New Fortune | Denkmann Family Office: Unique among FOs
Global Family Business Research Center

The Denkmann Family Office is wholly owned and managed by Ralf Denkmann and serves only one UHNW family in Germany. Over the past decade, the two parties have established a mutually beneficial relationship with bespoke and high-quality service. With the first- and second-generation families setting the foundation for the family business, the POPM SFO model provides high-quality financial services to the family in a professional and convenient way, which could be feasible in China.

Source: New Fortune, February 2015
Gao Hao (Director, Global Family Business Research Center, PBC School of Finance, Tsinghua University)
Liu Chung Hsing (Founder of Sino Suisse Capital, previously Head of UBS Ultra High Net Worth Division Greater China)
Ye Jiawei (Head of Philanthropic Foundations and Fundraising, World Economic Forum)

Family office, FO is designed to provide UHNW clients a complete and comprehensive overview as well as asset management. FO provides different service models for families and manage a wide range of areas, such as concierge services, financial investments, real estate management, family affairs, philanthropy, etc. The decision to establish or join a FO that is aligned with the family's interests will be based on values like professionalism, feasibility, exclusivity, and control.

Professionalism refers to the ability of FO to provide the most professional services in the areas required by the family; feasibility means the possibility of assembling a team, including investment managers, legal and tax experts, and others in assisting the family in generating returns; exclusivity refers to the ability of FO to protect the family's privacy and tailor management solutions; and controllability refers to the family's ownership and control of the FO.

The majority of FOs in Europe, America, and Asia are located at two extremes of ownership and control: at one end is the family-owned family-managed Single Family Office (FOFM SFO), and at the other end is the institutional or professional-owned, professional-managed Multi-Family Office (POPM MFO), but there are variations for the ownership and control structure of family offices. This article will focus on Professional-owned Professional-managed Single Family Office (POPM SFO).

Ralf Denkmann, a financial expert, founded Denkmann FO in Bordesholm, Germany, fifteen years ago, only serves the UHNW family. In July 2014, the family office group of Tsinghua University's  PBC School of Finance conducted research on the Denkmann family office. Denkmann FO has formed a professional team dedicated to real estate financing, cash management, family affairs consulting, and foreign exchange trading, with over 10,000 cash and foreign exchange transactions per year and up to 4 billion euros in foreign exchange exposure (about 32 billion RMB).

Domestic affluent families can use Denkmann FO's distinctive model as a guide: With the first and second generation families setting the foundation for the family business, POPM SFO can cooperate with the family, satisfy the family's professional needs and conveniently and provide high-quality financial services for the family business.

The unassuming Denkmann family office is headquartered in a small town of German with a style that is in keeping with SFO's philosophy of exclusivity, privacy, and customization.

The Unassuming and Professional SFO

Denkmann FO is a typical German company comprises of strong historical ties with the north of Germany, it also exhibits discipline and seriousness in implementation.

The inhabitants of Bordersholm, the former capital of the Kingdom of Prussia and the Weimar Republic, lead a slow lifestyle. The low-key FO headquarters mixes well with the neighborhood's residential sections, in contrast to the institutionalized MFO in New York and other major financial hubs. The FO table is united, and on the wall covered with foreign exchange K-line charts is a schedule of Germany's 2014 World Cup games.

Denkmann FO creates all trading strategies in-house, just like a boutique investment banking team. It has a front office department with four traders and a middle and back office department with four staff. FO provides "best execution strategies" to meet the trading needs of clients, including numerical calculations, real-time monitoring, risk management, accounting statements and administrative support.

Denkmann FO is one of the most significant private clients in bank forex trading, like HSBC, Julius Baer and LBBW.

Familial Background and Development History

Since the 1980s, the UHNW family had invested in real estate in Germany, focusing primarily on upscale commercial properties in secondary cities. Many of the world's leading brands were located in the family's invested shopping centers, which had long-term value-added potential, 10 years later, FO began a long-term partnership with them.

