Hedge Funds to Private Investment Offices – More than a Tendency, less than a Trend

By: Bijesh Amin, Co-founder and managing director, Indus Valley Partners

Recently several high-profile hedge fund managers, Michael Platt of BlueCrest Capital, Scott Bommer of SAB Capital and Steve Cohen of SAC Capital (now Point 72), have decided to hand back investor capital either due to hassles over regulation and investor over-reach (i.e. the need of investors for “transparency) or due to the lack of clear cut market opportunities for generating alpha. But whether this represents the early days of a more fundamental trend of hedge funds handing back Limited Partner capital and focusing more on managing General Partner assets is hard to say. The likelihood is that this is not a trend; there will not be wave of hedge funds deciding that the Private Investment Office (PIO) model is their future.

However, for the reasons already stated and for another – that of succession planning – there will be a tendency for some hedge fund managers to become less asset gatherers – concerned with the net asset values of investor portfolios – and more asset managers of their own net worth.

The traditional family office – single and multi – will be joined by a third “Private Investment Office (PIO)” run more along the lines of a traditional hedge fund in terms of investing style. Unshackled from third party investor constraints such as VAR limits or mandates specifying volatility thresholds, these PIOs will return to a more traditional hedge fund approach of aggressively seeking alpha either opportunistically or systematically based on a specific strategy or set of strategies. George Soros, now running Soros Fund Management as a Family Office, could revert to taking outsize positions on macro-economic events such as his $10 bn dollar bet on the devaluation of the British Pound back in 1992, without making his investors shudder.

Rethinking the economics of their operating platforms

Franchise-sized firms with assets under management in excess of $5 bn that opt to become PIOs will need to rethink the economics of their operating platforms. Even more so smaller hedge funds that can sometimes charge back their entire IT expense to their management company.

Without the need to acquiesce to investor concerns over “institutional-level” infrastructure and – more fundamentally – without the ability to charge up to 20-30% of operating costs back to the fund, PIOs will be leading the use of cloud-based platforms to support their investment operations. That is not to say that cloud platforms are not institutional; but investors are often more concerned that funds go with tried-and-tested vendor platforms rather than with emerging players that may offer the same – or better functionality – at a much lower total cost of ownership. This will inevitably change as traditional fund complexes see the level of quality in cloud and mobile infrastructures that PIOs will be able to deploy at a fraction of the cost and often with higher levels of data security and usability.

The regulation of Family Offices/PIOs will be a matter for debate in the years to come. The fact that third party investors are longer part of the picture does not necessarily mean that some form of regulatory filing will not be required. Based on the size of the assets under self-management, their counter party relationships and the invested asset classes, regulators may still prove to be burden not quite shed…

Finally, as the tendency for managers to decamp into PIOs continues, and as the share of global wealth accumulated by the top 1% continues to grow (thus increasing the absolute number of Family Offices and their collective assets), new models of investment and co-investment are emerging that may displace more traditional players. For example, Family Offices and PIOs may engage in “club deals” that eschew investing in traditional PE funds run by the likes of Blackstone or Carlyle Group (and paying their fees) in favor of direct investments, using their own in-house teams to source opportunities, perform investment appraisals and structure deals.

In Silicon Valley, the family offices of Internet billionaires such as Mark Zuckerberg’s Iconiq Capital could bet on a host of technology-driven start-ups previously the hunting ground for more traditional Venture Capital players. Perhaps the term Financial Sponsor will need to encompass these emerging players in addition to the traditional PE firms.

The current size of family offices (both single and multi) represents $1.7 trillion in assets. Total hedge fund assets under management stand at just under $3 trillion. Even a tendency and not a trend could swell assets over time controlled by Family Offices/PIOs by double digits in percentage terms. Not a trend perhaps, but more than a tendency.