Does money beget money? To the outsider with no, or little money, that old proverb probably seems true. Rich people have a lot of money, and that helps them make even more money. But, ask those running a family office, and the answer might be somewhat different.
Many family offices have lost huge sums of money on bad investments, and will continue to do so. Of course, many have also made huge sums of money, and will continue to do so. Money isn’t so much of a factor of that success, much more investment judgement and timing.
Family Capital doesn’t give investment advice, but here’s some discussion around what it believes are some interesting investment themes popping up in the family office world in the last year. And they are themes that will play themselves out for sometime yet...
Everyone and their mother appears to be interested in fintech these days. The money pouring into the sector is staggering - according to the consultancy group Accenture, $5.3 billion of investment went into fintech in the first quarter of 2016, a 67% rise on the same period a year ago. Banks, venture capitalists, private equity firms, corporates and others have ploughed more than $50 billion into nearly 2,500 fintech startups since 2010.
Investors are chasing fintech unicorns – start-up companies with listed valuations of a billion dollars, or more. Some say there’s around 46 of these unicorns and potentially many more waiting to explode on the scene. But is there much family office money piling into the sector? There is, but probably not as much as might be expected - and most of it is indirect, through VC funds and private equity. Fintech experts say the sector is due for some consolidation. “There will be a bloodbath in the sector when the big tech groups like Google and Microsoft decide to commit to the sector,” says one London-based analyst.
Here’s what one family office principal had to say about fintech: “There will be some winners, but picking them is as difficult as with other small companies. And the jury, including the Basel one (over regulation), is still out, when it comes to passing a verdict on what this will do to banks. Banks greatest asset is trust. Do we trust these new disruptors? What happens when they are hacked or the system taken down by rogue elements? Since they are not regulated, who is responsible/accountable? So they may reduce cost, but the risks are not known?” So, concern about best, outright scepticism at worse about fintech...
Like any new investment theme, the big money is likely to be made by the vendors. Individuals like the German entrepreneur Michael Gastauer, who is the founder of WB21, one of the fastest growing fintech startups in Europe. Gastauer has already set up a family office. So, maybe that’s where the more interesting angle is from a family office perspective - new ones set up because of the boom, rather than old ones making a killing from the sector. And the other issue for family offices - automation of their processes and the introduction of artificial intelligence in investment decision-making.
Family on family investing
There’s been a lot of interest around family offices buying into family businesses. After all, it makes sense. Often the wealth behind a family office is derived from a family business, either still owned, or sold. So, with the adage about sticking to your knitting, many family offices feel they know about family businesses and like to invest in them because of this.
Here’s a good example of such an investment. Fermont Private Holdings, the family office of the Bechtel family, owners of the eponymous engineering and construction company, invested a few years ago in the second generation-run California-based In-Shape Health Clubs, and provided much-needed capital to the group. Also, Warren Buffett is one of the biggest proponents of buying value companies like family businesses - and it’s certainly not done him any harm. Family businesses are also buying other family businesses.
Such deals are popular with family businesses and offices because of the family behind the office often understands the mentality of these businesses. They are also popular with cash-strapped family businesses wanting to expand, like In-Shape Health Clubs. Expect this type of investing to grow rapidly in the years ahead, but unlike fintech, it will be a much more low key affair. That may make it more successful.
Private equity appears to be gaining favour again with family offices, or at least that’s what studies suggest. There’s probably a number of reasons behind this. Firstly, some private equity houses are bending their rules on how long they are willing to flip an investment from five to seven years, or even longer. This helps to create more of a “long-term” investment mentality, which family-linked investors often prefer.
Secondly, fees are being cut to make it more encouraging for limited partners to commit funds. Thirdly, some private equity managers are taking more skin in the game, which shows a greater commitment to the investment than what may have been the case before the financial crisis of 2008. And lastly, despite many family offices wanting to do direct deals, there’s a limit to how many they can do. Due diligence costs are often high with these deals, and the risks sometimes outweighs the returns. As such, many family offices will continue to be LPs in private equity opportunities.
Michael Sonnenfeldt, the founder and head of the ultra-high net worth membership group Tiger 21, said back in 2009 that the wealthy were so angry with the performance and the redemption restrictions of hedge funds during the financial crisis that they’d be reluctant to invest in the them in the future.
Although Sonnenfeldt’s prediction might not be completely have played itself out, he certainly has a point. It’s difficult to get any quantitative data on the portfolio allocation of family offices into hedge funds. But it’s probably right in saying that it’s considerably less than it was before the financial crisis. And trends in the sector aren’t encouraging family offices back to hedge funds. Last year, more hedge funds shut down than at anytime since 2009, when the financial crisis reached its height. Tougher regulation and investor scepticism towards the sector have tarnished enthusiasm towards hedge funds.
The main trend as far as hedge funds and family offices are concerned is probably the number of hedge fund managers throwing in the towel and converting to family offices. That is probably only going to continue in the years ahead.
The idea of investing with others in a pooled structure has gained ground in recent years. That’s probably because co-investment for family offices represents a nice half-way house between full-scale direct investment and private equity. There is more skin in the game than private equity, but some of the risk of going it alone is mitigated when pooling investment with other parties.
Again, like most things family office-related when it comes to investing, it’s difficult to get an idea of how many co-investing deals are being done in the sector. But anecdotal evidence suggests it’s risen substantially in the last 10 years, and will continue to do so. Co-investing partners are often fellow family offices, but not always, private and investment banks have also done many co-investment deals with family offices. Expect these types of deals to increase in the years ahead.