Finding the Right Advisor for Your Family

With an introduction to open architecture and the outsourced CIO as background, let's move on to the specific challenge of finding the right advisor for your family.

Dimensions of the Problem to Focus On

Though every family will have its unique needs, most families will find it useful to focus on the two main dimensions along which advisors fall. These are what we might call the “bundled-versus-unbundled” spectrum and the “open-versus-closed architecture” spectrum. Finding the right place for your family on these two dimensions will very substantially simplify the challenge of finding the right advisor.

Bundled versus Unbundled

An advisor who bundles its services is mainly selling convenience, simplicity, and one-stop shopping, but at the cost (usually) of quality and family knowledge (we'll discuss why in a moment). At the extreme “bundled” end of the spectrum, the advisor might already have in place such services as custody, brokerage, asset allocation, money management, performance reporting, fiduciary services, and a broad range of “softer” services some families will need, such as check-writing, intergenerational counseling, and so on. These services might all be performed by the advisor itself, or some or all might be outsourced.

At the extreme “unbundled” end of the spectrum, an advisor is mainly selling best-in-class services across the board, but at the sacrifice (usually) of simplicity. An unbundled provider will wait until it understands the family's needs before recommending custodians, brokers, asset allocation strategies, money managers, and so on. Even performance reporting can be outsourced these days.

Extreme bundled advisors tend to be closed architecture, whereas extreme unbundled advisors tend to be open architecture, but that is not universally true. In particular, as we move along the spectrum from completely bundled to completely unbundled, we will encounter every possible variety of bundling and unbundling mixed up with every possible variety of open and closed architecture.

Open versus Closed Architecture

A purely closed-architecture advisor will employ a service platform that relies on its own in-house capabilities, sometimes across the board, sometimes only in money management. A purely open-architecture advisor, on the other hand, will employ a service platform that offers no products of its own. Instead, it will search for the best and most appropriate products for its clients across the board. As with the bundled-versus-unbundled dimension, advisory firms can fall anywhere along the spectrum from completely closed architecture to semi-closed architecture, and from semi-open architecture to completely open architecture.

To illustrate how we might approach the problem of locating the optimal position on the bundling and architecture dimensions, let's look at the experience of an individual family, the Schulbergs.

The Schulberg Family

In 2005, the Schulberg family had liquid assets of $23 million. In absolute terms, of course, that was a large sum of money. But as a percentage of the total wealth of the family, the liquid assets were dwarfed by the value of the family's operating business: a regional cable television company that was growing very rapidly and was already worth, in 2005, an estimated $100 million.

What Business Is the Family In?

In looking at the range of advisory options available to it, and in trying to reduce the sheer number of possibilities to a manageable few, the Schulberg family asked itself two very simple questions (the answers to which, however, are not always simple). The first question was, “What business are we in as a family?”

Because the ultimate destiny of the Schulberg family would be far more dependent on how well the family managed the cable TV business than on how well the family managed its liquid wealth, the family sensibly concluded that it was in “the business of running a business.” It was important that the family apply most of its time and talents to the cable business to ensure its success. That didn't mean that the family would ignore what was happening with the liquid assets, but it did have important implications for the kind of advisor the family would need.

Because the family would have little time to devote to the management of its liquid assets, the Schulbergs realized that they needed an advisor that fell toward the “bundled” end of the business. Such an advisor would take most of the complexity and most of the time-consuming activities associated with wealth management off the family's shoulders, leaving the family free to focus on operating the business. This one important decision eliminated many possible competitors for the family's advisory business.

How Does the Family Feel about Conflicts of Interest?

In terms of the open-versus-closed architecture spectrum, the Schulbergs asked themselves a second question: “How do we feel about conflicts of interest?” Some families will be very sensitive about conflicts, seeing them as going to the very heart of the issue of trust, without which no advisory relationship can flourish. Other families will see conflicts as an inherent part of the advisory business, and as an issue to be managed, not avoided.

