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Family Offices' Direct Investing Hunger: What's Driving It?

Christian Armbruester

21 January 2020

The following article is from Christian Armbruester, chief investment officer of the European firm , a database and analytics firm tracking single family offices, such as those in the Europe, the Middle East and Africa region. To find out more, see an article here that includes a registration link. 

There are more than 10,000 family offices globally, controlling more than $4 trillion in assets, according to a recent study by Ernst & Young. These organisations by definition are all private, and it is therefore not a great surprise to learn that they also invest privately. According to another survey by UBS, 45 per cent of family offices want to increase their direct investments in the next 12 months. So, what is the attraction of making investments outside of the regulated markets and, more importantly, what are the risks? Moreover, are family offices better equipped at making direct investments and is this trend likely to continue? 

Source: UBS, Campden Wealth

To answer these questions, we must first explore the driving force behind the need for wealthy families to set up their own private offices or, in other words, why would anyone want to leave the comforts of today’s private banks in the first place anyway? Mostly that has to do with the fact that a bank or wealth manager is an agent, who makes money from providing services, whereas a family office makes money from principle investments. This rather large difference in the respective risks the parties need to take in order to succeed, has increasingly meant that families’ purpose build their own setups to manage their wealth. This has also made it easier to coordinate what is essentially the main focus of a family office and the governance, succession and behavioural risks associated with passing on wealth to the next generation. 

Clearly, there are benefits in doing things with a better focus and perspective, but are family offices also better at making direct investments? As ever, the answer to that question depends on the people and capabilities that one has to perform the vital parts of doing bespoke, private and unregulated investments. If the family office is in the fifth generation and all the heirs have ever done is to spend their inheritance, then you wouldn’t think of giving junior the keys to a huge real estate development in the middle of nowhere. 

On the other hand, if the patriarch, he or she who created the wealth in the first place is still active in the family office and has specific expertise or a relevant skill set, then it may make sense to run the deal in-house. That argument needs to be taken with extreme prejudice however, and just because the family made their money from building a great widget business, does not necessarily qualify them to invest in a fintech or biotech deal. 

So why are families piling in? For one, there is the fear that the markets will collapse again. Remember, families are long-term investors and as such making an investment and not knowing whether it will work out until far into the future is not seen as prohibitive. Whereas, potentiality taking a 20 per cent hit on marking equities to market is seen as a much greater risk. Bonds are out of favour anyway, as the inflation rate for wealthy families is running at about 7 per cent (source: Forbes Index of Living Extremely Well), and the low (or even negative) yields just aren’t good enough. What about hedge funds? Please, the perception is that managers are greedy, the returns are lower than what we can get in the markets, and there is a complete lack of understanding of how they work or what the underlying risks are. That pretty much leaves doing real estate, private equity or private debt. The question is, are there ways to get exposure to these investments without going direct? Of course, there are many funds that provide diversified portfolios of private companies, loans and commercial or residential property. There are also countless structures through which one can invest to suit individual appetites for risk, liquidity or terms.

Why invest direct versus a fund? It’s akin to buying a house that is all done up versus a development opportunity whereby we can add value through doing the work ourselves. Clearly, doing a number of direct deals gives more flexibility and control over our portfolio. We can exit deals when we want, and we can get more bespoke exposure to specific companies, regions or sectors. But, the amount of work remains the same and replicating the capabilities of dedicated teams of large funds, banks or other investment managers could be quite costly. Not only in hiring the expertise, but also because the infrastructure and processes to manage many projects is not easy.

It seems highly unlikely that a family office would possess all the skill set in house to invest in a diverse portfolio of direct deals or that they could do so more efficiently than other dedicated professionals and the operational scale upon which they function. It is therefore probably more of a myth that family offices are better suited to doing direct deals, but it seems highly unlikely that this will cause an abatement in recent trends and we should expect family offices to do more direct deals in times to come.