Let me pitch an investment job to you:

Manage a pool of patient capital with the goal of long-term compounding.
A flexible mandate that doesn’t constrain your curiosity and creativity.
Go where you see the most attractive risk-reward.
No heckling by investors. No need for quarterly letters or unwanted publicity for your returns. No risk of key accounts suddenly pulling their capital.

Is that something you might be interested in - Bob Ryan Entourage | Meme Generator

Oh, but also: you have one client and they may fire you at will. Based on your performance. Or because they’ve lost trust in you. Or because, unfortunately, they just don’t like you anymore. It’s unlikely, but possible, that someone’s migraine or conversation at the country club kills your latest venture or even sends you packing.

I’ve worked at two family offices. These were small outfits with less than a dozen employees, mostly investment professionals and accountants, dedicated exclusively to the welfare of one very wealthy family respectively. I grew up in a small town in Southern Germany, unaware of what real wealth looked like. An overt display of prosperity meant parking a Porsche on the street rather than in a secluded driveway. Working for mysterious billionaires with a “go anywhere” strategy seemed exciting.

And while the day-to-day work may have been mundane, I observed a curious phenomenon at both firms. You want your wealth to be managed by talented employees you can trust. But talented investors are typically ambitious and they seek both challenging work and a way to become wealthy themselves. And they are keenly aware of the risk of being at the mercy of a single client. This is the family office conundrum which spawns a quiet maneuvering for power and control.

I was reminded of this by HBO’s show The White Lotus in which the staff of an upscale Hawaiian resort wrestles with the antics of its VIP guests. The show is a slow burn but perceptively illustrates how the gaping wealth disparity spawns resentment, violence, theft, and can lead to complete mental breakdown (ok, the latter involved some drugs, too).

The White Lotus" Arrivals (TV Episode 2021) - IMDb — Staff of the White Lotus resort welcoming their VIP guests.

In the show a female guest becomes infatuated with the massage therapist’s skills. She proposes to fund a private practice, only to drop the idea days later without a second thought. One person’s fleeting obsession causes massive emotional volatility in the other’s life.

While this may seem inconsiderate or even cruel, I believe situations like it are almost inevitable when the two parties inhabit completely different realities (or different reality tunnels, if you will). Worries like the ones that have kept me up at night for the past week (“how will I pay rent, what am I going to do when my lease is up”) are simply not part of a wealthy person’s experience. While there may be plenty of worries related to money, such as how to earn more, avoid taxes, or plan the estate, there are no worries about not having enough.

At the same time, based on my limited experience, the very wealthy face an uneasiness about the authenticity of their relationships unknown to the rest of us (for convenience I will group myself withy all of my readers, though I know that some of you fall squarely in the camp of the very wealthy). They face a nagging doubt whether any person stepping into their world is driven by ulterior motives. Does this person like me or do they like what I represent? Do they see me as a person or, perhaps even unconsciously, as a way to gain money and status for themselves? Am I a human being to them - or just a dollar sign?

Which is why they often seem to treasure any relationships built before their wealth was created or revealed. Those friendships are untainted.

You need a high degree of trust to let someone handle your wealth. The quality of the relationship between the family and its investment manager is paramount. And yet, neither side can fully trust the bargain. The employee knows their position is ultimately precarious. And the family knows that any trust and affinity are built on the foundation of a transactional motive. First and foremost, the family represents an accumulation of capital that provides employment.

“No two family offices are alike.” Anyone who has worked in the space.
“And each dysfunctional family office is dysfunctional in its own way.” My guess.

And while at first glance the family can be certain of its power in this relationship, employees are aware of this imbalance and can mitigate the fragility of their position through a variety of strategies:

Create complexity. Wall Street has always been good at turning simple ideas into complex products which require handholding and justify higher fees. Want to decrease the risk of being removed as a manager? Engage in strategies that are opaque, that are based on relationships, that require specialized training, or that spawn complex tax and legal work. In other words: increase switching cost.
Turn the office into a platform. Once you’ve convinced the family of pursuing bespoke and active investments, you face the challenge of hiring and retaining talent. Talent likes growth and one way to grow assets is to raise outside funds or add more families to the mix. This also lowers the concentration of clients and provides leverage on fixed expenses. However, many families aren’t interested in the investment this requires and the regulatory oversight it creates.
Invest in operating companies. Another option is to buy control of operating businesses which offer both organic growth and interesting puzzles to solve. They require active oversight, relationships with management, and increase the portfolio’s complexity and concentration compared to owning the index.

The larger and more complex the office becomes, the more the family has to rely on their staff to explain what is going on. The power balance tilts in favor of the experts who can now generously protect the family from all the mind-numbing minutiae. Eventually the family may wonder: who is really in charge here? Could I get off this train if I wanted to?

I encountered all three of these elements in my recent thread on JAB, the investment holding of one of Germany’s richest and most secretive families, the Reimanns. (Correction: it seems the family is now Austrian in an effort to avoid inheritance taxes.)

