Ten months ago, our family office made a decision to become part of the family office community. During that time I have had the chance to attend nine different conferences put on by seven different conference organizers, and I have had the chance to meet close to three hundred families. By going through this process I have learned a number of things. The most important item and one that makes 100 percent sense to me is that there is a major family office investment trend.
Family offices are moving away from funds as a result of fees, transparency issues, nonalignment of interests and the inability to understand all of the investments within the fund. Because of these issues (and a few others), family offices are moving toward direct investments, coinvestments and partnering with other families in the specific area in which each family created its wealth.
A Trend In Direct Investing
In a recent Bloomberg News article by Margaret Collins, Devin Banerjee and Chad Hagan, “Wealthy Families have $4 Trillion Up for Grabs,” it was mentioned that wealthy families are embracing their inner Warren Buffett, albeit on a smaller scale. Where they used to hand most of their assets to managers to invest, now they are following the likes of Warren Buffett, Michael Dell and Bill Gates; many are acting like private equity firms and investing directly into deals. This is becoming more and more evident in that many of the large institutional firms are trying to court wealthy families and allowing them to invest alongside them in deals.
According to a Family Office Exchange survey in April, of 80 offices surveyed, almost 70 percent engaged in direct investing, and they outperformed buyout firms in 2015. The survey showed that direct deals returned an average of 15 percent—more than double private equity results that year.
Direct investment strategies are also being used by some of the major university endowment funds. A good example of this is the direct investing into real estate by one of the largest endowments in the world, Harvard University. For example, the fiscal year 2015 was challenging for many investors as global markets reacted to falling oil prices and concerns about slowing growth in China. However, Harvard’s annual return of 5.8 percent outperformed a number of other benchmark indexes, and real estate played a leading role in boosting the endowment’s overall return for the year. Specifically, Harvard’s direct real estate investments posted the highest annual return of all portfolio asset classes at 19.4 percent, trouncing its second- and third-best-performing asset classes.
According to a letter from HMC President Stephen Blyth in the endowment’s 2015 fiscal report, the real estate return of 19.4 percent was driven primarily by the “exceptional, continued success of a direct investment strategy started in 2010.” Blyth stated, “In fiscal year 2015, the Harvard direct real estate program returned 35.5 percent, as their internal real estate team and their joint venture partners continued to create outstanding value throughout their portfolio.” That performance reinforced the advantages that can be found by devoting a percentage of an investment portfolio to not only direct investments but also, in this case, direct real estate assets.
A Way To Minimize Expenses
Chad Hagan, from the previously mentioned article “Wealthy Families have $4 Trillion Up for Grabs” and whose family built its wealth in private health-care and financial businesses, said, “After a decade of direct investing we found that we actually saved millions, which were reinvested in companies and assets which resulted in huge, huge savings!”
Family offices understand there is a cost to do business and costs associated with the transactions. In fact, they are happy to share in the expenses, a sentiment disclosed in a white paper written by Cohn & Reznick and summed up by Noam Abrams, vice president of private equity at the Vinik Family Office, which is headed by the owner of the Tampa Bay Lightning hockey team, Jeff Vinik. “We like to know where our money is going,” Abrams told RIABiz, a news site for the advisory community. “Why pay a substantial management fee and carry for something that you don’t know? We believe that we can get better alignment doing one-off deals.”
The white paper went on to cite transparency as another reason direct investing is beneficial. “Families are getting away from black box investing, where they give their money to a private equity firm as a traditional limited partner and let them do as they please,” said Steven Thayer, a partner at Handler Thayer LLP, which provides legal services to family offices. “After the Great Recession of 2008, people really started paying attention to what was going on inside that black box. Family offices didn’t want to cross their fingers and hope that the outside investors were making the right investments. They really wanted more control over the investments that were being made.”
The Trend Is Increasing
The trend of direct investing is increasing and has been for a number of years. PitchBook, a research and data collection firm, reports a substantial increase in direct investments by family offices. It recorded 97 such deals in the United States in the past five years, compared to 56 in the previous five years. And these figures are likely a fraction of the real total, given that family offices tend not to share information about their transaction activity.
A 2014 UBS and Campden Wealth family office report disclosed that about 80 percent of family offices had participated in coinvesting as a solution for direct investing. Many family offices see coinvesting as win-win because they get to invest directly in deals alongside an investment firm or family office that created its wealth in a specific industry, and, at the same time, do not have to pay any extra fees. The other benefit is that they also do not have to hunt for the deals themselves, which often entails raising their profiles in the marketplace—and many family offices are loathe to do so.
Challenges Of Direct Investing
So if direct investing is a trend for family offices due to potential higher returns, transparency, and lower fees, then why are all families not doing this? Ultimately, it comes down to the family offices’ resources, expertise, deal flow and acumen to successfully execute a direct investment strategy.
The challenges and risks of investing directly are many, according to experts. Family offices that attempt to invest directly by luring managers from high-paying funds to run their operations are not always successful in their efforts. The other option is to manage everything in-house, but to do so they have to have an (1) understanding of the industry, (2) ability to do the proper due diligence, (3) underwriting ability and 4) expertise or the skill set to fully evaluate the opportunity. Any missteps in this process could cause an acquisition to turn south, which ultimately could put a dent in the family fortune.
A Direct Investment Solution
After becoming a part of the family office community and speaking with hundreds of families, family office CIO’s, family office legal professionals and many patriarchs, I believe that the best way to invest directly is to invest alongside a family office that has created its wealth in the specific industry that you want exposure to.
If you want to invest in the oil and gas industry, find a family that you can invest next to. Investing next to or with a family is not the same as investing with a fund that is investing other people’s money. When investing alongside a family, you are invested with the patriarch’s own capital. In addition, you are able to piggyback in an area in which the family’s knowledge, expertiseand track record were created—benefits that one could never put together like the family has over the last 30 or more. And, unlike private equity firms or funds, families do not feel the pressure from investors to get out of a deal in a certain time frame, which allows for better investment decisions than those in which fund managers may force exits at certain times.
A family office that is still active in a specified industry provides:
• an understanding of the industry
• due diligence
• underwriting ability
• expertise
• a track record
• a principal mind-set
• deal flow
• management
• internal infrastructure to manage the asset
• a tax-efficient mind-set
• ability to provide off-market opportunities
• low or minimal fees for the transaction(s)
Conclusion
Direct investing is a trend that is increasing and will continue to be an investment option. So find a family that has made money in the industry in which you want to invest, and once you are comfortable with that family, coinvest to allocate to that respective investment space.
DJ Van Keuren is a director for the Arsenault Family Office in Colorado.