After the fall of the Berlin Wall in 1989, the German government used investment policies to entice investors to promote the rise of the East. East Germany developed slowly and investors didn't reap the benefits in the short term. This UHNW family was resourceful and increased investments in the West German region and in the Netherlands, Belgium, Luxembourg, the UK and the US.

The family makes investment in Germany directly and joint investment overseas. In 2005, the family retained German assets, and most of the other real estate was sold to an American real estate investment company for about 600 million euros (about 4.8 billion RMB). The family has real estate in New York, Palm Beach, Cannes, Zurich and other large cities and resorts.

The first generation, who worked hard to enter the real estate industry, is now 78 years old and has passed the business to the second generation, while retaining the right to supervise and advise. The "retired" entrepreneurs focused on the foreign exchange market, which set the direction of the future FO.

In the late 1990s, the family founder met Ralph optimally at a real estate financing panel at a banking forum and looked forward to cooperating with Ralph. Ralph established Denkmann FO quickly in order to join forces with the family.

Governance Structure
Ralph holds all the equity and management rights. He decides the governance structure and job arrangement, The SFO signs a short-term contract with the family to control all the assets of the family and is completely independent. Both FO and the family have the right to terminate the contract at any time. The family can establish FO by itself or change cooperation, that is, the cooperation between the two sides is based on long-term trust.

Denkmann FO consists of three separate offices in Bodelsholm, Singapore and Zurich and employs a total of 10 staff (Figure 1). At the headquarters in bodesholm, Antonio Tivita, who oversees the front office trading division and is in charge of trading on the foreign exchange market, manipulation, strategy development and pricing. Carola Tilch is in charge of the middle and back office risk control and administration department, which performs numerical calculations, risk analysis, management control, and client relations.
Figure 1. Governance Structure of Denkmann FO
Ralph has a separate Linden FO in Singapore, sharing the middle and back office department with Denkmann FO, which was established to cover the Asian trading time zone of the FX market and to enter the Asian market and expand its customers. Currently, Linden FO serves the same UHNW family and the Zurich office is developing new business.

Bidirectional Selection Mode
Just as Four criteria for founding or choosing the FO, the family's prioritization of each criterion determines the model of the FO, and Denkmann FO belongs to the POPM SFO model in terms of ownership and control distribution, which is favorable to them.

For the family, why not opt to join an established MFO and instead choose to hand over ownership and control of the family assets to a nascent SFO?

The family has a strong demand for real estate financing, but the lack of resources, energy and expertise makes it difficult to communicate with financial institutions one by one. Although financial institutions, such as investment banks, are competent, they can’t be fully trusted because of conflicts of interest.

In addition, the institutional MFO covers the global market. Although the service content can be adjusted according to the needs of customers, it is difficult to tailor a full set of services for families.

So why didn't the family start with a FOFM SFO, instead of working with a professionally owned and managed POPM SFO? Is it feasible for families to establish their own SFO?

In this case, the first generation on the one hand, had to develop their main business and did not have the energy to set up another FO team, and on the other hand, the family might lack knowledge of financing and foreign exchange, and it was difficult to find a trustworthy professional team, and establish strong banking relationships.

Yet Ralph can expertly address these issues. Denkmann FO connects the family to the bank and helps the family overcome three major financial governance challenges, namely avoiding information asymmetry, incentive incompatibility, and liability mismatch by comparing services, researching pricing, and optimizing contracts. so as to avoid the mismatch between information and price.

After collaborating with the FO, the family loses power, whereas the SFO just manages its wealth but still has the final say and impacts investment decisions. Additionally, the partnership is extremely adaptable; even if there has been a long-standing relationship, it is be broken at any point with little financial outlay.

