Family offices and boutique hedge funds often share an entrepreneurial nature and outlook, and the similarities don't end there, the author of this article argues.

Hedge fund assets gained 7.3 per cent in the 12 months to end-March, reaching $3.07 trillion, and returns have been positive so far this year, which building on some earlier gains, might suggest that the torrid period for that sector is over. Even so, the hedge fund industry’s glory years of two decades’ ago are a distant memory for some, given concerns about how returns have often lagged mainstream market indices, a fact that doesn’t go down too well given the relatively high fees that hedge funds typically charge (although there has been some compression recently). Hedge funds have become more highly regulated, in reaction to the 2008 financial crisis and scandals such as that of the Ponzi scheme crook, Bernard Madoff. And that increase in regulation may be encouraging those who prefer to operate in a less regulated environment to turn elsewhere, such as family offices. This is the argument of Louis Gargour, founder and managing partner, LNG Capital, a European credit alternative asset manager. In this article, Gargour claims that there is now a new period of co-operation between hedge funds and family offices. Whether or not this is the case, the editors of this news service are pleased to share these insights with readers and invite responses. Email tom.burroughes@wealthbriefing.com

The growth of family offices has been one of the more notable developments in investment management in recent years.  The 2016 EY Family Office Guide estimated that at least 10,000 single family offices now exist worldwide, half of which have been established over the past 15 years.  Bloomberg estimates that family offices now control assets worth over $4 trillion. 

Family office structures have become increasingly attractive compared to hedge funds as hedge funds have become more regulated.  While the exciting “wave of the future” in investment management in the 1990s was hedge funds, the increased regulatory requirements which hedge funds are now burdened with means that is no longer true. Family offices are now sometimes considered the new hedge funds.  Indeed, there has been a steady stream of high profile hedge funds such as Soros and Bluecrest that have converted to family offices

The difficulty hedge funds have faced keeping pace with equity indices and the resulting number of high profile funds winding down and returning funds to investors has been well-reported. A total of 1,057 hedge funds closed or were liquidated in 2016, according to Hedge Fund Research. However, it is still possible for managers with the right strategies to out-perform and there is evidence that boutique managers are finding success pursuing smaller deals and niche opportunities that are not available to their larger competitors.

Meanwhile, the expansion of family offices has seen them increasingly adopt more institutional organisational structures as they seek to retain a greater level of control over their investments. Family offices have now reached a level of maturity and sophistication where they are able to pursue their own in-house strategies and are actively seeking out and engaging in direct and co-investments.

This steady expansion and professionalisation of the sector means that family offices have an ever-growing demand for specialist expertise and experience and they are increasingly turning to hedge funds to find that essential talent.  Boutique hedge funds are particularly well placed to support family offices in this way, due to the close similarities and synergies between the two industries.

Family offices and boutique hedge funds often share an entrepreneurial nature and outlook.  While new family offices are often founded by the latest generation of successful entrepreneurs who look to maintain a “hands on” approach, boutique hedge funds are launched by similarly entrepreneurial financiers looking to manage their own operations and pursue their own strategies. Family offices and boutique hedge funds also exhibit a similar level of agility that allows them to adapt quickly to changing market dynamics to exploit new opportunities as they arise, supporting their entrepreneurial talents.

The similarities between the two sectors mean boutique hedge funds and family offices are highly complementary and through collaboration there are significant synergies that can be realised for their mutual benefit. One of finance’s “mega-trends” in recent years has been the increasing number of co-investment deals by investment managers and allocators. Initially this was undertaken by larger players like large private equity outfits and pension funds, but is now being replicated by smaller players like hedge funds and family offices. In both cases managers of money and providers of capital are cooperating for their mutual benefit.

A second “mega-trend” has been the increased funding of the real economy by non-bank sources. As the banking sector in the post-crisis era has been constrained in its ability to lend, there has been an emergence of new credit investors investing in the real economy. This has been particularly prevalent in infrastructure investment where private equity and large institutional investors have been taking a particularly active role, collaborating through large co-investments. This broader trend is creating more opportunities for credit managers and family offices to collaborate in new, lucrative areas.

Family offices have a particular need for credit expertise, due to the sector’s large exposure to and appetite for fixed income investments. In this space, managers can act as a valuable conduit for family offices, using their established contact networks to deliver a steady flow of potential deals that are not on the radar of big banks due to their smaller ticket sizes. However, the smaller size of these deals is often a key advantage for boutique managers and family offices. They allow investors to dictate more favourable terms and provide more alpha generation opportunities.

In our experience, we have found that family offices often prefer co-investments, as the active participation of managers guarantees that they are not simply acting as agents.  However, this preference fits naturally with hedge funds’ investment processes, allowing family offices to join deals that have already been thoroughly researched and where rigorous due diligence has already been conducted. The added firepower that family offices bring to these deals helps hedge funds negotiate and structure more advantageous deals. Utilising the extensive experience of hedge funds in this way, family offices can secure the same favourable terms that funds secure while retaining control of their investments. 

With anticipated increases in volatility and lower correlations likely to support hedge fund performance and imminent interest rate rises particularly benefiting credit specialists, we expect that this new dynamic between hedge funds and family offices will become increasing popular and evermore rewarding.