The role of the family office in ultra-high-net-worth (UHNW) wealth stewardship has evolved significantly in recent years, growing both in scale and sophistication. Part of that evolution includes family offices placing increasing emphasis on direct investing in private markets, with use of private funds as the fast emerging vehicle of choice to structure such investments, particularly when different branches of a family invest together or the investment is made with other families.
A recent white paper published by IQ-EQ, entitled The Great Global Wealth Transfer, highlighted that the new generation of UHNW individuals is showing a much greater focus on alternatives, favouring more ‘exciting’ investment opportunities in private equity and venture capital.
In this context, private funds are among the new options emerging on the wealth and investment scene, utilised by sophisticated investors at the high end, including UNHWs and family offices. At IQ-EQ, we are seeing a clear trend towards the use of private funds among the ultra-wealthy – be it within families, between families, or between different branches of families across the world.
Family office investment in private funds as a complement to private equity
Whilst the trends towards UHNW investment into private assets and alternatives is clear, those families and their family offices have now reached a sort of ‘fork in the road’ where some family offices might feel sufficiently equipped to ‘go it alone’ and invest directly utilising private funds. Equally, many family offices will instead solicit the support of private equity (PE) firms. Some family offices do both.
It’s important to remember that most family offices initially support a single family with modest resources, before building their capabilities and often eventually sharing resources with other families to benefit from economies of scale. In practice, the fact that many wealthy families are backers of leading PE groups means that the relations between the two are likely to remain of a complementary nature.
In terms of allocations in investment portfolios, there is no doubt that private equity will continue to remain a key focus for family offices. The UBS Global Family Office Report 2020 names PE as family offices’ favoured asset class, with 77% investing in it – primarily via funds. The report further highlights that 69% of family offices view PE as a key driver of returns, with 73% of those investing expecting it to deliver higher returns than public investments.
Ultimately, it is notable that family offices are building their own talent pools and sharpening their skills by hiring from investment banks, which means that over time their expertise might be able to match that of PE professionals. At the same time, they are outsourcing certain specialised roles and tasks (including private fund administration) to complementary service providers such as IQ-EQ.
Private funds: A vehicle of choice for family offices
The main purpose of using private funds is to collect interests, be they intra- or inter-family, into mostly private assets like family businesses, private equity, venture capital and real estate. We are already seeing increasing usage of private funds among UHNW families in our client base, and believe that this trend is set to continue, with significant opportunities on the horizon to further leverage private funds to meet the needs of family offices.
This increased demand is also being driven by broader wealth succession trends. For example, more and more UHNWs and their family offices see private funds as a tool to help ensure the smooth and efficient succession of wealth. With the passage of time paired with the growth and increasing complexity of family wealth, many ‘simple’ legacy holding structures have actually played a part in wealth corrosion. Stunningly, 70% of wealthy families lose their wealth by the second generation and 90% lose it by the third generation, which is reflected in the well known American proverb “shirtsleeves to shirtsleeves in three generations”. This reality has driven the need and demand for more sophisticated structures, and private funds are part of that story.
With private funds, assets may be allocated by merely transferring private fund shares, interests or units to family members or to trusts for their benefit; there being no necessity to liquidate those underlying assets in the fund to effect an allocation. Instead, family members who wish to redeem their shares, interests or units in a private fund must do so by means of the orderly guidelines for exit, as contained in the fund’s constitutional documents.
Such institutional-style governance is also driving younger generations’ interest in such funds as it helps improve transparency within the family and professionalise the approach to investment – including portfolio construction and strategy as well as borrowing policies and risk tolerance. As such, private funds are proving a very useful vehicle to help integrate and bring along the next generation into the custodial stewardship of the family wealth.
The significance of regulation in the appeal of private funds
The evolving regulation of private funds in many jurisdictions has also played a part. Looking back, fund regulation has historically focused mainly on retail-style funds, with such regulation increasing and tightening significantly over the years, in many cases in response to various scandals.
As well as increasing regulation of retail-focused funds, many jurisdictions have also established new private fund regimes allowing for more light-touch and proportionate regulation, but in very clear and narrow parameters. Those private fund parameters normally include a limitation on the maximum number of investors (usually 15 to 20). Investors must be professional and sophisticated, like UHNWs and their family offices, with the prerequisite investment knowledge and understanding of risk – as opposed to retail investors who often do not have such knowledge and thus require heavier regulation to help protect them. These private fund regimes have also allowed for fast-tracked authorisation.