Germany requires financial services firms with more than two clients to obtain a relevant license, and if they become MFOs, they need to secure a sufficient number of clients and asset size to offset regulatory fees. The policy affects the FO model. Ralph notes, "If we establish a partnership with another family in the future, we would consider establishing a new SFO rather than changing the Denkmann FO to an MFO."

It is also the case that both have chosen to keep the SFO model. Due to the family's substantial wealth, it is able to afford the fully customized services provided by Denkmann FO while maintaining the family's anonymity.

Ralph was aware that working with wealthy families, particularly new families, was challenging. The new family didn't trust the FO, and the FO was unaware of their actual assets. It was better to preserve a long-term collaboration with the current family rather than growing the firm.
After a long period of cooperation, the Nash equilibrium point is formed and both parties will value the trusting relationship and the tailored and high quality services established over the years.

Business Scope and Financial Innovation
Denkmann FO initially optimized the family's real estate financing structure from bank relationships, interest rate negotiations, financing structure planning to contract drafting, providing professional cash and liquidity management for the family.

The family had been using long-term financing for their real estate investments until Ralph came up with a new transaction structure. Since short-term interest rates are typically lower than long-term rates, he applied for short-term financing from banks for 1-3 months, engaged in spot to forward foreign exchange swaps, and eventually used the premium to cover the bank interest.

This successful model continued until 2001 when the German tax regulator started to implement the "Halbeinkünfteverfahren" (half-income method), which imposes an additional tax on investment income of between 28% and 60% depending on the status of the natural person or partner. Denkmann FO stoped trading foreign exchange in the course of real estate financing. The first generation of family members got a taste of foreign exchange trading and wanted to continue.

Today, Denkmann FO has four main business segments: real estate financing, foreign exchange trading, cash management and family affairs.

Real Estate Financing
Real estate financing is not used for foreign exchange transactions after 2001. The current service segment includes cash flow calculation, liquidity assessment, risk management, cost (interest rate) estimation, capital structure analysis, accounting and administrative support.

Foreign Exchange Trading
The family's exposure to foreign exchange has reached up to 4 billion euros since 2001, when Denkmann FO began treating it as an asset and carefully controlling the foreign exchange trading process. The FO performs a similar function to an institutional broker by establishing a connection between the family and the bank and comparing 8–10 institutions. Analysis of foreign exchange risk and cash flow, cost optimization of transactions, outsourcing of currency management, pricing and analysis of bank solutions, product/forex reporting, etc. are among the primary responsibilities of FO.

Cash Management
Foreign exchange transactions require a variety of foreign exchange accounts at different banks. according to the client's payment, a certain amount of foreign exchange may need to be held. FO provides unleveraged cash and earnings management, using means to improve the yield of foreign exchange in the bank account.

Family Affairs
Only two generations of the client's family are involved in the family business, with the second generation inheriting it at the age of 52. Denkmann FO is involved in family issues on an informal basis. Their estate and yacht are managed by a dedicated concierge, private auditor, accountant, and attorney. As a result, the FO provides top-level design solutions that are customized for the family or refers the family to reputable third-party institutions. For instance, when it comes to passing down family wealth, the first generation of family members wish to convert their individual accounts into joint accounts shared with their heirs. Or, take, for instance, the 2005 transfer of family wealth from Germany to Switzerland, which the FO deemed to be in compliance with family advisers, lawyers and auditors.


Investment Philosophy and Trading Strategies
The FO manages the majority of the family's assets, with the family managing a tiny share and the FO handling financing structure. The family keeps its fixed asset investments prudent and waits a long 10 years for the government to waive VAT before enjoying the advantages. The Denkmann FO employs some of the family's financial resources to take audacious risks in the extremely liquid foreign exchange market, where trade volumes appear extraordinarily huge because to the availability of 30-100 times leverage. The family is once again looking for excitement.

First, Antonio builds a portfolio containing 70 currency pairs by analyzing macro fundamental economic data. First, the most suitable currencies for trading are selected based on the macroeconomic stability of each country and the maturity of the capital and banking markets. For example, the unstable Argentine peso will not make the cut because the country is politically unstable and the currency is less liquid.

