Tapping into family office investors

What private equity fund managers need to know.

37

Over the past few years family offices have become increasingly significant players in financial markets. These offices, which invest on behalf of the world’s ultra-wealthy, have substantial, and growing, pools of money.

For example, George Soros’ family office manages assets worth an estimated US$25-billion (over R385-billion). The office for the Ortega family in Spain, which is most famous for the fashion brand Zara, manages a portfolio of over US$13-billion (over R200-billion).

These are just two of the largest examples of what is a growing global phenomenon. According to EY, the number of family offices around the world has grown from 1 000 in 2008, to more than 10 000 today.

These investors are also deploying their money in more diverse ways. The most recent annual survey of family offices by the UBS Group finds that private equity is becoming an increasingly attractive area for these kinds of investors. The UBS survey found that private equity – both through funds and direct investments – now represents the second-largest allocation among global family offices, at 19% of their portfolios. This is largely a result of these investors looking to diversify and find alternative sources of return. This is as true in South Africa as it is anywhere else.

Hedge funds have lost some of their attraction due to concerns around high fees and disappointing performance; property has not been as lucrative as it has been historically due to the weaker economic environment; and listed shares have delivered poor returns for several years. Private equity has outperformed all of these asset classes, and indications are that it will continue to do so.

Family offices are managing wealth that is intended for multiple generations. Their objective is not simply the highest possible return, but to protect a legacy and long-term value.

Family offices have therefore shown a growing appetite for these kinds of investments. Some of the largest of them have employed former investment bankers to manage these investments directly. Rather than the traditional approach of going through a private equity fund manager, they are making their own acquisitions of private companies.

Sometimes this is done alongside established private equity funds. In other cases, they may choose to act alone.

The attraction in this approach is that it offers far more flexibility than using a fund manager. They are not tied to a specific mandate to invest in only a specific sector, for example, but can deploy capital wherever the opportunities seem most attractive. Family offices are also used to being fully in control. They are not always comfortable delegating investment decisions to a third-party manager.

In addition, the interests of private equity funds and family offices do not always align. Family offices are managing wealth that is intended for multiple generations. Their objective is not simply the highest possible return, but to protect a legacy and long-term value.

Increasingly, family offices are also looking to be a force for good, and for their money to deliver social as well as financial returns. This is going to become even more the case as wealth passes to the next generation. Millennials are estimated to inherit US$41-trillion (R630-trillion) from their baby boomer parents over the coming decade. This younger generation has a far greater interest in making an impact in society and want their investments to reflect that.

This is the environment that private equity fund managers need to navigate in order to be relevant to this pool of investors. If they are to attract money from both smaller family offices looking to diversify and even larger ones with their own private equity teams who may be looking for additional opportunities, they must have a compelling proposition that appreciates what family offices require.

Impact investing is an area in which they could be particularly relevant. As this is both a specialised and highly diverse area, family offices, whatever their size, are unlikely to have the expertise to identify and monitor the most meaningful opportunities. Since the point of impact funding is not just to earn a financial return, but also to deliver positive societal benefit, there is also a need to measure the scale and effectiveness of that impact.

Family offices will struggle to do this in-house. Private equity fund managers who can centralise this monitoring into the fund administration system could therefore present them with an attractive proposition. Private equity fund managers also need to be conscious of family offices’ desire to be more flexible and nimbler in their investments. They don’t want to lose that when engaging a third party.

The way funds are administered is therefore critical. The structures should not be opaque, complex or difficult to understand. If they are to attract money from family offices, they need to show that they are not unwieldy.

Khurshid Fazel (left) and Michael Denenga (right), Partners at Webber Wentzel

Finally, private equity fund managers need to consider their fee structures. The traditional 2% management fee is unlikely to look appealing to family offices. They want something that is more relevant to their needs. Managers should therefore consider alternatives. Waiving part, or even all, of the management fee in favour of fees based entirely on performance may be one option. Foregoing management fees during the commitment period of the fund is another.

Ultimately, private equity fund managers need to be prepared to listen to the specific needs of family offices and be prepared to innovate around them. That will give them the best chance of attracting and retaining capital from this significant potential client base.

[Images: Supplied (featured), Pixabay]