Family Office Investment Activity into Funds and Data on How They are Investing
Author: Shuyej Uddin (Venture Capital Fellow)
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Family offices have a strong influence as limited partners which are crucial for Emerging Fund Managers. Between 2020 to 2021, family office investment activity within Venture Capital (VC) has grown by 2.4%. At the same time, family offices are investing not only in equities and hedge funds, but also alternative assets such as gold, unique metal, and farmland. So, the question is, where are family offices investing, in other words what are the family office investment activities? How are they investing?
This report is broken down to two sections. First, we explain family office investment activity into funds. Second, data on how they are investing. To explain these two sections, we first note the definition of a family office. Family offices are private wealth management advisory firms that serve high networth investors. They manage investments of affluent individuals or families. Family offices offer budgeting, insurance, charity, business, wealth and tax services.
Family Office Investment Activity into Funds
Figure 1 suggests most wealth is located in North America. Figure 2 is based on a survey of family offices that have $15 million to $2.5 billion in assets under management. Figure 2 shows that Silicon Valley investors contribute most to family offices with 24%. With North America being the home of most global wealth, therefore from figure 2 we can suggest that the US has the most wealth and we should expect most family offices to be located in the USA. What can further validate the previous point, is the fact figure 3 suggests approximately 86% of assets under management of newly added family offices are assets between $15 million to $2.5 billion. The next point is to understand the types of family offices, of which compromise three factors. First, single family offices. Second, commercial multi family offices. Third, private multi family offices. Figure 4 implies most family offices compromise single family offices, at 80%.
Figure 1: Global allocation of wealth
Figure 2: Data on where most family offices are located
Figure 3: New Family Office Assets under Management
Figure 4: Types of family offices
The next question is to understand why they manage funds. Deloitte provided family office fundamentals which can explain why family offices manage funds. First, they support the maintenance of family’s wealth. The first point is important as due to regulation, aligning with economic interest can be difficult. So, family offices need to make sure wealth performs better than the economy and wealth does not reduce during a recession. Second, they promote a family’s legacy, vision and values. Third, they coordinate, integrate and support customised services for families including lower fees. The third point is important as it supports families to easily manage funds. Fourth, protection from economic and personal risks. Fifth, protection of family privacy. Given that we have outlined why family offices manage funds, this can play a key role in understanding current trends within family offices.
Next, we analyse the current trends within family office with current emerging trends as follows. First, family offices are relying on technology for strong investment and data analysis, to provide effective wealth management services. This can better support the better management of wealth, as AI and robotic process automation will ensure more efficient allocation of resources, and offices to focus on investments that are more than likely to generate strong returns.
Second, there is a growing support of cultural values to manage funds. Due to the pandemic, the wealth management industry had suffered. As a result, family offices have reevaluated their strategies to support family legacy, vision and values. Wealth allocation is based on goals, and there is an increasing pressure the goals reflect family legacy.
Third, due to the fact they support management of funds, future generations are increasingly building close relationships with family offices. Figure 5 shows that since 2000’s, when family offices became common, family offices have been growing as future generations seek to use family offices to manage funds. At the same time, future generations have realised traditional methods have not been as effective in managing funds, so family offices are driving investment towards alternative assets including private equity and real estate. We explain this notion further in our next point. Moving forward, as inter-generational wealth becomes common, there will be opportunities for family offices to offer training on financial planning to the next generation.
Figure 5: Family office popularity between different generations with data on 3rd generation predicted to grow
Fourth, family offices are considering their long term investment allocations. Family offices are focusing on sustainable investing with 33% of family offices investing in sustainable investment products, ESG investment with 62% reporting this as important and 25% investing towards ESG products, and illiquid investments such as infrastructure, private equity and private credit with alternative assets expected to grow at a CAGR rate of 9.8% by 2025. One driver for this change is due to the pandemic, and with economic disruptions, family offices have the ability to drive economic growth by investing in industries that have strong prospects. Better investment allocations will ensure family offices protect family wealth from economic risk, as they can directly influence economic progression through their wealth, which in turn can also support the transition of wealth to future generations. Figure 6 illustrates further data on the areas of sustainable and impact investments.
Figure 6: Sustainable investments and impact investments
Another point is that direct investments have increased with Technology, Financial Services, and Healthcare benefiting the most from investments. Figure 7 demonstrates that the three areas of investments compromised 57% of investments. At the same time, Real Estate is a popular sector too, in a report conducted in 2019, a net 16% aspired to increase direct property holding by 2020.
