Family Offices and Investment Governance – Learnings from Yale

Investment Governance is one of the most important issues for Family Offices as this is about achieving the best investment results for the family owning the assets. In other words – for Family Offices Investment Governance is one of the most important aspects. 

Investment Governance is about achieving the best for the principal  

Why is Investment Governance so important? In most cases the asset owner delegates the day to day investment management activities to specialists such as employed in-house portfolio managers, third party asset managers or by allocating assets to a funds such as mutual-, hedge- or private equity funds. Investment Governance is about achieving the best investment results for the owner(s) of the assets. This this is a classical Principal/Agent problem. How can the principal who owns the assets ensure that the agents – the managers of his estate - act in the best interest of the owners.  

It is important to understand that “best” does not always mean “highest” because the risk taken to achieve the result must be factored in. In addition, the time horizon and liquidity needs have to be considered. What “best” means for the principal is of utmost importance for the management of the Family Office as only then a suitable governance system can be put into place. 

Elements of Investment Governance  

What is Investment Governance about? Investment Governance is essentially about defining (i) who is in charge of decision-making when it comes to deciding on (a) asset allocation, (b) investment manager selection and allocation and (c) incentive schemes and fee models; (ii) what type of portfolio and risk reporting will be put in place and (iii) what is a suitable monitoring system to ensure adherence to the agreed parameters. Last but not least it is about (iv) putting the committees or boards in place including corresponding documented rules to ensure systematic and consistent governance. 

Fees and incentives are key  

In practice the incentive system for the mangers is the most important area of sound Investment Governance. Again - it is key is to align the interest of the agents with the interest of the principal. One of the most important element for this is the fee structure. The Yale University Investment Office*) employs the following model to enhance alignment with managers: 

1. Management fee covers reasonable overhead cost. This fee is renegotiated as the volume of assets grows. 
2. Performance fee as a share of profits above a selected benchmark¸ the latter can be challenging for investments in non-liquid alternative assets. 
3. Co-Investments by managers ensure that managers participate in profits and losses. 

Most of above can be implemented in a Family Office context. Of course the specifics will depend on the principal’s bargaining power. Especially the question of allowing for co-investments might be a considerable obstacle for both principal and agent. Without a clear Investment Governance principals and beneficial owners might face situations where their investment results are not aligned with their objectives and needs. Thus, a proper Investment Governance is key. 

*) The Investment Office of Yale University manages an endowment of approx. 25 billion USD as per their annual report “2016 The Yale Endowment”. The fee model is outline on page 22-23.