The trend of direct investing continues to accelerate, as many high-net-worth practices have moved away from traditional private equity funds in recent years due to a combination of poor performance, high fees and a lack of control.
New research from Cerulli Associates finds that 67% of high-net-worth focused practices expect to increase their allocations to direct investments over the next two years. Meanwhile, only 22% indicated their plans to increase their use of third-party-managed private equity funds.
Cerulli describes “direct investments” as private investments in operating business, venture firms and real estate. Direct deals give investors the opportunity to invest directly in a portfolio company.
These types of investments can offer compelling benefits to HNW practices, particularly as the private equity market has evolved.
Direct investing allows HNW practices and family offices to retain nearly complete control throughout the investment process and offers greater flexibility in negotiating terms with the underlying company, often leading to lower fees and better investment terms.
Cerulli says multifamily offices are among the HNW practices leading this trend.
Many family offices are seeing greater demand for these types of investments from younger and entrepreneurial-spirited clients, according to Cerulli.
“Direct investing has caught the attention of younger clients who want to get more involved in their family’s investment decisions and make a positive impact with their wealth,” notes Asher Cheses, an analyst at Cerulli.
According to Cheses, another main factor that is gaining interest among next-gen clients is environmental, social, governance (ESG) and socially responsible investing (SRI).
“As a result, family offices are beginning to make a more concentrated effort to introduce investments that are aligned with younger inheritors’ values, including clean energy, gender equality and human rights,” Cheses said in a statement.
While the advantages are clear for family offices (e.g., higher returns, increased control, value-add to engage next generation of clients), direct investing does pose some significant challenges.
According to Cerulli, the most frequent issue noted by family offices was the challenge of sourcing and vetting new direct deal opportunities.
The other challenge is that there is competition from existing private equity funds.
“Most private equity shops have a well-developed infrastructure with experienced staff, giving them a significant advantage over new family offices looking to enter the direct market,” according to the report.
Because of this, many family offices seek outside help, often in the way of co-investing with an established partner that has the expertise that they lack. According to Cerulli, co-investments allow family offices to leverage outside expertise – from the due diligence process to capital structure to management of the underlying holding company.
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