Family Offices Are in Expansion Mode, and Love Alts
Art by Amy Matsushita-Beal
One thing Shaquille O’Neal, George Soros, and the Rothschilds have in common: They use family offices to run their investments. With an emphasis on alts and other forms of long-term investing, the offices don’t always beat the market, year in, year out. This doesn’t matter, though.
Family offices are on fire. As their selling point is growth over the long run, to pass along wealth to families’ future generations, they now are enjoying an unprecedented expansion: Two-thirds of them have been established since 2000, according to the most recent annual UBS study of the offices.
The top of the wealth pyramid doesn’t like to parade its investment operations to the general public, so family offices keep their activities on the down-low. That’s why you don’t hear much about the doings of these private investing entities serving the very rich. Some manage money for just one family, while others, known as multifamilies, invest on behalf of several.
And they have a great deal of freedom, going far beyond the mutual funds typically offered by standard investment advisors. That means they can range into private equity and hedge funds, along with various other alternative investments like timberland. And that also means they can go out on the risk curve further than the average investor might feel comfortable with.
Their performances aren’t too shabby, although not always comparable to retail investing. In 2017, the average family office returned 15.5%, the UBS report found. On the surface, that looks unimpressive—the S&P 500 was up 21.6% that year. But the gap reflects the difficulties of comparing private and public investments. The private ones adopt the long view and usually take a while to deliver, as opposed to a stock index like the S&P, whose movements can be tracked daily.
What They Invest In
Take private equity, one of the stalwarts of family office portfolios. PE has been one of the best-performing assets in recent years. In 2017, it returned an average 18%, according to the UBS study. The average family office portfolio was 22% in private equity.
“If you look at the returns and you look at the returns on a risk-adjusted basis, private equity has done very well in both the US and globally,” said Richard Kos, founder and president of Kos Consultants, which works with the offices. To him, private equity is “a little bit like real estate to the extent you have appraised values embedded in the returns. It tends to smooth out the risk, so the risk looks lower than it probably really is and it gives you a very good risk-adjusted return ratio.” Another appeal of private equity, according to Kos, is that “family offices have realized there is a liquidity premium inherent in the expected returns for private equity that, given their long-term time horizons, they can capture.”
Finding common themes in family office investment policies is tough, as each family has a different risk appetite. Portfolios tend to vary, but they do share one thing: a love for alts. You name it, they like it—infrastructure, oil wells, farmland, PE, private debt.
Except for hedge funds. Since 2015, family offices have been trimming their hedge fund allocations. UBS said that the average hedge fund allocation is down to 5.7% as of 2017, a drop of 3.2 percentage points within a year.
Why? “Hedge funds continue to be looked at with a concerned eye in terms of performance and then performance related to fees,” said Kos. Sub-par returns amid high fees have plagued the hedge world for a while now. In a challenging 2018, Hedge Fund Research figures indicate, hedge funds did less worse than the S&P 500, dropping 4.1% versus the stock benchmark’s 4.4%. In 2017, the S&P 500 overshadowed hedge funds, gaining 21.8% to 8.6% to the hedge operators. And many hedge funds charge 2% of assets yearly and 20% of profits.
That’s the same as PE funds. The difference is that hedge funds are active in the day-to-day market. Thus, emotion-driven stampedes can suddenly trample them. In fairness, lots of hedge funds have little or nothing to do with equities. The most prominent categories of hedgies, however, are long-short and quant funds, which tend to concentrate on stocks and use elaborate strategies to best the S&P 500 and other indexes, not always with success.
Individual stocks are prominent with wealthy families, who have 22% in US and 6% in developing market equities. Perhaps the perceptual difference among family office investors vis-à-vis stocks and hedge funds is that hedge funds are thought to promise better returns than the stock market. Stocks, if bought with wisdom and held for a long time, do very well for people. Ask Warren Buffett.
Alts, with their long time horizon, are the most popular with family offices, making up 46% of their portfolios. Take real estate, which is hot in family circles. “Frankly, it’s an area where most family offices create a lot of their wealth,” said Kos. Not that real estate is a slam-dunk, can’t-miss proposition, of course. Commercial property got slammed in the early 1990s and housing was decimated in the financial crisis.
The worry with real estate, Kos observed, is that many family office property purchases may be overvalued. Meanwhile, interest rates are on the way up, never a good situation for real estate, which depends on borrowed money. “There’s concerns as capitalization rates rise what that’s going to do to the re-pricing,” Kos said. Just the same, it does well over time. The FTSE NAREIT index, which is a widely used proxy for commercial real estate, is up an annual 15.6% over the past 10 years, almost equaling the S&P 500 in a near-record bull market for stocks.