Secondly, trading opportunities are identified based on interest rates, exchange rates, exchange rate expectations and volatility. Antonio monitors investment parameters, especially the volatility of exchange rates, which is the main driver of returns. The FO will trade a portfolio of individual currencies at the right time.

The trading team first identifies the exchange rate trend and selects a currency portfolio, then provides the family members with a trading strategy with a complete numerical calculation that the client will discuss with the FO, including information on the time horizon of the trade, the derivatives to be used, the range of exchange rate fluctuations, the amount to be pledged and the expected yield.

Denkmann FO focuses on counter-trend trading. According to Antonio, macro data shows an indicator of the quality of a country's long-term development, but forex market trading is more about changes in expectations and risk awareness. Recognizing the over-exaggerated side between demand and supply is key to provide the best risk-reward ratio for trading strategies. The magnitude of exchange rate adjustments then requires a technical analysis of the past and trends.

Assuming a currency hits the upper region of a defined range, the FO will choose to sell short or sell a call option (Short call) on that currency, gaining premium regardless of the subsequent rise or fall. Conversely, if a currency hits the lower end of a defined range, the FO will sell a short put on that currency and receive a premium. If the rate continues to fall, the FO takes a long position (Figure 2)
Figure 2. Income from buying call options (FO is the opposite of the seller's profit and loss
For instance, in a currency pair with an upward trend, assuming the option has a term of 3 months, the FO sells a knock out option (Knock out) consisting of a call option sold at the Strike price and the Barrier level, and the FO's income is the uplift at the end of the term. Barrier options have a slightly lower premium than Plain vanilla options, and when the asset price hits the barrier level, the option is immediately voided and the seller no longer has any obligation, but the FO also receives an immediate premium for this without having to wait for the option to expire. Theoretically, the FO is able to obtain the uplift in 1 day for a period of 3 months, and the FO's job is to make a lot of numerical simulations to determine the performance price and the barrier price. Antonio notes that this has been the most successful trading strategy of Denkmann FO for almost a decade.

However, foreign exchange trading forms a portfolio with the family's mainstream investments in real estate, foreign exchange earnings only occupy a small portion of the family's capital, and options trading is very risky and does not apply everywhere.
The family is flexible in its investment guidelines. The first generation love foreign exchange and will occasionally propose to the FO to open a position in a particular foreign exchange, so the investment guidelines follow each transaction. Family members can afford to take losses and are willing to take risks in forex trading. They don’t have a strict loss line and will reduce their quota in the forex market if they lose 20-30% in the current year of trading.

Decision-making Power Allocation and Monitoring Mechanism
Proposal Right
In the Denkmann FO model, both parties can initiate transaction proposals. When preparing for foreign exchange trading, FO first performs numerical simulation, and then provides information and discusses with the family. Family members have an influence on the decisions. The first generation studied the foreign exchange portfolio composed of 70 currencies at the weekend and directly proposed on Monday or said to Ralph: "our transaction in 2012 was very successful. Can we do it again? Let's calculate."

Supervisory Power
With regard to the return on investment and the degree of completion of objectives, the family only looks at the results. FO only needs to help the family make more profits. In the real estate financing business, the goal of FO is to find the best financing plan among multiple banks. The family only needs to obtain the lowest interest rate cost, the amount of investment required initially and the rate of return. In the foreign exchange business, the family pursues a three digit return (a return on investment of several hundred percent). Therefore, the process setting is the responsibility of FO, and the decision-making power is actually in the hands of the family.

The long-term cooperation and excellent benefits have established deep trust between the two sides. The first generation know every transaction made by FO and check every transaction in detail. Occasional mistakes do not affect the trust of the family. Therefore, the family has no formal monitoring or evaluation mechanism for FO.

