Allocations to private equity by family offices are on the rise, with the asset class offering potentially impressive returns and access to hard to reach sectors such as technology.
While wealthy individuals represent a vast, untapped market for alternative investments, family offices (FOs), who typically have patient capital, and a long-term, multi-generational outlook, are increasingly allocating to private assets.
“Equities has always been the number one asset class family offices invest in, but over time, inch by inch, private equity has been encroaching upon that and, for the first time last year, private equity allocations surpassed equity allocations in family office portfolios,” reports Rebecca Gooch, global head of insights for Deloitte Private, referencing the firm’s recent study.
Despite a tougher environment, with distributions and exit activity slowing down, amid persistent inflation, rising interest rates and geopolitical upheaval, in 2023 private equity accounted for 30 per cent of the average family office portfolio, up from 22 per cent in 2021, while public equities accounted for 25 per cent, down from 34 per cent in 2021, according to Deloitte. This year, in 2024, nearly 30 per cent of family offices plan to invest more into private equity.
Within a diversified portfolio approach, aimed at meeting the FO’s key objective of protecting and growing family wealth through generations, private equity is “the darling of the asset classes amongst family offices”, she says. “These families often gain their wealth from owning and operating large scale businesses, and entrepreneurship is part of their DNA.”
Investing in private equity also allows FOs to involve the next generation into the family enterprise, with the younger cohorts viewing private equity investments as a “core priority”.
High tech fever
Growing interest in private equity ties in with the fact that FOs, and especially next gens, are “avid investors in technology”, their focus being on healthcare tech, biotech, fintech, green tech and artificial intelligence.
Family offices invest in new technologies for higher returns but are also eager to integrate them into their operating businesses, with the next gens often driving this trend, adds Ms Gooch.
“People talk a lot about AI, but the private asset space is the only place investors can invest in these glittering new technologies,” believes Mike O’Sullivan, chief economist at Moonfare, and former CIO, international wealth management division at Credit Suisse. The few AI public stocks available are “very expensive and very crowded”, he adds.
While public markets have been shrinking over the past two decades, the private economy has been growing, with private equity transactions, buyouts and infrastructure investments. Investments in private equity, infrastructure and venture capital (VC) are all led by new technologies and innovation, with the venture sector including “loads of up-and-coming AI stocks” and quantum computing stocks, says Mr O’Sullivan.
Since 1999, the number of private equity-owned companies in the US rose from approximately 1000 to more than 16,000 today, according to PitchBook. Over the same period, US public companies have halved from 8000 to 4000.
“The private investor’s portfolio of the future will include a lot more private equity and venture,” predicts Mr O’Sullivan. “But the tough thing is being able to identify and pick the good funds and get access to them.”
Dispersion of returns
Private banks have been building dedicated teams to service the growing number of family offices, but questions arise on their ability to offer access to the best investment opportunities and managers.
“Many private banks don’t yet have multiple relationships with big private equity houses,” says Mr O’Sullivan. This is especially true in Europe, while in the US there is “better distribution” between private equity and the wealth and asset management industry.
“Private banks and even big family offices need to work a lot more building those relationships, which takes time. It’s a question of building up not just access, but information and credibility.”
Moreover, he says, funds sold to clients tend to have the “biggest bias towards an incentive” and are not necessarily the top-performing funds.
While this bias applies to any traditional or alternative investment, it has a greater impact in private equity, where return dispersion, or the difference between the best and the worst performing funds, can be “up to 25 to 30 per cent”. This is a “big issue”, as returns compound over time.
It is also crucial to build out a diversified portfolio of private investments including infrastructure, secondaries, buyout funds, venture, each of which performs in different ways, according to different mega trends in different parts of the cycle, says Mr O’Sullivan. In fact, many private banks, as well as investors, tend to invest in one or two funds.
Many private banks don’t yet have multiple relationships with big private equity houses
Mike O’Sullivan, Moonfare
Avoiding the grinder
As a result, FOs tend to bypass private banks when it comes to investing in private equity and the venture capital (VC) space, both for funds and for direct investments.
“FOs feel more comfortable if they have a direct relationship with a private equity house rather than going through the grinder of a private bank,” says Mr O’Sullivan. “It is like buying a luxury good: you feel much more privileged and maybe safer if you buy it from the producer rather than going through a distributor.”
A small number of platforms are emerging, though, offering investors information on funds, access with smaller minimum investments, in line with regulation, and education.
“I don’t expect private equity and venture to become commoditised in the same way as trading platforms for equities, because there’s a very limited number of platforms who have relationships with private equity funds,” he predicts.
Yet, private banks remain a relevant channel for FOs, for “their ability to find and source investment opportunities” through their dedicated teams, believes Ahmed Husain, Neuberger Berman’s head of family offices, Emea.
Given their size, private banks can meet more managers than a family office can. “They are also important for their due diligence function, often providing an initial screen of ideas and strategies worth looking at, especially for smaller families,” he says, although research shows incentives do drive advisers’ behaviour.