The Schulbergs fell into the former category, partly because, in the early 2000s, the family had experienced a brush-up with conflicts of interest in the investment banking business. The family's investment banker had recommended that the cable TV company issue junk bonds as a way to gain access to the financing it needed to propel its growth. This turned out to be good advice, except for one problem: Another unit in the investment bank was buying up smaller issues of junk bonds (like those issued by the Schulberg's company), gaining leverage over the company and trying to force a sale of the company or a buyback (at a premium) of the bonds.

This experience had sensitized the Schulbergs to the dangers of conflicts of interest, and consequently they decided to limit themselves to the “open-architecture” end of the advisory spectrum. This decision also eliminated many competitors and, combined with the family's decision about bundling, allowed the family to focus on a very small group of appropriate advisory firms. It was to this limited group of four or five firms that the Schulbergs sent a request for proposal (RFP) designed to assist them in distinguishing the strengths and weaknesses of these few remaining competitors.

Defining (and Redefining) the Definition of the “Right” Advisor

Ultimately, the Schulbergs selected a firm that offered what it called “outsourced chief investment officer” services. This firm bundled most of the services the Schulbergs would need to manage their $23 million: asset custody, asset allocation, manager selection, and performance reporting. All the family needed to do was review the periodic performance reports to monitor the portfolio. The advisor was also mainly open architecture in the sense that it selected providers of these services in a best-in-class manner, taking nothing of value from any vendor.

All went well for seven years, at which point the Schulberg family sold its cable television company for cash and stock. The family could simply have continued with its existing advisor, but the Schulbergs didn't become wealthy by allowing inertia to dictate their fate. Instead, the family convened a series of family meetings, including the family's key advisors, at which it reasked the two key questions: “What business are we now in as a family?” and “How do we now feel about conflicts of interest?”

Obviously, the family's situation was now—mid-2011—quite different than it had been in 2005. Back then, the family had been deeply involved in building a strong regional cable TV business. Now, the Schulbergs were sitting on a pile of cash and securities—including a concentrated position in the acquiring company's stock—of nearly $300 million dollars.

Family Intellectual Capital

Thus, when the Schulbergs reasked themselves the question, “What business are we in as a family?” the answer was quite different. The Schulbergs were now no longer in “the business of running a business,” but in the “business of managing liquid wealth.” These are very different activities, and the consequences for the Schulbergs were momentous.

Earlier in the chapter, I mentioned that bundled advisors offer simplicity at the cost of family knowledge. During the almost eight years that the Schulbergs' liquid wealth had been managed by its bundled advisor, the Schulbergs had learned almost nothing about the business of managing wealth. Their investment results had been satisfactory, but the family's advisor had made all the decisions and therefore the results in terms of the family's human capital had been unsatisfactory, indeed.

The family knew nothing about the role of an asset custodian, knew nothing about how brokerage was handled in their account (the answer to this would not please them), understood nothing at all about the very complex business of selecting money managers, and they viewed the asset allocation process as a black hole. The Schulbergs reviewed their performance reports regularly, but exactly what those reports meant had never been very clear to them. In effect, the family had become an intellectual ward of their advisor during those years.

At the time, that sacrifice in the family's intellectual capital had been worth it—the Schulbergs had been focusing on larger issues and their liquid wealth had been mainly a sideshow. But now the management of the liquid wealth was the entire ball game for the Schulberg family—screw that up and it would all be over. What the Schulbergs badly needed was to become as good at managing liquid wealth as they had been at managing a cable TV business. And just as it had taken many years for them to learn the ropes and become adept at the one business, it would also take many years to become adept at the other. But the family needed to start learning right away.

Consequently, the Schulbergs decided to terminate their bundled advisor and to engage an advisor whose services would be as unbundled as possible. The family had a lot to learn, and the best way to start the learning process was to participate with a good, unbundled advisor in making decisions about every aspect of the wealth management process.

