Single-family offices across the world are moving deeper into private markets in response to higher inflation, rising interest rates, and central banks scaling back their market support, a UBS Global Wealth Management report revealed earlier this month.
Among 221 family offices surveyed—with an average total wealth of US$2.2 billion—many are planning to shift their strategic asset allocations to further emphasize private equity, real estate, and private debt. A strategic asset allocation reflects an investor’s long-term approach.
“Most family offices are looking at all of this with the viewpoint that No. 1, inflation will at some point come down, but will be at a higher level than we had prior to Covid; no. 2, that [central bank] policy rates, as we all know, are moving higher, but in real terms, probably won’t reach a very high level given the high indebtedness post Covid; and no. 3, that growth is coming down but it’s not crashing,” says Max Kunkel, chief investment officer for the wealth management’s Global Family and Institutional Wealth division.
Given this view, family offices have to consider “what is the asset allocation that is likely going to help me in achieving my overarching goal—which is growing wealth in real terms with the lowest possible volatility,” Kunkel says.
Unlike many investors, these wealthy families, all of whom are UBS clients, can lock up their capital for several years without concern, allowing them to reap higher returns than if their money was invested in liquid public markets.
Penta recently spoke with Kunkel and Josef Stadler, executive vice chairman at UBS Global Wealth Management, about this shift into private markets by some of the world’s wealthiest investors.
Moving Away From Public Bonds
The jump in inflation rates globally is prompting family offices to consider the role of bonds and cash in their portfolios, the survey found. Some have cut back on public fixed income for years because of low yields, and the prospects that bond rates would rise (meaning prices of these securities would fall).
Fixed income has been under pressure for about a year-and-a-half from expectations of rising rates and inflation, Stadler says. That’s led to a correction in interest-rate sensitive securities that’s taking place alongside equity-market corrections. The broad US S&P 500 index, for instance, was down more than 18% for the year as of the market’s close on Monday.
“The fundamental question is to what extent will this interest-rate volatility pause for the asset class to be investable again,” Stadler says. “We don’t know.” The rise in rates could pause now, or short-term rates could spike to 4.5% (from about 3.2% today). Until there is clarity, “the majority of our clients—a significant majority—is not able or willing to commit to fixed income,” Stadler says.
Also, he adds, investors are experiencing a secular switch that is bad for bonds. “We were used to low inflation, low interest rates and high growth; now we’re [experiencing] high inflation, high interest rates, low growth,” Stadler says. “That’s a tectonic shift that’s here to stay for some time.”
A Shift to Real Assets
In response, the single-family offices UBS surveyed are turning to real assets within alternatives. For fixed-income exposure, 21% prefer to invest in real estate, particularly in China, the Middle East and Africa, and in Latin America, according to survey results. In the next five years, 37% of family offices surveyed plan to increase their allocation to real estate.
“Ultimately it depends on what is the role of fixed income in the portfolio,” Kunkel says. “Is it principally to provide yield? Or principally to provide diversification? Or is it to provide relatively low returns but equally with low volatility?”
Families are also increasingly considering private debt as an alternative. In 2021, family offices that were surveyed had about 2% of their assets in this asset class. But 27% of offices surveyed plan to invest in private debt offerings in the next five years, UBS found.
Private debt markets present family offices with opportunities to invest in loans that are often made to middle-market companies that otherwise can’t get access to lending because of increased regulatory requirements on banks, Kunkel says. By investing in these private loans, investors can typically get access to higher-yielding, floating-rate debt, which is attractive in a rising rate environment.
A Preference for Direct Private Equity
In 2021, strategic asset allocations for families were largely the same from the prior year and the year before that. UBS surveyed 191 families last year and 121 in 2020, the first year this survey was conducted. The one exception to this consistency was private equity, which steadily rose as a percentage of assets.
In 2019, families surveyed allocated 9% to direct private equity and 7% to private equity funds and funds-of-funds; by 2020, that allocation had moved up to 10% for direct investments and 8% for funds. In 2021, direct investing increased to 13% of assets while investments in funds stayed the same.
The main reason for this steady shift is simple: 74% of families likely to increase their private equity allocations believe these investments will continue to outperform public equities, the survey said.
Also, more than half of families surveyed believe private equity offers a broader investment universe than available in public markets. In the US, for instance, the number of new public offerings shrank to 165 in 2020 from 380 in 2000, while the number of private-equity backed companies has grown more than five-fold to 8,892 in 2020 from 1,698 in 2000, UBS said .
“You see that public markets have become more concentrated and private markets have become more accessible,” he says.
Family offices also lean toward direct investing as they see it “as an extension of the entrepreneurial activities of the principal,” Kunkel says.
Often, these offices will invest in funds to spread risk and in the direct investments where they believe they can add the most value, he says. Importantly, Kunkel says, family offices don’t invest in private equity blindly.
“They are focused on diversification, due diligence, and where do I have differentiated access,” he says. “If they don’t fully understand what they are investing in, they’re not investing in it. If they don’t see that [a given investment] is diversified enough given the risks they are exposing themselves to, they are typically being more cautious about it. If they see no differential access they have, then they rethink whether the allocation should have been as high as they might have previously thought.”
In the next five years, 42% of family offices in the survey expect to boost their allocation to direct investments and 38% expect to boost their allocation to funds, the survey found.
What the Future Holds
Overall, the strategic asset allocation of these families was 57% in traditional asset classes and 43% in alternatives, including private equity and real estate.
Last year, the overall allocation was 60% to traditional assets and 40% to alternatives. While it’s difficult to predict what the survey results will show next year, Stadler says, “the trend is clear.”
One shift that could show up next year is in sustainable investments. The survey found that 56% of family offices globally allocate to sustainable strategies, with the percentage varying by location. US families allocate only 39% to sustainable strategies while families in the Middle East allocate 70% of their investments.
While the overall percentage of assets dedicated to these strategies didn’t change from the year before, family offices surveyed this year said they are becoming more selective when it comes to applying sustainability standards and environmental, social, and governance considerations “because of a lack of clarity of where the trend is moving,” Stadler says.
According to the survey, investors are on the lookout for so-called greenwashing and are looking for ways to better evaluate impact. Investors are starting to say that “probably it’s best for us to do our own analysis and draw our own conclusions before we ask people to opine for us—that’s new,” Stadler says.
It’s possible more investors will consider private market impact investing, which can give them more control, particularly if they invest directly in companies. Just as families have turned to private equity and private debt, “that will be the natural outcome for sustainable investments as well,” he says.