While top-performing in the private equity space is a “nuanced word” and means different things to different people, “the obvious hurdle” for large private banks is that smaller managers do not have the scale to be on their platform, while big managers may not want to be intermediated by a bank, says Mr Husain.
Private banks have extensive networks and resources to source opportunities, acknowledges Phil Watson, CIO at New York-based multi-family office Mondrian Associates, and former chief innovation officer at Citi Private Bank. But they also face high competition, have extensive due diligence processes and regulatory constraints. They must also balance the need to provide personalised advice with the challenge of scaling their services to meet the demands of numerous clients, he says.
“While private banks may have extended distribution and demand that attracts general partners (GPs) to them, multi- and single-family offices can be more agile and focused compared to private banks,” he explains.
“Additionally, their long-term investment horizons and flexible capital allow them to participate in a broader range of deals, including those that might be too niche or early-stage for private banks,” adds Mr Watson.
Direct hits
While FOs invest in private equity mainly through funds and funds of funds, which offer the benefits of diversification and GP expertise, allocations to direct investments represent 38 per cent of their PE portfolio, according to a recent UBS study on 320 family offices across seven regions of the world.
The popularity of direct investments is higher among the largest family offices, according to UBS. Of those with more than $1bn in assets, almost half of allocations go towards direct investments.
“We are seeing a bigger portion of family offices investing in funds and funds of funds, which speaks to the overall environment, where diversification, especially in some of the very innovative and fast-moving sectors where private equity minded family offices want to invest in, is becoming more important,” says Max Kunkel, CIO of global family and institutional wealth, UBS Global Wealth Management.
According to Deloitte, though, FOs prefer direct private equity investments over funds, with the latter accounting for 10 per cent of the average family office portfolio, versus 17 per cent of direct investments. FOs with assets under management of more than $1bn allocate more of their portfolios to private equity funds (17 per cent) than to direct investments (14 per cent) and are more than twice as likely to invest in private equity funds than those with less than $1bn in AuM, according to the consulting firm.
This may stem from the fact that many large offices continue to maintain a small staff size, even as their AuM grows, leaving them with few hands to source, perform due diligence for, and manage direct investment opportunities. It is also likely that larger FOs have greater access to limited partnership investment opportunities within funds than smaller offices.
According to another recent study, from US bank BNY Mellon, 71 per cent of FOs plan to make six or more direct investments over the next 12 months, a 15 per cent year-on-year increase.
Competing with private equity funds
A private equity fund may offer a more diversified access point to an investment area, by number of investments and vintage, explains Mondrian Associates’ Mr Watson. It also allows the FO to leverage the fund manager’s experience in niche or specialised areas, and benefit from its network and “strong capital base” to provide access into opportunities that a FO may not get to see directly. The due diligence provided by the fund manager is valued too.
Conversely, FOs prefer direct investments over funds due to control and transparency. “By investing directly, FOs can tailor investments to their specific interests and goals, avoiding higher fees associated with private equity funds, and directly influence the growth and strategic direction of the companies in which they invest,” says Mr Watson. This hands-on approach also allows them to build deeper relationships with management teams and potentially achieve better alignment of interests in the near and longer term.
Interestingly, in this tougher environment, start-ups and firms may favour funding from FOs to that of private equity/VC fund capital, with FOs effectively emerging as competitors of private equity funds themselves.
Family offices can provide “added flexibility and patient capital”, which may be less rigid compared to other funding sources.
“Family offices can provide longer investment horizons, and hence more likely to promote longer term growth and innovation. This is valuable at a time of longer exit terms and reduced liquidity too,” says Mr Watson. Additionally, FOs can offer valuable strategic guidance and networking opportunities, by leveraging their established business connections.
“Family office capital isn’t tied to fund cycles like private equity/VC capital, which leads to greater durability of capital in building sound stable businesses,” adds Neuberger Berman’s Mr Husain. “Also, there is increased probability of acquisition from the family’s operating business.”
But in the current difficult environment, it is important for FOs to take a more active role, which can help create value and hence make the asset more desirable. “The key skill is to think more like an operator and owner, and less like an allocator,” adds Mr Husain.
Confident allocations
Despite worries about slowdown in realisations and exit activity over the next 12 months, FOs continue to have confidence in the asset class’s returns, according to UBS. On average, 71 per cent of FOs investing in private equity are doing so to diversify their investment portfolios, while 71 per cent think the long-term returns are likely to be better than in public equities.
Distributions are slowing, mainly because “the IPO market is not working” due to investors’ risk aversion, explains Moonfare’s Mr O’Sullivan. Global private equity and VC deal value and volume in 2023 were at their lowest in at least five years, according to S&P. Secondary funds have been growing, though, with some of the large secondary funds in the last year making big capital raises, adds Mr O’Sullivan. “The private equity secondary market is one of the more active areas and effectively, that’s recycling capital through the industry”.
