Family Offices and Their Increased Appetite for Alternatives

As family offices grow in both size and sophistication, they are evolving into more complex and discerning investors. Historically, family offices focused on preserving wealth through traditional investments such as public equities and bonds. However, as these entities have expanded, their investment strategies have matured, leading to a marked shift toward alternative investments. With increasingly diverse portfolios, family offices are capitalizing on private equity, real estate, venture capital, and other alternatives to enhance returns, reduce risk, and hedge against inflation.

In this article, we'll go over the growing trend of family offices shifting toward alternative investments such as private equity, real estate, and venture capital. By the end of this article, you'll have a better understanding of why these alternatives are gaining popularity and how family offices are navigating the associated challenges.

The Shift Toward Alternative Investments

According to a survey conducted by KKR, family office allocations to alternatives are increasing. The CIO’s of 75 family offices surveyed expect their alternatives exposure to grow from 42% to 52% from 2022 through 2024. On the other hand, equities exposure is expected to decrease from 32% to 29% (Institutional Investor).

Outperformance

The move to alternatives reflects several factors, most notably the pursuit of higher returns. Public equity markets have become more volatile, and traditional asset classes like bonds have seen declining yields due to prolonged periods of low interest rates. By contrast, alternative assets like private equity and real estate have consistently outperformed over long periods. For example, despite strong returns from the public markets recently, private equity has outperformed the S&P 500 over the past 5, 10, 15 and 20 year periods. The Pitchbook North American Private Equity Index returned 18.8% over the past 5 years, while the S&P 500 only returned 9.9% (FS Investments).

Illiquidity premium

Family offices, with their long-term investment horizons and sizable capital, are particularly well-suited to take advantage of the illiquidity offered by alternatives. Family offices may view the illiquidity of these investments as a potential benefit, allowing them to capture the "illiquidity premium" — the extra return expected from holding assets that cannot be easily sold. Unlike institutional investors, they are not constrained by short-term performance metrics, allowing them to invest in private markets, which often require locking up capital for extended periods. 

Diversification & Inflation Protection

Diversification through alternatives allows family offices to reduce their exposure to traditional asset classes, such as stocks and bonds, which are highly correlated with broader market movements. Alternatives, by contrast, often have low correlations with public markets, enabling family offices to build more resilient portfolios that can withstand market volatility. Additionally, many alternatives are considered effective hedges against inflation. Real estate, infrastructure, and commodities often perform well in inflationary environments because their values tend to rise with increasing prices. Real estate, in particular, benefits from inflation as property values and rental income typically grow in step with inflation.

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Challenges in Alternative Investments

Despite the clear benefits, alternative investments come with challenges. 

Illiquidity: Even though it was mentioned earlier that illiquid assets tend to be a non-issue for family offices, they can still pose risks. Despite the long-term investment horizons of family offices, the illiquidity of private investments can still pose an issue, particularly during periods of economic uncertainty when accessing capital becomes crucial. 

Fees: The higher management fees and performance fees (carried interest) associated with private equity and hedge funds can eat into returns if not carefully managed. 

Minimums: Many alternative funds require high minimum investments, sometimes in the range of $1 million to $10 million or more. This can limit smaller family offices or those looking for greater diversification across asset classes or managers.

To navigate these challenges, many family offices are building in-house expertise or relying on specialized advisors to perform due diligence, assess risks, and manage the complex financial structures that come with alternative assets. This topic will be discussed in the following blog post.

Dakota Marketplace for Family Offices

Dakota Marketplace empowers investment firms to forge direct connections with family offices, strengthening their sales and relationship-building efforts. By offering a focused outreach approach, the platform helps firms efficiently pinpoint and engage with key decision-makers. Additionally, it streamlines the fundraising process by acting as a bridge that links family offices with investment opportunities.

To explore family offices in Dakota Marketplace, book a demo!

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Written By: Alex deMarco, Investment Research Analyst