Benchmarking has long been standard operating practice in the manufacturing industry. In the last 20 years, it's gotten more attention in the service industry. And now family offices are beginning to think about how they too can measure performance so they can compare themselves to their peers, improve quality and control costs.1

The top two U.S. family office industry groups, Chicago-based Family Office Exchange (FOX) and New York-based Institute for Private Investors (IPI), recommend benchmarking as an effective way to improve business processes and outcomes. FOX uses its Office Complexity Index to measure the effectiveness of 10 family office metrics.2 IPI produces an annual report that compiles member performance in its Family Performance Tracking Results so that its members can see if they beat the index.3

In early 2006, we at Family Office Metrics completed our own benchmarking study of 10 family offices, each of which has more than $1 billion under management (the 1BFO). Our goal was to identify the quality and the cost of the family office investment management process. Specifically, the 1BFO examined investment management at family offices looking to answer two key questions: “Is the family office doing the right things?” and “Is the family paying a reasonable amount?”

By looking at the 1BFO results, you can see how your family office compares to a group of multi-billion dollar offices. Then, you can assess how efficient your family office is functioning, and consider making adjustments to ensure that your office reaches its maximum potential. But first you have to understand and embrace the whole concept of benchmarking.

WHAT'S A BENCHMARK?

Benchmarking is the act of comparing individual performance to a standard in order to understand how to improve the individual performance. Each benchmark must meet five criteria: It must be specific, measurable, actionable, relevant and timely.4 The benchmark must be specific enough to define an activity from start to finish, and it must be quantifiable. The benchmark must be actionable so that when it changes, outcomes or results also change. Finally, the benchmark must be timely or it won't be meaningful or usable. If the potential standard doesn't pass all five tests, it doesn't qualify as a benchmark.

A family office typically benchmarks its activities from a functional perspective,5 like investments, financial controls, fiduciary responsibilities or back-office support. Then, it compares its performance to its peers. To provide the best information, a family office should consider its approach in light of strategic planning, tactical implementation, and the audit of outcomes for its benchmarking project.

WHY BENCHMARK?

Benchmarking the family office is important because it's a tangible way for stakeholders to measure the family office's performance standards of quality, satisfaction, cost and timeliness.6

  • Quality is the degree to which a set of inherent characteristics fulfils a need or expectation that is stated, implied or obligatory.

  • Satisfaction is the perception that a service provider's performance meets or exceeds the user's actual or perceived expectation.

  • Cost is the amount of money needed to put a service into action. Costs can be divided into direct costs and indirect costs.

  • Timeliness is the amount of time that it takes to complete a particular process; it also can be the speed or the frequency of the process.

HOW IT'S DONE

Benchmarking addresses five important vectors (that is to say, components) in the “business of the family office.” The first vector examines your current practices: What exactly are you doing? To answer this question, use formal documentation (including flowcharts) to review your current business process.

The second vector is prudent industry practices. What compliance and regulatory requirements exist that influence your approach to your own risk controls? It makes sense to examine your family office members' governance responsibilities and management reporting requirements.

The third vector is the practice of your peer group. Start by observing what your peers are doing through industry member groups, industry conferences and professional organizations.

The fourth vector is your commitment to continuous improvement: What do you do to make sure that your business performance improves every year? Two ways to keep a family office from standing still or marching in place is to implement “management by objective” programs and incentive rewards for improved performance.

The fifth vector is to examine the best practices that exist outside of the family office industry. How can you adapt them to your family office? What works in other types of businesses? For example, a company that's not in the clothing business but relies on the Internet and telephone for sales would improve its customer satisfaction scores by looking at a successful clothing company such as Lands' End Inc.7 By looking outside of your industry, you may see activities that can allow you to make substantive, not just incremental change.

Start your benchmarking project with a focus on your business process:

  • Prioritize your business activities and start with the one most important to you. First, identify core competencies — what you do best — and where you expect to be in the near future. When you compare where you are and where you want to be, you'll create “gaps analyses” that identify potential benchmarking issues in your family office. Start with a very narrow focus. For instance, a major function like investment management support has many sub-functions, such as “selecting managers” and “portfolio review,” each with important process steps. You'll be surprised at how “wide” a narrow focus will become when starting the benchmarking process.

  • Document your current business process to create a baseline. As you do this, your business management methods and success measures will become apparent. Often, the act of documenting the process will point out things that you thought were being done that are not being done.

  • Identify your quality, satisfaction, cost and timeliness objectives. What will you measure? Why do you want to measure these activities? This sounds easier than it is. In fact, it's probably the hardest part of the project. Set your own standards for your family office, or base them upon existing authorities. Then identify specific activities you want to measure, like your investment due diligence process or your approach to performance reporting.

