Family Offices Embrace Illiquidity Risk for Long-Term Gains

In the ever-evolving landscape of global finance, family offices are increasingly willing to take on illiquidity risk in pursuit of greater long-term returns. This shift reflects a broader trend among these wealth management entities, which are navigating a complex array of market dynamics, from post-pandemic recovery to geopolitical uncertainties and rapid advancements in artificial intelligence. Understanding how family offices are adapting to these challenges provides valuable insights into their investment strategies, governance, and operational frameworks.

The Landscape of Family Offices Today

To gain a comprehensive understanding of the current mindset among family offices, J.P. Morgan surveyed 190 family offices worldwide, each with an average net worth of $1.4 billion. The findings revealed a fascinating picture of how these entities are managing investments, governance, succession planning, and operational challenges in a rapidly changing environment.

A Shift Towards Alternative Investments

One of the most significant trends identified in the survey is the growing preference for alternative investments. Nearly 80 percent of family offices are now collaborating with external investment advisors, marking a multi-year shift towards diversifying their portfolios. This willingness to embrace illiquidity risk is evident in the average allocation of 45 percent to alternative assets, with private equity being the most commonly held asset class at 86 percent. In contrast, infrastructure investments are less prevalent, with only 9 percent of family offices including them in their portfolios.

In addition to focusing on alternative investments, family offices are also developing core, liquid portfolios. On average, these portfolios allocate 26 percent to public equity and 20 percent to fixed income and cash. This balanced approach allows family offices to pursue higher returns while maintaining a level of liquidity for operational needs.

Cybersecurity: A Growing Concern

As family offices increasingly embrace digital solutions and online platforms, the threat of cyberattacks looms large. The survey revealed that nearly a quarter of family offices have experienced a cybersecurity breach or financial fraud, yet only one in five reported having adequate cybersecurity measures in place. Alarmingly, 40 percent of family offices identified cybersecurity as a critical area for improvement. This highlights the urgent need for family offices to bolster their cybersecurity frameworks to protect their assets and sensitive information.

Managing Operational Costs

Family offices are also grappling with rising operational costs while striving to attract and retain top talent. This balancing act can create tension, particularly when it comes to staffing roles and services. To address these challenges, many family offices are adopting a hybrid approach, outsourcing certain functions to streamline operations. For instance, large family offices with over $1 billion in assets report average annual operating costs of $6.1 million, making strategic outsourcing a priority. Meanwhile, nearly 40 percent of smaller family offices, with assets ranging from $50 million to $999 million, are also outsourcing investment management to some extent.

Preparing the Next Generation

Succession planning and preparing the next generation to inherit wealth are paramount concerns for family offices. Surprisingly, nearly 30 percent of respondents indicated they lack a structured approach to equip younger family members for this responsibility. Despite recognizing the importance of succession planning, many family offices admit they need assistance in this area. Interestingly, over one in five respondents globally choose to shield the rising generation from the full extent of the family’s wealth, a practice more common among smaller family offices. However, in an increasingly interconnected world, this approach may not be sustainable or advisable.

The Evolving Role of Family Offices

While managing financial assets remains the primary objective for family offices, many are adopting a longer-term perspective. Nearly 70 percent of respondents identified succession planning and preparing the next generation as key goals, with over 40 percent emphasizing the importance of continuing the family’s entrepreneurial legacy. Family offices are also increasingly seen as vehicles for achieving philanthropic and legacy objectives, with varying interpretations of what "legacy" means across different families.

Notably, U.S.-based family offices appear to be more focused on philanthropy and impact investing compared to their international counterparts. One-fifth of surveyed U.S. family offices have an in-house head of family foundation or philanthropy director, while only 2 percent of international family offices report similar structures. This disparity presents an opportunity for family offices to integrate their philanthropic and investment strategies, reflecting a holistic approach to wealth planning.

Conclusion

The landscape of family offices is undergoing a significant transformation as they adapt to the complexities of modern finance. By embracing illiquidity risk, prioritizing alternative investments, addressing cybersecurity challenges, managing operational costs, and preparing the next generation, family offices are positioning themselves for long-term success. As these entities continue to evolve, their ability to align financial strategies with broader legacy goals will be crucial in navigating the challenges and opportunities that lie ahead.

Natacha Minniti serves as the international head of 23 Wall at J.P. Morgan Private Bank, where she leads initiatives to support family offices in their quest for sustainable growth and legacy preservation. For more insights and op-eds, visit here.