As a follow up on Family Capital’s earlier article Five Big Ideas for Family Offices, we look at Five Big Themes likely to affect family offices over the next few years. Inevitably there are some overlaps...but many original ideas as well.
- More family offices are chasing fewer deals
- VC and startup investing is a growing trend
With family offices spending more of their time trying to buy minority and majority stakes in businesses around the world, where to get access - deal flow - to these businesses is becoming more of an issue. Most deals come from personal contacts of the family behind the family office and/or the staff of the family office. But even if you’re Michael Larson, who manages Bill Gates’ money at Cascade Investment, sooner or later those contacts might look a bit stale. Co-investment and club deals might seem the next best avenue, but these might inevitably be more expensive if there are fees required for the arranger. They may also be less lucrative if more individuals have to be cut into the deal.
Family offices are increasingly saying there is too much money chasing too few deals, which inevitably means the good deals get bought up quickly and the less good deals end up in the in-tray of almost every family office in town before being rejected. That’s leading some investors to get more excited about venture capital and startups.
As Family Capital reported a few weeks back, startups love family offices - and it would appear that family offices are increasingly fond of startups. That could suggest that deal flow might come more from startups in the years ahead. Of course, the risk is higher, but the rewards are huge if the right deal is chosen. As the internet of things becomes even more universal, more startups will inevitably become very lucurative unicorns. That trend will surely entice more family office investors - although also many other types of investors as well.
- Asset allocation isn’t getting any easier
- Private debt and real estate are the bright spots
Away from the sexy stuff of taking stakes in companies and finding the next unicorn, many investment teams at family offices still have to deal with the slightly less sexy business of the allocation of assets to portfolios. In a low return environment this has become more difficult in recent years. Add into this equation the less than exciting performance of many hedge fund strategies, and the costs and time considerations linked to private equity funds, coupled with real negative interest rates in most developed markets, asset allocation has become more of a chore.
But it’s not all doom and gloom - there are some bright spots like real estate and private debt. Family Capital talked about the latter in an earlier post - and real estate in an even earlier post. And, of course, there’s always passion investments like art and classic cars - but few investment officers are called upon to use their allocation skills in these areas. Maybe, better to leave that to the family...
- Loyalty might become less important as criteria for senior jobs
- Hedge fund conversion to family offices means more finance types joining FOs
- The fashion for direct deals means private equity specialists are being hired
The staffing of family offices is always going to be an issue. But here’s some recent thinking on the subject. Senior positions at family offices are often staffed by someone with a long-term professional link to the family principal behind the family office. They may have worked in the initial business that made the money in the first place. Often they are accountants or lawyers. But that trend may be changing, at least at the margin. Given the number of hedge funds that have converted to family offices in recent years, more senior family office staff have a finance background. And with direct deals becoming ever more important, expect those with private equity backgrounds to gain more senior positions at family offices in the years ahead.
- The mundane - like cash flow - often gets ignored
- What’s more important direct deals, or asset allocation?
The importance of priorities for family offices is something that often gets overlooked in the rush to buy stakes in other businesses, or some other interesting investment idea. Family Capital discussed this issue recently in relation to the treasury function of a family office. The priorities around cash flow can’t be pushed down the list of priorities - salaries of staff and cash flow to the family are imperative. Another priority that needs defining is the chief investment officer function. The CIO must be allowed to do their jobs - seek out assets and allocate them. Most are trained around knowing about liquid assets, few know much about buying companies - so don’t mix the two.
- Single-family offices aren’t being targeted...
- ...but there’s much potential regulation around the periphery that could be a concern
At the current moment, few regulators appear to be concerned about single-family offices. In America, the issue of what exactly comprises a single-family office and whether that entity should be regulated has died down. The Dodd-Frank Act, which brought up the issue of family offices back in the late 2000s, seems ancient history these days. Unless the financial sector blows up again then it’s probably alright to assume that any detrimental regulation directed at single-family offices in the foreseeable future isn’t likely. Of course, this doesn’t mean that family offices aren’t affected by peripheral legislation like proposed changes in estate taxes in the US, or similar potential new tax burdens on German family businesses - but at least family offices aren’t been targeted directly.