Rich families go solo on deals, moving away from private equity

This article was written by Margaret Collins and Simone Foxman from Bloomberg News. It appeared first on the Bloomberg Terminal.

Family offices, which manage the financial and personal affairs of the wealthy, are increasingly taking stakes in companies and committing staff to such efforts rather than investing in private-equity funds.

About 81 percent of offices have at least one full-time employee sourcing and evaluating direct investments, according to an annual survey by the Family Office Exchange released Wednesday. Of the 118 offices polled, firms had an average of three employees involved in the investment process, two of whom had some responsibility for direct stakes.

Driving this push is the perceived lack of returns elsewhere, said Kristi Kuechler, president of the organization’s private-investor center. The average family office surveyed reported a 7.2 percent return last year and there’s less conviction that stocks, bonds and hedge funds will provide stellar returns. In fact, those surveyed reduced their allocation to hedge funds on average in 2016 and most don’t plan to increase it this year.

“The one place family offices think they can still generate double-digit returns is in operating businesses and real estate,” Kuechler said.

Direct investing in companies has become increasingly popular among wealthy families that see value in sidestepping private equity firms’ fees, which typically are 2 percent for annual management and 20 percent of profits. Going direct can also give families more say in investments and allow them to hold stakes longer than many funds permit.

More on how the world’s rich families are putting private-equity funds on notice

The strategy requires manpower to find opportunities and investigate their financials, and then complete the transactions and manage stakes. In some cases family offices are teaming up on deals, said Kuechler. “That’s a huge trend,” she said.

It also means family offices need to ramp up their deal-making expertise. Such firms are already competing more for investment talent against traditional financial firms, said David Druley, chief executive of Cambridge Associates, which advises investors including family offices.

“They need people that are good at manager selection, that are good at strategy selection and understanding where to deploy capital and how to be effective,” Druley said Tuesday at the Milken Institute Global Conference in Beverly Hills, California.

Read more on how family offices are scooping up talent

More than half of families in the survey said they plan to increase direct investments in operating businesses or real estate this year. Returns from those direct investments averaged 8 percent last year, according to the survey. That figure may not reflect realized gains because some investments in private companies may not have been sold, Kuechler said. In 2016, family offices dedicated an average 12 percent of their portfolios to private investments, 7 percent directly and 5 percent through private-equity funds, according to the report.

On the hedge fund front, family offices dropped their average allocation to 10 percent in 2016 compared with 12 percent in 2014, said Kuechler.

“We’ve seen a steady decline in the hedge fund allocation over the last several years,” she said. “And there appears to be very little appetite for increasing the allocation.”

When asked if they plan to increase their allocation this year, 85 percent of respondents said no.

Natural resources, including commodities, had the best return last year for the respondents, averaging 15 percent. Domestic equities followed with a 13 percent return, compared with a total return of 12 percent for the S&P 500 index. Real estate investments by families returned an average of 9 percent, according to the survey.

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