ESG and alternatives on the radar of the wealthy
Asia is expected to become the major hub of the world’s richest families within a decade. According to estimates by UBS, there are more than 600 billionaires in the region and if this exclusive club continues to expand, they will overtake their US counterparts in just four years.
The number of single and multi-family offices in the region is growing along with the number of billionaires. These private management and/or advisory firms cater to principal money or client monies from ultra-high-net-worth individuals. One-third of the region’s billionaires already have a formalised family office and we expect some of the rest to also eventually establish offices for managing their own wealth.
Single-family offices in the US have shown greater appetite for growth strategies because the assets are better performing in certain emerging markets. But in Asia, wealth preservation is more appealing as many single-family offices prepare for succession and intergenerational wealth transfer.
Many family businesses which were underinvested in technology and systems are now embracing digital solutions to remain competitive and sustainable. Many single-family offices are acquiring tools supported by artificial intelligence to provide insightful business and/or investment data, enabling the principals to make informed decisions.
The ultra-wealthy are increasingly conscious of how they are perceived by the public and how their investments influence society and the environment, so impact investing or responsible investing has become a key way to contribute to greater social and environmental benefits.
According to UBS and Campden, 61% of family offices are active in, or expect to be active in, impact investing, and 47% say impact investing is a better use of capital and will have a greater social impact than philanthropy.
Generation Y or millennials are helping to drive this trend by having a say in the management of their family’s assets. We have already noticed an increased focus on impact investing within purpose-driven family offices.
Socially responsible investing is still in its infancy in Asian family offices. But investments that emphasise environmental, social and governance (ESG) criteria are growing in popularity and we believe they will gain more traction in coming years. Currently, most single-family offices in Asia do not maintain a large in-house investment team and use outsourced managers to manage their ESG or impact investments.
From our observations, not many family offices in Asia are assessing their ESG investment goals well, or accurately ascertaining their risk attitudes. In light of this, the outsourced investment manager needs to think about how an investment takes into account the investor’s goals, consider the evolving ESG trends, and build appropriate tools to support investment decisions and engage investors on a continuous basis to promote more transparent and forward-thinking responses.
Purpose-driven family offices that have articulated missions and have their own in-house manager or investment team tend to run their ESG investments as professionally as other institutional investors. These are very rare in Asia. We also see shareholders and management in the family enterprises behind such family offices making efforts to incorporate ESG criteria in running their businesses. For example, we are now seeing organisations transform their products to be more responsible to society and environment, and sponsoring or launching their own sustainable development goals programme.
These offices firmly believe that ESG issues can affect the performance of investment portfolios to different extents across companies, sectors, regions, asset classes, and through time horizons. They adopt conventional ESG investment strategies such as positive or negative screening, thematic ESG investing, ESG integration and impact investing.
With regards to the investment process, each family office will have their unique selection method and buy-in criteria for their chosen projects or underlying investments. Many of them will use proprietary tools like ratings, certificates or labels from research houses.
But it’s hard to apply a universal benchmark because all family offices demonstrate very distinctive investment goals or expect varied outcomes. We may perhaps see this when there are adequate benchmarks for different market segments that cater to the diverse investing themes or strategies.
Many family offices are diversifying their portfolios by allocating capital to alternative or non-traditional investments such as hedge funds, private equity and real estate as they search for higher returns, lower volatility and tap true alpha uncorrelated to traditional stocks and bonds.
Most families at the centre of a family office have a greater comfort level investing in private equity because their family’s original capital was also created by a successful private business.
Most single-family offices in Asia have maintained or increased their private equity exposure. The next generation has a greater inclination toward alternatives. Indeed, single-family offices that hold complex priorities unique to the family they serve share a common belief that alternative investments can play a role in long-term wealth accumulation as these firms are sophisticated investors that are at ease in bartering liquidity to capture upside, and can use volatility to their advantage in periods of market displacement.
Single-family offices exhibit varying goals with their direct deals. Some are looking to diversify away from the traditional family business, while others may be trying to find strategic investments that can generate synergies with their enterprises, gain tighter control of investments, or simply utilise their expertise in a particular sector to uncover unnoticed gems. But in general, they are all seeking to access assets that can grow faster than traditional assets such as stocks and bonds.
Family offices are increasing their direct minority-stake investments, but unlike traditional financial investors, family principals themselves act like strategic investors, with very active participation in the strategic management of investee companies.
Direct investments now make up approximately 39% of total family office investments, and this allocation is expected to grow in coming years as capital shifts into higher yielding, more illiquid assets. Co-investment deals with other families will become more popular as they aim to negate risks.
But many family offices are failing to undertake broader, deeper and more robust initial and ongoing due diligence assessments of alternative investments. An all-encompassing assessment should cover both traditional investment due diligence and operational due diligence. The evaluation must be able to uncover full information of the investment vehicle, the manager firm, and the investment and risk management processes.
Alternative investment strategies are typically active and return-seeking and thus have higher risk. The in-house or outsourced family office investment manager should develop rigorous evaluation of the investment and risk management operation.
Regular appraisals should be conducted on investment performance and compliance agendas. Family offices should pay special attention on how their alternative assets are valued as many of these investments use estimated value rather than actual market prices.
Rising operational costs and low returns on investments threaten the sustainability of in-house investing in family offices. According to a World Economic Forum report, nearly one-third of family offices lack in-house expertise.
Insufficient talent is the key obstacle hindering in-house investing at family offices because top-rated investment professionals typically work at institutional houses. They are more comfortable in a large team setting than within the kind of lean operations run by the majority of family offices. So outsourcing is a popular way for family offices to reduce costs and gain operational efficiency.
Over 20% of businesses have passed through the first succession. We see more resistance from the new generation to take the reins of family enterprises. We also see many companies in the third or fourth generation succession stage where there is little to no emotional connection to the founder, bringing unique challenges to succession.
* Eva Law is chairman and founder of the Association of Families in Asia.