  • Create an action plan. This plan should include tasks, constraints and milestones for accomplishing the benchmarking program. Plan the work and work the plan. Give yourself plenty of time to gather data from your peer group, because you'll be required to explain the approach and the objectives as you proceed.

Once you've started to document your process and begun to plan, consider reaching out to your peers. There are two ways to do this: First, approach a peer directly to get the best information in the fastest time. However, another peer family office may have privacy and confidentiality concerns and be unwilling to provide you with information. Moreover, you may not know another family office of a similar scope and scale to yours. So you can try the second approach: Participate in a moderated peer group. The moderator of the peer group identifies the important characteristics of the peer group, then targets family offices with those characteristics as candidates for participation. A peer group has the benefits of multiple participants and more data. Moreover, a moderated group with well-designed data gathering protects privacy and maintains a family office's competitive advantage.

THE 1BFO

To illustrate, let's take a look at some of the 1BFO results — the moderated peer group study conducted by Family Office Metrics.8 The 1BFO used an online survey and a follow-up cost analysis. Participants were asked, among other things, to rate components of their investment management process on a scale of 1 to 10, from “not important” to “very important.”

Our underlying premise was that all family office services are a means to three ends: client focus, service comprehensiveness and client personalization. Therefore, the 1BFO was designed so that all of the benchmarks illuminated at least one of those three categories. It was designed to relate the quality, satisfaction and timeliness benchmarks to the cost benchmarks. While the 1BFO was focused primarily on the investment management process, it also gathered data on other family office activities to present a complete picture of family office activities and costs. Here's what we found.

PRUDENT PRACTICES

Building upon industry standards, we identified the Foundation for Fiduciary Studies9 (FFS) prudent investment practices as our framework. We adapted the FFS model slightly to fit the typical family office “manager of managers” investment model used by 1BFO. We also constructed a basic cost accounting model that segregated direct and indirect costs to illustrate the cost structure of investment management.

We divided the investment management process into six steps:

  1. discovery, education and analysis;
  2. investment policy statement;
  3. allocating assets;
  4. selecting managers;
  5. monitoring managers; and
  6. portfolio review.

We asked both qualitative and quantitative questions.10 The 1BFO collected data about the quality and timeliness of the six steps along with client personalization, investment return measures, performance measures and risk controls. We also probed the offices' satisfaction with investment consultants and other services.

The 1BFO also collected quantitative data on time spent in the investment management activities in each of the six steps and in other investment-related activities, such as cash management, accounting and tax compliance. From time-study data, the 1BFO identified the numbers of personnel, what they do and personnel costs across the spectrum of family office activities, including how they related to four asset classes: marketable securities (traditional); hedge funds; private equity and venture capital; and real estate.

The 1BFO created 130 quality, satisfaction, cost and timeliness benchmarks for the investment management process of the multi-billion dollar family office. Overall, the 1BFO confirmed that this family office peer group follows a structured investment process like the six steps.

QUALITY AND COSTS

The quality metrics we designed describe how important the investment officers participating in the 1BFO considered the FFS standard. You can ask yourself: “How important are these standards to my own family office?” Your answer will help you when comparing yourself to the 1BFO. If your metric is less (lower or less frequent) than the 1BFO, you might want to consider why.

In the 1BFO, a structured investment management process is considered important if quality metrics range from 78 to 92.11 (See “What's Important?,” p. 44.) The higher the quality metric, the higher the importance. The 1BFO showed that the most important step to this family office peer group is the discovery, education and analysis step; the least important is the investment policy statement. Further, the 1BFO showed family investment officers expect to review all steps of the investment management process with their clients at least once a year.

The 1BFO also revealed that the six steps accounted for more than 70 percent of the total cost of investment management. A closer look revealed that they are not all equal: The most important step in terms of cost is selecting managers, which accounts for over one-third (39 percent) of the total cost of the six steps.

There are five specific underlying tasks associated with selecting managers; we wanted to see how the participants prioritize these tasks. (See “Selecting Managers,” p. 46.) The most important task proved to be providing access to managers; modeling the effect of an additional manager to the portfolio is less important. All investment officers expected to review these tasks with clients at least once a year.

VALUE

Everyone wants to get his money's worth. So we determined the “value” attached to each step in the six-step investment management process. We did this by looking at the ratio of the quality metric to the cost metric. This ratio produces a value metric, in essence, a measure of productivity. Taken individually, larger value metrics are better than smaller value metrics. In other words, activities with relatively lower costs and high quality produce the most value.

The 1BFO showed that the investment policy statement (IPS) had the largest value metric of 11.14, which is not surprising, as its cost metric was the lowest. Selecting managers (SM) produced the smallest value metric of 2.23. (See “A Look at Value,” this page.) A smaller value metric — like that associated with selecting managers — suggests that it may be prudent to improve quality or increase labor productivity.

