Some are realizing they don’t have the capabilities to make quality investments directly in companies.
After years of slowly expanding their allocations to direct investments, some family offices are suffering losses and reversing course. In some cases, they are even halting the practice entirely.
Family offices invest directly in private companies when they believe they have an edge, often as an extension of the family’s business interests. If a family has significant experience in the manufacturing sector, it might be strong in evaluating investments in manufacturing companies and complementing those with investment funds to spread the risk.
Direct investments have performed well, returning 21 percent in 2021, according to RBC’s 2022 North American Family Wealth report. As a result, family offices have been allocating more to them. Direct investments accounted for 9 percent of family office portfolios in 2019, 10 percent in 2020, and 13 percent in 2021, according to UBS’s 2022 Global Family Office Report.
Since then, inflation, rapidly rising interest rates, market volatility, and a slowing U.S. economy have hurt investment performance and family offices are realizing they may not be quite as good at direct investments as they thought.
Over the past six months, family offices have slowed their direct investing or halted it entirely with the intention of turning that responsibility over to asset managers, according to Ronald Diamond, founder of Diamond Wealth, which represents more than 100 family offices ranging in size from $250 million to $30 billion, and helps them invest in private markets.
“People are learning and they’re going to learn the hard way,” Diamond said.
The majority of single family offices (74 percent) make direct investments, according to a 2023 family office report by FINTRX, a family office database, and Charles Schwab. But Diamond said most of them aren’t as wealthy or sophisticated as one might imagine. Most single-family offices have been established only within the last two decades and can’t afford to hire dozens of qualified investment professionals and operate like a handful of the biggest names, according to Diamond. A majority of family offices are struggling to operate and invest like these top firms.
A single-family office needs at least $250 million of wealth to operate in an ideal way, including to adequately source, evaluate, and make direct investments on its own, Diamond said.
Whether direct deal flow is slowing depends on the family office and the deal, said Brian Formento, head of client solutions and investment strategy at UBS Private Wealth Management.
“The jury is out on direct investment performance,” said Formento. But the better performers have involved wealthier families who have taken larger stakes in companies and industries that they know well. The experience of family offices “depends on their ability to manage the due diligence process,” he said.
If a family office doesn’t have the resources to execute direct deals and get returns in line with the best investors, it should reevaluate that allocation, according to industry experts.
“I would agree,” Formento said. “If you don’t have the resources for due diligence, you need a firm that not only has the capabilities, but a good vantage point to see deal flow.”
Bill Hagan, director and portfolio manager at Hirtle Callaghan, an outsourced chief investment officer to more than $20 billion in family and institutional assets, said his clients’ interest in direct investments hasn’t waned.
“Many of the direct investments we consider are brought to us by managers in our program whom we have invested with for a long time. They have a proven track record of long-term successful outcomes. We guide our clients to think longer-term about direct investment opportunities which helps them manage through short-term periods of volatility,” Hagan said.
Without guidance, a family office doing direct investments might not be able to stomach that volatility well, advisors added.
https://www.institutionalinvestor.com/article/b8ycj3j4nv76wt/Family-Offices-That-Learned-The-Hard-Way-Are-Halting-Direct-Deals
