Examining the many forms of portfolio management
The range of investment activities a family office is responsible for is extensive and varied. They include overseeing liquid assets, alternative assets (e.g., real estate, hedge funds and private equity funds), single-stock positions, direct investments in private companies and impact investing such as environmental, social and governance (ESG) and socially responsible investment (SRI) funds.
There are also considerable differences in how wealthy families go about overseeing investments. Some families manage all their investments in house, while others are more delegatory, choosing to outsource some or all the investment functions.
For these reasons, sharing universal best practices for investment management across family offices is not within the purview of this article. However, there are broadly distinctive ways in which family offices structure the management of their investments, which overlap somewhat with the organizational and behavioral types of family offices described in detail in my book.
In addition, there are investment activities that warrant discussion because of similarities, challenges and best practices within them, including direct investing, venture investing, social impact investing and art and collectibles investing.
Defining family office investment styles
Delegatory – Many family offices, regardless of the magnitude of their wealth, choose to outsource the management of their portfolio to third parties. This outsourcing tends to stem from the views of the principals and family office executives. Interestingly, the decision to outsource does not necessarily depend on the family’s level of financial sophistication or resources.
Families that choose to outsource their investment activities are comfortable relying on others for investment advice and execution and farm out these responsibilities to banks, brokerage firms, asset managers and investment consultants.
Active-controlling – With the tremendous growth in wealth accumulated by financial services firms, founders and other investment professionals, it is not uncommon to see former hedge fund managers, private equity principals and finance executives creating family offices as these individuals are familiar with investing, the markets and the various partners and platforms available.
Family offices overseen by these types of principals often establish their own investing businesses within the office and actively trade their portfolios, particularly in those markets or asset classes in which they have expertise.
While less common, there are also principals who, despite not having backgrounds as investment or finance professionals, decide to tackle the lion’s share of investing responsibilities. In these cases, the family office is staffed like an investment management firm or hedge fund with a chief investment officer, active traders and portfolio managers. These types of investors may still delegate execution to third parties. However, it is the controlling nature over a significant portion of their investable assets that distinguishes these family offices from others.
The hybrid approach – Some family offices take a hybrid investment approach on behalf of their principals and family members. These family offices may be characterized as active-controlling with respect to a particular strategy or asset class, then outsource other investment management needs to banks, brokerage firms, asset managers or investment consultants. Many principals, as well as the executives they hire, have a penchant for certain types of investing and therefore manage these activities themselves.
“Direct investing” or investing directly in private companies, is an example of an investment type that principals pursue based on specific interests. Moreover, family offices, often dictated by their size, may also internally manage the cash and short-duration, fixed income portions of their portfolio, believing that they can do so as well, and at less cost, than outsourcing these tasks to a third party.
Finally, there are those family offices that prefer to actively trade particular asset classes or strategies. In some cases, they do so to develop a performance track record that they, or the team they hire, can market to other investors as a separate asset management business.
The benefits of understanding the preferred approach
It is important for principals, family office executives and those who provide advice and services to these types of investors to understand these distinctions. For principals, it offers perspective regarding new hires and portfolio management—done in a way that satisfies their desire for control or ability to be more actively involved in certain investment activities.
For family office executives, this understanding also helps with staffing decisions for investment functions and solidifies where to focus more time, often in the areas where the principal has expressed a desire to be actively involved, whether individually or via the family office’s investment team.
Finally, for service providers, understanding what the family is doing with their investment capital as well as how they are doing it, can help them better assess the advice and services they should offer.
For more delegatory families, this may mean broad support in areas such as asset allocation, manager search, selection and reporting. For more active-controlling family offices, it means serving as an execution partner in one or more asset classes or for select strategies.
Figure 6.1 Private investing–direct investing
Source: World Economic Forum, “Direct Investing by Institutional Investors: Implications for Investors and Policy-Makers,” 2014
Introducing a growing family office wealth strategy: private investing
Private investing, also referred to as “direct investing” (figure 6.1), is where a wealthy family makes an investment into a company directly instead of through an intermediary such as a private equity fund.
Many family offices reduced their exposure to traditional investment strategies after the financial crisis of 2007–2009.1 Such strategies often rely heavily on portfolio allocations to public securities such as stocks and bonds. Instead, they turned increasingly to nonpublic (i.e., private) investment markets, and have since become major players in the financing of private companies.
Family offices are now an important source of capital for start-ups, middle-stage financings and other private deals of all sorts, including the high-flying financing market for private companies with $1 billion-plus valuations known as “unicorns.”
This is an excerpt from The Family Office, A Comprehensive Guide for Advisers, Practitioners, and Students. Now available where books are sold.
Adapted from The Family Office by William I. Woodson and Edward V. Marshall. Copyright (c) 2021 Rybat Advisors, LLC. Used by arrangement with the Publisher. All rights reserved.
Our experienced family office team can provide the resources and expertise needed to effectively address the issues and challenges you face. For more information regarding our capabilities, visit our family office services webpage today.1World Economic Forum, “Direct Investing by Institutional Investors: Implications for Investors and Policy-Makers,” November 2014, http://www3.weforum.org/docs/WEFUSA_DirectInvestingInstitutionalInvestors.pdf.