So, what is “the family”, anyway? Just about everyone in private wealth management circles refers to a group of related clients as “the family”. THE FAMILY – a monolith – a group whose members have interests, objectives, concerns, and assets that can be managed in common.

The problem with “THE FAMILY” is that there is no such thing, at least not when it comes to wealth management. The individuals, trusts, foundations, corporations, LLCs and other entities that make up “THE FAMILY” are all unique, and to throw them together and treat them as a homogeneous unit serves no good end (except perhaps to maximize the assets under management).

Families themselves make this same mistake sometimes, particularly when wealth is new, children are young, and the ink has barely dried on the documents creating all the wealth holding structures – trusts, partnerships, foundations. At this point, the patriarch or matriarch may be excused for thinking that the assets belong to THE FAMILY, and making investment decisions based on the notion of a single pot of wealth, but for this family the process by which the single pot is divided into separate pots, each with its own distinct purpose, constraints and time horizon, has already begun. It is critical for the family’s advisors and for family members themselves to understand each pot, and to consider it as a separate investor.

A specific example may help highlight the risk of investing on behalf of THE FAMILY. Let’s say that the Smith family accounts with MetroBank include Dad’s investment account, a trust account for a GST-exempt trust intended to benefit the Smith children and grandchildren, and an account for the family’s foundation. Let’s say, further, that the MetroBank investment advisor recommends that the Smith family invest a portion of their assets in MetroBank’s Alternative Fund, a fund-of-funds designed to give individual private investors access to a broader array of investments and managers. (This suggestion might have raised fewer eyebrows before the market chaos of 2008.) The Smith FAMILY account – all the accounts viewed as a single pool – is large enough to warrant considering the investment, and it fits within the family’s broad investment guidelines and asset allocation. Particularly if family decision-makers are enthusiastic about Alternative Fund, there may be a temptation to make the investment for THE FAMILY and figure out later from which accounts the cash for the investment should be pulled.

But a quick look at the separate accounts raises a host of questions:

  • Even if Dad’s account has the cash, does the investment suit his time horizon? If he is retired, what are his cash needs? If the Alternative Fund, like many fund of funds, won’t make distributions, then will Dad’s cash flow be constrained? If Dad should die while holding the investment, it might generate a discount for estate tax purposes, but a lockup provision might create a liquidity problem for his estate. Even if there is no lockup provision, the liquidity constraints experienced by many funds in 2008 and beyond are evidence that liquidity may be unavailable just when it’s needed most. What are the track records of the individual funds held by Alternative Fund? Does MetroBank conduct any regular due diligence in connection with the fund? What is its long term mandate? Is the fund’s style subject to creep over time?
  • The GST-exempt trust is intended for the benefit of Smith children and grandchildren. It potentially has the longest investment time horizon, so it may be a good candidate to make the investment. However, its trustees – not the investment advisor, not Dad, not the beneficiaries – are responsible for making the decision whether or not to invest, and they should keep in mind that they have a fiduciary duty to invest to meet the needs of the trust’s beneficiaries. What are the beneficiaries’ projected cash needs? If the beneficiaries have other sources of income and principal, then perhaps the trust account might benefit from a long-term investment horizon. But if a grandchild is born with a catastrophic medical condition, will the trustees be able to liquidate all or a portion of the investment quickly if necessary to pay for medical treatment not covered by insurance, or ongoing care? Another concern: will the Alternative Fund generate substantial phantom income – say, lots of short term gain – but not throw off cash, thereby creating a tax liability will need to be paid from other assets? And who will bear that tax liability – the trust itself, or is the trust a “grantor” trust, so that the trust’s income, gains, losses will flow to an individual (perhaps Dad) who will be responsible for the taxes? If Dad will bear the taxes, does he have the cash to handle the liability (a question which needs to be answered before Dad’s account invests in Alternative Fund…)
  • Considering whether an investment in Alternative Fund makes sense for the foundation account raises the same issues of liquidity, asset allocation, due diligence and long term cash needs as the other two accounts, along with a new question: will the fund throw off UBTI and thereby create a tax liability for the foundation? Even if the fund doesn’t throw off UBTI now, is its investment mandate broad enough that it might in the future? If the investment otherwise makes sense for the foundation, is there a separate sister fund for non-taxable investors?

The point of bringing up all these questions is not to put in doubt the validity of the investment for the Smith family accounts – this is in no way a cautionary tale about alternative investments. Rather, the point is that any investment needs to be considered investor by investor – viewing each account separately. Taking the easy way out and treating the Smith family accounts as THE FAMILY – failing to recognize the very different investment profile, risk tolerance, cash flow, time horizon, liquidity needs, tax circumstances of each account – can put family wealth at risk.

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