Family offices have long bought alternative investments. But as the number and size of family offices increase, they are playing a bigger role in co-investments, direct investments and alternative asset formats broadly.
Data from Fintrx’s “Q2 Family Office Intelligence Report” show that family offices—in particular younger, newer family offices—are showing a clear preference for direct investments in private credit and private equity, rather than externally managed funds.
That does not surprise Peter Naismith, the head of investor representation and a partner in law firm McDermott Will & Schulte, who says that families that have investment teams tend to prefer the freedom that comes with direct investing.
“There are returns to be had [in private credit], and families feel like they can have more of an impact with direct or co-investments,” Naismith says.
When families choose to work with external managers, Naismith adds, they tend to prefer separately managed accounts, rather than investing in a traditional commingled fund.
“In some cases, it can give them more rights in terms of liquidity or termination,” he explains.
Still, as family offices increase their presence in private markets, many are running into the same types of challenges institutional investors have dealt with for years. Direct investments and separately managed accounts can have their benefits, but they also require the investor to have the resources on hand to have an internal deal team. Small- and medium-sized family offices frequently turn to multi-family-office platforms to help manage some of the overhead. Even with that support, both kinds of offices are finding themselves taking a fresh look at risk management, exit plans and expected returns, as portfolio companies face mounting macroeconomic challenges.
Finding the Advantage
Shang Chou, co-founder of and managing partner in Pasadena, California based multi-family office Dishmi Capital, says many families are refining their approach to alternatives and direct investing by examining opportunities through two distinct frameworks. First: Is there an access or informational advantage the family has that could potentially generate alpha? Second: Is there a tax alpha advantage that could be realized, based on how a deal is structured?
“Alternatives are really mature asset classes at this point, so we encourage our families to look at the bigger picture, rather than trying to just pick off excess returns that might not be durable,” Chou says. “If you’re taking more of a structural approach, you can start to see where your biggest advantage is in terms of the structure of a direct investment, for example. Then, concurrently, you can look to things like hedge funds to bring in diversification or absolute return and create a more resilient portfolio.”
For those families willing to work with external managers, sources say the structural approach can mean making fewer commitments, as well as taking a closer look at existing relationships.
“The families we talk to are being much more prescriptive about the types of exposure they have,” says Jeffrey Stevenson, managing partner in New York-based VSS Capital Partners. Distributions in paid capital are “probably one of the biggest factors in manager selection right now. Families are asking more about exit planning, the different types of exposure in the fund. The questions are more granular and specific.”
Reaching for Diversification
Beyond structure, family offices are seeking diversification wherever they can find it. Daniel Scansaroli, managing director and head of portfolio strategy and multi-asset solutions in the chief investment office at UBS, says in many cases that means going global, both in listed exposures and alternatives. Private infrastructure is also playing a bigger role as family offices look for ways to participate in the artificial intelligence boom while also managing risk.
“There is some tension when it comes to AI because families see the rapid growth on the part of the hyperscalers and have a bit of [fear of missing out], but there are also questions about whether we’re in a bubble,” Scansaroli says. “I think families see the rise of AI as a potentially transformational opportunity, but they want to remain disciplined and maintain some level of diversification.”
Scansaroli says UBS maintains two specialized groups focused on advising family offices about portfolio construction and governance to help those offices navigate the added complexity that comes with global diversification and rapidly evolving investment opportunities, such as AI. Trade wars, inflation and traditional, kinetic wars are also adding macroeconomic uncertainty and causing some families to adjust their investment approach. The UBS advisory groups are often tasked with mapping out the potential impact of a change in investment strategy.
“We will do stress-test analysis, as well as growth-rate-potential analysis on the whole portfolio, whether the assets are held with us at UBS or elsewhere,” Scansaroli says. “We think it’s important to look holistically in order to understand what opportunities might be transformational or if there are ways to optimize the portfolio for tax efficiency. As the macroeconomic picture gets more complex, it’s important to keep a close eye on portfolios and make sure they are still meeting the goals of the family.”
Tags: Alternatives, co-investments, Direct Investments, diversification, Family Offices, Private Markets