Trend of Family Offices Allocating to Direct Investments vs. Fund Management Structures

In the years following the financial crisis, we’ve devoted a lot of resources toward covering the trend of direct investing by institutional investors like endowments and pensions, as well as family offices. The recession came and many large investors suffered poor portfolio returns as many funds that were thought to be well-hedged or otherwise diversified proved susceptible to broader market forces. The reaction by most investors was to reconsider their portfolio strategy and risk management practices. More than a few of these chastened investors decided to manage more capital directly and eschewed passive LP commitments in favor of co-investments alongside funds and even wholly direct investments managed in-house.

This trend didn’t go unnoticed by us and we’ve held entire conferences on the topic, produced dozens of resources on direct investing, and spoken with hundreds of families and LPs in our network about their investment programs and how their allocations have shifted in recent years. (We’re even devoting a full day of our Family Office Super Summit this year to direct investing and deal flow: It’s not just us, either; I did a quick review and found multiple news articles and industry publications just this month that discuss the broader trend, an institutional investor’s direct acquisition, a family office real estate investment program, etc. So, with all this talk of direct investing by institutional investors and family offices, I wasn’t surprised when I received a cold-email the other day from a GP wondering, “It seems as if family offices want direct control over their investments. Do you think there is a market for family office interests as limited partners?”

I wanted to share my answer because I believe it’s important to remind everyone, myself included, that many family offices are deploying capital as an LP in at least one investment fund, often several. I don’t pretend to know what the portfolio breakdown is for every family office or pension fund, but of the many investors I have met, most are allocating through LP funds. Here was my answer to the inquiry:

I think that it’s important to recognize the increase in direct investments and co-investments by family offices and institutional investors – not only in real estate but also private equity-like investments where they are acquiring private businesses or supplying direct growth capital, etc. However, we probably underreport the traditional limited partnership interests held by most family offices. Family offices investing as an LP is a little bit of dog bites man, whereas family offices playing the role traditionally occupied by the GP/fund manager is more man bites dog. So, I think it’s worth reminding readers (and myself) that family offices do continue to invest as an LP and even in the family office that we represent, we’re still open to LP commitments but just pushing for real value and less extreme fees.

When Ontario Teachers started doing private equity I think that many GPs feared a new world where pensions and institutional investors no longer needed fund managers but obviously that isn’t the case because GPs earn their fees with outperformance and constant attention to the investments and few allocators have the time/infrastructure/expertise to devote to managing internal investments directly. Same goes for family offices, most just aren’t set up for that type of direct investment program but many would like to at least dip their toes in it where possible even if it’s only one deal a year and only a percentage of their capital base.

If there’s a deal that we can’t do (mostly development, where it’s harder to do in-house as a family office) then we’re OK paying fees. I think that goes for most families and if the family is going to pay a GP they’d like to either be paying for strong outperformance relative to other investment opportunities, get a break on the fund terms, or have the chance to develop internal capability through a co-investment or resource sharing. Institutional investors want to be able to ultimately reduce or eliminate fees paid to fund managers and GPs but that’s more of a long-term goal and I know very few (handful) of family offices that truly manage all capital in-house. For the foreseeable future, those GPs that outperform and present an attractive offering to LPs will still win allocations.

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