For example, if your family office value metric for selecting managers is less than 2.23 and your quality metric is larger than the benchmark, then you should focus on improving labor productivity. Your family office should invest in tools or technology to reduce the effort of high-value personnel on routine tasks, to raise labor productivity and improve business performance. Use the value metrics benchmarks as a tool to see if your family office is getting the biggest bang for its buck. If not, it's time to make, or at least consider, some adjustments.

It's been said that you can't manage what you can't measure. To determine how you're doing, you must measure and compare your work activities across multiple dimensions, using benchmarks that are specific, measurable, actionable, relevant and timely. In the end, benchmarking the quality, satisfaction, cost and timeliness of your family office output versus a peer group is one of the best ways to build and maintain a family office committed to continuous improvement.

Endnotes

  1. Interest in benchmarking has been encouraged by the Malcolm Baldrige National Quality Award, which is given by the United States National Institute of Standards and Technology and created by the Malcolm Baldrige National Quality Improvement Act of 1987. It aims to reward quality in the business sector, healthcare, and education. For details on benchmarking standards, see the American Productivity and Quality Center website, www.apqc.org. Note that benchmarking in a service industry — like the family office — is problematic because unlike the manufacturing industry in which there are facilities, products or inventory that can be measured, service is intangible.
  2. See the FOX website, www.foxexchange.com, for details on its approach to benchmarking the family office.
  3. See the IPI website, www.memberlink.net/memberlinkpublic/, for details on its annual report on family investment performance.
  4. Dave Trimble, “How to Measure Success: Uncovering the Secrets of Effective Metrics,” www.prosci.com/metrics.htm.
  5. Jon Carroll, “Functions of a Family Office,” Journal of Wealth Management, Vol. 4, No. 2, Fall 2001 at pp. 23-27, www.fametrics.com. For a summary of the functional perspective, see Capgemini 2005 World Wealth Report, www.us.capgemini.com.
  6. The four dimensions of quality, satisfaction, cost and timeliness are generally accepted in the literature as relevant to any business activity, setting or industry. For an excellent discussion of the dimensions of quality and how to apply methods to measure it, see David Hoyle, ISO 9000 Quality Systems Handbook, 4th ed., (Elsevier, Burlington, Mass. 2005) at pp. 18-79.
  7. Personal conversation between Dr. Donald R. Cooper, Florida Atlantic University, Boca Raton, Fla., July 2006. Cooper also noted that it's important to consider “best practices benchmarking that goes outside of the industry to avoid the ‘craft consciousness’ of any one industry.” See also Donald R. Cooper and Pamela S. Schindler, Business Research Methods, 8th ed. (McGraw Hill/Irwin, Boston, 2004). For the table of contents and power point presentations on each chapter, see http://highered.mcgraw-hill.com/sites/0072498706/.
  8. For recent benchmarking studies on family office investment management, operations and technology, see the Family Office Metrics website at www.fametrics.com.
  9. See Foundation for Fiduciary Studies, www.ffstudies.org, for details on the foundation's prudent investment practices and standards.
  10. You can participate in the study, as well as see the qualitative questionnaire and definitions of the activities in the investment management process, at http://www.websurveyor.net/wsb.dll/26910/IMS2006.htm.
  11. The quality metric captures the relative importance of the six steps to the individual family office investment management process. The quality metrics of each of the six steps are summaries of the underlying tasks identified in the step.

WHAT'S IMPORTANT?

A study of 10 family offices for billionaire families reveals that “discovery, education and analysis” is the most important step in their investment management process

Investment Management Process Quality Metric* Timeliness Metric
1. Discovery, education, and analysis 92 At least every 12 months
2. The investment policy statement 78 At least every 12 months
3. Allocating assets 88 At least every 12 months
4. Selecting managers 87 At least every 12 months
5. Monitoring managers 82 At least every 12 months
6. Portfolio review 80 At least every 12 months
BENCHMARK (average) 85 At least every 12 months
* The higher the quality metric, the greater the importance of that category to the families surveyed.
Source: Jon Carroll

SELECTING MANAGERS

Out of five tasks associated with this step, unrestricted access to managers is key

Selecting Managers (subtasks) Quality Metric* Timeliness Metric
To objectively and proactively monitor the universe of securities and managers 89 At least every 12 months
To follow a due diligence process in selecting managers, brokers, custodians, and other service provider 92 At least every 12 months
To provide access to managers not restricted by the investment policy statement 94 At least every 12 months
To identify the risk attributes of selected managers 87 At least every 12 months
To analyze the effect of the addition of a manager to the portfolio 73 At least every 12 months
BENCHMARK (average) 87 At least every 12 months
* The higher the quality metric, the greater the importance of that category to the families surveyed.
Source: Jon Carroll

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