That all said, most private fund regimes require that a locally licenced and regulated administrator (like IQ-EQ) be appointed, not only to ensure that the strict private fund criteria are met, but also importantly to ensure compliance with applicable anti-money laundering (AML) legislation and fulfilment of the necessary due diligence.
The actual legal forms of private funds vary somewhat, including for example companies (e.g. “protected” or “variable” cell companies), limited partnerships and unit trusts. In many jurisdictions, updates have in fact been made to these structures to accommodate the demand for private funds.
Private funds now available in many jurisdictions
Whilst historically jurisdictional choices for private funds were limited, the above trends have been noticed and acted upon by a number of the world’s leading financial hubs. Click the expandable sections below to find out what each of the listed jurisdictions has to offer in this space.
Jersey and Guernsey
The Channel Islands can be considered as the pioneers in the private funds domain; they were among the first to update their private fund regimes to attract interest among fund promoters.
The framework for the Guernsey Private Investment Fund (PIF) was introduced in 2016, with the Jersey Private Fund (JPF) regime following close behind in 2017.
Through Luxembourg’s Specialised Investment Fund (SIF), introduced in 2007, family offices can structure their private asset and alternative investments and professionalise their wealth holding activities. The SIF can invest in all types of assets and could remain self-managed when implemented for a family as it isn’t then qualified as an alternative investment fund (to be distributed to third party investors).
The Luxembourg SPF regime (Société de gestion de Patrimoine Familial) is an interesting alternative, also introduced in 2007. It offers family offices a legal and tax environment similar to a fund. It’s very popular among investment clubs and new family office investors looking to set up a flexible and efficient investment vehicle in Europe.
Singapore and Hong Kong
The new Singapore variable capital company (VCC) structure, which can be set up as a stand-alone entity or as an umbrella entity with multiple sub-funds, is already proving a hit with multi-family offices, some of which participated in its pilot programme. CEO and Founder of the multi-family office Envysion Wealth Management, Veronica Shim, was quoted iby CityWireAsia as saying, “setting up a VCC will allow us to streamline this process and launch different fund strategies under one umbrella”, which we have seen in practice as well. Also, we understand the Singapore authorities will soon introduce “VCC 2.0”, which will include further enhancements that will likely appeal to single family offices.
Staying within Asia, there have been recent reforms announced and driven by the Hong Kong government and Financial Services Development Council regarding the recently launched HK Limited Partnership Fund, which in many ways is akin to the Singapore VCC. As in other jurisdictions, this new vehicle is linked with various initiatives and incentives to drive growth in Hong Kong, especially in the family office and private funds space, but is also driven by the demand coming from mainland China.
Cayman has long been cited as an innovator in the wealth and investment space, and private funds are no exception. Similar to those of the other jurisdictions cited, Cayman private funds may be structured as companies, partnerships or trusts, each of which provides protection for UHNWs by limiting investor exposure to fund liabilities.
On the regulatory front, the recently introduced Private Funds Law 2020 expands the scope of Cayman Islands fund vehicles that must be directly regulated by the Cayman Islands Monetary Authority (CIMA). It specifically excludes “non-fund arrangements” like joint ventures, holding vehicles, and single family offices, although compliance with relevant AML regulations of course remains a necessity.
Such private fund regimes are all very attractive to UHNW families and their family offices given their clearly defined parameters, flexible governance, tax neutrality, light-touch regulatory characteristics and short application timeframes, whilst still ensuring compliance with relevant AML regulations.
Private funds on the rise
To conclude, when you bring together the aforementioned wealth succession trends, the increased appetite for direct private asset investment among UHNWs, the newly proportionate and lighter-touch regulations and the wider choice of legal structures, there is no doubt as to why we’ve been seeing a surge in the number of private fund structures being established in recent years.
As UHNWs and their family offices seek to develop new areas of investment activity, private funds have a key role to play within and between families. Within families – as families grow, diversify geographically and culturally – they can take advantage of different legal, tax and succession regimes. Private funds offer a very useful mechanism for bringing families together with common investment strategies and interests while accommodating the different branches of the family located around the world.
Looking ahead, as international regulatory frameworks for private funds continue to evolve, family offices are set to make real gains from an increasing array of attractive solutions.