Figure 7: Direct Investments
Fifth, another trend is to protect family risks. One of the reasons for this trend is due to increased cyber risks, with 20% family offices experiencing the risk. As we noted, protecting privacy is the role of family offices, and the use of technology is becoming common. As processes become more digitized, protecting clients from cyber risks is a major trend.
The next point of interest is to understand the impact of COVID on family office activity. Despite total household wealth dropping by 4.4%, at the start of 2020, by the end of 2020 wealth grew by $400 trillion with factors such as market recovery and government stimulus driving these changes. Family offices are expected to grow, as global wealth is expected to grow. Why are they expected to grow? Since the pandemic, 55% of family offices rebalance their portfolios, in response to the pandemic, to maintain their long term strategic allocation. At the same time there are operational risks and strategic risks which need to be assessed, due to demand for connectivity and remote working.
So, we have exposed the market, current trends and the impact of Covid. However, to truly understand family office activity, it is important to have a separate section dictated to how family offices are investing. Therefore, in the next part of the report we focus on how family offices are investing.
Data on how they are investing
There is a strong focus on Private Equity investments with 77% of family office portfolios allocated to Private Equity. We noted that future generations are no longer interested in traditional methods, and are seeking alternative assets. One area has been private equity. With a 73% increase in investment from the two years up to 2019, between 2017 to 2019, Private Equity has been deemed as the second most significant asset class to family offices, with first place reserved for equities. Most notably, Healthcare has been the most common industry for Private Equity investments, but also sustainable investments have become popular as seen in figure 8. However, despite the progression of investment towards Private Equity, it only accounts for 22% of the average global family office portfolio. Nevertheless, Private Equity is the best asset class for family offices with an average return of 16% for direct investments.
Figure 8: Proportion of current portfolio allocated to sustainable investments
An aspect of Private Equity is Venture Capital. There has been a 2.4% increase in investment towards Venture Capital, a figure which was quoted earlier. The reason for the increase is due to a growing risk taking nature by family offices, as previously family offices were risk averse. At the same time, family offices have been willing to take the risk due to limited brand name funds, established funds getting larger which require early stage risk, and ability to invest more capital through co-ventures alongside emerging managers with 90% of family offices making co-investments. Figure 9 further demonstrates more family offices are willing to consider co-investments. In addition, market outlook is negative, and family offices would be willing to take risks to protect wealth against the negative outlook on markets. In fact, the Venture Capital portfolio returned over 14% return, and public equity reported a net 7.1% decrease in investments, as suggested in figure 10. So, we can conclude Private Equity investments are a growing field of investments by family offices.
Figure 9: Willingness to consider co-investments
Figure 10: Future Portfolio Allocation
As part of learning about how family offices are investing their funds, it is important to understand their concerns or challenges when investing funds. Figure 11 demonstrates their key concerns. In addition, the key concerns are strongly linked to why family offices manage funds which is explained next. Cyber Risk is a key concern as it affects privacy, market volatility and geopolitical uncertainty is a key concern as it affects protection from economic and political risk, succession is a key concern as it affects the promotion of family legacy, vision and values, engagement with the next generation is a key concern as it affects the ability to provide customised solutions, wealth consumption and taxes is crucial in order to preserve family’s wealth maintenance.
Figure 11: Current Concerns of the next 12 months
Generational Wealth
Due to the generational transfer of wealth, and since 2000 family offices have become popular, family offices are useful for future generations. Family offices invest wisely, and with improvement in technology to analyse data and investments, family offices can be more accurate. From what can be digested from this report, is that family offices are increasingly investing in Private Equity funds, to protect their legacy, vision and values. They are also allocating capital towards industries that can support economic recovery such as Technology or Healthcare.
DISCLAIMER:
This is not to be construed as legal, financial, or tax advice and is for informational and educational purposes only. It is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Sutton Capital Holdings Corporation, Sutton Capital Advisors, and Sutton Capital Ventures I LP makes no representations and gives no warranties of whatever nature in respect of these documents, including but not limited to the accuracy or completeness of any information, facts and/or opinions contained therein.
After all of this, I see very little on proper risk management strategies, to protect their expanding portfolios. i.e. Tail-Risk Hedging, Options overlay and volatility management strategies.