Alternative assets play an important role in a family office portfolio, with private equity becoming an ever vital component. Moreover, family offices are solidifying their position as the dominant force in the asset class by increasing their allocations over time.
An average family office portfolio is weighted 50% towards alternative assets, 22% of which are in private equity, including venture capital and co-investing, according to The Global Family Office Report 2015 by Campden Wealth Research and UBS. Office-to-office deals typically constitute a tenth of a family office’s private equity allocations, the report adds.
According to May’s 2015 Preqin Global Private Equity and Venture Capital Report, family offices increased their average allocation to private equity as a percentage of total assets from 17.9% in 2010 to 27.2% as of January 2015, the largest for any investor type.
An increase of over nine percentage points is impressive, particularly when comparing the second most prominent investor type of endowment funds, which only increased their level of commitment by 0.5 percentage points to 12.8%.
“In general, family office investors prefer long-term investments with lower volatility and capital preservation. Many of them take an extremely long-term view on their investments, often over a multi-generational time frame, and the balance that private equity provides between growth in returns and capital preservation suits that approach,” says Dami Sogunro, manager of private wealth, Preqin.
Seeking returns
Family office professionals state there are two primary reasons driving current higher allocations by family offices to private equity. The first is the persistently low interest environment and the second stems from a natural inclination by principals to the asset class as most are entrepreneurs themselves.
Souter Investments — the family investment office of Sir Brian Souter, co-founder and chairman of Stagecoach Group — was set up eight years ago with a primary focus on private equity, explains Andy Macfie, the managing director.
“Sir Brian always had an interest in private equity, being the recipient of funds when Stagecoach was a young, growing, unlisted company. Following the IPO of Stagecoach in
1993, Sir Brian created founder and chairman of Stagecoach Group — was set up eight years ago with a primary focus on private equity, explains Andy Macfie, the managing director.
“Sir Brian always had an interest in private equity, being the recipient of funds when Stagecoach was a young, growing, unlisted company. Following the IPO of Stagecoach in 1993, Sir Brian created He concurs that the increase in allocations primarily emanates
from a search for higher returns, noting that family offices are prepared to accept the illiquidity of the market due to their long term commitment to the sector. “We generate consistently better returns in unlisted investments than other alternative investments,” he says. “We have significantly increased the proportion of unquoted investments and are still pushing to increase this further as we continue to see better returns in direct unquoted investments,” says Macfie.
Stagecoach dominated the Souter Investments portfolio in 2007, with direct unquoteds representing just 7%. Now, the portfolio is biased towards the 33 unquoted investments representing 38% of the portfolio. Stagecoach has reduced as a proportion of the total portfolio from 66% to 44% in the period, despite its own excellent performance.
Ideal investors
Having an entrepreneurial spirit could be one reason for family offices being judged as the ideal investor for the asset class. More importantly, notes Preqin’s Sogunro, family offices are not subject to the same investment restrictions as other investor types, such as banks and insurance companies.
Therefore, unlike funds, family offices are able to negotiate on a wider set of terms with management teams or co-investors. This is because family offices normally have flexible capital deployment models, which means there are no fund term, minimum or maximum investment size.
Nonetheless despite these advantages, family offices are at a disadvantage when compared to the wide breadth of investment capabilities that many of the institutional investors and private equity firms have.
Investment in personnel is vital in order to effectively cover the market. Family offices may have greater flexibility, but at the same time, most do not have professional teams and try to manage this complex asset class without adequate internal resource. Arguably, family offices require a proper in-house team to analyse deal flow and make the right investment choices.
Souter’s Macfie agrees, noting that his firm’s greater activity has been made possible by a larger team which has expanded from two to eleven personnel during the past nine years. “We certainly think that Souter Investments is well suited to private equity given our commitment to, and extensive experience in, the sector. We also are able to hold investments for much longer than most private equity funds. Very different skills apply when investing in unquoted companies compared to quoted investments and you need a larger team to generate and process opportunities,” he says.
Investment strategies
Souter Investments takes a general approach to sectors, explains Macfie, though there will always be an interest in transport, given Sir Brian’s background and experience. The firm invests quite significantly in transport in the regions where Stagecoach has no interest, so is not involved in passenger transport in the UK, North America or western Europe but is active in eastern Europe, Australasia and Turkey. The non-transport portfolio is much bigger than the transport portfolio. “Outside of transport we focus on the UK, can invest anywhere between £2m-£25m and depending upon risk/reward, target an internal rate of return of at least 15%,” says Macfie.
Preqin’s Sogunro observes that buyout and venture capital fund-types are the most established markets in the private equity universe, and are thus the funds that family offices are most likely to be familiar with (see chart). He says this is especially true in the mature geographies of Europe and North America, where family offices may have already developed relationships with fund managers over many years. “In Asia, on the other hand, the developing nature of the major economies puts more emphasis on venture capital and growth funds, and a Preqin survey of Asia-based investors in general, not specifically family offices, in June 2015 found that 43% of them thought venture capital funds currently present the best investment opportunities,” he says.
Fees
Family offices are also taking greater note of the level of fees charged by investment managers. Souter’s Macfie observes that although the market contains a number of very good private equity fund managers who are able to generate very acceptable returns pre-fees, the post-fee returns for investors are significantly lower. “A big driver for us favouring direct investments is high management fees, which are charged from the moment you make an investment commitment. Also, we have good visibility of deals through our network and when we go direct we know exactly what we are investing in and the costs involved. There is no pressure to invest money or sell investments due to fund pressures,” says Macfie.
Family offices need to be mindful that managers do need to be paid for quality co-investments and selecting deals based on the fees charged can be the wrong strategy. Nonetheless, family office professionals observe that some are passing up good investments due to fees and this is prompting increased appetite for co-investment with other family offices.
