Managing threats to wealth

Thursday, 01 May 2014
Education and flexibility are key to keeping wealth in the family, write Charles Gowlland and Frank Akers-Douglas.

Understanding and mitigating threats to clients’ wealth is clearly a vital skill for any family office advisor. A recent survey of ultra-high-net-worth families identified a number of key areas of concern; some of these themes are explored in more depth below.1

Volatility in the financial markets

The volatility of financial markets, particularly in recent years, has highlighted the shortcomings of many investment strategies. As always with investment, a successful outcome depends on assessing a number of factors, such as time horizons and attitude to risk, and then implementing an appropriate strategy. A key area to address will be the family’s broader asset allocation, looking at both where their assets and liabilities are, and how these interact. If, for example, a family has an urgent cash call, but has insufficient liquid assets, they may find themselves in some difficulty.

It is sensible to assess how much risk the family wishes to take. In more complex circumstances, this may involve splitting up a fund into separate sub-portfolios, each with appropriate mandates and risk budgets. A flexible approach, and having the vision (and means), to take advantage of market dislocations can be advantageous too. Those who cashed up in early 2008 and did not reinvest until they thought the crisis had safely passed missed out on very significant rises in investment markets.

Tax and legal changes

When it comes to tax and legal changes, flexibility is also key. To take a particular example, the Finance Act 2006 introduced changes to the way trusts are taxed that meant innovative structures suffered badly. Those that were more flexibly constructed were at a definite advantage.

HMRC’s attitude towards tax avoidance has hardened considerably in recent times, and its scrutiny has become international in scope. Generally, family office clients tend to recognise the benefits of avoiding aggressive schemes that could result in years of litigation. There is also greater recognition that there is more to life than saving taxes, and that taxes are an inevitable part of life if you wish to live in a politically stable and culturally developed democracy.

This age of tax scrutiny has had its desired effect and resulted in less aggressive avoidance and a greater focus on how investments perform.

The key thing is to both accept that change is the only constant, and try to anticipate what those changes are likely to be.

Family breakdowns

Conflict within families is far from uncommon: divorce, long-running disputes and tension between generations are just three factors that can lead to very real threats to wealth.

Indeed, half of the respondents to the family office survey had misgivings about the younger generation managing the family wealth. The best way to protect against this potential pitfall is through long-term education, and effective communication between the generations. In particular, a family constitution can be a useful control mechanism for the concerned older generation, as well as a road map for future ones.

However, it is also important not to rely too heavily on external assistance when educating the younger generation. Discussing the family’s assets should be a regular and informal part of family life, rather than something that is examined solely behind closed doors or in the presence of professional advisors.

Educating the younger generation should be a gradual and ingrained part of family life that builds the children’s knowledge up until they reach the age at which they are ready to handle significant assets responsibly.

Equally, it is important for older generations to practise what they preach and not spend frivolously while instructing their children to take an abstemious approach. Ultimately, it all comes down to long-term education. If children see the older generation behaving responsibly, they are more likely to follow suit and behave responsibly themselves. Consequently, the limitations of the powers of financial advisors must be recognised, even though such advisors have a key role.

Financial mismanagement

Respondents identified financial mismanagement as their most pressing concern in terms of threats to wealth. A lack of family control and discipline can clearly result in financial mismanagement, although having too much control concentrated in the hands of one family member can be equally disastrous. In the latter scenario, the death of the controlling member can result in long-suppressed issues coming to the fore, with potentially calamitous results for the family’s wealth.

Again, a family constitution can help avoid mismanagement and, as is the case when heading off other potential threats, diversification is key: power, as much as the assets themselves, is expressed at its best when diversified in an appropriate manner.

It is also important to have trusted advisors. Good quality, long-term advisors who understand the family’s dynamics can prove invaluable in heading off potential threats to wealth.

  • 1‘Managing Family Dynamics’, Smith & Williamson, October 2013
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Charles Gowlland, Frank Akers-Douglas

Charles Gowlland is an Investment Director in the London office of Smith & Williamson.
Frank Akers-Douglas TEP is a Partner at Smith & Williamson.

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