Drawing on extensive resources and expertise, we invest on a discretionary or advisory basis across the full range of asset classes. We always adapt our investment approach to the wider circumstances of the family.
No two family clients have identical investment needs. Many ask us to manage their entire portfolio; others wish to provide greater input to the process and to have a high degree of interaction with our team. We regularly work with investors who draw upon their own expertise in specific sectors.
Some of our clients are in the first generation of family wealth; others have many members across multiple generations, where succession and governance can be key investment issues.
Some families who employ a variety of investment managers, use us as their gatekeeper to oversee investment strategy, research, administration and reporting.
In all cases, our clients can draw on a global investment perspective, knowing that our teams in London, Zurich, South Africa and Jersey will address the nuances of local markets and cross-border tax requirements.
Building portfolios requires sophisticated analysis and monitoring, but we seek to deliver our service with simplicity and transparency. Our reports tell you what we have done and why, and the investment performance we have generated, at an agreed frequency. We will coordinate fully with your other advisers inside and outside Stonehage Fleming and we believe our charges are clear and fair.
We manage investments in the context of your family’s wider financial circumstances, and we work with fiduciary, legal and tax experts, both internal specialists and external partners, to address tax issues impacting portfolio construction; these often span jurisdictions, entities and structures.
We take account of the impact on investments of the varying needs of generations, as attitudes to risk/ reward and time horizon may vary substantially within the same family. Whether you appoint us to manage a global portfolio spanning multiple asset classes, or a more narrowly defined investment mandate focused on direct equities, fixed income, cash or private capital, a cohesive approach is vital.
Investors now have an extraordinary array of instruments, products and service providers available to them. Distinguishing between these on the basis of performance alone is challenging and potentially hazardous. However we may help you with your investments, there are a number of core principles that underpin our approach. The time horizon of our clients often spans generations, so we aim to grow wealth in real terms.
We invest with a high margin of safety, diversifying risk across and within asset classes, but take advantage of opportunities when the risk is justified and understood. We aim to enhance returns by making active judgments on individual securities and external managers, including investments in private capital. All holdings are subject to exhaustive research enabling us to invest with conviction, and portfolios are continuously monitored - both in terms of their composition and in the context of wider family assets.
With the backdrop of continuing low interest rates and periodic bouts of extreme market volatility, private capital has attracted increasing attention and investor demand in recent years. The key attraction of the asset class has been its returns, with the industry consistently out-performing public markets by a meaningful margin as shown by Chart 1.
Within the asset class, there are of course a multitude of segments, some showing returns substantially above the average and some substantially below. Another attraction has been the ability to invest in high quality private companies. This feature has had particular resonance for entrepreneurs and families whose own wealth typically originated in a successful private business.
The two principal options for investing in private capital are investing directly in companies or investing via funds:
Whilst highly attractive in theory, investing directly in companies is frequently much more of a challenge than it might initially appear. The key consideration is the extent of a family’s available resources, both financial and human.
Many families in business believe they can harness their business knowledge, skills and contacts to generate higher quality deal flow and opportunities than a typical private equity house, but most of them have found it challenging to convert this theoretical advantage into practical reality. They also come to realise that the portfolio management skills required for investing in businesses which they do not manage or control are not the same as the business skills required to run their own company.
Building a portfolio of direct investments requires not only a significant amount of capital, typically $50-100m as a minimum, but also requires one or more family members or a third-party professional, plus a supporting team, consuming significant time and/or cost.
Typically, a private equity team will look at about one hundred proposals for every investment it undertakes and the amount of work required to progress and monitor these transactions is substantial.
The reality therefore is that among business-owning families there are many who have:
For these reasons, many families conclude that while they rightly wish to utilise their own skills in the sectors they know best, they also frequently seek exposure through funds or other professional channels designed to:
Where investing directly in companies is not a viable option, the best route is to invest via private capital funds. In some cases, families may choose to combine these routes, investing in particular private opportunities directly but accessing other opportunities via funds.
