Going direct – it’s an undeniable trend. It is a not only a shift we’re seeing not only in companies operating in the consumer space, but it’s also pervading the listings of private tech companies and increasingly family office investments.
While family offices have historically relied on asset managers to perform due diligence on potential investments and entered deals as limited partners, over the past few years, there has been a shift in this approach. Increasingly, larger family offices are becoming more sophisticated, building in-house investment infrastructures and pursuing direct investment strategies. Here are 5 reasons why.
Greater control and decision-making ability
According to a new report by FINTRX, covering data points on 2750 Family Offices — on average 41% of family offices invest direct with close to 60% in Asia. This is supported by the UBS Global Family Office Report, that estimates within the average private equity portfolio, 54% of investments are direct. These types of investments are more attractive than funds as they not only provide greater transparency and decision-making authority but also increased control over other investment drivers. These factors not only appeal to entrepreneurial families but also the next generation who desire to be more ‘hands-on’ when it comes to overseeing their family’s businesses and finances.
What’s more, the built-out internal investment infrastructure that direct investing necessitates is essential for the continued growth of the family office as the next generation who may lack investment knowledge prepares to take over the vast wealth and investment responsibilities of the family office.
Better value and interest alignment and return
By engaging in direct investing, family offices can use their permanent-capital status to better align their mindsets, values and interests with their investment strategies to maximize genuine cash-on-cash value rather than short-term rates of return.
Many ultra high-net-worth (UHNW) investors who started as entrepreneurs and built successful businesses often identify with those in similar situations. Thus, they may prefer investing directly in founder-led or entrepreneurial driven opportunities in industries where they already have expertise and connections and can make more than just a capital contribution to start-ups success.
Family offices are also generally able to hold investments for longer periods than traditional equity funds, which can yield more significant returns through direct investment. According to Bain & Co, permanent capital investors who compound their returns in the same direct investment vehicle for over 24 years, achieve almost double the return after-tax. This is in comparison to investors who buy and sell a series of equally performing investments within the traditional five- to six-year private equity lifecycle. This differential is achieved through improved optimization of exit timing, greater efficiency in taxation strategies, the eradication of buying and selling costs as well as the down time between capital deployments.
Reduced fees and expenses
Another driver behind the family office’s direct investment trend is the reduction of fees and costs this presents. For decades, family offices have paid the industry-standard 2% management and 20% performance fees, or more when investing in top quartile funds.
With falling asset values and unprecedented financial market volatility in recent years, has come the questioning of traditional investment strategies. This has led affluent families to investigate alternatives such as direct investments outside of funds, co-investment opportunities and club deals with other wealthy families in their networks, to preserve capital, manage risk and minimize fees and expenses.
The strength of Family Office networks
Affluent families are generally well connected, as are the businesses they run. Recently, however, family offices have begun to strengthen and broaden these connections, much like their private equity peers, to not only keep up with market trends and best practices but also foster opportunities and proprietary deal flow.
These stronger, more diverse connections facilitate networking and information-sharing amongst larger numbers of family offices. This, in turn, helps those involved to diversify their investments and leverage each other’s deal flow.
Some family offices have taken their collaborations a step further, pooling their capital and expertise, and entering cooperative investments or “club deals”. This form of collaborative investing not only enables greater diversification but also reduces risk and leverages the expertise of close family networks in industries where these families already hold a significant strategic advantage.
Making an impact
As the next generation enters the family office and prepares to take the reins, many are asking how they can put the family’s wealth to work for good. While philanthropy was often their predecessors’ answer, and in many instances still has its place, for this generation, market-based tools like sustainable and impact investing are often far more appealing. Instead of making money and then giving it away, these forms of investing offer the opportunity to make money and do good simultaneously, a model which the younger generation considers far more sustainable.
These avenues offer several direct investment opportunities. In terms of performance, according to the Global Family Office report, 69% of sustainable investments matched investors’ expectations, while 16% exceeded them.
Direct investing is not without its challenges and getting started is often significantly more complex and resource-intensive than some realize. However, when effectively planned for and managed, it can, as many family offices are successfully demonstrating, be both highly rewarding and lucrative for all involved.
SOURCE : FORBES