Emerging managers to benefit from return of family office capital
There has been a sizeable growth in seed deals and day-one investments as family offices increasingly regain their confidence in hedge funds.
“We are seeing more family offices get involved in start-ups. With the decline of the funds of hedge funds industry, more family offices are investing directly in hedge funds,” said Kevin LoPrimo, managing director at Global Prime Partners, a boutique prime focused on smaller managers, speaking at the Hedge Fund Start-up Forum in London.
A study by Preqin found family offices allocated 19.5% of their portfolios to hedge funds in 2013, an increase from 16.6% in 2012, and 14.9% in 2011. Family offices, historically the core client base of hedge funds, retreated from the asset class in the aftermath of the financial crisis, where many suffered from gates, suspension of redemptions or worse exposure to frauds such as Bernard Madoff.
The return of family office capital is a welcome development and is likely to provide opportunities for smaller, niche hedge funds, which tend to get ignored by conservative institutional investors such as pension funds and insurers. Many of these institutions are subject to stringent risk criteria and concentration limits which restricts them from investing in smaller, sub $250 million managers.
Family offices are not bound by such restrictions. Eighty per-cent of family offices told a Barclays Prime Services they would invest in a hedge fund with less than a one year track record, while half would seed a day one manager. A J.P. Morgan study in May 2013 revealed 37% of family offices would increase the number of start-ups in their portfolio, while 86% said they would invest in sub-$100 million hedge fund managers.
“Family offices, particularly those in Switzerland, the UK and US, are expressing more interest in hedge funds,” said Phillip Chapple, executive director at KB Associates, a London-based boutique hedge fund consultancy. He added it was also advisable to offer these early stage allocators a discount in exchange for these initial investments.
This growth in direct family office investing comes at the expense of funds of hedge funds. The troubled asset class comprised just 32% of investor respondents to a survey by the capital introductions arm of Goldman Sachs Prime Services, a fall from 35% in 2013, and a far cry from their 2008 heyday when they accounted for 61% of respondents. The gradual demise of funds of hedge funds comes amid substandard performance following the financial crisis, not to mention their added layer of fees.
“Funds of hedge funds have been suffering since 2008. However, over the last six months, we have been hearing there has been growing investor interest in funds of hedge funds. Nonetheless, most investors are going direct to hedge funds because they do not want to pay the added layer of fees at funds of hedge funds,” said Adrien Galy-Dejean, chief operating officer at Heieck Siebreacht Capital Advisors.
US investors are also looking beyond US-focused hedge funds in search for alpha, added Chapple. “Many US focused hedge funds are correlated to the US economy and they are offering good beta but not alpha. US investors are therefore looking for niche managers outside of the US, which are perhaps focused on frontier markets, the Middle East, the Far East or credit,” said Chapple.