For family offices hoping to understand the complexities of today’s market, a significant shift is occurring: alternative investments have evolved from being a niche strategy to an essential element of a robust, diverse portfolio. Beyond just financial returns, private investments provide unique benefits that simply don’t exist in public markets. Key advantages include learning from experienced fund managers, effectively managing risks, and participating in direct co-investments. In this article, Cory Shea, the Founding Partner at Clockwork, shares six types of alternative investment opportunities for family offices, detailing what to anticipate and potential pitfalls to consider.
#1. Private Equity & Venture Capital
When it comes to historic returns, venture capital shows a median return of around 14%, with the top performers reaching as high as 35%, while the lower end may drop to -5%. Private equity mirrors this at a median of 14% as well, with top decile returns around 30% and a bottom decile return of just 1%. With these kinds of returns, both private equity and venture capital have become very popular options for family offices. They provide a managed way to invest in companies that have significant growth potential.
What’s worth noting for family offices is that venture capital and private equity funds come with higher fees, which can be quite substantial. However, the funds handle the bulk of the workload. That includes all aspects of sourcing, due diligence, and portfolio management, allowing family offices to take a more hands-off approach. One key aspect to keep in mind for venture capital, in particular, is that it’s crucial to work with top-tier managers, ideally those in the top decile. Otherwise, returns may fall short of expectations.
#2. Private Credit & Yield
Private credit and yield-focused investments are about providing capital without acquiring equity in a company. The investment lifecycles tend to be shorter, resulting in quicker cash flow turns. However, the upside potential tends to be limited to an agreed interest rate or return on capital. The returns typically range from low single digits to mid-teens in the United States, with opportunities for higher interest rates available globally or in specialised direct lending scenarios.
Understanding the inherent risks, including the potential for total or majority capital loss, is crucial, much like with equity investments. In cases where the company encounters failure, credit investors might hold a senior position, allowing them to recover partial returns through the sale of assets before equity holders receive any distributions. Therefore, robust underwriting of a company’s fundamentals and financial health is essential.
#3. Direct Investments
Investing in companies directly, whether through private equity or private credit, can give family office investors an opportunity to invest in alignment with their values. They offer the chance to back private companies and ecosystems that speak directly to their investment strategy. They also present a cost-effective option, as they typically incur no management fees or carried interest. Historical returns can vary significantly, much like venture capital. They can range from total capital loss to exceeding 25% for top-performing investments, emphasising the importance of diversification.
Family offices should note that direct investing carries a higher risk profile than investing in professionally managed funds. Unlike traditional investments, direct investing demands substantial time input for sourcing new deals and ongoing monitoring throughout the investment lifecycle. Moreover, securing allocations at the direct investment level can be challenging.
#4. Real Estate
Why invest in real estate? This asset class can generate passive income through rental yields while providing capital appreciation as property values increase over time. Depending on the property type and investment structure, real estate often delivers consistent returns and serves as a safeguard against inflation. On average, the median return is 10%, while the top decile sees returns of 23%. Conversely, the bottom decile may experience negative returns of 7-8%.
Leverage is key when investing in real estate. Projects with excessive debt can encounter significant challenges stemming from unexpected delays or expenses. Additionally, timelines frequently extend beyond initial projections, regulatory issues may arise, and specific markets are subject to unique risks, as illustrated by the office space sector during the pandemic and the ongoing trend of remote work. It is essential to consider these factors when evaluating an investment opportunity.
#5. Real assets
Real assets, which include infrastructure, commodities, and farmland, serve as effective hedges against inflation. They generally exhibit lower correlation with broader investment portfolios. These assets can deliver consistent returns over extended periods, presenting family offices with the opportunity to gain exposure to tangible value compared to traditional financial assets. Historical return ranges have fluctuated between 20% and -5%, with median returns in the mid-single digits.
What should investors be mindful of? Capital expenditures associated with real assets tend to be very large. Furthermore, individual projects introduce unique circumstances, such as geopolitical issues, regulatory hurdles, as well as operational challenges.
#6. Lifestyle collectables
Why get into collectables or alternative assets? Because they can be a lot of fun! Plus, there’s a chance you could even turn a profit. Think about art, cars, watches, wine, and other unique items. Many people overlook these when creating a formal investment strategy, often viewing them as just expenses. However, while they might not always show up in return calculations, they often hold some value over time and can potentially yield returns in the long run. What’s more, they tend to be less influenced by market fluctuations.
To sum it up
Navigating the landscape of alternative investments requires a strategic approach, especially for family offices aiming for sustained growth. Implementing a thoughtful framework is essential to avoid common pitfalls and minimise potential losses. Proactive strategies like portfolio allocation, setting investment limits go a long way. Also, deciding between fund vs. direct exposure can significantly influence outcomes. Liquidity management remains paramount, and remember that you can always negotiate on fees, especially with larger investments or co-investments. Lastly, a consistent, staggered approach to deploying capital over time allows for exposure to multiple market cycles, mitigating vintage risk and promoting long-term success in the dynamic world of alternative investments.
