Investment

Back to the Future – for families, there’s nothing new about investing in private businesses

The interest of family offices in private assets is continuing to increase, as they become fretful about prospects for global stock markets.

Cambridge Associates, the consulting firm, believes they would benefit financially by allocating 40% of portfolios to the asset class, in the wake of its outperformance.

I believe we are returning to an era where trusted private businesses will continue to regain the prominence they enjoyed generations ago, with the help of disruption

Cara Williams, senior partner of rival consultant Mercer, says it is hard to say that a 40% allocation would work best for every family office. 

But she adds: “Lots more people are on the search for private equity opportunities than historically.” Returns have been strong over twenty years, and exceptional of late. 

Unlisted private assets include farmland, real estate, infrastructure, energy, venture capital, private equity and private debt.  

In a review earlier this year, consultant Bain & Co said the flow of capital into private markets has been “unprecedented.” It cited financial engineering, high-speed computing and a loosening of financial regulations. 

“Global financial capital increased 53% from 2000 to 2010, reaching some $600 trillion, or 10 times real global GDP. Bain’s macro trends group projects that it is swelling by half again and will reach approximately $900 trillion by the end of 2020.”

Companies no longer need to list their shares to access cheap capital, implying that family offices need to invest in private markets to access quality opportunities.

While ready to assist, Mercer’s Williams warns outcomes could become less compelling, as the availability, and quality, of deals becomes less plentiful. Past performance – even over twenty years – can never be guaranteed for the future. 

Venture capital has become particularly hot as young tech entrepreneurs make their fortunes at a pace never seen before. Consultants have warned families of the risk of becoming sucked into late-stage fundings and floats.

Family offices probably don’t need telling. They have already become wary of stocks and bonds whose prices have been pushed to record highs thanks to the scale of liquidity unleashed by central banks. 

They are tired of backing asset managers charging a hefty fee when cheap passive funds are available.  They are weary of backing top-quartile US equity managers who all lose the status five years later, according to research by S&P Dow Jones Indices. The value managers, who they used to favour, are suffering worse than most.

Investors are wary of the quality of data supplied by corporates, and a fall in the number of broking analysts. They are concerned by the lack of liquidity in parts of the market, and fear it will disappear in a crisis, making mark to market a painful exercise.

US advisory firm PGIM has crunched data from 1996 which suggests that private assets preserve wealth more effectively than listed assets during periods of stagnation and stagflation. From a housekeeping point of view, marking listed assets to market is no fun during a slump when prices go into freefall.

Over the centuries, Europe’s family offices have prospered by investing in their landed estates and businesses, with limited resource to stock markets. The Yale endowment demonstrated twenty years ago that the premium returns which can be earned from private assets were worth seeking.

In May, family investor Marcus Thompson told Family Capital: “I believe we are returning to an era where trusted private businesses will continue to regain the prominence they enjoyed generations ago, with the help of disruption.”

Cambridge Associates says long term investors like family offices: “stand to benefit not only from the potential for higher returns, but also from the tax-advantaged nature of private investment.”

Its research shows that median returns from family offices with a 15%-plus tilt to private assets have generated annualised return of 8.1% – 160 basis points higher than those with 5% or less.

Recruitment specialists confirm family offices and endowments are keen to recruit professionals capable of handling private assets in a competitive market. 

The Ford Foundation currently wants to hire an investment officer who, ideally, would have “private equity investment expertise with significant knowledge of the impact investing market.” The David & Lucille Packard Foundation is seeking a professional “with a background in private equity and venture capital.” 

Family offices are keen to find expertise to challenge private equity firms which charge base fees of 2% plus 20% of performance and lack transparency. Many are keen to reduce their dependence on them. Pritzker Private Capital has become renowned for the way it co-invests with its peers.

Consultant Deloitte says: “We are seeing a steady increase in co-investment as vendors seek investment from new sources and family offices either establish their own fund structures or seek partners to by-pass traditional investment pathways.”

It all takes time to find the right co-investment partner, as it points out.  But amid the current feeding frenzy, it makes sense for family offices to take all the time they need. 

Few others have that luxury.

 

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