Many highly affluent families created their original wealth from private investments, so it’s no surprise that research we recently undertook at iCapital Network reveals that single-family offices have a notably high predilection for private equity assets, particularly private equity funds.
Six out of 10 single-family offices are investing in private equity, with 90% allocating 10% or more of their investment portfolios to PE funds or direct investments, according to iCapital Network research.
Breaking that down further, a little more than 70% allocate between 10% and 20% to private equity, while 20% maintain allocations of 20% or more. That kind of appetite is consistent with the target allocations of many institutional investors.
Most striking is that close to 9% are allocating more than 50% of their portfolio to private investments. An ultra-wealthy family has the autonomy to invest in the ways that best suit long-term goals. The relatively high allocations to private equity parallel the approach used by many large endowments to attempt to manage downside risk and increase return potential over extended periods of time. The high allocations may also represent something else: a very high level of comfort with the asset class.
Entrepreneurial DNA
Families at the center of a family office may have this higher level of comfort with private equity because their family’s capital was created by a successful private business in the first place or their approach to making money is to acquire, fix and build assets and businesses in certain industries.
With that experience can come a certain level of confidence in vetting and understanding direct investments and in the idea of investments in private equity funds more generally. Private equity investments leverage and reinforce that background by giving the family opportunities to add value and industry expertise to companies and funds that they choose to partner with.
Many wealthy families can afford to take a longer-term investment approach. They understand that the potential premium for illiquidity comes from allowing companies to pursue strategies that often require four to six years to execute. These families also appreciate the active role that fund managers play, working closely with their portfolio companies to achieve their goals. Such alignment and consistent engagement typically do not exist in the public markets.
Our research on single-family office investments in private equity identified three additional motivations that propel single-family offices toward this asset class:
Potentially superior investment returns: A large percentage of single-family offices say they have achieved strong performance with their private equity investments, especially in contrast to other vehicles and asset classes. Performance is the most influential factor in why private equity is viewed so favorably by single-family office investors. While the typical single-family office is historically sensitive to fees, it is also highly attuned to performance and always looking for superior investment returns.
U.S. private equity funds have produced net returns of 11.8%, 10.5% and 13.2% over the last 10, 15 and 20 years, respectively, as of September 30, according to Cambridge Associates. Seven out of 10 single-family offices investing in private equity reported they had better returns from private equity than from their traditional portfolios of stocks, bonds, equity and fixed-income mutual funds and separate accounts, ETFs and other indexed vehicles, according to iCapital research.
Family involvement: A somewhat distant second factor is the opportunity for family members to take a hands-on investment role. This pertains almost exclusively to direct investments, and there are times when the family can provide valuable insights and leadership drawn from their own experiences as business owners. Again, it’s speaking to the entrepreneurial genes that often reside within ultra-wealthy families.
Negotiating power: A relatively small percentage of single-family offices cite preferential terms as a meaningful benefit of investing in all forms of private equity. This is often the result of working in conjunction with another family office to source investments and pooling assets to maximize their negotiating position. It’s worth noting that proportionately few single-family offices operate in this way, but that is likely to change as these organizations become increasingly professionalized.
Looking Ahead
While past performance is not indicative of future results, it does seem to be an enticement for future commitments, with allocations to private equity from current and first-time investors expected to increase, according to our research. Of the single-family offices currently investing in private equity, more than half expect to increase their allocation in the next year. Of the group that was not investing, nearly 30% plan to allocate to private equity in the coming 12 months.
The inclination to increase allocations has several ramifications. First, we may see the demand among single-family offices for interesting and exclusive deals and high-quality funds escalate. This may signal a shift in how significant private wealth will be deployed. But we will also see a growing need for best-in-class tools to facilitate informed decisions. Sourcing opportunities and finding the best managers are among the biggest challenges of all investors, whether they are institutions, family offices or wealthy individuals.
Second, more investors may take notice of private equity beyond the long-term adherents to the asset class. Typically, ultra-wealthy families are private and offer little transparency into what they are thinking and how they are investing. Their attraction to private equity is notable given that family offices are considered proxies for high-net-worth and ultra-high-net-worth investors. As a result, family offices are often viewed as bellwethers by the wealth management community as advisory firms continue to develop their offerings in ways that will attract and retain wealthy clients.
Hence, wealth advisors who are targeting clients in the upper stratum of wealth will likely take note of the trend toward private equity.
Ultimately, single-family offices increasing interest in private equity could shape the thinking within the broader industry about this asset class.
