The Rise of Direct Investing by Single-Family Offices

May 22, 2019

The recent growth of single-family offices (SFOs) continues its upward trend. A recent study by Ernst & Young estimates at least 10,000 family offices exist around the globe, with more than half established within the last 15 years. These family offices controlled in excess of $4 trillion as of the end of 2018. As the number of SFOs worldwide continues to increase and the amount of wealth controlled by SFOs rises to unprecedented levels, the sophistication, investment strategies and needs of SFOs are changing as well.

SFOs historically have been, by their nature, private and opaque institutions. Because SFOs generally are structured to meet the needs of the family client, they vary significantly in their sophistication and infrastructure. While one SFO may have a robust internal team similar to a traditional private equity fund, another SFO may employ a wealth manager whose principal job is to prudently allocate the family’s assets. Families often treat their family offices as an extension of the underlying business that generated the family’s wealth, closely guarding investment strategies, investment opportunities and best practices.

Over the last several years, however, SFOs have begun to network in a manner similar to their traditional private equity peers. A recent study reveals that 85 percent of SFO senior executives made concerted efforts to expand and enhance their business development outreach programs. The most commonly cited reasons for doing so are to gain access to (1) best practices and market trends and (2) business opportunities and proprietary deal flow. As SFOs reallocated dollars away from hedge funds and other high-fee third-party investment options, direct investing saw an uptick in activity from the same SFOs. About 45 percent of family offices said they plan to invest more in direct investments in the next 12 months, according to UBS’ “Global Family Office Report 2018.”

Many SFOs differentiate themselves among target companies by touting their depth of knowledge in the industries in which the families historically generated their wealth, as well as their ability to hold investments for longer time periods than traditional private equity funds. As a result, SFOs tended to concentrate their direct investment in areas in which the family has expertise.

However, as the investment landscape evolves, SFOs are looking for ways to branch out. Increased networking and information-sharing among SFOs are at least partially motivated by a desire to diversify the SFO’s investments and leverage each SFO’s deal flow. SFOs typically review hundreds of deals per year, investing in only a small fraction. Passing on these deals can represent an opportunity cost to SFOs. In attempting to capture some of this value, groups of SFOs pooled their capital (and expertise) and invested in “club deals” to achieve greater diversification while still leveraging the expertise of a close network of families in industries where the families in the group have a demonstrated strategic advantage.

The continued focus on direct investing is expected to continue as SFOs seek outsized returns and greater control over their investments and continue to allocate investment dollars away from the high-fee options offered by third parties managing alternative investments.

The McGuireWoods Family Office Roundtable Series provides a lightly moderated discussion on the best practices and market trends affecting family offices and direct investing, and provides a forum for family office executives and decision-makers to network and develop deep relationships among their peers. To learn how to get involved, please contact Bryan Bylica, J.D. Costa or your principal McGuireWoods contact.