Family Offices, Foundations Smile On Private Equity; Majority Favour Primary Route - Study

Tom Burroughes

10 December 2013

Editor's note: An earlier version of this article appeared in WealthBriefing, sister publication to WBA. As the issues involved are relevant to the Asia market, we think readers will find them relevant also.

Private equity is a popular asset class with family offices and foundations, with one in three of respondents to a recent survey saying they commit at least 20 per cent of assets to the sector.

A survey among 30 family offices and foundations undertaken by the publication Private Equity International and Swiss-based Montana Capital Partners reveals that more than half of institutions questioned have allocated more than 15 per cent to private equity.

The study, carried out in June this year, found a different pattern among different type of investors, suggesting family offices and foundations are taking a particularly long-term approach. Family offices, given the relative flexibility of such institutions compared with pension schemes – the latter are often constrained by specific rules – have often been at the forefront of investing in alternative asset classes, such as private equity and hedge funds.

Private equity has experienced a gyration in fortunes in recent years. Prior to the 2008 financial crisis, the sector, buoyed by plentiful credit, witnessed a buyout boom; the sector went sour when bank leverage sharply contracted, leaving many investors sitting on unused cash, hitting internal rates of return.

Industry figures suggest the fund-raising climate – and general sentiment – for private equity has improved. According to Preqin, the research firm, a total of $139.1 billion of money was raised by a total of 209 funds in the second quarter of this year. However, there is a notable issue of unused funds – “dry powder” in the sector at present, that organisation has noted. As of August this year, Preqin reckons there could be more than $1.0 trillion of such dry powder.

Average allocation

The PEI/Montana report showed that the average allocation for pension funds and insurance companies stands at 7.3 per cent and 3.6 per cent respectively. The average private equity allocation among the family offices and foundations in PEI’s study was 14.7 per cent.

Some 39 per cent of respondents said they would be upping their allocation to private equity in the year ahead, while just under a third will be maintaining current levels.

“It’s clearly positive for private equity fund managers to see such strong interest among these investors and that many are looking to up their allocations is testimony to the relationships the industry has built with them,” Dan Gunner, director of research and analytics, PEI, said.

“The asset class has matured to a point where smaller investors feel very comfortable with it and, being more flexible than some of the bigger institutions, are able to exploit opportunities with non-traditional assets.

“It’ll be fascinating to see how their relationships with GPs evolve as family offices increasingly look to exploit direct and co-investment opportunities as well as those in the secondary market.”

In terms of accessing the asset class, the majority of family offices investing in private equity – 87 per cent of those questioned - use primary funds. Fund of funds are also popular with more than half of those institutions questioned using such vehicles. Over one third are co-investing with funds while one in ten look for co-investment opportunities with other family offices.

The secondary market is increasingly popular for family offices keen to exploit attractive cash flow profiles, earlier liquidity opportunities and a shorter J-curve. Around two thirds of the institutions questioned are actively investing in secondary funds. A third currently purchase direct secondary positions and one in ten has sold positions in the secondary market.

Some see increased secondary activity as a consequence of regulatory change, which means that banks and other financial institutions are being forced to offload assets, often at discounted prices. Some 30 per cent of the family offices and foundations questioned expect that supply of assets to slow.

The majority of respondents, however , agrees that the secondary market is now well established and deal volume will stay at the same level and stabilize in the short term, particularly at the small end of the market.

Most family offices are forecasting IRRs of 15 per cent from primary fund investments.