Last week I talked about the Family Office Deal Flow Summit and how Family Office Direct Investing is beginning to gain a lot of traction in the investing community. This week I would like to elaborate with some details on what that translates into for Family Offices in practical terms. First of all, why is this shift happening?
Single family offices currently account for more than $2.4 trillion in investable capital globally, making them sizable competition to the Private Equity and Hedge Fund industry. As the number of high net worth individuals increases around the world, the family office industry continues to blossom, as does its investment strategy. The current trend is a move away from investing through funds and towards direct investing. This wave of change can be attributed to a need to address the opacity of funds after lost capital following the crash of 2008, challenges in the fiscal year 2015 due to a collapse of commodity prices, and concerns over slowing growth in China. The growing desire for transparency and proprietary control has led 70% of family offices to opt for direct investing in 2016.[i]
The following three major characteristics of funds have spurred family office direct investing.
- Fees – Most funds traditionally charge a 2% annual management fee and keep 20% of the profits.
- Opacity – After 2008 and the implementation of the Dodd-Frank financial regulations (the House passed the Financial Choice Act in June 2017, which effectively guts Dodd-Frank – the bill’s destiny now rest in the hands of the Senate), people became more concerned with where their money was invested.
- Misaligned Interests – Funds do not necessarily allow families the ability to invest in industries of their choosing.
Further to the above, investing through a fund returned 15% less than direct investing for family offices in 2015, [ii] and it is projected that this trend will continue. Because the family office can hold on to the stakes for as long as they want there is also the potential for greater tax efficiency in addition to the greater returns.
Family office direct investing however comes with its own set of challenges. Not all family offices have the experience to successfully execute deals or generate deal flow. Families can however leverage their own experience and existing relationships by partnering with other families in investments in their respective industries of expertise.
The bottom line – family office direct investing is expanding and so is the way and complexity with which family offices invest.