How Family Offices Threaten Hedge Funds

Family offices threaten hedge funds by attracting and luring away the talent, and possibly clients, too.

An Ernst and Young report estimates there are over 10,000 single family offices globally, and half of them have sprung up in the last 15 years.

Rising global wealth is a contributing factor for the growth in family offices, particularly in Asia, where there are now 637 billionaires and roughly 300 family offices, according to UBS. To put in comparison, over a decade ago there were less than 50 family offices on the continent.

Globally, the ultra-wealthy are increasingly setting up their own operations, and with their resources, they are willing and able to pay top dollar for talent.

Family Offices Threaten Hedge Funds by Going After Their Talent

“We’re seeing family offices really raising the bar when it comes to the quality of investment professionals they’re hiring," said Angelo Robles, founder and CEO of the Family Office Association.

Mr. Robles added, "What’s even more telling is that some really experienced and exceptional hedge funds managers and private equity fund managers are joining family offices.”

There are two main ways how family offices are attracting hedge fund talent:

Participatory Compensation Arrangements

Under participatory compensation models, family offices give executives a stake in the family office, select investments, or both.

Family offices are increasingly following this model, according to Forbes, attracting talent by promising them "a piece of the action".

This model has its rewards and risks. Under participatory compensation, family office executives can earn millions of dollars in a year, while in other years they might not get paid.

Long Term Investment Horizons and Outlook

Super wealthy families generally have a long term mindset with their investments, unlike hedge funds, which are judged by quarterly performance. For fund managers, it may be appealing not being critiqued solely on a bad quarter, but instead be judged by the long term result.

While there is upside in not being pressured to perform the quarter, strong performance in the current moment will not result in an immediate and full payout for the adviser.

Using the participatory compensation model, as a reflection of the family office's long term outlook, payouts will be stretched out over a period of time (years) to mitigate risk-taking, according to Usha Bhate, Executive Director of the Institutional Investor.

Family Offices Taking Hedge Funds' Clients, Too?

With the recent and increasing wealth coming out of the continent, the new crop of family offices in Asia are adding a unique twist to the family office business model by setting up their own funds and attracting outside investors.

Tolaram Group, a Singapore-based family office, not only has poached talent from New York hedge fund Millennium Management, but is also planning to launch a hedge fund, as mentioned in a Bloomberg article.

Currently eight single- and multi-family offices in Asia have started or plan to start their own funds , and Tolaram CEO Manish Tibrewal believes more family offices what will do his is doing.

However, there may be investor concerns about new family offices' lack of investment track records and investment decisions influenced by family members whose interests may not align with those part of the fund.

What Hedge Funds Can Do To Protect Themselves Against Family Offices

Outsource Middle- and Back-Office Operations

Despite family offices attempting to poach hedge fund talent, the main reason hedge funds fail is operations-related.

So if hedge funds fail because of poor operations, what does outsourcing have to do with protecting a hedge fund from a family office talent grab?

Well, outsourcing the operational functions allows hedge funds to focus on their core competencies rather than deal with non-investment related matters like technology implementation, back-office reporting and staffing, etc.

A lack of operational expertise will likely result in reporting errors, over- or under-staffing, and failure to leverage the technology. Such mistakes and inefficient use of resources can be costly.

Fortunately, hedge fund operations outsourcing providers have the resources and expertise to handle these duties and provide their services at a lower cost than if they were done in-house.

Investments generate revenue, operations doesn't. Operations is a necessary component, but if managed inefficiently, costs will rise, threatening profit margins.

As a result of outsourcing:

  1. More time can be spent focusing on winning investment strategies, deterring investors from moving their assets over to a competitor.
  2. The money saved can be used to reward hedge fund mangers for good performance, making their current employment more attractive and rendering them less willing to switch to a rival firm.

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Family Offices May Pose Challenges to Hedge Funds

Family offices threaten hedge funds in terms of competing for investment talent, as illustrated by Tolaram and Millennium Management. The compensation arrangements and long term outlooks on part of the family office are attractive to fund managers.

It is less clear if family offices threaten hedge funds by starting their own funds. Given that family offices starting their own hedge funds is still a relatively new idea, it is too early to say the impact this trend will have on hedge funds.

Outsourcing may not solve every problem for hedge funds, but by allowing fund managers to focus on their core competencies, save money, and run a more efficient operations, hedge funds can focus on better returns for investors and better rewards for performing fund managers.

Through these practices, hedge funds at least have some line of defense against rivals poaching talent and clients.

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