Smart Money Doing Private Equity in House as General Partners Warn of Lower Returns, Dumb Money Pours IN
I’m late to a Bloomberg story that ran under the anodyne headline, Wealthy Families Have $4 Trillion Up for Grabs. The Washington Post used the more apt World’s Rich Families Are Putting Private Equity Firms on Notice.
The message is simple: super rich families are figuring out that private equity firms are charging more that they are worth. The very rich, starting in a serious way in the 1980s, have brought more of their investing in house in the form of “family offices”. At the small end, they replicate what a private banker would do, as in put them in various investments, without the conflicts of interest or (hopefully) the ego issues (as in a private banker would have incentives to recommend in house products and actively-managed stock and bond funds). They might also oversee direct investments, such as in real estate or angel/venture investments.
The biggest families are getting more serious about doing private equity on their own. Given total annual fees estimated at 7%, they don’t have to hit home runs to beat private equity performance. In addition, they don’t have the bad incentives of private equity. For instance, the general partners make money irrespective of whether their deals succeed or not, making them too willing to do marginal deals, since a fund can afford a few dogs and still eke out a decent return. Similarly, private equity funds often sell winners earlier than is optimal to show tangible investment results prior to raising a new fund.
In December, a half-dozen of some of the richest families in the U.S., from agriculture to beverages, gathered in a conference room on the 10th floor of an office building in Miami.
This was not some cabal to rule the world. Instead, for an hour over coffee and bagels they listened to a dealmaker for billionaire brothers J.B. and Tony Pritzker talk about how to buy companies….
Now, following the likes of Buffett, Michael Dell and Bill Gates, many are acting like private equity firms, buying large stakes in companies or acquiring them outright. Families can exert tighter control over their money, give the kids something to do and cut their deal fees.
But the trend has meant that private equity shops have been forced to scramble to make sure they don’t lose a critical source of money for their buyout funds. Blackstone Group LP assigned an executive to court wealthy families, and Carlyle Group LP and other private equity firms are allowing many to invest alongside them in deals.
...MORE‘Saved Millions’And here is the real threat: the family investors are putting the soi disant pros of private equity to shame:
“After a decade of direct investing we found that we actually saved millions, which were reinvested in companies and assets — huge, huge savings,” said Chad Hagan, whose family built its wealth in private health-care and financial businesses.
Almost 70 percent of family offices engage in direct investing, according to an April survey of 80 offices by the Family Office Exchange. And in 2015 they outperformed buyout firms. Direct deals returned them 15 percent on average, the survey showed — more than double private equity results that year....