Rights to Control Risks
The risk control is the responsibility of the middle and back office departments. All the actions and transaction data of the front office traders are output to the middle and Back Office Excel model by the Bloomberg system. The four middle and back office employees sort out the customer account positions and liquidity from the data and report them daily. built-in monitoring system is connected to Bloomberg in real time. In addition, FO can call up all data or charts within ten years. All the data are recorded and stored in the daily backup server, which can be called the "black box" of operation. Even if the office is on fire, it can restart operation in another place in 5 hours.
Ralph Denkmann (right) is most proud of creating an elite team. They know the foreign exchange market well and have established good cooperative relations with global banks.
Communication with Family Investment Managers
Communication between mutually independent families and FOs is important. The second generation often communicate with the FO about real estate financing, and Members of the generation involved in foreign exchange trading can contact FO more than ten times a day more easily.

The family and the FO have at most two formal meetings per year, one of which is an annual summary and compensation discussion, and the rest is done almost entirely remotely. The first generation have been to office ten years ago. Communication with the second generation is mainly via e-mail and smartphones, while communication with the first generation is done traditionally by fax, paper or telephone.

The FO's schedule with the first generation is quite tight, sometimes taking in two hours of time that the FO needs to decide with him about the next days. When the family members don’t have time, the FO will follow itself. Nevertheless, the family members are well informed about the FO's execution progress and are involved in the decision making.

For Ralph, communicating with the first generation of entrepreneurs is extremely challenging. He explains, "The entrepreneur has been taking risks in business his whole life. And that's precisely because he has proven so successful. Sometimes he has the instincts of an entrepreneur, unlike the instincts of investment managers. One must accept risk to make triple-digit returns in the foreign exchange market, but sometimes it's not the right risk to take. " He thinks that convincing him becomes our biggest challenge.

Ralph cites the example of family members who previously invested in gold on gut instinct, and the lack of strategy led to failure, while the entrepreneur readily accepted. The first generation was convinced that trading opportunities were everywhere, so Ralph and Antonio asked first generation to take a break or travel and not take risks when the market was unclear sometimes. when client asks for information and data to inform a decision, the FO emphasizes the risk of the trade and strongly advises the client not to make a foolish move. However, the family members do not complain or regret even if they eventually suffer a loss since it is their own decision.

There is a lack of clarity in the investment decision making power. The family is the ultimate owner of the wealth and should have a say legally, but the role of the FO is to help the family manage the financial assets from a more professional perspective. The ambiguous decision-making mechanism of the FO increases the possibility of making mistakes and directly affects the professional operation of the investment manager based on market judgment.

Income and Expenses
Although the Denkmann FO lost a lot of money during the global financial tsunami in 2008, the family is still satisfied with the income generated by the Denkmann FO so far.

The family needs concierge services, and undertakes the management of real estate and yachts by professionals such as accountants, auditors and legal advisers, The income of FO covers their salaries and management fees of FO.

"Everything goes without a hitch" Antonio states, "The FO returns can range from -10% to +10% for the unleveraged portion and from -50% to +100% for the leveraged portion."
Initially, the Denkmann FO received a percentage based on the annual investment return. While some of the decisions were influenced by the family beneficiaries, the FO decided to adopt a fixed-amount fee model. the FO gave up performance bonuses and traded professional services for fixed compensation, meaning that if the FO's investments cost the client €100 million next year, the FO would lose bargaining leverage in annual compensation negotiations, and if the investment returns earned an additional €100 million next year, the family members might raise the FO's fixed compensation. But the FO will not get a huge bonus like an investment banker.

The two compensation models experienced by Denkmann FO have their pros and cons, each in terms of family or professional manager management of the FO.