It looked like a fascinating case study of a transition from a Mittelstand chemical company to a global investment firm. I typically err on the side of doing too much research which leads to lengthy and infrequent write-ups. This story didn’t seem compelling enough for a full deep dive, so I cut my research short after reading about a dozen articles. Turns out I read the wrong articles!

First off, I got a lot of pushback on Twitter on JAB’s portfolio. It’s true, many of its holdings aren’t exactly premium brands and some operate in the notoriously difficult restaurant space. Coty, a long-time holding, has been a turnaround situation since acquiring a portfolio of assets from Procter & Gamble and splurging on stakes in the Kardashian’s cosmetics companies. Still, JAB’s equity value had doubled since its team had embarked on its new strategy in 2012. The jury, it seemed to me, was still out.

But what I really missed was the unfolding drama around power, accountability, and incentives. Exactly the kind that I should have expected given my own experience with the family office conundrum.

But let’s start at the beginning.

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A brief history of JAB and the Reimann family

The story begins in 1823 in Pforzheim, a town at the edge of Southern Germany’s Black Forest (about an hour from where I grew up.) Local businessman Johann Adam Benckinser (initials “JAB”) acquired a chemical lab from its bankrupt owners and hired a promising young chemist named Karl Ludwig Reimann from the Universität Heidelberg (where Reimann had been the first to extract nicotine from tobacco).

Reimann married one of Benckinser’s daughters and took over the company after Benckinser’s death. The company expanded to a new plant in Ludwigshafen (today seat of Germany’s largest chemical company, BASF) and grew steadily.

The family’s darkest chapter occurred when Albert Reimann Sr. and his son Albert Reimann Jr. became enthusiastic supporters of the Nazi regime. In 1937, Reimann Jr. wrote to Heinrich Himmler: “We are a purely Aryan family business that is over 100 years old. The owners are unconditional followers of the race theory.” The company as well as the family’s estate employed forced laborers who were subjected to abuse.

After the war, the Reimann patriarchs denied their affiliation with the regime and the full story was not uncovered until a few years ago when JAB commissioned a historian (all of this was detailed in the New York Times).

In a wild twist, the historian uncovered Reimann Jr.’s affair with a young employee, Emilie Landecker, whose father Alfred had been Jewish. Emilie’s mother was Catholic and, anticipating the danger, Alfred ensured that his children were baptized. While his children survived the war, he was deported and murdered in 1942.

It seems the relationship between Reimann Jr. and Landecker continued after the war and resulted in three children. Reimann Jr., who had no children with his wife, eventually “adopted” those three children as well as six others. When he died, each inherited 11.1% of the Benckinser company (orange box on the below chart).

Reimann Jr. also neglected to tell any of them that he owned the company. They believed he was merely an executive. His will also forbid them from selling to anyone outside the family. Thus they found themselves unprepared to lead the company which, despite a successful expansion into consumer products such as detergents, reportedly lacked scale and competitiveness.

The heirs needed a leader and found one in a German Harvard MBA and former BCG consultant named Peter Harf.

Harf radically restructured the company. He further expanded into consumer products, looking for markets with “non-cyclical growth and strong brands but without a clear market leader.” In those industries, the consolidators would win “almost automatically” through synergies and greater scale. He acquired some 25 companies, including the Coty cosmetics business from Pfizer.

"We had a lot of marginal pieces in our portfolio. I'm not afraid of taking risks. I'm not afraid of losing. I'm not afraid of buying something.” Peter Harf

Then he split up the company, took the detergents business public, and merged it with the British Reckitt & Colman into Reckitt Benckinser.

After starting with a mid-size private chemicals business, the family now had stakes in two public companies: Reckitt Benckinser and Coty. Along the way, five of the heirs were paid out.

Harf also joined the board of directors (and later became chairman) of Interbrew, which subsequently merged with the 3G-controlled Brazilian AmBev to form Inbev, the world’s largest beer company. Harf witnessed firsthand 3G’s playbook of industry consolidation and cost-cutting.

Around 2010, he was ready for a new chapter. He pitched the family on using JAB as a 3G-like platform for private equity-style deals. He brought on two additional executives, Reckitt-Benckinser’s Dutch CEO Bart Becht and the French Olivier Goudet from Mars.

To align their interests with the family, the three would invest their own capital into JAB as well as receive options. Today, the family owns 90% of JAB and its executives the remaining 10%.

Harf struck another deal with the family: they would refrain from making public comments and even, according to one source, take an oath of secrecy. In exchange, he would compound their capital and protect their privacy by being JAB’s public face.

In his investments Harf was looking for consumer brands with steady growth, robust cash flows to support leverage, and in industries ripe for consolidation. Beer and chocolate had produced a small number of global players. "Coffee,” however, “only had Nestlé, the industry was fragmented." And it offered a growth tailwind because Millennials were "the best coffee drinkers ever.”

“If you go back in the U.S. 20 or 30 years ago, people would have their hot coffee in the morning and drink their Coke in the afternoon,” Mr. Becht said. “That has changed today.”

This started an acquisition spree up and down the “coffee and breakfast” value chain: from Keurig pods to coffee roasters and chains serving sandwiches and donuts.

