October 30, 2024
Family offices are increasingly transforming into highly sophisticated investment entities, with many now hiring in-house experts to manage their growing portfolios of alternative assets. This shift is part of a broader trend where family offices are looking to reduce their dependence on external managers and take more control over their investment strategies.
In doing so, they aim to optimize costs, improve decision-making processes, and align their investments with the family's long-term vision and values. Mentioned in the previous blog post, family office allocations to alternatives are increasing. KKR’s survey concluded that the CIO’s of 75 family offices surveyed expect their alternatives exposure to grow from 42% to 52% from 2022 through 2024. This increase in alternatives warrants more investment expertise.
In this article, we’ll be covering how family offices are evolving by bringing investment expertise in-house, examining the key benefits, challenges, and strategic advantages of this shift. By the end, you’ll have a better understanding of why many family offices are making this transition and how it could impact their long-term success.
By bringing on board investment specialists from sectors like private equity, venture capital, and real estate, family offices are enhancing their ability to evaluate deals, perform due diligence, and manage risk. In fact, according to research from Institutional Investor, 73% of family offices that have preserved wealth for three generations or more now employ chief investment officers (CIOs), compared to 57% for first- or second-generation family offices (Institutional Investor). In-house investment teams enable family offices to customize their investment approaches and make quicker, more agile decisions. These professionals are often tasked with managing both traditional and alternative assets, with a particular focus on private equity and real estate investments.
Family offices must look for candidates that possess strong financial analysis skills, including expertise in valuation methods (DCF, comparables), financial modeling, and capital structures. They must excel in conducting thorough due diligence on financial, operational, and legal risks, as well as analyzing market trends. Additionally, they should be adept at structuring and negotiating deals. These professionals often come from backgrounds in investment banking, private equity, venture capital, or management consulting, with many holding advanced degrees like MBAs or CFA certifications.
However, hiring an in-house investment staff is very expensive, especially for family offices with AUM below $500 million. According to a report from Citi Private Bank (Citi), around 39% of family offices with AUM below $500 million reported not having a CIO, compared to only 22% for those with higher AUM. This discrepancy is logical, as hiring and retaining a full-time CIO represents a substantial financial commitment that smaller offices may not be able to justify. As a result, family offices with less than $500 million in AUM are 50% more likely to use an outsourced CIO (12% versus 8%).
Family offices are increasingly focusing on alternatives because of their potential for high returns and diversification benefits. However, these investments are also more complex and require specialized knowledge. In-house experts provide family offices with the necessary expertise to evaluate deals, understand market trends, and navigate illiquidity issues associated with private markets.
Having an in-house investment team helps family offices invest more effectively in private equity funds for several reasons:
Due Diligence: Internal teams provide deep expertise to thoroughly assess private equity funds, ensuring alignment with the family’s goals and risk tolerance.
Cost Efficiency: By managing fund investments directly, family offices can reduce fees typically paid to external consultants or advisors.
Customized Strategy: In-house teams can tailor private equity fund selection to match the family’s long-term vision, focus on specific sectors, and optimize portfolio diversification.
Faster Decision-Making: Internal experts enable quicker and more informed investment decisions, giving the family office a competitive edge
In addition to investing in private equity and venture capital funds, family offices are increasingly participating in direct deals and co-investments. This has become a significant trend, as co-investments allow family offices to invest alongside private equity firms in individual deals, often without having to pay the typical management fees associated with private equity funds. This not only reduces costs but also provides family offices with greater transparency and influence over the investment. These types of transactions can also result in higher potential returns relative to traditional fund investments.
According to a report from BNY Wealth Management, 62% of family offices made 6 or more direct investments last year, and 71% are planning to make a similar number or more over the coming year (BNY). The ability to invest directly or co-invest alongside private equity firms also allows family offices to diversify their portfolios while maintaining control over specific deals. This approach provides family offices with the flexibility to invest in sectors or geographies where they have expertise or a particular interest.
To fully leverage the benefits of hiring in-house experts, family offices should implement several best practices. A Partners Capital white paper highlighted the following recommendations for success:
Strong Governance: Establish a clear investment committee to oversee decisions and ensure alignment with family goals.
Diversification: Spread investments across geographies and asset classes to reduce risk, especially in illiquid alternatives.
Direct Investing: Leverage direct deals and co-investments through thorough due diligence and partnerships.
Risk Management: Implement a risk framework aligned with liquidity needs and family risk tolerance.
Education and Adaptability: Continuously educate the team and adapt strategies to evolving markets.
Family offices are becoming increasingly sophisticated in their approach to alternative investments by hiring in-house experts to manage complex portfolios. This shift allows them to conduct more thorough due diligence, participate in direct deals, and align investment strategies with the family’s long-term goals. While hiring in-house talent can be costly, the benefits of greater control, cost efficiency, and more personalized investment strategies make it a worthwhile investment for many family offices.
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