Where the World’s Wealthiest Families Are Putting Capital – And Where They Aren’t

Family offices are planning to increase their exposure to private equity — the second biggest allocation in their portfolios — amid doubts that hedge funds can protect their wealth in a downturn, according to UBS.

Illustration by II

Illustration by II

Wealthy families aren’t showing hedge funds much love, favoring other alternative assets amid concerns of a possible recession next year, according to UBS Group’s survey of family offices globally.

“Family offices have doubts about hedge funds’ ability to protect wealth during economic downturns,” UBS said in a report on its survey of 360 offices in North America, Europe, and Asia. “They dislike what some deem to be relatively high fees when compared to performance.”

The Swiss bank found that family offices, with an average $1.2 billion of wealth, divested from hedge funds in 2018 for a fifth straight year. With more than half of those surveyed expecting a recession next year, respondents planned to increase their exposure to private equity and real estate as well as stocks in emerging markets.

Their hedge fund allocations slipped globally over the past year to 4.5 percent, less than a quarter of the 19 percent allocation that wealthy families made to the popular private equity industry, according to the report. One portfolio manager at a multi-family office in North America told UBS that hedge funds have been getting less of its money because returns over the past eight years could have been achieved by “throwing darts,” according to the report.

The decade-long bull market has increased the wealth of family offices while their structure and governance have grown more sophisticated.

“Family offices are becoming a bigger force in financial markets,” Munish Dhall, deputy head of global family office at UBS, said during a presentation of the bank’s findings in New York. “They are growing rapidly.”

Alternative assets account for a large portion of family office allocations, rising 1.4 percentage points last year to more than 40 percent of their portfolios, the survey shows. UBS explained that families have been seeking yield and diversification in alternative asset classes after years of low interest rates and concerns over heightened volatility.

Private equity, including direct investments, represents their second biggest allocation at 19 percent of their portfolios, according to UBS. Family offices have the most capital in global stocks, with 32 percent of their portfolios in emerging and developed market equities.

The family offices surveyed by UBS reported that private equity was their best-performing asset class over the past year. Private equity will also be the biggest beneficiary of planned allocation increases in 2020.

UBS found that a net 39 percent of family offices planned to increase direct investing in private equity next year, with a net 28 percent expecting to make larger allocations to funds managed by private equity firms.

Family offices like direct investments because they have more control and avoid fees charged by fund managers. “It appeals to entrepreneurial families and the next generation who want to be more hands-on,” UBS said in the report.

Over the past year, actively managed direct investments in private equity delivered average returns of 16 percent — the biggest gain of any asset class in the survey. While private equity funds had lower average returns of 12 percent, those gains met the expectations of the majority of family offices surveyed by UBS. Private equity fund of funds also largely performed in line with expectations, posting an average return of 8.6 percent.

Real estate is the next most popular category within alternative assets, with a net 16 percent of family offices planning to increase direct investing in the sector next year. The survey showed more wealthy families are also planning larger allocations to real estate investment trusts.

Hedge funds, whose 2.3 percent gains over the past year failed to meet expectations, were the sole group within alternative investments that won’t see a net rise in allocations from family offices next year. At least for now, they’re expected to hold steady.

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Wealthy families are adjusting their portfolios after their global average returns “cooled” over the past year to 5.4 percent, UBS said in its report. The fourth quarter was particularly tough, the Swiss bank said, with investors navigating geopolitical tensions including the trade war between the U.S. and China.

Emerging market equities are also viewed favorably by wealthy families, according to the UBS survey. The bank found that 29 percent of family offices will increase their allocations to developing markets next year, while 7.7 percent are planning to reduce exposure to developed market equities on a net basis.

UBS pointed to the long-term trend of “market liberalization” as a factor in their preference for emerging markets.

“Many investors report they find the longer-term fundamental compelling and are willing to look through short-term volatility,” UBS said in the report. “In China, for instance, competition is intensifying and the state is acting to stimulate the economy and markets.”