Investment

Family offices are hammering a big nail into the fund management coffin

Family offices can be forgiven for feeling aggrieved with the performance of value-driven stock pickers, to whom they pay a generous fee to look after their hard-earned capital. And asset managers look set to pay a heavy price.

During much of the last 25 years, returns from value managers, who like cheap stocks, have been beaten by growth investors who believe expensive stocks can continue to rise. Growth has produced 10.3% a year since  1994, against 8.8% from value, according to Standard & Poor’s. Hedge fund returns, which tend to be rules-based, have ebbed. The performance of Warren Buffett’s value-driven listed portfolio has failed to impress since 2008. 

It is becoming increasingly clear that technology is the engine driving the trend. The funds which take account of its potential are the growth stocks which are soaring, despite a setback caused by premature enthusiasm in 2000. The rest are laggards. Tech-driven venture capital is trouncing tedious small-cao stocks. Even Buffett is showing interest in technology via a thwarted $5 billion bid for Tech Data and a purchase of shares in Amazon.

One family adviser says: “Clients are fed up to the back teeth with value funds and stock pickers. They have suffered bad performance for one, three and five years. They are voting with their feet.”  Another said: “They are taking back control.”

Family offices are reinvesting in passive funds, venture capital and private assets, forcing asset managers into a world of outflows and fee pressure. They are coming to the view that it would be better to take direct control of private assets than risk falling victim to errant managers like the UK-based Neil Woodford.

According to family office adviser, Obediah Ayton investors are hungry for a new direction: “We’re coming across families that are putting hundreds of millions of dollars into individual companies. They’re building multi-billion dollar allocations on their own. There are families building incubators and accelerators and even in one case funding innovation from the ground up in an Edison lab-like campus.”

Years back, Scottish billionaire Sir Brian Souter opted to manage unquoted investments at his family office, Souter Investments, rather than paying a flat fee to managers to run his money badly. Others are clawing back assets, such as the UK-based Rayne Foundation, whose fortunes were built on UK real estate.

The tech surge began in 1975 when Bill Gates and Paul Allen founded Microsoft to develop operating systems for a broad range of personal computers. Microsoft went on to market and update its systems, seeking to offer value for money. 

After listing its shares in 1986, the company achieved global growth while adding further affiliates. By achieving scale Microsoft kept its prices low – a consistent feature of big tech. Some, like Facebook, opt to charge clients nothing, while making money from advertising and data sales. 

Cloud applications and a management revamp have given Microsoft shares new impetus in recent years. Microsoft’s market value was $1.06 trillion at the end of September, making it the most valuable company in the world, according to the FT Global 500 index. Apple, Amazon, Alphabet, Facebook and Alibaba are close behind.  The only top ten stocks not perceived as tech-driven are Berkshire Hathaway and JP Morgan, both determined to catch up.

Never has a sector risen to such pre-eminence in such a short time. Healthcare is the latest sector preparing for a tech-driven renaissance after the mapping of the human genome. Mobile phone-driven fintech is challenging the banks. The retail trade is being tested to destruction by suppliers using tech, as well as customers placing orders online. Why should asset management be any different?

Technology funds reaped benefits with an average return of 350% over the ten years to October, against a 250% return from the S&P 500, according to Citywire. Strangely, however, chief executives have been slow to build on their achievements, no doubt because they thought the tech bubble would pop one day. 

Exchange-Traded Funds (themselves a tech-driven product) have offered tough competition by doubling in worth to $6 trillion over four years. But this isn’t entirely the result of their low fee. It also relates to their superior performance, as a result of the dominance of tech in passive indices they track. 

Tech comprises 23% of the S&P 500, or 33% if you take account of its influence over other sectors, like consumer discretionary.  This weighting is higher than active portfolios, even where they use an index benchmark. Research from S&P Dow Jones shows up to 90% of active managers lagged their indices over ten and fifteen years.

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