“Conflicts Really Matter Now”

Even before the cable business was sold, the Schulbergs were sensitive to the issue of conflicts. But back then advisor conflicts would at least compromise only a small portion of the family's wealth. Now financial conflicts of interest would go right to the heart of what the family needed to do. As a result, the family was now much more focused on identifying advisors who were located on the extreme open-architecture end of the open-versus-closed architecture spectrum.

Gathering Names

As I mentioned above, the choices available to families like the Schulbergs have grown like kudzu. But this is where the process of narrowing the advisory choices down to those that are likely to be most appropriate comes in. The Schulbergs knew that they wanted an unbundled relationship, and they knew that they wanted an open-architecture relationship. Hence, they were in a position to be specific when they asked around for recommendations.

The sources for advisory recommendations used by the Schulbergs were the ones most families would use. They spoke to their legal and tax advisors, their bankers and trustees, and families in similar circumstances. They also used the resources of intermediary membership organizations such as the CCC Alliance in Boston, the Family Office Exchange in Chicago, the Family Wealth Alliance (also in Chicago), and the Institute for Private Investors in New York. CCC, FOX, the Alliance, and IPI have had long relationships with many different types of advisors, and also have had the benefit of feedback from their family members about which advisors do what, who is doing a good job and who isn't, and so forth. Finally, the Schulbergs spoke to members of their regional family office networking group.¹¹

Note that another route the Schulbergs could have taken was to engage one of the firms that specialize in finding appropriate advisors for families. Although it may seem odd to pay someone to find an advisor you will then have to pay, the advisor selection process has become so complex that for very large families this route may make a lot of sense. The main challenges here are (a) how to find the right search firm (there are a few good ones and a lot of bad ones), and (b) keeping control of the process (discussed in the next section).

When the family had a list of four or five advisory firms that met its unbundled/open-architecture requirements and that came highly recommended, they were ready to circulate an RFP (request for proposal) to those firms.

The RFP Process

Until about a decade ago it was almost unheard-of for a family to use an RFP as a tool in its advisor selection process. But as families have become more serious about engaging advisors who are both appropriate and first rate, it was natural that they would borrow a tool from the institutional world. Still, the RFP process is fraught with dangers and difficulties. Let's examine some of the major pitfalls.

The Problem of Mimicking Institutions

Unfortunately, by the time families began to use RFPs, the institutional RFP process had become seriously calcified. Initially, institutional investors such as pension plans and endowments used the RFP process as a sensible and focused tool that was part of a larger process designed to identify an appropriate financial advisor (typically a pension consultant). But by the time families began to use RFPs, and to look to the institutional world for models, the RFP process was often a sham. There are only a limited number of serious pension consultants in the United States, and after a couple of decades everyone knew everything about all of them. Thus, the RFP process was little more than an attempt to demonstrate diligence where none actually existed: Institutions already knew which firm they were going to engage long before they sent out the RFP.

As an example, I know of one public pension plan that has religiously distributed an RFP to consulting firms every three years since at least the mid-1980s. But that pension plan is still working with the same consultant it was working with in 1985. It's possible, of course, that in every case the plan trustees carefully evaluated their existing consultant against others, and that in all six searches they concluded that the existing consultant was the best choice. But given the fact that the existing consultant and its personnel have changed unrecognizably over those 18 years, and given the regular and loyal payment of campaign contributions the consultant has made to the public officials who appoint the trustees of the pension plan, we might be forgiven for being suspicious.

In point of fact, the RFP process in the case just mentioned is and for many years has been a joke. And this is true of all-too-many supposedly honest advisory searches in the pension plan world, and, increasingly, in the endowment world (which, like families, mimicked the pension plans' use of RFPs). As far as families are concerned, the important point of this is that no one in the institutional world has given much thought to the RFP process for many years. Therefore, simply mimicking the institutional approach is unlikely to prove useful and may actually lead families into trouble.

