If I thought all I could achieve over the next ten years was 13 percent annual growth I’d junk my company and start over. – Anonymous Founder

Sooner or later most successful businesses lose the founder’s intensity and vision, and attention eventually shifts to the mundane business of making money.

Founders grows old, the heirs lose interest, marriage, divorce, and death intervene and before they know it all that’s left are trusts, dividends, and decline.

It doesn’t have to be that way.  Some families stay on top for centuries.  A Bank of Italy study a few years back found that many wealthy Florentine families have stayed wealthy for 600 years.

And a recent IMF paper concludes that “for given portfolio allocation, individuals who are wealthier are more likely to get higher risk-adjusted returns” and “high returns both bring individuals to the top of the wealth scale and prevent them from leaving it.”

Education, culture, and entrepreneurial talent all play a part and an internal investment office for UHNW families may help promote generational alignment and cohesion.

As professor Mandy Tham at the Singapore Management University writes, a constructive family office can serve as a forum where the generations can negotiate and agree on investment goals and legacy.

But building a family investment office to last is not easy.  Too many family heads confront what Noam Wasserman, professor, author, and dean of Yeshiva University’s Sy Syms School of Business calls the founder’s dilemma.

Founders who want to manage empires will not believe they are successes if they lose control, even if they end up rich. Conversely, founders who understand that their goal is to amass wealth will not view themselves as failures when they step down from the top job.

Family office confidential

What some founders and CIOs really think about building and running an investment office.

A family office investment operation will never earn as much as the family business, so why have one?

The business of money management is all about risk mitigation and wealth preservation and first-gen founders aren’t usually built that way.

A notably successful individual had this to say after we showed him our latest 10-year Endowment Performance Rankings a few weeks ago.

Keep in mind that these are terrific returns for diversified, multi-asset, global portfolios and these CIOs are the best in the business.

Bowdoin and former CIO Paula Volent topped the charts with a 13.3 percent return, MIT and Seth Alexander finished a hair’s breadth behind at 13.02, Brown and Jane Dietze ranked third with 12.3, and Princeton and Andy Golden fourth at 12.2.  

After studying our rankings and returns, he paused for a moment and then said “Charles, if I thought all I could achieve over the next ten years was 13 percent annual growth I’d junk my company and start over.”

[The average return by the way, for our pool of one-hundred endowments over one billion dollars AUM, was 9.2 percent with a mean of 9 percent.]

I don’t want a chief investment officer looking over my shoulder.

Jon Hirtle, co-founder of Hirtle Callaghan, has been managing family and institutional money for almost forty years.

We asked him why successful founders don’t always see eye to eye with endowment style chief investment officers and here’s his reply.

I’ve been poor and I’ve been rich. Rich is better! — Beatrice Kaufman, author and raconteur, 1895-1945

Here’s some good news for those UHNW families who have worked hard to make it and hope to keep it.  Turns out that contrary to conventional wisdom, wealthy families are likely to stay wealthy over multiple generations.

“We can predict strongly, based on family background, who is likely to have the compulsion to strive and the talent to prosper” writes professor Gregory Clark, University of California, Davis.

James Grubman, Ph.D. family wealth consultant agrees.  If we focus on the families rather than the family firms, we find “significant longevity and success across generations.”

He rejects the apocryphal adage that it’s shirtsleeves to shirtsleeves in three generations and the related oft-quoted statistic that 70 percent of family businesses don’t survive the second generation.

After combing through the literature, Dr. Grubman traced each hoary myth back to the same narrowly focused study published in the mid-1980s. His conclusion?  These pessimistic views of family business survival simply aren’t true.

The Quick and the Bold

According to the Center for Family Business at University of St. Gallen, a privately-held firm is considered family-owned if a family controls more than 50 percent of the voting rights, while a publicly-held company is defined as family-owned if a family holds at least a 32 percent share of the voting rights.

Although it’s hard to get an accurate fix on the number of family businesses in the US – between 7.2 and 32.4 million in one recent study – there is broad consensus that family controlled enterprises are key drivers of U.S. GDP and employment, accounting for anywhere from 14 to 54 percent of private sector GDP and 14 to 59 percent of the private sector workforce.  Walmart alone, with 2.3 million employees, adds 2.4 percent to GDP.