Families have two main options for building a portfolio of funds: they can invest directly in funds or they can invest via an access vehicle such as a fund of funds2. Similarly to investing directly in companies, a family’s choice is likely to be driven principally by the extent of their human resources and the amount of capital they have to deploy.
The key to success is a disciplined approach. There are four golden rules of fund-investing outlined below:
It should be understood that selecting the right managers is even more important in private capital than it is in public quoted investments. The reasons for this are that performance records of private capital managers are much more widely dispersed and because the best performing managers establish a competitive advantage in accessing deals, they tend to sustain their advantage over a lengthy period.
There is significant dispersion of returns from one year to another and we therefore recommend that clients phase their fund investments over a number of years, thereby achieving diversification over the entire economic cycle. The objective is that, having built up an initial portfolio spanning three to four years, a family’s private capital portfolio will become self-sustaining and they can use the distributions generated to fund future commitments and capital calls.
The extraordinary post-crisis economic conditions have led to an erosion of returns in private capital, whilst continuing to out-perform public markets. However, this has not affected the whole asset class equally. As may be seen in Chart 3, falling returns have disproportionately hit the largest end of the market where returns for top quartile managers have fallen closer to 15%, reflecting intense competition among managers for the largest, high profile transactions. This is not the case for mid-market managers or smaller managers where returns have remained, on average, well above 20%.
In part, these higher returns reflect a degree of additional risk associated with smaller businesses, but also reflect the fact that private equity managers can add greater value to smaller and mid-sized investee companies. In addition, the returns in these segments are less driven by financial engineering since leverage is less prevalent than at the large end of the market.
As a result, families wishing to invest directly in private equity funds should be careful to consider a broader range than the large-cap funds which frequently market directly to them. In particular, accessing smaller funds will allow them greater scope to capture the higher returns available.
The life of an average private equity fund is ten years and may, in some cases, be longer. For many wealthy families, this kind of time horizon does not pose any problems. However, it should be pointed out that recent studies highlight a mismatch of liquidity horizons as being the single largest risk in private capital funds4.
Families and their advisers should therefore make absolutely sure that they will not need to access the money they are committing before the end of the fund-life.
So, what are the options for families seeking to access the asset class via investing in funds?
The most obvious route is to invest directly in those funds. This avoids an additional layer of fees and gives the family direct access to the managers. For families looking to follow this route, we would recommend they consider the following:
FINANCIAL REQUIREMENTS: Whilst the minimum investment allocation for building a portfolio of funds is less than for building a portfolio of direct private equity investments, it remains high. The minimum investment that most leading private equity managers will consider is $5m or higher. If a family is to build a portfolio of ten funds, this will require an allocation of $50m.
HUMAN RESOURCES: Whilst not as intensive as for direct investing, the execution of a strategy focused on private equity funds requires one or more family members to dedicate all or a significant part of their time to researching and accessing such managers or to hire a dedicated resource. Given the estimated 5,000+ private equity managers, this is not a task to take on lightly.
ADMINISTRATIVE BURDEN: The administration of such a portfolio is also relatively labour-intensive, which should not be overlooked.
One option is to use the feeder funds put in place by many of the larger private banks. These routinely offer their clients the ability to invest in several of the largest ‘brand name’ private capital managers. This has the advantage of being a relatively easy way to access some of the higher quality managers with a significantly lower minimum investment amount.
The principal disadvantage of this route is that such offerings are typically very expensive (in some cases, prohibitively). Furthermore, in addition to charging higher fees to their investors, the banks also charge as much as 4% to the underlying manager for all money raised. Many of the best private equity managers view this as exorbitant and therefore refuse to work with the banks. This tends to mean that the managers who do work with the Banks are the large, frequently listed private capital managers - the very managers for whom returns are falling, as mentioned above.
Families should therefore examine the potential fee drag carefully in order to determine its impact on returns.
For families who do not have sufficient available capital to invest directly in funds, the best route is to use an access vehicle such as a fund of funds or similar. These vehicles will typically build a portfolio for a group of investors, thereby reducing the minimum capital requirement per investor.
Fund of funds managers offer a number of advantages. They are typically highly professional groups with good experience of constructing portfolios and therefore significantly reduce the risk for their investors. Most importantly, they normally have good access to the top tier private capital funds, an important consideration as we have seen above.
