Peter Schatoff, Senior Relationship Manager

According to a survey of KKR’s network of family offices, 52% of their portfolios will be invested in alternatives in 2024. As the alternative asset category continues to grow in size and scale within our client’s portfolios, it is only natural that family offices will continue to hire directly from hedge funds, private equity and real estate. In this article, we explore how the diffusion of employees and practices from different investment disciplines will impact the future state of the modern family office by directly increasing the need for fund administration.

Key employee compensation and keeping close to the gross returns

Generally speaking, many family offices we interact with prefer fixed costs versus basis point charges for vendors or employees as they feel it penalizes outperformance. We see that family offices carved out of investment funds typically carry over a blend of fixed and variable compensation structures for their key employees. Most readers are familiar with the 2/20 hedge fund incentive structure that represent a management fee and a performance fee which is simple enough to track, but we show that private equity compensation models are becoming more and more popular across our industry. Incentive carry vehicles like profit shares for key employees further blur the lines between fund administration, general partner accounting, and standard family office accounting practices. In selecting a fair compensation structure do you choose an American waterfall model, where profit is calculated on each deal, or is European style waterfall where profits are distributed only after capital contributions have been recovered by the LP? Perhaps a blend of both PE and Hedge fund compensation is more suitable? Nuanced structures like these require service providers who can take a consultative approach in working with your tax advisors, attorneys, and operations personnel to implement.

Scale and the need for a flexible fund administration solution

At what level of complexity does a family office reach the point where they can no longer self-administer their assets? How many family members or nested partnerships are too many to track using spreadsheets or SaaS? Are you launching a new fund?  Complex investment partnerships can be as difficult to track as PE or Hedge funds. Family offices are especially unique in that over the course of multiple generations, you will have family members regularly entering and exiting investment structures as a result of normal life events (birth, marriage, death, divorce). Traditional fund administration shops are geared towards the general partner investor and not the limited partner, as anyone who has tried to repaper/reregister/transfer an alternative investment can allude to (fees, strict transfer/redemption windows). Some family office providers do not have the ability to represent complex allocations on-system and are simply performing the calculations off-system and manually. Our experience shows that when evaluating vendors, it is crucial to choose one that can effectively straddle both the GP and LP spaces to remove these friction points.

Shadow account functionality – Trust but verify

Complex family offices almost always keep shadow books to check against a provider’s figures. Independent validation of potentially thousands of sources of data across multiple clients against a vendor can take up hundreds of hours a year. This legacy work need not be done in-house and can free up your staff to execute more impactful work. Fully move your secondary set of financial records away from internal spreadsheets, key person dependencies, and manual processes to a comprehensive technology-enabled service to check against your official books and records. 

Conclusion

When evaluating vendors for family offices, it is important to plan for the long-term complexities that might render a provider obsolete within a few years. As family offices continue to grow in size and complexity, a flexible general partner/fund accounting capability must be given serious consideration during your selection process.