A March 2017 article in The Wall Street Journal described the family office as an investment phenomenon. Indeed, the story referred to the co-investment practices of 15 of the United States’ wealthiest families ultimately growing into a network of 150 high-net-worth families. Family offices are what the article describes as “disruptive force” entities that are being “set up to manage the fortunes of the wealthy, and able to operate under the radar.” Family offices are capable of conducting transactions that “traditionally were the province of big companies or private-equity firms,” and they are “making their presence felt with their growing numbers, fat wallets and hunger for deals.”
This lurid language might seem somewhat hyperbolic, but the trend line is unmistakable. Family offices are on the rise, and the numbers are staggering. In 2008, an estimated 1,000 single-family offices were in the world. Less than a decade later, EY reports the number has grown to more than 10,000 family offices globally. Family Office Exchange reports, while most estimates peg the current number of family office in the United States to somewhere between 3,000 and 5,000, the real figure could be closer to 6,000.
Because family offices do not have to be licensed or registered, precise figures on family offices and foundations remain somewhat elusive. Despite their growing influence and importance, family offices have been a somewhat underreported segment of the investor community.
The biggest reason for the spike in family offices is straightforward — higher levels of family and individual wealth, both in the United States and around the world. 2015 saw a 6.4 percent increase in the number of billionaires globally, to nearly 2,500. From the financial rocket fuel of Wall Street, to the entrepreneurial potential of Silicon Valley, the time it takes to make staggeringly large amounts of money has decreased, and the path to extreme wealth has never been more accessible. Research conducted by Dominic Samuelson, CEO of Campden Wealth, suggests family offices currently hold assets in excess of $4 trillion.
While some have cited high fees or subpar returns as a motivating factor for shifting to a family-office investment model, the spike in family-office popularity likely has more to do with the fact family offices give investors essentially complete control — something that is particularly appealing to a group of people with a disproportionately high degree of experience and affinity for independent business-building leadership — all with little or no regulatory oversight. Provided investment advice is confined to “descendants of a common ancestor within 10 generations, plus others such as key employees, adopted children and former spouses,” they are not required to register with federal regulators.
Although the generally accepted “threshold of affordability” for family offices is $100 million, the higher that number goes, the more common family offices become. North of $250 million in investable assets, family offices are actually becoming the investment vehicle of choice.
Not only are individual family offices becoming more popular, but so are the larger family-office networks like the one I described earlier. These networks make it possible for wealthy families to invest in private equity-style club deals and engage in a wider range of more aggressive and ambitious investment strategies.
PLUSES AND MINUSES
The lack of licensing and registration means family offices can stay keenly focused on their own portfolio instead of on thousands of clients. They also have the resources to hire top accountants, attorneys and due diligence professionals before structuring a deal. As always, the golden rule applies: He who has the gold makes the rules. Family offices are, increasingly, where the money is.
Dealing with one client and one office instead of trying to raise $50 million from 500 different clients has some obvious appeal. The structural simplicity can help with timing and pricing, and streamline negotiating processes, all of which can create efficiencies and lessen costs. Family offices tend to be more flexible and return-driven than typical investors; they tend to want specific answers to questions such as, “When am I going to get my money back?” and “What is the anticipated growth?” And their investment behavior is generally less susceptible to regulatory changes and market trends.
On the other side of the ledger, family offices have some inherent disadvantages, as well. Because the network is very small, it can be difficult to get an outside perspective. Other potential pitfalls begin with the family nature of the organization. The inherently insular and generational community can lead to some very different policies and perspectives over time. Historically, subsequent generations who inherent significant wealth have a different understanding of the tools and techniques that have been used to effectively grow that wealth. The desire to “not screw it up” can lead to flawed decision making, perhaps most commonly by overpaying on fees to get a silk-stocking advisory firm with a brand name.
As with any family structure, family offices are also vulnerable to the same potentially disruptive or corrosive dynamics that are present in one form or another in almost every extended family. Combining family and business has its upsides, but it also creates the potential for complications. The No. 1 point of contention has nothing to do with investments but, rather, family politics. Sibling rivalries, petty jealousies and deteriorating relationships between spouses are all-too-common and familiar sources of discord and disruption. But in a family office, they can do more than make for a tense Thanksgiving dinner or an awkward family reunion — they can lead to inertia, inefficiency or infighting, with a price tag that ultimately runs into the hundreds of millions. For that reason, advisers that do very well in family office practices often function as much more than advisers; they are almost family counselors.
Private Equity International reports family offices have the most positive attitude to private equity since PEI began surveying them five years ago. The organization’s most recent Annual Family Office and Foundation Private Equity Survey, conducted in conjunction with Montana Capital Partners, reveals “family offices and foundations continue to be among the most active investor groups in private equity.” They are also a fairly stable investor group and a significant source of new capital to private equity funds. The survey suggests the “often entrepreneurial DNA of family office and foundations” makes them a good match with private equity. A UBS and Campden Research survey of 242 family offices found a similar trend: In 2016, family offices globally continued an ongoing trend by decreasing their allocation to hedge funds by almost 1 percent, and increasing their allocation to private equity and private debt by 2.3 percent.
Family offices are becoming more ambitious and are evolving to embrace new opportunities accordingly. They are forming new partnerships to conduct buyouts and acquisitions; they are financing startups, purchasing distressed debt, real estate and esoteric insurance products; and they are even lending to companies and occasionally going into battle with companies as activist shareholders.
None of this growth has escaped the attention of large investment banks, which have recently begun appointing senior bankers to cover family offices. Hedge funds have also taken note. The Wall Street Journal found that, since 2011, about “three dozen hedge funds have converted into family offices after returning their clients’ money.” While this trend may still be somewhat under the radar relative to the impact on the industry, Ward McNally’s observation in the Journal gets to the heart of the matter: Family offices are “as quiet as you possibly could find,” but “they’re writing extremely large checks.”
Jason Kavanaugh is CEO of Concorde Investment Services, a national securities broker/dealer.