afforded by their family offices.
A thorough review of risk sub-categories further serves to highlight how a family’s risk profile can extend beyond any financial concerns. Certain risks may be difficult to broach and impossible to quantify by monetary measures, but may still present the most significant threat. For example, intergenerational communication issues within the family could be of great risk in the design of an efficient inheritance strategy. Similarly, highly concentrated decision-making power and knowledge can lead to material management risks if such key persons become no longer able or willing to steer the family’s fortune.
Step 3: establish a risk hierarchy
After the family’s risks have been identified, the third step is for the family office to establish a hierarchy based upon each risk’s probability and potential impact. As you’d expect, those risks with the highest likelihood of occurrence and highest potential impact need to be classified as top priority and be addressed first in the risk mitigation process.
To set out and label risk priorities clearly, many businesses and fund managers use Key Risk Indicators (or “KRIs”). Again, this approach can work equally well for family offices – further evidencing the rise of institution-like governance in the family office space.
Step 4: formulate strategies for top-priority risks
Step four in the process is for the family office to analyse each top-priority risk and formulate a suitable mitigation strategy. Those mitigation strategies must then be documented into an action plan.
Step 5: commit resources
Step five is a logical extension of step four and is the family’s commitment of its resources to implementing the action plan through the family office. These resources may be financial capital but can also be human capital, both from within and outside of the family office (e.g. specialist outsourcing partners).
Step 6: monitor continuously
The sixth and final step in the risk management process closes the risk continuum. As top-priority risks are addressed and resolved, it is imperative that the risk landscape be continuously monitored to identify any new risks arising from evolving family dynamics, changes in business/investment activity and the ever-changing macro environments in which the family is operating.
It’s also important to facilitate an open communicative environment and active dialogue on risk findings so that efficient mitigation measures can be put in place as required. Further, a sound and clear escalation process within the governance of the family office should be in place to help ensure the intended risk mitigation actually happens in practice.
To this end, the family office’s governance framework should include a formal risk committee (perhaps with one member being an expert third party). Beyond ongoing risk monitoring, this committee should periodically review the family’s risk appetite and investment guidelines in light of any changes in the asset classes, markets or any other risk measure important to the family.
Without proper risk processes and governance, a family office may well find themselves unable to act strategically and decisively to manage the family’s risks, including through various market cycles as well as unexpected disruptions like the COVID-19 crisis. Indeed, the ongoing pandemic has proved to be a wake-up call in many ways, including in the context of family office wealth stewardship and the increasing importance of robust risk oversight as part of that stewardship.
How IQ-EQ can help
The importance of effective risk management is not new to us at IQ-EQ. We speak from experience, not only in terms of our decades supporting (U)HNW families, but also our extensive experience in the funds and institutional space.
With a fully authorised alternative investment fund manager (AIFM) platform, IQ-EQ has already established a robust risk reporting system for our alternative investment fund clients and for our valued family office and private clients. Our clients benefit from the full expertise of a professional fund manager that is familiar with the specialised needs of wealthy families and their family offices.
To find out more about how IQ-EQ could support your risk management requirements, please don’t hesitate to contact me:
T: +352 466111 3388