But it’s not just their numbers that gives them clout, explain professors Asker, Farre-Mensa, and Ljungqvist, “private firms invest substantially more than public ones on average, holding firm size, industry, and investment opportunities constant” and their “investment decisions are around four times more responsive to changes in investment opportunities than are those of public firms.”

Some family businesses are exceptionally good at navigating life’s twists and turns.

Take the Zildjian company for example, the oldest family-owned and operating business in the USA.  Supplying the world’s percussionists from Norwell Massachusetts since 1929, Avedis Zildjian the elder began forging cymbals – those shiny shimmering saucers – around 1620 in Constantinople.  Four hundred years later they are still at it.  Same family, same specialty.

By the way, they are not the oldest family business by a long shot.  The record was held by Japanese temple-builder Kongo Gumi, in business from 578 to 2005.  Bad luck and a fading heritage finally did them in.  But what a run.

Does a Family Office matter?

All growth is not created equal — McKinsey & Company

It’s never been easier to start a wealth management advisory business and never been harder to grow it. Very few investment advisors achieve national size and status without a product or technology edge.

Of the approximately three thousand RIAs and OCIOs in the US, only about eighty have managed to accumulate over five billion in AUM.

According to the Investment Adviser Industry’s snapshot 2022, “most investment advisers (88.1%) are small businesses with 50 or fewer employees and one or two offices.”

These small advisors, from $100 million to $5 billion AUM, grew at a compound rate of about 6% over the four-year period from 2017 to 2021. The largest advisors on the other hand, those over $100 billion AUM, grew more than twice as fast, 14.9% over the same four years.”

Concentration creates another roadblock. As we noted in our last Outsourced Chief Investment Officer (OCIO) report, just eight providers out of the one hundred seven we listed – Aon, Blackrock, Goldman Sachs, Mercer, Russell, SEI, State Street, and Willis Towers Watson – manage well over half the OCIO assets, $2.073 trillion of the $3.74 trillion AUM.

So how do you build “the next great investment institution” as Jon Hirtle, executive chairman of Hirtle Callaghan describes the challenge? Why are there so few breakthrough OCIOs?

Barring a rare exception, there are only three ways most wealth and institutional money managers grow — buy, sell, or merge.

Those that finally opt for better-resourced allies are in good company. Echelon Partners 2022 RIA M&A Deal Report tracked 340 announced transactions in 2022 alone, the tenth straight year of record acquisitions.

The problem is, most mergers and acquisitions crash and burn. Roger L. Martin, former dean of the Rotman School of Management at University of Toronto, noted in a Harvard Business School article that 70% to 90% of all acquisitions are “abysmal failures.”

Why? “Companies that focus on what they are going to get from an acquisition are less likely to succeed than those that focus on what they have to give it.”

Professor Martin offers four suggestions to improve M&A outcomes.

• Be a smarter provider of growth capital.
• Provide better managerial oversight.
• Transfer valuable skills to the acquisition.
• Share valuable capabilities with the acquisition.

But if the dream is to build an enduring investment powerhouse, you had better pick the right partners.

Mr. Hirtle cautioned in a recent Financial Advisor interview that “a lot of acquirers are ‘financial consolidators’ who will be ready to sell again in three to five years after making an acquisition. Clients and staff do not want to deal with that kind of disruption a second time, so it is important to join with a stable firm who values you as a long term partner.”

What do you guys really want?

Know what you own, and know why you own it — Peter Lynch

These are “interesting times” for institutional investors.  Covid and a market crash in 2020, stimulus frenzy and valuation-highs in 2021, war and the end of free money in 2022. Whew.

But despite the volatility, there’s nothing like a decade’s long bull market to fatten school coffers.  Just about every endowment on balance is better off than it was a decade ago, as our ten-year return numbers show.

NACUBO and TIAA will have more to say on the matter in their online session this Thursday February 23rd at 2-3:30 ET as they showcase their annual semi-official endowment league tables.

We recruit chief investment officers and finance professionals for families and institutions, so our 2022 endowment performance tables focus on the individuals who manage the money.

