Family offices develop a taste for private equity

Global wealth has been growing over the past 30 years in spite of market turbulence caused by the various crises from 1987 to 2008. 

In developed markets, the positive returns from real estate and equity capital markets have contributed to a steady year-on-year growth in global wealth. In emerging markets, economic stabilisation, lower inflation, market liberalisation, growth of local capital markets, and significant infusions of foreign direct investment have created unprecedented wealth.

As an example, Brazil had a sustained 3.2 per cent GDP growth over the past 20 years and between 1990 and 2012, there was $912bn (€809bn) in M&A volume, with more than 8,000 Brazilian companies changing hands to internal and external buyers.

Many wealthy families around the world have been establishing family offices to administer their fortunes. These range from a team consisting of the patriarch or matriarch, the chief financial officer of the underlying operating company and a secretary, to a fully-fledged corporate entity with a large complement of more than 100 specialists. These address legal, tax, philanthropy and succession issues, manage the investment portfolio, consolidate and report on all the family’s bank accounts, and provide “concierge” services such as paying the salaries of the household staff or booking hotel rooms for family members. 

These ‘single family offices’ focus on one family which may include different generations and related family members. Some of these single family offices have morphed into ‘multi-family offices’ which provide the same services as single family offices but –for a fee –attend to the needs of unrelated wealthy families. 

There is also a large and growing number of wealth management boutiques, usually established by ex-private bankers and asset managers, which call themselves family offices but tend to focus strictly on portfolio management. 

Wealth preservation

Because the principal focus of family offices is preserving capital for future generations (or causes), their investment horizons tend to be longer term than those of traditional investors. This makes them active participants in illiquid and alternative investments such as real estate, private equity, and hedge funds.

While real estate – both residential and commercial – is the universally preferred investment class among the global wealthy, single family offices have been increasing their participation in private equity investments and, as such, have been an important alternative source of capital to small and medium enterprises. 

The 2015 UBS/Campden Wealth Global Family Report estimates the average family office allocates 22 per cent of its portfolio to private equity and of that, two-thirds is invested in direct private equity deals rather than through limited partnerships, co-investment opportunity or deals arranged by investment banks.

Among families who still retain part or all of the family business, the tendency is to invest in direct private equity deals, traditionally in local and national markets, and usually in an industry sector the family is familiar with. Many of the principals behind the family office want to “stay in the game” and remain active and hence may actively participate in sourcing the private equity opportunity, negotiating the terms of their investment and taking passive or active roles as board members.

Where the family has completely sold the business which was the source of the family wealth, or where they want to avoid an overexposure to their local  market or industry sector, the tendency is to invest in funds structured by investment banks or private equity firms, and increasingly, with other family offices as co-investors. 

Wealthy families are talking much more with each other through their family offices at local, regional and increasingly global levels and are to some extent disintermediating their traditional banking relationships. The main challenge when it comes to co-investing with other family offices is finding the right partners who share the same values and objectives.

Single family offices tend to prefer direct private equity investments rather than investing through funds. On the other hand, multi-family offices are generally less prone to invest in direct private equity. If they invest in private equity at all, they will do it through the vehicle of an institutional fund syndicated through an investment bank or private equity firm, or as limited partners in a co-investment opportunity. Portfolio management firms which call themselves “family offices” tend to avoid investing in private equity altogether.

Training ground

The family office can be an important training ground for younger family members to “cut their teeth” in managing the family wealth. However, many family offices specifically prohibit family members from joining the family offices and prefer to hire external specialists in portfolio management and corporate finance. 

Private equity is an interesting asset class for family offices but many families either avoid these investments because they lack the internal corporate finance expertise required to analyse the investment opportunities, or worse still, may think they have the internal expertise but end up investing in the wrong deals. 

Recruiting and retaining specialist staff is a major issue for family offices and this has created an opportunity for specialised third-party investment boutiques to assist family offices in sourcing and negotiating direct private equity investments and also representing the families on the boards of the companies they invest in.

The global wealthy are increasingly turning to family offices – be they single or multi-family offices – as an efficient way of addressing the complexities of managing their wealth across multiple jurisdictions. And because capital preservation over a longer investment horizon is their preferred investment orientation, illiquid and alternative investments such as real estate, private equity and hedge funds will continue to grow, especially in this low interest rate environment. 

As with all investments, the issue is to have the expertise, be it in-house or outsourced to analyse and monitor the investment. This is especially true when it comes to private equity.    

Gerard Aquilina is an independent family office adviser based in London and was previously a senior leader with UBS, Barclays, HSBC and Merrill Lynch