When examining this route, there are a number of considerations:
COSTS: Access vehicles and fund of funds will charge an additional layer of fees. These may be more or less significant and in all cases, investors should try and minimise the drag from these additional fees. For funds of funds in particular, fees are commonly charged on the basis of an investor’s total commitments rather than on the value actually invested at any given time. As with bank feeder funds, this will have a significant drag on the ultimate performance.
DIVERSIFICATION LEVELS: A criticism that is frequently made of funds of funds is that they are over- diversified. A typical fund of funds will frequently contain 30 or as many as 50 underlying funds. As a result, it will have exposure to 500-1,000 companies. We believe that this is over-diversified and that, as a result, the returns will rapidly mean-revert rather than capturing the fullest potential of the top-performing managers. One way around this is to select a vehicle with a more focused portfolio.
INVESTMENT STRATEGY: Whilst there are a growing number of niche fund of funds focusing on specific niches or sub-segments of the private capital market, many of the largest fund of funds are having to deploy several billion dollars annually. In these cases, their ultimate investments are likely to be with the largest brand-name private equity funds and subject to the lower expected returns we referred to above. Families should therefore look carefully at the investment strategy and expected portfolios of funds of funds to ensure that they will be gaining exposure to some of the higher returning segments.
FLEXIBILITY: Fund of funds are frequently like oil-tankers, it takes them a long time to get moving (capital is typically drawn over a 7-yr+ period) and when they do, they are difficult to stop! The challenge for a family is therefore that they are required to make a firm commitment to invest over a number of years. A number of fund of funds now offer annual programmes which we believe offer a structural advantage to investors, enabling them to have greater flexibility in adapting their commitment levels to their own changing circumstances.
We believe that private capital returns have justified the recent attention that the asset class has received in recent years. For investors with a sufficiently long time horizon, private capital can play an important role in achieving their overall return target. However, given the illiquidity associated with the asset class, it is important to give thought up-front to the most appropriate route for an investor’s individual circumstances. The most important factor here will be a sensible evaluation of the resources that a family can realistically dedicate to this sector.
For some families, especially those with relevant business expertise, direct investment may be the preferred route. However, this often proves more difficult than anticipated and the option of investing at least partially through funds should always be considered.
Where families do choose to invest in the asset class via funds, there are a number of options as well as golden rules which should be respected in order to avoid disappointment and to achieve the best returns from their investment.
For those who choose a combination of direct, funds and funds of funds it is obviously important that the investment strategy and implementation is properly coordinated to avoid excessive concentration of risk.
1 Source: Cambridge Associates LLC U.S. Private Equity Index is compiled from 1,231 U.S. private equity funds (buyout, growth equity, private equity energy and mezzanine funds). Returns are net of fees, expenses, and carried interest. Bloomberg: S&P 500 Total Return Index. All data as at 30.09.2015. Past performance is not a reliable indicator of future returns.
2 For Professional and HNW investors subject to suitability
3 Source: Cambridge Associates US Private Equity Index & Selected Benchmark Statistics 30.6.15. Data label refers to the difference between upper and lower quartile performance. Past performance is not a reliable indicator of future returns.
4 British Venture Capital Associate study, Risk in Private Equity - new insights in to the risk of a portfolio of private equity funds - (BVCA October 2015).
5 Source: Preqin . Benchmark data as at 04/01/2016. Data relates to average performance of first quartile buy-out funds globally for period 1999-2015. Past performance is not a reliable indicator of future returns.
The term ‘wealth management’ implies more than just the management of an investment portfolio, and most wealth managers claim to add value across the whole spectrum of their clients’ affairs. comprehensive understanding of an individual’s total wealth may be plausible for clients whose affairs are relatively straightforward, and who have the bulk of their assets in cash and marketable investments. however, this becomes more complex and challenging when a substantial proportion of an individual or family’s wealth is tied up in a family business and perhaps a number of other directly held investments.
