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April 17, 2019  

Family Offices Bypassing Fund Managers

In a potentially troubling trend for hedge funds, family offices are increasingly willing to invest directly in alternative assets and complex situations.

The world’s wealthiest families have long been among the most prolific allocators to hedge funds, with some surveys indicating family offices, on average, deploy 25% of their capital to hedged strategies. But disillusionment with fund performance and fees is prompting family offices from New York to Monaco to analyze and execute alternative investments in-house — even if that means paying top dollar to hire seasoned investment professionals.

“Hedge fund fees are too high and performance is too low, and family offices are less willing to throw around the large amounts of capital needed to justify getting a side letter with preferred terms,” a family office advisor said.

Case in point: A New York family office with several billion dollars of assets recently hired an analyst to vet an investment in Chinese convertible bonds — the type of investment that traditionally would have been handed off to a hedge fund manager with expertise in that area. The move paid off: The family office invested at least $100 million in the strategy, earning a 100%-plus return in a little more than six months, a source said.

Another source pointed to a family office in India that last year redeemed $250 million from a hedge fund manager specializing in Brazilian debt — then poached an analyst from the shop to build a position directly.

Steven Saltzstein, co-head of Family Office Networks, which counts some 10,000 members globally, said the trend toward direct investments among family offices is dampening demand for hedge funds. “You just look at the number of launches,” Saltzstein said. “That absolutely coincides with family office investment. This [stock] market that we have been happily living in for the last nine years has absolutely decimated the rationale for hedge funds.”

A March 21 report from hedge fund tracker HFR showed the number of fund launches in 2018 fell to an 18-year low.

A report published last month by Family Office Exchange noted that in the past, family offices might have considered investing directly in businesses similar to the ones where they made their fortunes. Now, they’re looking farther afield. “Today, families around the globe are building out more internal resources in the family office as they seek a more strategic and more diversified direct-investment portfolio,” the report said.

Nearly 80% of family offices surveyed by Family Office Exchange said they are “actively or periodically” looking at deals to invest in. “The appetite for direct investments appears to be increasing,” the report said.

Another large New York family office is in the process of liquidating its entire hedge fund portfolio, which historically accounted for up to 30% of its assets. The chief investment officer is convinced that a global recession is looming, and that the fund managers he works with are vulnerable to sharp losses — even though most have generated 20%-plus returns in the past three years.

“They’re all really good at what they do, and I could be wrong. Maybe they can weather whatever’s coming,” the investment chief said. “But it’s not a risk I’m comfortable taking.”

Short-term, he plans to park the proceeds from the redemption orders in U.S. Treasurys. Longer-term, the family office aims to increase its direct investments in private equity and infrastructure.

One hedge fund manager questioned whether family offices have the desire and patience to develop the in-house resources and expertise required to pursue complex investments on their own. “Think about the time it takes to just find the right guy to do these esoteric things you’re talking about,” the manager said. “Chinese convertible debt? How many experts in Chinese convertible debt are there? And how many are willing to be snapped up on a short-term basis? And how much are you paying them for it?”

Family offices are well aware of the challenges of developing a direct-investing program, according to Family Office Exchange. In some cases, families are pooling their resources by partnering on one or more investment opportunities. “Families are structuring these partnerships in flexible ways, with some families consistently leading the deals and others generally choosing to follow a lead family,” the report said.

Another hedge fund manager that runs about $300 million of fixed-income investments said he’s feeling the effects of the trend toward more direct investing among ultra-wealthy families. The firm has “all but given up” on marketing to family offices, the manager said.

There’s little consensus on how much of an appetite family offices have for hedge funds. In a recent survey of big hedge fund investors, Barclays found family offices maintain some of the most aggressive exposures, with 25% of their portfolios deployed to hedge funds. But a survey that UBS and Campden Wealth conducted around the same time pegged the figure at a little more than 5%, following several years of net redemptions.