JAB’s focus was on maximizing cash flows to support debt and enable further acquisitions. For example, they extended payment terms to their coffee suppliers to up to 300 days, three times as long as Nestle.

Only some of the companies seemed to fit the theme of market consolidation and were re-assembled into larger entities. The above timeline also omits that JAB tried its hand at luxury goods with Jimmy Choo and Bally. Today, many of its portfolio companies are public again: Keurig is now Keurig Dr. Pepper Snapple, JDE (Jacobs Douwe Egberts) consists of the former Peet’s, D.E Master Blenders, and Mondelez's coffee business. Krispy Kreme is public and Panera is going public via SPAC.

Harf made a comment that left no doubt about his perception of himself and JAB:

“JAB is not a family company but an investment holding and an active investor. Our model is difficult to copy. It is based on trust. We’re most comparable to the Swedish Wallenberg family, Jorge Paulo Lemann in Brazil, or Warren Buffett.”

So what did I miss?

First, German outlet Manager Magazin highlighted that JAB’s executives now derive substantial additional compensation through the private equity business for which they’ve raised some $17 billion from investors like the Peugeot and Santo Domingo families, Byron Trott, and Singapore’s GIC.

The magazine reported that JAB had hired executives from Mars for an expansion into petcare, which would be majority-owned by the private equity funds. It seems that one of the hires downloaded confidential documents before leaving which resulted in a lawsuit between Mars and JAB. Thus, a conflict of interest became apparent in which JAB’s capital and reputation could be at risk for a venture that benefits the management team and outside investors.

Harf also seemed to have entrenched himself personally at every level of JAB’s subsidiaries. JAB hired a designated successor, David Kamenetzky, who was supposed to restructure and simplify the web of companies and implement more formal oversight. The new structure was supposed to be “modeled after public companies,” which I interpret as a kind of formal board of directors.

Harf’s position at JAB had been built on trust and a long-standing relationship with the family. And, I would argue, it was entrenched by pursuing JAB’s hands-on and increasingly complex investment strategy.

Reportedly, Harf didn’t want to retire as originally planned. Perhaps understandable given the ongoing turnaround at Coty. It also echoes the careers of many other investors whose passion keeps them in the business

Under the new structure, Kamenetzky would have had power over Harf’s contract. And yet Harf had the right to fire Kamenetzky. And that is exactly what he did.

In the end, it seems like the magazine’s scathing articles may have had an effect. The family recently appointed a new vice chairman and designated successor to Harf.

Hence my three takeaways for anyone managing a family office or dealing with the burden of wealth:

Don’t wait until your deathbed to tell your heirs. Being completely unprepared for a challenging transition may leave the family shell-shocked and teach them to completely trust and rely on professional managers. Once set in motion, that train could prove hard to stop.
Alignment of interests through skin in the game works - up to a point. Having the executes at JAB put their own net worth on the line was a good idea. Unfortunately, compensation from the private equity business and other roles can dilute this incentive.
If you hire competitive people, expect them to behave that way. Talented and ambitious employees will seek to mitigate risks to their position, look for interesting work, and aim to get wealthy themselves. They will strive to win and gain status among their peers. This isn’t necessarily a bad thing. Keep in mind that the most talented people are unlikely to join a firm offering neither growth nor challenges. But carefully consider the motives when evaluating new strategies and initiatives.

Lastly, the magazine pointed out JAB’s underperformance compared to the S&P 500. My first instinct was that this comparison was not entirely fair. The family’s previous holdings in Reckitt Benckinser and Coty also underperformed the market. But the capital was redeployed into a private equity strategy and therefore the stock market, plus an illiquidity premium, should be the benchmark. The more relevant question might be whether the entire fortune should be invested in one thematic bet.

Nevertheless, I wanted to add, no family office would just invest tens of billions into cheap index funds. It just wouldn’t happen. That’s when I first saw the conundrum at work. Just as nature abhors a vacuum, talented investment professionals will see the portfolio as a blank canvas to express their own creative investment instincts.

And the family office that does invest in a simple portfolio of index funds? I would never even hear about it. It would be boring as hell. Just ask the single employee managing Nevada’s $35 billion public pension while eating leftovers for lunch. “His daily trading strategy: Do as little as possible, usually nothing.”

I hope you enjoyed this piece. Please feel free to share it with your friends working at family offices. Let me know if you agree or disagree. Or if you want to hire me as a consultant. I’m kidding. Well, sort of. I still have to figure out how to pay my rent, after all.😉

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Disclaimer: I write solely for entertainment purposes. This is not a recommendation to buy, hold or sell any securities or other financial instruments and does not constitute an investment recommendation or investment advice. Always do your own research and consult your investment advisor. I may at any time own or transact in any of the securities mentioned.

Sources: Bloomberg 2018, WSJ 2018, NYT, 2019, Manager Magazin, 2021, Manager Magazin, 2020, Manager Magazin, 2018, Handelsblatt 2018, The Times 2018

Insecurity Analysis

JAB and the Family Office Conundrum