A recent report prompted questions on how and why single and multi-family offices contrast in their enthusiasm for the direct investing approach, and what sort of incentives and pressures shape their attitudes.
When a recent US report showed that single family offices are far more likely to make direct investments than their multi-family office counterparts, it naturally prompted thoughts as to why.
The study, produced by FINTRX, a family office data, research, and intelligence platform, and sponsored by Charles Schwab, shows that the lion’s share of single family offices around the world consider direct investing, a noticeable trend fueled by the desire for superior yields and to reduce intermediaries’ fees. (A separate report by UBS in 2019 estimated that within the average private equity portfolio, 54 per cent of investments were direct.)
The FINTRX report estimates there are about 3,500 to 5,000 family offices throughout the world that have one or more employees and some form of external investment activity. Some 39 per cent of these are single family offices, and 61 per cent are multi-family offices. Out of that population, 83 per cent of the single family offices expect to allocate assets directly. With MFOs, however, the picture is almost the reverse – 70 per cent are not making direct investments and only 30 per cent are considering doing so. Across all FO types, 50.9 per cent are considering the direct route and 49.1 per cent are not doing so.
While exact financial sums are difficult to pin down – direct investments don’t have to be disclosed like a large stake in a listed company – one can speculate that the total runs to trillions, given the size of the world’s private equity sector alone, for example. (There is an estimated $2.44 trillion of unspent capital in PE, aka “dry powder”. Assuming that a fraction of that is in direct investing, it is still a big number.)
How to explain the difference?
“Although the amount of MFOs making direct investments is increasing, there are still more SFOs going direct. We attribute this to more specialized skills within different sectors, often where their wealth was created. In addition, there is the desire to use these specialized skills to have operational impact on the companies they invest in. Lastly, the long-term hold times are easier to navigate within an SFO structure vs an MFO,” Russ D’Argento, founder and chief executive of FINTRX, said.
Family Wealth Report is regularly regaled by wealth management practitioners about how direct investing is a hot trend, in turn part of the flow of money into private capital markets (equity, debt, real estate and infrastructure).
Single family office’s enthusiasm for direct investing may also explain – as FINTRX explained here – why these organizations are less shy about courting media and industry attention than they used to be. (SFOs in Europe, by contrast, tend to be more coy, in this publication’s experience.) A reason is that an SFO which no-one knows about or is publicity-shy may miss out on the hottest deals.
SFOs built by a family linked to a particular industry may want to make use of that expertise when putting money to work, and that can be easier to do than corralling a number of different families to do the same within a multi-family office.
Annoyance over fund fees and administration charges may also explain why some SFOs are going direct, Michael Zeuner, managing partner, WE Family Offices, told FWR.
“Single family offices are getting frustrated with some of the big private equity firms and their management fees. Even if the fund is mediocre, they [private equity firms] make a ton of money from management fees. So single family offices would rather do this investment themselves,” he said.
For family offices that have, for example, $1.0 billion AuM or over it makes sense to source, manage and structure investments directly. On the other hand, with multi-family offices, the end-clients of the offices are not writing the checks, but MFOs can get more alignment of interest if they prefer to pay via a performance fee (over a specific return watermark) rather than pay an annual management fee, he said.
It can be more difficult for clients of MFOs to disintermediate certain actors in the investment supply chain. But direct investing also has its risks, Zeuner said, because he thinks is a danger of family offices going direct and ignoring the value of expertise by private equity firms.
“There is a danger of throwing the baby out with the bathwater,” he said.
"Whether done by single family offices or the MFO model, there appears little doubt that the direct investing trend has weight," Paul Ferguson, managing director of Schwab Advisor Family Office, said:
“We believe a main cause of the trend toward increasing direct investing is related to broader trends in the financial services industry: lower fees, greater control and greater transparency.”
“First, direct investing allows for upside returns without paying the 2 per cent management fee and 20 per cent carried interest traditionally charged by private equity firms. Second, direct investing allows family offices to control the actual companies purchased and the timing of purchases and sales. The greater control of direct investing allows family offices to invest for a 100-year time horizon, as opposed to the five to seven-year exit of a private equity fund. Finally, by investing directly, family office have better transparency into financial data about their investment,” he added.
Direct investing is also being noticed by banks, keen to avoid being cut out of the loop (and fees). Citigroup recently set up a direct private investments business to distribute private deals and expand its share of clients’ wallets over this business, for example.
In other words, if family offices thought they could bypass other players in the investment field by taking a direct approach, they might find it not as simple as they first thought.