Family office
|
Hedge Funds & Prime Brokerage Anatomy™
|
Another one of those things, like LIBOR and supply chain financing that seems so ordinary, unfussy, sensible and harmless; that, in its way, points up the holy terror of non-linear interactions in financial markets.
When wealthy families attack ... each other
Normal investment funds — even hedge funds — have an element of arm’s length about them, in that there are parties involved who entrust each other with grave responsibilities, large sums of money and so on, and if any of them are unnecessarily cavalier things — and more to the point, regulators — can get ugly fast. Regulators in financial services care about the fragile interests of the poor, defenceless super-rich; they presume that grizzled old broker-dealers who interact with them can look after themselves. This has not always proven to the be the case, but still.
Investors are generally diverse, and different people to the investment managers, and for everyone’s peace of mind there are rentseekers agents employed make sure things are done properly. Custodians, depositaries, fund administrator types who can supervise subscriptions and redemptions, manage account movements and calculate NAVs; all of whom will be distinct from the investment manager and for that matter the fund directors themselves, each of whom will likely have compliance and operations teams, to ensure everything is done as it is meant to be, and that the auditor can easily sign off the accounts.
A family office is a vehicle established by a ultra high net worth investor to manage her own, her family’s and on occasion her friends’ money. How the other half lives, huh? These people move in circles mere mortals cannot imagine: they have enough dough to employ their own financial wizards to work it to their great advantage. Like gulls around a seaside chippie, the rentsmiths soon arrive. An office manager, some operations people, a general counsel, and before you know it they are have a full-scale paramilitary organisation.
But it isn’t quite the same if it is all in the family. These gatekeeper roles are a little bit more “optical”, seeing as if anything goes tetas arriba, there aren’t any outside investors who might complain. So you might see some of these roles doubling up: the same guy who invests 50% of the fund is also director of the fund company, and CIO of the investment manager.
Now blood is thicker than water, and everything, but this only takes you so far, and when rich families do fall out, it can be spicy. This can put external counterparties in an awkward position: You may have a $500m portfolio, and discover that Bob is no longer talking to Fred, they don’t agree on investment strategy, and while common sense would recommend that, for the purpose of not losing even more money they should talk to each other, they won’t. This leaves you in an invidious position. To whom do you listen? What can you do? The cold logic of the situation says, “close the relationship out” — this is prudent, but may upset the seventh wealthiest man in Azerbaijan.
The Voldemort factor
Still, internecine squabbles don’t happen that often, and as long as they don’t, at one level, GFOs are harmless, dull and dreary: well, not dreary, exactly — it’s hard not to be a bit glamorous when you have a superyacht in Monte Carlo and your own Island in the Caribbean — but for a prime broker these are like hedge funds, only smaller — usually smaller; not always — and with no outside investors making them all the more harmless: no ERISA money, no — well, limited — AML worries, no sudden NAV drops on account of precipitate withdrawals from dissatisfied investors. Just steady sailing from a super wealthy fellow running her own money, and therefore well-incentivised not to throw it around.
All that passed for conventional wisdom until late March 2021.
We know now, thanks to the gruesome CS Report on Archegos that family offices present other risks: “key man reliance”, “volatile performance”, “mediocre operational management practices” and “poor risk management practices and procedures”. And the “potential fraud risk is higher for a family office ... than for a commingled fund managed by an SEC-registered investment adviser.”
Well, all of those things, presaged and recorded on the permanent record by wise but now departed risk managers, came together in a perfect storm of pressurised apocalypse when a family office called — well, friends: being a horcrux, you won’t be surprised to know that, in the virtuous circles that comprise the financial markets, it is spoken of only in hushed tones, beneath grave countenances, and obliquely, as the client who shall not be named — went up in a carbolic smoke ball, taking the thick end of $10 billion of prime broker capital with it.
There was a further risk, not adverted to in the CS Report on Archegos but idly speculated upon in the financial press by those with a taste for schadenfreude: did TCWSNBN lose all its money, or did it somehow manage to squirrel some of it away?
We know the family office withdrew all its excess margin from a number of brokers in the days leading up to the catastrophe — it is presumed, to meet margin calls coming in thick and fast from other brokers. But every broker has an imperfect, asymmetrical view of the customer’s behaviour: it sees money going out the door; it does not see to whom.
Now it is one thing to rob Peter to pay Paul, as the saying has it. But to rob Peter and Paul and then kick the balance out to the sole shareholder in a dividend... would that be brass of a whole different ball game, wouldn’t it? To be clear: the JC has no information about this at all: the suggestion, made elsewhere in the press, is wild speculation; it seems unlikely and would surely fall foul of voidable preferences in most places, but it remains an uncomfortable technicality of corporate veil: the family office and its owner are different, legally distinct persons. At first blush, the prime broker’s straightforward contractual claim is limited to the net assets of the corporate entity to which it is contracted.
It would make a great play.