House Rules
That family offices are unregulated goes without saying. Still, they have their own set of rules, after a fashion.
“They’re self-policing institutions,” Dave Fox, president of the Global Family & Private Investment Offices Group at Northern Trust told CIO. They tend to be run at such a professional caliber that they “look and feel a lot like they are regulated,” said Fox.
The reason is that family members want to see how their investments are doing against long-established benchmarks. “Many of them set themselves up in such a way that they benchmark off of institutions that are much more scrutinized,” Fox said. An office’s money managers want to be able “to go to their family members and tell them that they got that level of rigor that they apply against their portfolio.”
Team Recruitment
Staff can also vary. Most offices are traditionally run by financial advisers and wealth managers, but can also be close friends and sometimes relatives that happen to also be investment professionals. The latter is usually found in smaller families, which average a staff of three to five people who wear many hats. The largest offices are stocked with pros, but with possibly only the super-elite as an exception, most families want to know who they’re dealing with.
Fox said the majority “are still looking” to third-party managers, but may also have an investment consultant that works with their in-house chief investment officer. “They’ll take advice from a lot of folks externally, but they’ll form their own investment philosophy and investment policy statement,” he said. “Every family is different in terms of how much of their portfolio they want to distribute out to their heirs or reinvest back in other businesses that they still own or into the portfolio.”
Getting hired at one of these establishments is rigorous, much more so than other institutions, but it pays well. And there can be a psychic reward: The investment pros sometimes get to meet celebrities and athletes they normally wouldn’t meet in the financial sector.
“When we’re looking for new people, we’re obviously going to do what everyone else does… but our interview process is a little different,” Monte Lee-Wen, president of his first-generation family office Casoro Capital, one of the firms parented by his multifamily real estate business, the PPA Group. Lee-Wen’s organization has accumulated close to $1billion in AUM throughout its 17-year history.
First is the initial screening, skill testing, and personality profiles, where prospects do their technical interviews, sometimes as a group. Next is Lee-Wen’s “core values” interview, which determines how well the candidates will fit the office culture. “So one thing that’s really important for us is we have five core values and we like to live by those,” Lee-Wen said. “At the end of every year, we give an award for who lives these core values.”
The values: speak to inspire, care, be teachable, be bold, and be exceptional.
“It goes back to that philosophy of we want to work with people we like, that we like, that we trust, that we want to have and build relationships with,” Lee-Wen said. “And even if they’re a stellar candidate, they’ve passed all the skills tests, they’re a rock star, they’re a rock star analyst, if they don’t pass that values interview, they don’t get hired.”
Giving Them What They Want
These money butlers are not just serving their masters financially, but the families’ beliefs, as well. Unlike a pension fund, which needs board or state government approval to implement a strategy such as environmental, social, and governance (ESG) moves, families have that flexibility where they can fire at will.
“We can move as fast as we want or as slow as we want,” Lee-Wen said. “There’s really no red tape other than what we want to spin just as we feel out an investment frankly and how much we trust the people we’re doing business with.”
Another trend is the rise of the multifamily office, which is essentially a private investment management firm. Unlike a traditional single family office, where the goal is to grow the wealth of one dynasty, multifamilies must deal with the desires of as many as 10 clans.
“There are some family offices that are so large that they almost look and feel like an asset management company and they’re checking their own trends position, they’re competing for deals in the same way as any large asset management firm,” said Fox, adding that many have the resources in-house versus reliance on external resources.
“I just think it’s cheaper and you can leverage probably a bigger team and you’re not paying for all that by yourself,” said Lee-Wen. “You’ve got multiple families hiring people so their salary is not all dependent upon you, and a lot of times they have more infrastructure and more expertise.”
Family Matters
These aren’t just investments to preserve and increase the wealth for future generations. They also support lifestyles and fund particular causes. Approximately 38% of families were involved in sustainable investments in 2018 (the top being clean energy, water, gender equality, and health care), and almost half planned to add to these investments in 2019.
The idea is to “pass down a mission or value, philanthropy to their future generation and make sure that the money doesn’t run out because they want to spend it judiciously,” said Fox. “It isn’t just about investment returns.”
Over the vast span of time, certainly, those investment returns need to keep rolling in.
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