The direct approach to making a difference

2018-02-23T14:16:19+00:00February 22nd, 2018|

With global high net worth wealth on track to exceed US$100 trillion globally by 2025, it’s no surprise we’ve seen a surge in the number of family offices set up. Definitions vary, but consultants EY estimate there are at least 10,000 single family offices globally – at least half of them set up in the last 15 years.

Perhaps once regarded as little more than hobbyists or amateur investors, Family Offices have become increasingly sophisticated. In the search for both returns and diversification growing numbers are looking beyond traditional assets such as stocks and bonds, and are willing to get their hands dirty as active and value add investors. Few trends illustrate that more clearly than the growth of direct investing.

Rather than relying on limited partnerships or deals arranged by investments banks, family offices are increasingly going it alone. The Global Investment Survey earlier this year?? [2017] by membership group the Family Office Exchange found that 81% of family offices have at least one person working on direct investments. It also found that 57% intended on increasing their allocations.

Already, according to UBS, the average family office portfolio has 9.3% in direct venture capital and private equity; that compares to just 7.1% in private equity funds.

Looking for control

Partly, this may be down to less than satisfactory returns in other asset classes, perhaps disappointment with traditional products and their legacy treatment and remedy post crisis or the simple desire to “enjoy” their investment in a more tangible way. The same survey found family office allocations to hedge funds are now just 6.2%, for example, with money going to other assets, such as direct investments.

Family offices have also found they can achieve better results from their direct investments, with average returns in 2016 at 8%, compared to just 6% for the private-equity industry. At the very least, direct investing enables family offices to avoid the private equity industry’s “2 and 20” fees.

Crucially, however, it also gives them more flexibility. Direct investors can, for instance, hold stakes longer than many private-equity funds permit and at different thresholds which provides greater optionality in the future. And this is probably the key: Ultra high net worth investors want more control of their investments whether this is exercised through passive or active engagement.

The last decade has seen an unprecedented democratisation of information, with increasingly detailed investment data and insights easily accessible online. This enables anyone prepared to do the homework to develop opinions and make informed investment decisions themselves. At the same time – and not unrelated to this– there’s been a growing sense of distrust of much of the established financial services industry.

The result is that the days of investors passively listening to a strategy being outlined by a wealth manager – perhaps the same as advised their parents – are gone. Today’s ultra-high net worth individuals are informed, engaged and active and generally better advised than before.

We can see this not just in the rise of direct investing, but also growing interest in impact investing, which has seen a surge of interest among family offices. The younger generation particularly want to see their money make not just a return but also a difference, as well as avoiding any environmental or social harm. The UBS report found that more than 28% of family offices active in impact investing and nearly 95% planning to keep or boost their philanthropic investments next year.

A wider universe

This is just another example of how democratisation of information and the drive to a personalised approach to investments has also widened the range of asset classes being considered. The long-established passions of the ultra-wealthy for art, wine and property, have been joined by investments in start-ups, high growth businesses, infrastructure and commercial real estate. Many have significantly outperformed the traditional assets such as stocks and bonds.

Of course, private banks and wealth managers do still have a role to play, but when it comes to direct investing the genie is out of the bottle. It’s potentially exciting, rewarding and it’s engaging for a group with both the time and the resources to devote to defining their investment strategy. These investors are unlikely to be willing to go back to just box-ticking at an annual meeting with their wealth management firm.

It is, of course, not for everyone. Designing and executing a successful direct investment strategy takes time and effort. It requires wealthy investors to clearly identify their goals and the areas they want to invest in: Are they seeking income as well as capital gain? What investment periods do they want and require? Where do they have at least some experience or knowledge to help them make more informed decisions?

Investors will need to identify both the sectors (fintech, consumer, retail and so on) and types of investments that are most suitable (early stage, growth or real estate). As with any investment, due diligence and post investment risk management is everything.

Family offices willing to put in the hard work are likely to reap the benefits, however. The evidence suggests they can not only match but outperform investments through external managers and funds. Perhaps more importantly, though, direct investment gives wealthy individuals an opportunity to see the difference their investment makes in the companies and causes they support first-hand. In that way, it offers a return no other investment can really match.