The world’s ultra-wealthy are doing fine. Part of the reason why is that families with a lot of money use family offices, dedicated bankers drafted in from the real world to invest their funds wisely as an in-house private wealth-management firm. Because of the nature of the job, there are relatively few of them. One estimate last year put the number of US family offices at between 5,500 and 6,500, with an average of three pros per office.
For the past five years, Swiss bank UBS has been releasing an annual report about family offices around the world. The 2018 edition, based on 311 online surveys and 25 qualitative interviews, shows family offices are not doing too badly. The average portfolio return was 15.5% in 2017, up from 7% in the previous year. Considering the average amount of assets managed by each family office is $808 million, that is not bad. (The average net worth of each family is $1.1 billion.)
How they invest that money is insightful to even those with of us without a 1967 Ferrari 275 parked outside their summer home.
While a 15.5% return is very good, it is less than the S&P 500’s return of 21.8% last year. That is because family offices on average only have 28% of their investments in stocks. While it means that they missed out on more of what is officially the longest bull market in US history, it also means they have a well-diversified portfolio.
Following equities and fixed-income, the next biggest source of family-office investment is in private equity, with 21.6%. It is difficult to compare private and public investments, but it can be done and the data suggests that private equity offered a higher rate of return than public equities over time (paywall). The American Investment Council also says its analysis for 163 US public pension funds points to higher returns (paywall), net of any management fees. PE funds do offer some risks, though, for smaller investors; you cannot pull your money out of them whenever you like, for example.
Half of family offices told UBS they intend to invest more in private-equity direct investments over the coming 12 months. No wonder that Blackstone, the world’s largest manager of private equity and real estate, thinks it could have $1 trillion in assets under management by 2026.
The next biggest investment is in real estate, with 18.1%. “We know families which have bought residential and commercial buildings all over…buildings in Paris, London, New York and things like that,” one partner in a family office told UBS, which reflects an investment window of seven to nine years. Property prices have been rising around the world in the biggest cities since the financial crisis—so much so that people are worried about bubbles in places like Hong Kong and many cities are actively trying to deter foreign investment in property.
But as with private equity, family offices are seeking a higher return over a longer time frame than most stock investors would look for.
Family offices are joining many other investors by cutting back on hedge funds. Their allocation is only 5.7%, down 3.2 percentage points from the previous year. Hedge funds, which bet on declines as well as gains in stocks, have struggled to attract capital and justify their high fees amid a buoyant stock market. Billionaire David Einhorn’s Greenlight Capital, for example, has seen its assets since 2014 shrink by more than half, to $5.5 billion (paywall).
“I think hedge funds are expensive. I think they’re illiquid. I think they’re lacking in transparency,” one CEO of a family office said. “It’s funny, in the long equity world, fees have come down quite significantly over a period. Hedge funds have come down a bit, but they’re still kicking and shouting about the fees. And if you’re making 20%, I’m quite happy for you to have a lovely big fee. But I know most of the hedge funds haven’t been making 20%.”
The rise of passive investing has been one of the stories of this bull market. Many ordinary investors, having realized it’s difficult to pick the individual stocks themselves, are instead pouring money into low-cost index funds that track standard benchmarks. Exchange-traded funds (ETFs) and mutual funds now have trillions in assets and number 3.3 million worldwide—70 times more than the number of publicly listed companies.
But family offices are not there merely to take young J.R. Winthorp III’s money and put into Apple stock. Despite all the evidence that passive investing will outperform stock-picking, 74% of family offices are employing an active approach to their equities investments, according to UBS.
The biggest takeaway is that family offices keep 7% of investments in cash. That is a huge amount to set aside, earning almost nothing. And that is actually down 3.9 percentage points from last year. “Our biggest risk would be unforeseen huge market downturns, where we would need a large amount of cash to fall back on,” said one senior wealth advisor. “That is something that we’re always trying to manage against.”
Family offices are focused on returns, yes, but they are also focused on protecting their wealth. What none of them want to do is lose their money.