Family investment's ground rules

PORTFOLIO POINT: Two questions of structure need to be determined before family investment begins – one is the structure of the family itself.
Lucinda Chan (right), a division director of Macquarie Private Wealth, deals with many successful investors who are now trying to hand over both wealth and investment skills to their families. In common with many advisers she uses family trusts and DIY funds (often with the entire family as trustees) to structure investing.

Although the shares of many stockmarket companies – including Macquarie Bank itself – are struggling on the market, Chan says her clients have not ceased gearing (or borrowing to achieve investment success). Chan says wealth families are generally comfortable continuing to gear about 30% of their holding – that is, they have borrowings equal to 30% of the total value of their portfolios, which may be diversified across shares, bonds and property.

As a 25 year veteran of the investment markets, Chan some highly practical tips for anyone facing the rewarding but challenging issue of guiding family wealth. One of her key messages: Make it very clear always who's in the family and who's not in the family. In other words, partners and de factos can be inside or outside the family investment arrangements but either way they must be considered.

The interview

James Kirby: Traditionally, when people pooled money together as a family, the family trust was the key vehicle. Why do people use them?

Lucinda Chan: I think you need to take a step back. Prior to determining your financial strategy, you need to consider the type of structures: the trust structure, or company structure or a super fund, or an individual or jointly held as a couple – which you see a fair bit of. The whole idea of that is to determine the proper structures and to then asset-allocate, asset-protect for tax efficiency reasons and for investment efficiency reasons as well. The trust structure in the hands of the beneficiaries at the marginal tax rate is always going to be a lot less than say an individual tax rate.

What would the gap in tax rate be, between the two, between the trust and the individual?

Well, if you’re an individual, the maximum is 46.5% and that includes your Medicare levy. As a trust, it depends very much on your structure '¦ usually around 31.5%. Company tax is 30%, super is 15%, pension is zero.

What’s the limitation of family trusts?

Well I guess the key limitation is activity has got to be within the trust deed. If it’s not stipulated, they can’t do it. So all that has to be set up at the outset: the way you want to structure, the way you want to asset-allocate, how to do things has all got to be laid out in the beginning. Once the structures are produced already, the trust is produced, the deed is produced; you can’t change it. You have to make amendments to make alterations, which will require a number of people to sign it accordingly. That can be a bit fiddly, and it will cost you a few dollars to get things amended.

Do you mean extra fees?

Yes, that will happen.

Are you recommending DIY funds for entire families?

Yes, the super funds are attractive because of the tax rate implications and the capital gains over a period of time. Again, that’s why those super structures are very attractive. There is a strategy that you can look at: for example, concessional tax for certain age groups. Those super funds are actually very good, because it takes into account co-contributions and other possibilities.

Would you actively recommend DIY funds as a family investment vehicle?

Not necessarily. It depends on the age group of the individuals, and whether that’s what they’re looking to do because super funds can be an environment where your money is trapped and you can’t take it out. A family trust is a little bit different, where you have a bit more flexibility. With super funds; anything you put in is to remain in that structure either in cash or asset allocation of some kind. You can’t pull it out until you are a certain age, so there are limitations.

Do you think parents should directly finance mortgages for home purchases?

Well, I guess if it’s your only child, you feel obliged to do that, and I think that’s what a lot of people do talk about when we see them; they’d like to help their children. But to do that is almost like them gifting it away. There is no real benefit to them directly. I would have thought it would be better off for the children to go get the first-home buyers grant and use the grant to do what they need to do. I don’t think direct home purchase is a good idea. That’s my personal opinion. More generally, why give them money after we pass away when we can actually help them and see that they will achieve what they want to achieve now.

What’s your objection to that principle of giving money directly?

Well I think for the parents that are giving away their money, it’s a complete gift to children and there is no tax benefit in any way, so they’re not getting any gain by doing that; whereas if you pass away and leave it in a will or in an estate, then the money can go across to the children tax-free. That to me might be a more constructive way of doing it. So that’s my objection. They might be better to help the children along the way, by maybe helping them invest in say equities or something like that, put some money forward, help them to do a bit of gearing perhaps; I think it’s a much better way.

Would you actually suggest to people that they co-invest; or how would you suggest they begin that process when they come to your office?

I’d say the key is, for people that are still working and have grown children, they can co-invest and will get a tax benefit. From that, by co-investing with the individual, they are splitting the capital gains, they’re splitting the dividends, they’re splitting the franking, they’re splitting everything. So the co-investing is actually quite a good way to help them hand-in-hand.

So you favour strategies that are perpetual?

Absolutely, yes. Tell the parents, don’t give Christmas presents, don’t give gifts, what you do is you buy them some shares; you teach them, you educate them, and as they grow older, they take an interest in that, and that’s the sort of thing that we try to promote.

