Family office are flexing their muscles when it comes to the search for better returns. Tom Bill takes a closer look at their evolving investment strategies
A nine-year period of ultra-low interest rates has inevitably affected how investors deploy capital. For private family offices, it means shaking off their sleepy reputation. In the search for higher returns, many are taking a more hands-on approach to investment, and increasing their exposure to higher-yielding assets like real estate.
It represents a natural evolution for an investment model that only became widespread in the 1980s, but also follows greater scrutiny of traditional asset managers. Institutional funds and hedge funds have battled against an outflow of investors’ cash as they struggle to justify investment methods and fee structures in markets that have become more difficult to second guess.
“Family offices have become sexy,” said Russ D’Argento, founder and CEO of FINTRX, a family office asset-raising platform based in Boston, US. “Running parallel to their sheer growth has been the increased sophistication of those running them.
Not only are the folks who are pulling the strings regarding investment decisions better versed on the process, they’re also positioned to make quicker decisions when they see unique opportunities.”
Assets under management (AUM) at family offices have grown as the model becomes more popular and the capital invested works harder. Family offices accounted for US$1.8 trillion of AUM in 2016 according to FINTRX, a figure that grew 29% from US$1.4 trillion in 2015.
The Landon family office has adopted the kind of sophisticated approach referred to by D’Argento. It has clubbed together with other European family offices to invest directly in real estate and private equity opportunities in the US, where it manages a combined US$550 million of market equity.
“We were once invested in around 25 private equity funds and when we analysed the overall returns we found they had been corroded by the fee structure,” said Rupert Edis, chief executive of JPS Finance, the family’s London-based office. “Most were charging an annual 2% fee on capital that had not even been deployed.” The more adverse global tax landscape has also played its part, says Mr Edis. “Increasingly, to preserve capital you have to grow capital.”
While not all offices are taking quite such an innovative approach, many are scrutinising their use of external asset managers. One executive at a family office with about US$1.7 billion of AUM said they had switched away from active stock-picking funds into cheaper, passively-managed exchange traded funds in recent years because finding returns that justified the high fees was difficult in a market inundated with capital from quantitative easing.
It has also wound down its exposure to bonds because of the low returns and, in line with many other family offices at this stage in the investment cycle, has reduced its use of hedge funds. “It wasn’t a very successful experience for us,” says the executive. “The idea was that hedge funds would make a lot of money in the downturn and many simply didn’t.”
All of which means real estate is typically at the centre of any strategic rethink, representing an increasingly important asset class for family offices. Some 55% of global offices had an exposure to real estate in 2016, which was 6% higher than the previous year, FINTRX data shows.
Indeed, private buyers accounted for 34% of global commercial real estate investment in 2017, which was the highest percentage in ten years, according to Real Capital Analytics.
“If you’re hunting for yield, it’s clearly there in real estate,” says David Adler, Head of Real Estate at Barclays Private Bank. “The vast majority of commentators do not see the spread between real estate yields and government bonds narrowing to any great extent in the near to medium term, despite any expected reversal of low interest rates, so the attraction will remain.”
Knight Frank’s Head of Capital Markets Andrew Sim concurs. “There is a huge volume of new private investor and family office money looking for real estate returns and new global channels of investment. From merchant families in regional Saudi Arabia to industrialists in tier-three Chinese cities, more investors are waking up to the benefits of real estate investments.”
Families are hiring more expertise due to a growing appreciation of the complexities of real estate, says Mr Adler. “In the past, you would sit back, collect the rent cheque and then address asset management issues, such as lease terminations or rent reviews, as they arose, often in a panic. The approach is now far savvier.”
By way of example, Mr Edis says the average total annual return on JPS’s real estate investments in the US has been 23% since 1994. “These are emerging market levels of return in the most developed economy on the planet,” he says.
“Our current strategy is based around offices and mixed-use developments with rental apartments. We are surfing the demographic wave of the millennial generation who want to reside in city centres in places like Boston, Atlanta, Washington DC, Charleston and Savannah.”
“Family offices like real estate because they can diversify risk,” says Anthony Duggan, Head of Capital Markets Research at Knight Frank and a strategist on the company’s Family Office Forum initiative. “If you buy a Vodafone share you are exposed to many different geographies. That doesn’t happen when you buy an office block in Berlin, and families like that.”
The sheer pace of wealth creation in places like Asia has also played a part, says Bunny Wang, Knight Frank’s Head of International Capital Markets in China. “Rapid growth of wealth requires careful thought about diversification and steady returns,” she points out.
“We worked with a family office from the tech sector who did this by avoiding traditional office investments, instead targeting a WeWork-type serviced office development in Boston.”
An executive from a third family office, with about US$5 billion of real estate AUM, said that a sense of control over wealth, which is often destined for the next generation, was a key consideration for family offices. “Funds can lock you into an investment for several years,” they say.
“No institution is going to fully understand the needs of an individual family office and we found that when we wanted liquidity to do deals that were consistent with our strategy, the lock-in period meant we couldn’t.”
The results of The Wealth Report Attitudes Survey underline the strong link between real estate and this growing and increasingly professionalised pool of private capital. Stock markets rose to record highs in 2017 due to US tax reforms among other factors, so it is unsurprising that 62% of the survey’s respondents said their clients had increased their exposure to equities.
However, the second largest rise was in real estate, with 56%, on average, reporting an increase across the globe. Some 38% of the wealth managers taking the survey said UHNWI investors were happy to take more risk, compared with 32% who reported they were less willing – underscoring the importance of higher returns.
The relative safety and liquidity of offices remained the most attractive sector for investors, with 40% declaring a growing interest, but Mr Duggan believes this will change in coming years as private wealth becomes even more sophisticated in its investment approach.
“The 1990s was all about the wave of institutional capital hitting real estate markets. That was followed by waves of private equity and sovereign wealth capital. The next 10 years will be all about the impact of private wealth".
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