Family Offices & Direct Investments in 2019

2019's markets give opportunity for less fees, transparency, and better control of the legacy

Opportunity

More and more, we are seeing family offices embrace direct deals. It helps get them more involved and contribute more intimately with important deals. Most importantly, there are less fees, more transparency, and usually quicker decision making.

Challenges

However, this does not come with challenges. Many of these direct investments might require a sector knowledge or a unique investment thesis to make the right investments with the right level of conviction. According to Middle Market Growth ,

“Many family offices are conservative and risk-averse, especially when investing in industries they are not comfortable with. Understanding a target’s business model and putting the right team in place to complete a comprehensive due diligence process will help.

Another challenge is the time it takes to close a deal, in part because of families’ cautious nature. In a competitive market, this can be problematic.

The biggest question for families to ask is, “Are we prepared?” The prudent thing to do is invest in resources and infrastructure needed to go direct. The need for a business development person, investment professionals and operational resources is often overlooked and families are unable to complete a transaction."

Another important aspect that is underestimated is the true time it takes to perform due diligence. Many times, asset managers hire consulting firms to do due diligence. This portion of the investment cycle can be one of the most critical. Often times, investors and wealthy families have to perform due diligence on the due diligence firms, which can require a heavy amount of time. Along with consultants, the existing team simply might not be enough. Having some strong additional team members added to the group with a private equity background that can add value will go a long way.

Interesting Stats

This is a new take on traditional portfolio management. Quoted from Think Advisor

“Only 29% of offices that responded to a survey reported that they used quantitative modeling to determine asset class allocations and position sizes — a typical approach of many investment advisors, according to FOX.

And just 65% of participants said they relied on the traditional building blocks of asset classes (domestic equities and fixed income), while 35% considered other asset categories.

FOX attributed much of the move away from conventional portfolio construction to interest in direct investments. Of the 29% that said they continued to use a quantitative model, 42% excluded direct investments from the model-driven outcome.

Not only that, but 55% of all participating offices said they did not include direct investments in operating businesses in their asset allocation.

Survey participants reported a 13.9% average portfolio return for 2017, with which 58% said they were very satisfied and 35% somewhat satisfied. By way of comparison, the MSCI All Country World Index returned 24% and the S&P 500 21.8%.

FOX said that given the last year’s robust global equity returns, it was noteworthy that family office participants’ average equity allocation held steady at 42% — 28% to U.S. equities and 14% to international ones — the same overall public equity allocation as at the end of 2016.“

How can a firm transition?

This can be a large adjustment for the typical family office that has new generations that are helping to carry on the growth and legacy of the fund. According to Nick Ayton “The growing frustration of the next labour force is yet another a ‘ticking time bomb’. The Gen X and Z, along with large swaths of millennials who have seen their parents financial struggle from market corrections in 1991, 1998, 2008, where the mums and dads were mis-sold financial products, endowment mortgages, savings plans, insurances and overcharged for everything. A new generation of workers who do not want the burden of paying for a university education and require the nature of work to be repackaged to meet their digital needs and ambitions. They are vulnerable to a dark Socialist path that appears to deliver equality and fairness, yet has proven over decades to be an inadequate system that again serves fewer people and takes the printing of money to new hyper-inflationary levels that encourages uprisings, civil unrest and the odd war.” These newer members who are responsible for the future of the fund are digitally smart, agile, and are plugged into the startup ecosystem. The new generation is familiar with: the future of on-demand work, new jobs that are created from automation of past ones, and the concept that education is practically free or subsidized on the internet. Many younger generations are also able to change careers & their thought processes, grow compensation quickly, and develop new skills with an 8 week bootcamp opposed to 4 years of student loans. This makes them strong emerging managers. kharis capital has an interesting framework on the transition towards direct investing that is shared below from their website

(1) BUILDING PHASE

It typically starts by building or inheriting a business, often developed over decades or generations; Family DNA is often deeply rooted in a specific industry

(2) YIELDING PHASE

As the years progress and business thrives, family-owners not only accumulate capital, but also a wealth of capabilities, knowledge and networks in their industry and areas of expertise

(3) STRUCTURING PHASE

To manage succession, inheritance or taxation, and the overall family involvement in diversifying the capital they have accumulated, family-owners tend to organize themselves into 'family-offices'

(4) DIVERSIFICATION PHASE

Family offices typically start with common asset classes, such as real estate, cash management or investment funds, often relying on outside expertise and managers

(5) INSOURCING PHASE

As family offices gain from their initial experiences, they seek to reduce costs by insourcing certain activities like proprietary trading and occasionally co-invest in deals offered by existing funds

(5) DIRECT INVESTMENT PHASE

Ultimately, the appetite for direct investment grows – not only to further reduce fees, but because PE funds do not provide a natural fit for family offices seeking to better use their longer time-horizons and industry expertise.”

Gold is becoming less of a store of value and several investors are starting to seek for other options with alternative asset classes & these types of direct investments as a global reserve currency. The fractional reserve banking model that has been accepted for decades is losing: confidence, luster from additional fees cutting margins, and transparency. In this time of lack of trust with people’s data, intermediaries, & fake news, we are all looking for something that is unable to be tampered with and immutable. Gold, real estate, and collectibles are becoming slower to liquidate with an emerging recession on our hands. A tokenized model that can bring more liquidity and a framework that supports it will be the future to faster liquidity, secondary markets, and a network of effects that will being more wealth to sovereign wealth funds, institutions, multi family offices, and high net worth individuals. The pressure is becoming more timely for this with private companies rushing to go public, a dollar that is devaluing, and recent Santa Rally that mirrored the 1987 crash.

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