Can you elaborate on your approach to families?

We educate them to invest in long-term, very strong balance sheet-type assets, or we also put some of their assets into cash, which would then lock them into some long-term bonds, two or three years out. It gives them some flexibility when the time comes, when those things roll over, those funds would then be used to further invest if the market improves.

We don’t actually have in Australia, any specific tailored tax structures for education, do we?

No, not really.

Is there anything that approximates to it?

I’ve not seen any to be honest.

So what about products such as education bonds?

They’re just products, which is not good enough. You actually need a process to understand at the beginning, with a plan, how to develop the plan into a growth or an income plan, depending on your circumstance. Investors say, 'We want 40% income, we want 50% growth and the rest in cash. Can you go about making sure we get there’, and our return is '¦ as long as we give 8–9% over the year, you’re doing a good job.

No one really has a standard formula, because everyone is different, because everything is custom-made.

What about gearing? When you sit down with a family as opposed to an individual, is there any difference?

If they are relatively young, gearing is a good way to go for that family trust, because over time, if they have a staggered age group of 13, 15, 18, for example, then you’ve got different age groups there, you can stagger the investments over a period and the beneficiaries would depend very much again on the lifestyles of the existing people in the trust. The way to build wealth over time is to obviously try to use a little bit of gearing, we see roughly 20–35%.

We don’t advise investors to borrow 100%. That’s crazy, you don’t do that, particularly for family accounts where you know this is something over 10 years. You have to build into it, and that’s why, as assets get bigger each year, you then put another layer on top of that. Maybe you might increase it a bit more because they’ve done extremely well, and now as the kids are getting another year or two older, there’s a better understanding within the group as well. So they might be able to take on a little bit more risk.

And this would be across a diversified portfolio?

Absolutely.

Would this portfolio of investments go beyond shares and bonds?

Yes, it will have direct property, it will also have shares in the market. It will probably have very little cash – cash will be about 10% of the portfolio; it would be very, very minimal.

Is that a standard approach on cash – in all weather, if you know what I mean?

Yes, you could say that. And of course we will then look at other asset classes, whether they be managed funds, for example, that are international. You look at that angle as well, so you give them a bit more growth exposure but with a calculated risk in it, so the risk is not too out of the ordinary, that would impact them.

In these overseas investments, do you recommend hedging?

We probably do. Some, we do take currency hedging out of it, some we don’t, because some of them have threshold management within the managed fund that already takes that into account. So they all would vary.

In family investing, as opposed to individual investing, what are the contentious issues that arise?

Well, family investing can be complicated if there are family disputes. It’s always going to be very difficult to get agreement.

And what would those disputes typically be over?

Well, they tend to be sometimes agreeing on the type of asset allocation. You can have four people in a family trust; two might be very risk averse, the other two are quite happy to take whatever comes.

So that may be nothing to do with age; that just might be disposition?

Exactly. So you are like an arbitrator giving them the pros and cons, and eventually they will agree, but sometimes it can be process over three to four weeks when you want to do the deal tomorrow! It just takes time, that’s all. Usually most tend to have a leader who actually does organise or take control of the funds coming through, so it’s easier to manage, but decision making is always going to be complex. I think in terms of seeing growth or income or mixes of both, it’s always quite easy to direct them and guide them, and those ones that are very savvy, you usually don’t have too much of a hassle. It’s the ones that are educated already and some are uneducated in investments – that’s where you get a lot of controversy.

What other problems do families face?

The only other thing that sometimes does crop up is when these siblings have a partner or are married. That’s where another issue comes up quite often: the concern of the family investments being touted in court because some divorce or something happens.

That would include de facto partners?

Yes, it is a very strong rule. De facto is a very, very strong ownership these days. That sometimes is very important; that’s why we’ve got to advise them to have a look at their deeds and make sure all these things are clearly clarified; that no one can access it because it’s purely only for the four people that are assigned to it.

So is this a pre-nup for families?

Almost, yes, you could say that. I don’t know what the word is, but it’s almost like that.

It gets pretty ugly when families fight.

So there are family trusts or even DIY funds that are 'live’ documents that have to be regularly reviewed?

Oh yes, most certainly. And say, for example, someone does pass away within the group, you also have their estate to consider, their portion of it. How does that get divvied out? Who gets what? It’s quite complex.

What is the key change you’ve seen this year?

They have gone back conservative, that’s for sure. Have they actually pulled out of gearing? No, they haven’t. With regard to taking on more risks: for a year now, they’ve all been sitting quite quietly. They’ve actually increased in their cash intake, so that has actually grown more, than their riskier investments. OK, so that’s natural, because the market’s cycled down, everything has cycled down. So everyone’s a bit gun-shy at the moment, but they haven’t given up. They know they won’t get a huge return this year, but that’s fine. They want to protect their capital.