The RFP Is Only a Tool

Even the best-designed RFP has to be viewed not as a magic bullet but as one tool among many to be used in identifying an appropriate advisor. In the institutional world, the RFP often represents the entire diligence process, except possibly for the final “beauty contest,” at which the two finalists present. Because most pension plans are seriously understaffed on the investment side and have trustees (policemen, firemen, teachers, bus drivers, political appointees) who know nothing about the investment process, this may be the only way they can proceed. But for families, where their own private capital is at stake, using the RFP as the only—or even as the principal—tool in the advisory selection process is a serious mistake.

Instead, the family process should begin (as described previously) by asking the key questions that will dramatically narrow down the field of possible advisors to a few who are likely to be appropriate. The family should then seek comments about those advisors from people in the business who are likely to know them: money managers, other families, other financial institutions, FOX, IPI, and so forth. Only then should they begin to think about using an RFP.

Preparing the RFP

Referring back to our friends the Schulberg family, we will recall that the family had narrowed its advisory search to a small handful of firms that offered unbundled, open-architecture services. The family had asked around to get informed feedback on this group of firms, and that feedback had eliminated one of the firms. (That firm had recently been acquired by a larger firm and, in the process, the firm's founders had left.) The Schulbergs were ready to prepare an RFP to the four remaining firms. There were a number of mistakes the family could have made in preparing the RFP, including those discussed below.

Keep in mind that we are sending this RFP not to one firm, but to several. No two firms will answer any of our questions, much less all, in the same way, or will even approach their answers in the same way. What we will receive back for our efforts will be thousands of pages of completely incomprehensible, radically inconsistent, totally incompatible responses. We will now have to engage McKinsey & Co. to make sense of it all (and McKinsey will charge us far more than the advisor would have charged us).

If we keep in mind that the RFP process is simply one of many tools we are using to find the right advisor, we will recognize that what we need to do is focus the RFP on a few key areas that are of intense concern to us. At this stage of the process we are not interested in the esoterica of how Advisor A (versus Advisor B versus Advisor C versus Advisor D) balances turnover versus tax lot accounting in assessing the tax-awareness of money managers. Instead, we want to focus on key differentiating features of the advisors we are looking at evaluating.

In the case of the Schulbergs, the family's main concerns focused on these issues:

• Which services are bundled and which are unbundled?
• What kinds of financial and nonfinancial conflicts of interest exist at each of the advisory firms?
• Which professionals would be assigned to the Schulberg account?
• How would the family's fees be calculated?
• How would the advisor's success or failure be measured?
• How was the portfolio design process approached at each firm?
• How did each firm identify, evaluate, and monitor money managers recommended to their clients?
• What kinds of performance reports would the family receive?
• And probably the most important kinds of questions, designed to get at whether or not the advisor knows anything about investing. Astonishingly, families regularly fail to inquire into this issue, resulting in engaging an advisor who doesn't really bring positive harm to the portfolio but who has no idea how to make money. Families ask, “How many analysts do you employ?” apparently unaware of the fact that most analysts are engaged in doing low-level diligence on money managers. Families ask, “How many managers do you follow?” as though quantity weren't the enemy of quality. Instead, a family should assess a financial advisor they way they (or their advisor) would assess, say, a multistrategy hedge fund. No one much cares how many analysts a hedge fund has, but only how good they are and how well they are being trained working under senior portfolio managers. No one cares how many opportunities a hedge fund manager is looking at, but only the quality of those opportunities. Other useful questions might fall along these lines: What is your process for identifying interesting investment opportunities? How well structured is that process? Do you implement your ideas yourselves or via external managers (or both)? How do final decisions get made about which opportunities will be pursued? How do you size opportunities? Unfortunately, few families ever ask such questions.

There were a million other things the Schulbergs could have asked about in their RFP, but each additional area of inquiry would, in fact, have compromised their ability to focus on the key factors that were of most importance. Later, when the field has been narrowed to two final firms, the Schulbergs will inquire orally or in writing into these other issues. In other words, the Schulbergs recognized the RFP for what it was: merely one tool among many in a well-designed advisory search process.