Performance share model: With obvious incentive effect, investment managers will actively participate in the market for higher returns, bringing more profits to the family and reducing the conflict of interest caused by information asymmetry between the two parties. Salary equals productivity at the economic equilibrium point, and the performance share compensation model linked to productivity can significantly increase the productivity of managers and teams. At the same time, performance sharing can enhance the ability of the investment team to work together to achieve business goals due to clear work objectives. The downside, of course, can’t be overlooked: performance sharing can distort a family's risk appetite by pushing managers to take more risks. In addition, this model is contrary to the long-term investment philosophy of the FO. Finally, it is difficult for the family to evaluate performance, especially in financial markets. The model is tied to market cycle fluctuations, and isolating the evaluation of investment managers is the biggest challenge. Are the absolute returns obtained due to the bull market or due to the excellent management of the investment manager? The performance share model does not easily reward investment managers based on their ability and performance.

Fixed compensation model: It reduces the family's risk exposure, and the risk of the investment manager; however, it reduces the incentive effect on the investment manager at the same time, which may lead to inefficiencies. In this model, compensation is decoupled from the general market trend, and avoid issues about performance appraisal. In addition, the fixed compensation model may not be as effective as performance sharing in motivating teamwork, and lead to brain drain. The family has the final say, and excessive family intervention may lead to poor investment performance due to professional constraints. In short, the fixed compensation model is more robust for the family.
The DFO compensation model does not apply to all sizes of FO's. Generally speaking, the compensation model of large wealth management institutions is tied to performance and the resulting risk exposure is managed by the institution's risk control department, which can, for example, set strict rules such as penalties for exceeding a percentage of the risk margin.

Ten years of Partners
With an average age of 37 and 8-10 years of working together in the FO team, Ralph has gathered a group of loyal partners to grow with FO. He selected team members with the utmost importance on individual personality traits, followed by professional networks. Most of the UHNW families live in big cities such as Hamburg or Frankfurt, where there are few local financial professionals, and forex trading requires familiarity with interest rates, the equity investment environment or financial derivatives, so it is not easy to find people who are competent and willing to stay in Bordersholm.

Human capital is the most important issue in the development of FO. FO can find talent when they work with each other. Antonio, for example, worked in the treasury department of a savings bank, where he was responsible for treasury management, foreign exchange trading, equities, treasury bonds and derivatives. Ralph met Antonio when dealing with this savings bank and appreciated his ability and character so much that he invited Antonio to join Denkmann FO to manage foreign exchange transactions.
Ralf himself worked in the bank's funding department in London, Luxembourg and Hamburg, where he was responsible for public financing for German and local governments. He met the first generation of his family while working in London, which was the reason for his return to his hometown of Bodelsholm to establish Denkmann FO.

Denkmann FO's employees voluntarily opt for a fixed salary, especially for front office traders, who do not receive additional incentives at the end of the year but are not penalized for investment losses. denkmann FO's employee benefits also include a weekly massage after an intense work day.

The team is what Ralph is most proud of, an elite team of experienced professionals was built over the past 15 years. They know the Forex market and customize 100% innovative trading strategies for the family, and have developed excellent relationships with global banks.

POPM SFO's Future in China.

The situation of many UHNW families in China is quite similar to the German family in this article. The first generation started the family business and wanted to diversify the family wealth. Starting an FO is difficult when the main focus needs to be on the business. POPMSFO brings freedom to the family and the family can disengage at any time.

In contrast to the MFO, the SFO model allows the family to tailor services, such as Denkmann FO's real estate financing and foreign exchange trading according to the needs of the client family. The POPM SFO model is a viable option in China, as the independent FO has more incentives to reach out, expand its network and seek opportunities for the family.

The Denkmann FO is the result of mutual trust between the family and the professionals, which is a challenge in China. The key is that "this" investment manager, who can establish a one-to-one "SFO-family" relationship, reduces agency costs. After all, for a family with deep professional experience and a willingness to grow with the family (from real estate finance to foreign exchange trading), and investment managers who can build long-term trust (not easily separated from the family and with good character) are hard to find but lucky to have.

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