UBS publishes an informative report that surveys family offices (“FOs”) from around the world on a variety of topics including investments, governance, succession, cost structure, and philanthropy. I’m slow to write about the contents of the report, but better late than never. I’m sticking to areas where I can pretend to know what I’m talking about, so we’ll highlight investments topics. Most of this will be a recap with some of my opinions and perspectives thrown in relating to topics of interest. The whole report is worth a look if you aspire to better understand how FOs invest, how they are structured, and how FOs work to meet the needs of their principals. There are even staff compensation data points for people considering a career path working for FOs. All charts are from the 2019 UBS Family Office Report unless noted otherwise.
Most Family Offices Are Relatively Young Organizations
About 2/3s of FOs were founded in the last two decades in a roughly even split. Almost 1/3 of FOs haven’t been through a full economic cycle. What will be interesting in the future is to see how many of these younger organizations react to market turbulence greater than what was experienced in 2016 and the end of 2018. Will these young FOs be positioned to capitalize on opportunities if/when we have sharp decline in asset prices, or will groups get too aggressive as the cycle continues onward and find themselves overextended in a time of potential opportunity. The experience of the investment professionals on the team isn’t the only factor at play here. Principal’s attitudes can change quickly when they see their net worth going in a negative direction and younger teams may have less trust with end decision makers relative to their more established counterparts when things get tough.
Another implication of the relative freshness of many FOs is these young groups are often evolving as investors looking for what aligns with their strengths and the objectives of their principals while generating results. I’ll save a deeper exploration of this topic for a later post because there is plenty of meat on that bone. Let’s just say strategy whiplash is very real. And it sucks.
Second and third generations are serviced in the same or greater quantity than the first generation. For those of you that don’t have as much experience interacting with a variety of FOs, teams founded by first generation wealth can have a very different character and mindset relative to FOs primarily serving subsequent generations. As always all FOs are their own snowflake, but my experience is G1 driven FOs tend to have a stronger entrepreneurial spirit than the average G2 or G3 lead organization with more engaged principals (not always a good thing). Serving younger generations is also a key driver of ESG investing becoming more prevalent in FO investment strategies. A quote from the allocation section expresses the view that generational changes are increasing the risk appetite of some FOs.
“A lot of money has been changing over to younger hands – and the next generation has a longer investment horizon and also a bit more risk appetite than the older generation.” – Portfolio Analyst, Multi-Family Office
Where Did You Get All That Money?
The breakdown of industries where families originally generated their wealth is interesting. At first I was surprised by finance and insurance being the source of wealth for ~1/5 of survey participants (~1/3 if you include real estate), but this is less of a shock considering families with deeper experience in financial services are more likely to build out an investing FO compared to families who generated their wealth elsewhere. The composition of survey respondents could be swinging the results with 360 2019 survey participants vs 311 in 2018. Or maybe finance and insurance jumping to the top is a result of all those hedge funds shutting down and turning into FOs? 2018 data is the second chart below.
FOs most commonly pursue a balanced investment approach while growth strategies are more prevalent than a focus on wealth preservation. AUM had relatively little impact on the type of strategy used by a FO, but different regions have notable discrepancies in strategy. North American FOs are more likely to focus on growth and invest more in equities because ‘Merica.
Where Are You Putting Money to Work? Alternatives ….. Duh
Alternatives account for over 40% of the average FO portfolio. Hedge fund allocations keep coming down. High fees, doubts about downside production, and junky performance (the real culprit) were cited as reasons for waning interest in hedge fund strategies.
Direct private equity investments made up a larger portion of portfolios than investments in private equity funds. This result was out of line with most of my personal experiences, but I also wouldn’t be surprised if some survey respondents included some family run businesses in this number. I could also just be ignorant and wrong.
Real estate was the most added to investment category at +2.1% vs 2018. Have to make sure your principals have that mailbox money. I wouldn’t be surprised if this continues to increase over time. Principals can wrap their minds around real estate faster than a variety of other strategies, tax efficiency in certain real estate investments can be material, and the labor lift needed for some FO approaches to real estate by the investment team can be relatively low. Real estate was a much smaller portion of portfolios for $1B+ FOs at 12% vs 20% of portfolios for FOs under $250M. The $1B+ FO crowd was generally in more liquid assets than their smaller peers.
The Family Office Magic 8 Ball
Survey respondents expect to increase allocations to alternatives in the future. Good news for sponsors raising those dollars. Direct private equity, private equity funds, developing market equities, and direct real estate were strategies most likely to see increased allocations in 2020 with more than a third of all respondents expected to deploy more capital into these strategies. None of these strategies are a monolith, but the projected allocation changes of FOs are interesting considering their concerns about risk.
55% of FOs believe a recession is coming in 2020, thought I feel like the we’re 12-18 months from a recession song has been playing since 2013. 42% of FOs indicated they were increasing cash reserves, but only 26% indicated they were increasing cash or cash equivalent holdings for their portfolios in 2020. 45% of respondents claim to be re-aligning investment strategy to mitigate risk. My experience in conversations with other FOs is the prospect of a recession is weighing heavily on decision makers with the length of the current economic cycle cited as the number one reason as to why a recession is near. I doubt these conversations with FOs are different than the ones any of the readers here might have had in the last several years.
What I find most interesting about these answers is 46% of FOs expect to increase allocations to direct private equity investments while a majority of FOs believe a recession is around the corner. Given the relatively young age of most organizations, roughly a third haven’t been through a full economic cycle. I hope organizations hired people with ample direct deal experience to help manage through an economic downturn because a recession could be a painful learning environment for many teams. There could be bifurcation in views and responses in the survey, but I imagine there is cognitive dissonance present in some respondents answers.
Below are some quick hitter observations on FOs views of private equity and real estate.
- FOs like direct private deals because of greater control and a reduction in fees. Below is a chart from the 2018 edition of the UBS Family Office report.
- Passive direct investments were the most disappointing portion of private equity portfolios.
- Growth investments were the most common type of private equity investment employed by FOs. Can say this lines up with personal experience and from comments out of groups that are trying to create opportunities tailored for FOs.
- Technology companies were the most popular for direct investments.
- Club deals were the least likely to disappoint, though return expectations were lower than buyout or growth deals.
- Below is a quote that I would call the FO investment direct dream. This will be a topic explored over time. I’m curious to see which FOs commit the resources necessary to execute on the dream and which ones will get disillusioned about the work necessary to execute direct strategies at a high level with in-house staff.
“I encourage families to get closer to the assets they own. The best way is to align yourself with other families interested in avoiding agency risk, pool your capital within the appropriate governance framework, and create collaborative vehicles. Families should spend more time focusing on how they can disintermediate financial institutions – such as private equity and venture managers. There is plenty of talent out there to bring this work in-house. I think we are going to see a lot more of this.” – Chief Investment Officer, Single Family Office, North America
- FOs have a strong local bias with their real estate investing. My experience is FOs can feel content with the opportunities in their back yards cutting down on the drive for teams to explore other markets. Staying on top of your local market is much easier when you know what’s coming down the pike because of the country club crew.
- Office was the most prevalent type of FO real estate investing followed by multifamily.
Please check out the report if you want to see additional details or commentary on topics that interest you.