It is not uncommon for a founding entrepreneur to have amassed a significant portfolio of specialist investments aside from their core business. these active, self-directed investors, who have been heavily reliant on their own knowledge and expertise, may invest for many years largely without the need for a conventional investment manager.
Typically, this type of entrepreneur only begins to consider professional investment advisers when they start thinking about succession, especially where their children or other successors simply do not have their specialist knowledge, influence and contacts, or do not share their interest in business.
Often, an entrepreneur will only then seek an investment adviser who can help manage the transition to the next generation:
Finding such a manager or adviser is, however, no easy matter:
The professional investment manager reduces risk through diversification across the whole spectrum of asset classes, whereas the entrepreneur tends to invest only in sectors which he understands and with people whom he knows, often resulting in a very concentrated portfolio. Risk is highly subjective and neither view is either right or wrong: they are just fundamentally different, and these differences have to be reconciled to begin developing a coherent investment strategy.
A multi-asset investment manager will typically espouse the benefits of diversification, built from the tenets of Modern Portfolio Theory and the work of a generation of Nobel prize-winning academics. In practice this means investing in a range of investments across asset classes, such that the overall portfolio sits at the required point of the risk/reward trade off.
The entrepreneur’s view is often far more personal than the investment manager’s because, rather than taking a holistic view, starting with analysis of the global marketplace, the entrepreneur sees risk and opportunity through the prism of his own practical experience. He or she has built a business relying on their own hard work and judgment, and has considerable belief in his or her ability to judge a business proposition.
In the early stages of the business venture, the priority is survival rather than the management of an asset. After a period, the successful business begins to provide a comfortable living, and eventually acquires significant capital value.
At the stage where there is significant value in the business, the theorist would argue the case for diversification, but the entrepreneur sees a growing business with increasing market share and decreasing risk of failure. As surplus cash is generated, some entrepreneurs may indeed seek to diversify by investing in a professionally managed portfolio. Others however, perhaps fuelled by the self-belief that is central to their own success, are more inclined to back their own judgment than hand money over to professional investment managers. An entrepreneur will often back individuals whose abilities he respects, as a result of first-hand knowledge, especially from past business relationships.
With the exception of property, which is a special case, most entrepreneurs do not invest outside their range of perceived expertise and are not often inclined to trust the ability of people with whom they have no direct experience.
The validity of this approach to risk management can be debated, and it can be argued that successful entrepreneurs may sometimes underestimate the risks in applying their undoubted business skills to investments in other ventures which they do not control. Their self-belief can be reinforced by mixing with other similarly successful businessmen, who have all generated much better returns over many years, than professional investment managers.
Often it is only when the core business matures, and/or when the entrepreneur begins to contemplate retirement and succession, that a more devolved form of investment management becomes an attractive option. For the reasons touched upon above, such individuals are likely to need convincing that a wealth manager possesses competencies which can genuinely add value. The wealth manager has no hope of gaining their trust unless he or she addresses and reconciles the fundamental differences of perspective in the management of risk.
As an entrepreneur approaches retirement, the need for succession planning becomes more immediate. Where there are family members ready and able to take over, there may be no need for a fundamental change of approach. However, in many circumstances the next generation do not have the desire or expertise of the founder, thus necessitating either significant changes in strategy, or bringing on board external expertise. Ideally there will be a transition period during which the founder will gradually hand over control, but this process is far from easy.
After forty or more years of taking all the decisions in successfully building up a valuable core business and a variety of other assets, the difficulties involved in a transfer of authority must be obvious:
The first and most obvious decision is whether the core business should continue under family ownership and management. This is a massive decision, which requires extensive planning, preferably over many years. It is the subject of a separate paper by Stonehage Fleming (Selling the Family Business).
As stated above, many successful entrepreneurs approaching retirement have invested in a variety of businesses, operating in similar sectors to the core business. In addition, there may be other substantial holdings including property, leisure assets and increasingly, valuable art collections. Unless the next generation is ready and willing to step into the founder’s shoes in each of these areas, the eventual loss of his knowledge, expertise, contacts and business skills may make some of these investments vulnerable.
