If you’re not worried, you should be worried, hedge fund manager Ray Dalio warned in a roundly mocked tweet earlier this month.
But that principle applies to family offices, which haven’t been overly stressed about the stock market crash, experts said.
“It’s actually surprisingly quiet” among those responsible for huge personal fortunes, Mercer’s Cara Williams told Institutional Investor Wednesday. “There hasn’t been a massive amount of panic. But this crash only justifies diversification across all asset classes.” And family offices are not diversified to the same extent as their institutional peers, such as pension funds and major nonprofits.
The propensity for, say, energy billionaires to invest directly in other energy start-ups and companies rather than across sectors and asset classes “is extremely widespread and extremely common,” said Williams, who leads Mercer’s family office consulting and investment unit.
“When the matriarch or patriarch has generated wealth from a specific industry, they’re making investments in exactly where they made their money,” she explained. “The issue is that they’ve got heavy concentration — both by region and industry. You get crises like this, and fingers crossed that your exposure happens to be in online merchandisers. But it might not be.”
Several family office investors — who aren’t clients — readily back her up.
Marty Bicknell, for example, made his fortune through money management, starting Mariner Wealth Advisers, which oversaw $28-plus billion at the end of last year. His personal money is now part of Montage, a platform for seeding promising niche investment shops and backing them with operational and other non-investment capabilities.
“Mercer maybe would not be happy with that,” Montage managing director Christian Scharosch joked to II on Tuesday. The Bicknells had decided their edge is in what they know — the same calculus that leads so many rich entrepreneurs to play in their own fields.
[II Deep Dive: Family Offices Are Torn: Secrecy or Deals?]
“There is a desire to invest in what you know, and I think that desire needs to be informed and educated by a support team,” Scharosch said. “Most of these families — especially the first generation — have become experts in that space, and allocating outside can be uncomfortable to them. What I’ve seen is that they can a have a certain allocation and will also become a board member or adviser to companies as they grow, and more often or not they have successful outcomes.”
In Montage’s case, they had observed over time that niche managers outperform large managers, and that family offices want to work with institutional-grade firms (when they do deign to allocate to outside managers).
One family office investor who came from the institutional world has personally wrestled with the question of whether his cohort are “10 years behind pensions” or leapfrogging their fee-and-fund-happy allocation style.
“Hedge fund fees are mostly BS: way too high, and for too much risk,” he said. “You also get fund managers that accumulate assets, and in downturns sell off assets at fire-sale prices because they have different types of clients,” some of whom get cold feet or liquidity crunches and have to redeem. As a family office with scanty cash needs, he said, “We’re willing to bear a lot more volatility.”
By investing in companies directly — many of which are outside the founder’s arena — “our results are a bit better, but with a worse Sharpe ratio.”
He spoke to II (from home, naturally) during one of the recent extreme stock market sell-offs. “I should be falling out of my chair today with how bad the market is,” he said. “But I feel pretty lucky. We still have ample capacity.”
Many of his family-office peers will be suffering sooner or later, he predicted, due to precisely the dynamic that Mercer’s Williams pointed out.
“There are large investors I’ve seen who are incredible business people,” the family office investor said. “Then you see their public and private investments, and I’m scratching my head. Having business experience is really important, but it’s not always applicable.”
The due diligence on such direct investments tends to be “poor,” according to Williams. “There is much more of an element of gambling,” she said. “And there’s where consultants can come off as quite dull. We don’t believe in a gamble — we believe in a solid investment. The situation right now may be a trigger” to get family offices on board with boring institutional-style portfolio management.
“But some people right now must be feeling like geniuses,” Williams said. “My guess is, it’s a fluke.”