Why family offices are starting to think like pension funds

The family office might have been around since the 19th century, but its repurposing as an investment vehicle has taken on a new prominence, writes Arun Kakar

Sagging interest rates – the norm since the financial crisis ten years ago – have made many family offices more active, driving them to deploy their capital more aggressively in pursuit of higher yields. Amid instability and saturation, HNWs are increasingly taking investment matters into their own hands

Of course, no family office is the same. Some are set up to consolidate accounts while others simply look after general lifestyle matters. But they do share an objective:  the preservation and protection of wealth for future generations, as a result of which they have tended to be characterised as sedentary in terms of their market activity. However, while as little as five years ago, low risk, long term assets were favoured, this has changed in line with the shift in direction of the investment climate over the last three years.

‘The capital they’re investing is working much harder,’ says Mark Pesco, CEO of First Names Group tells Spear’s. ‘Families are trying to get higher yielding assets and are therefore exposing themselves to different asset classes as well.’

Dubbed the last frontier of private capital, family offices have been undergoing what many fund managers are calling ‘professionalisation’. Offices are becoming much more efficient operations, creating their own investment vehicles to keep running costs low whilst diversifying their portfolio contents. Many are hiring consultants to advise on allocation, enticing them with generous compensation packages to bring their expertise in house. Some are even rebranding themselves as ‘family capital’ or ‘investment’ firms to depart from the associations of traditional family office activity.

‘There’s been a growing evidence that consultants are being used in private wealth management, and private offices may use them to help construct asset allocation and assets they may not have considered in the past, ’ Fred Hervey, Chief Investment Officer at Lincoln Private Investment tells Spear’s.

This move matches with the simple appeal of a family office as a proposition: control, customisation and agility are unmediated and private. There are currently around 15,000 family offices managing around $1.8 trillion in assets worldwide, estimates say.

These factors together are moving the modern family office into the domain of pension funds, where they are often finding themselves competing over the same types of investments. Indeed some Chinese multi-family offices have been seen bidding against some of the world’s largest pension funds and insurance companies for significant real estate assets – and they’re winning.

One of the most notable areas where family offices are moving into the same areas as pension funds is private equity. Five years ago, family offices’ activity in private equity was similar to that of government agencies: lower risk but stable assets used to be the flavour of choice.

Now they are the fifth largest investor behind sovereign wealth, insurance companies and, yes, private and public pension funds. But the appetite for higher yields, direct investment opportunities has intensified amid political and market volatility. Family offices share the same long term investment horizons as pension funds, and are following them on the path to less liquid opportunities.

As well as this investment backdrop, these ‘professionalised’ family offices are ruthless and effective outfits. They can bring vast sums of liquid capital to the table to support larger deals, and they are in most cases faster to put money down than private equity firms. Family offices typically have stronger relationships with fund managers too, and are offered individual and co-investment opportunities before anyone else. They can spend their money without the worry of fund expirations, bolstered by their experience in operating multinational companies with success.

‘Family offices are borrowing at less and looking for higher yield assets,’ adds Pesco. ‘A number of them we’ve seen have managed to reach double digit cash on cash returns, particularly in 2016.’

Thanks to their acumen and network, they are also able to expand their reaches further; exploring more sophisticated and exotic investment opportunities.

‘Family offices are not as capacity constrained as some large institutions,’ says Hervey. ‘They’re able to look at investment opportunities where there are £50-150 million funds that they would like to back. If you’re a very large institution, there’s no point in even looking at those, because you’ll fill it in a single hold – this flexibility is often related to scale.’

‘Many family offices are able to access slightly more unique, slightly more capacity constrained opportunities where you can really use a niche, and might be able to generate a return you couldn’t do otherwise.’

As this competition increases and family patriarchs begin to cede control to younger generations, strategies will continue to change as family offices continue to become more active. A PWC survey last year found that the 50 per cent of HNW next-gens want to diversify the family business, and 88 per cent want to do something that is ‘really special.’ One of the ways in which this is translating into the investment sphere is in impact areas such as education, energy and environmental conservation.

Impact investment is socially conscious, piquing the attention of millennial family members, but most importantly it also generates returns. Some 70 per cent of impact assets under management are held by private capital, in both debt and equity, according to the Global Impact Investing Network. That it has caught the attention of family offices signals this shift in thinking towards a longer term strategy, with wealth managers encouraging longer investment horizons – many of which are now dated at over 12 years.

Family offices, then, may indeed be ‘thinking like’ pension funds, but crucial differences between the two make them a new force on the market: as well as their agility and speed, the only ‘pensioners’ they are preserving capital for is their family and there’s certainly no liability payments to worry about. The sleeping capital is awake.

Arun Kakar is a graduate journalist at Spear’s