Where Is the Sample RFP?

In other chapters I have given examples of forms I discuss in the text: investment policy statements, spending policies, manager guidelines, and so forth. So where is the sample RFP? I have in my files dozens of examples of RFPs, some of which I consider to be quite well done, very focused, and useful to the families who circulated them. Why not attach one or two samples to this chapter?

The reason is that I want to emphasize the point that there is no such thing as a “good” RFP in the absence of detailed knowledge about the family that is conducting the search. Sure, there are better and worse ways of inquiring into specific issues, but that's a detail. The important point is that a terrific RFP for the Schulberg family might well be a terrible RFP for the Greene family, and vice versa. The time we devote to custom designing our own RFP will be time very well spent, because it will require us to focus on those few areas that we really care about. And by keeping the RFP focused, we will also be able to make sense of the results we receive, even if we are sending the RFP out to five or six firms.

Final Diligence

Once a family has received and reviewed the responses to its RFP, the next step is to conduct telephone conferences with each of the firms that are still in the running. The point of these calls is simply to go over responses that weren't completely understood by the family, or responses in which the advisor seemed to have missed the point.

Next, if at all possible, family members should visit each of the remaining competitors in their home offices. It might be the case, for example, that the individual professional(s) to be assigned to the family's account might be terrific—very people-oriented, very charming, very experienced, and knowledgeable. But who is working behind these people? If the home office is staffed by former brokers and insurance salesmen whose sole mission in life is to improve the profitability of the firm's accounts, we should probably know about that before we sign up. If the RFP response is warm and fuzzy, but the home office is clearly an impersonal bureaucracy, that is also something the family should know. If the individuals we have met are organized and focused, but the home office is disorganized and confused, that is likely to say something important about the experience the family is likely to have as a client of the firm.

Finally, the family should invite no more than two firms to meet with all important family members and any key outside advisors. The family—not the advisory firms—should prepare the agenda for these meetings, and that agenda should focus on the issues that are most important to the family.

Why meet with no more than two firms? Two reasons. The first is that if the family has truly done its diligence well, it should be able to identify the top two candidates at this point. If there are still four or five firms under serious consideration, the family simply hasn't done its job. The second reason is that having more than two firms present to families will only generate massive confusion. It's reasonably easy to compare Firm A with Firm B. But start adding Firms D, E, and F and everyone's head will be spinning. If a decision is made at all, it will be made out of sheer exhaustion.

Where Does Diligence Leave Off and Psychodrama Begin?

For families looking to engage an overall advisor for the first time, or when families have worked with an advisor but new family members have been charged with replacing that firm, the decision can be excruciatingly difficult. After all, we are talking about turning the hard-won family fortune over to people who are essentially strangers. Not only that, but we are not buying a technology, we are engaging specific human beings with whom we will be working. Many people who are otherwise decisive find “personnel” decisions to be very difficult. On top of everything else, most people would rather discuss their sex lives than their personal financial affairs with a stranger.

This difficulty tends to play itself out in the form of endless diligence, as families inquire ever-more-intensely into ever-less-important issues. They eliminate firms from consideration for reasons that are, objectively speaking, silly. Anything to avoid or postpone making a decision. It's all perfectly understandable, but also perfectly deadly. Short of engaging a completely incompetent or fraudulent advisor, the worst decision a family can make is to do nothing. Even a marginally competent objective advisor, though he or she might not grow our wealth at the rate we were hoping for, will at least stand as a bulwark against the kinds of bad decisions that will destroy our wealth.

Recognizing that advisor decisions can be difficult ones to make, it may help families who are having trouble bringing their search to a conclusion to ask exactly what it is that they fear.

What's the worst that could happen? Realistically speaking—again, short of engaging incompetent or fraudulent advisors—there are only a few serious mistakes we can make in our advisor search process.