It is highly unlikely that any founding entrepreneur will dispose of all such assets overnight and reinvest in the sort of balanced portfolio favoured by the investment industry. It will typically be a process in which the entrepreneur begins to adapt gradually to a new approach, and will need to be convinced every step of the way of the merits of the new philosophy. He or she will also need to be convinced of the ability of prospective advisers to add value in eventually stepping into his or her shoes, and providing the support and understanding they want for their family after they have gone.
The requirement therefore is to develop a transition plan which probably includes:
The plan must of course have a clear timetable with milestones, which will act as an important discipline and will only be modified with good reason, in the light of changing circumstances. It therefore goes without saying that the prospective wealth manager must have experience and capabilities which extend across the whole of the asset base, as it stands at the start of the process.
The ‘legacy’ positions present two particular challenges to new advisers.
The first is to ‘get under the bonnet’ of each company, understand its business model, and assess the strengths and weaknesses. The second is to negotiate an exit strategy, which can be an emotive process because of the long relationship between the client and the investment. It is key to the adviser’s role to understand these nuances, and provide an exit program that makes sense from both a personal and portfolio perspective.
Even the most astute entrepreneurs can be unfamiliar with the complexities of negotiating the exit of a position that may not have obvious market comparables. Consideration should be given to the length of time required to dispose of the position, whether it is tradable in the market, the degree of influence or voting rights in decision making, whether there are any lock-up periods and the relative importance of the investment to the entrepreneur personally (friends, partners or family who are involved in the business may be affected).
While legacy assets can be considered a hindrance from an adviser’s perspective, the client may be reluctant to dispose of them for very valid personal reasons.
Just as it is vital for the potential adviser to understand the client, it is equally important for the client to understand the constraints within which the adviser operates:
This type of client needs an adviser who can provide conventional asset management of the highest quality, but also has the capability, experience, insight and flexibility to deal constructively with the existing portfolio of specialist investments. The adviser needs to be challenging, but able to compromise and to take account of client views, without undermining his objectivity and frankness. Such an adviser will recognise the need for a transition period, where he is effectively operating as co-pilot, alongside the client.
He will also be building his relationship with the next generation and needs to be ready to support, advise and possibly challenge them, should they have both the will and the aptitude to continue the tradition of direct investment, at least for an element of their wealth.
The adviser must be accountable for all outcomes and ensure that his responsibilities are clearly defined, so that he puts up a robust and well informed challenge when required. Some advisers will find this type of relationship very difficult to handle, and will immediately recommend formal ‘text book’ family governance with decision making by committees. However this dilutes the control of the founder entrepreneur, and it is often wiser to recognise that most founding entrepreneurs find it very difficult to let go of the reins, so it sometimes has to be a gradual process.
The solution will lie in finding a balance, but decision making responsibilities need to be very carefully documented and transparent to all relevant parties, including trustees and beneficiaries.
The financial services industry builds scalability and cost efficiency by selling commoditised products, which are designed for ‘typical clients’. Wealth managers tend to be rather more flexible, but in most cases their business model relies on a relatively standardised approach which meets the needs of their chosen target market. The flip side is that such a model often cannot economically address the requirements of exceptional clients, whose affairs are particularly complex and who have built their wealth by backing their own judgment and making their own decisions.
Wealth management for entrepreneurs and business owners demands a model that is based on listening to each client and delivering genuinely bespoke services, especially in managing the transition to the next generation. It requires significant skill, broadly based knowledge and well defined responsibilities.
The adviser must have the breadth of experience to add value across the entire asset base and to challenge the entrepreneur, even within his or her own areas of expertise. Many entrepreneurs are strong personalities, and questioning their judgement can require courage.
It is not a job for the faint hearted!
On the 15th January 2015 Stonehage Group Holdings Limited completed a merger with Fleming Family & Partners Limited (‘FF&P’), a London-based Multi-Family Office. The combined company is called Stonehage Fleming Family & Partners Limited (‘Stonehage Fleming’) and is the leading independently-owned multi-family office in Europe, Middle East and Africa. Its advisory division provides corporate finance and direct investment advisory services as part of a holistic approach to advising wealthy families.
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