Endowment investment heads are the ultimate long-term, strategic investors.  They have an infinite investment horizon, a global playing field, and can invest in anything anywhere – within the broad policy limits set by their institution.  Their performance is a bellwether for what’s prudent and possible.

We don’t mean to slight the thousands of bright, creative, and top-performing investment professionals at foundations, family offices, and Wall Street firms, but it’s difficult to extract meaningful data on compensation or performance from opaque sources.  So, we go with what we can get.

In this report, we feature ten-year fiscal year-end 2022 investment returns for one hundred twenty-eight US and six Canadian institutions — the latest available.

We consider a ten-year span to be a rigorous and revealing measure of the strength of an institution’s oversight and long-term investment abilities, but we remind our readers that there’s much more to the story.

First the caveats

Keep in mind that the job of every CIO and investment staffer is to meet the objectives set by their board, not to beat Yale.

Every school has its own endowment payout rate and tolerance for risk and that’s what CIOs aim for.  Some schools rely heavily on income, others place more weight on growing the principal.

We all love the league tables (well, most of us) but board members and administrators set the parameters for investment execution, and they are the ones to judge whether their goals are met.

Next. There is no one reporting standard for endowment performance and no institutional body to enforce a standard even if there was one.

Many schools report their numbers net of all costs including external management fees, internal office costs, and the endowment tax, but not all.  Some report gross returns.  Others subtract external management fees but not office costs or the endowment tax.  Over a ten-year period that makes a difference.

Third,

Revenue is vanity, profit is sanity, but cash is king — Unknown

Michael Rosen, managing partner and CIO at Angeles Advisors in Santa Monica doesn’t think much of Karl Marx or the heavy hand of state intervention. In Mr. Rosen’s words “wealth derives from the value created by capitalism.” And no country does it better than America.

He argues in his latest quarterly investment letter, titled Kapitalismus, that the most important factor in investment success is return on capital. GDP growth, revenue growth, even growth in net income? All those factors contribute value, but ROC outweighs them all.

Given the data, U.S. pensions may want to rethink their asset allocations before they climb too far out on the “alternatives” limb.

Follow the money

Why? Let’s start with relative stock market performance. According to Mr. Rosen, “Since 1990 the return on capital for U.S.  companies has always been positive and despite four recessions and four bear markets in that period, equities have risen 1,000 percent, with dividends reinvested bring the total cumulative return to over 2,000 percent.”

But how about those impressive Asian markets and China’s economic miracle?  It depends on who you ask.  Ray Dalio has been a China fan boy for years (Bridgewater manages about $5bn for CIC), however, Stratos Capital Partners, the late Scott Minerd, and even a few bold analysts at JPMorgan (until they recanted) consider the country uninvestable.

Mr. Rosen prefers to follow the money, i.e., equity returns.  Since 1992, the year China was added to the MSCI indices, Asia economies ex-Japan have posted enviable GDP growth of 9.5 percent per annum (all percentages p.a.), corporate growth of 14.8 percent and earnings growth of 12.6 percent versus U.S. comparables of 4.5 percent, 6.5 percent, and 10 percent respectively.

But when it comes to stock prices, what share-holders actually earned on their investments, the story flips.  Over the same thirty-year span “U.S.  equities prices grew at twice the rate of Asian shares, 7.8 percent versus 3.7 percent in Asia ex-Japan while China, with blistering economic growth over 9 percent for thirty years – handed investors equity returns of minus 1.4 percent.”

Mr. Rosen gives two reasons for U.S. equity outperformance.  First, “U.S. companies averaged a return on equity of 15 percent over the past 30 years, versus 11.2 percent in Asia ex-Japan.”

And second, Asian companies significantly diluted their earnings, averaging only 4.4 percent EPS since 1992 despite income growth of 12.6 percent.  U.S. companies, by contrast, grew EPS at 8.2 percent, not far behind income growth of 10 percent.

Mr. Rosen’s conclusion? “Economic conditions matter, of course, but the competition to earn a high return on capital defines sustained success, [and equity performance] for companies and for countries.”

US pensions, late to the party