Since the 1980s, with the rapid growth of the number of ultra-high net worth individuals in the world, Family Office (FO), an important type of institutional investor, has developed increasingly. The Economist estimates that there are currently around 5,000-10,000 family offices worldwide. By the end of 2018, the assets under management (AUM) of family offices worldwide had surpassed that of hedge funds, reaching about US$4 trillion, becoming an important participant in the global financial market, and still maintaining rapid growth.
Family offices in China have a short history of development, but their growth rate and potential are highly anticipated. In 2018, the PBC Global Family Business Research Center of Tsinghua University conducted research and interviews on 20 Chinese family offices, and formed the first report on the development of the family office industry in China. The average AUM of the interviewed FOs was RMB 8.8 billion to RMB 10 billion. In 2021, Tsinghua Wudaokou Global Family Business Research Center and the Hong Kong Financial Services Development Council will once again conduct a systematic survey on 30 leading Chinese family offices to form the “China Family Office Development Report 2022”. The average value is 29.7 billion yuan, and the AUM of more than 80% of the interviewed FOs is more than 5 billion yuan, which is about three times the year-on-year data in 2018. Among them, the average value of a single family office (SFO, which serves only one family) is 24.9 billion yuan, and the average value of a multi-family office (MFO, which provides services to multiple families) is 35 billion yuan.
Based on the latest research data, this article attempts to show and analyze the investment philosophy, investment objectives, and asset allocation strategies of Chinese family offices, and present the unique characteristics of such institutional investors. The 30 FOs surveyed included 14 SFOs and 16 MFOs. 21 FOs mainly provide services for mainland customers, and 9 FOs provide services for both mainland and Hong Kong customers. Among the MFOs, 14 are independent institutions founded by professionals, and 2 are MFOs formed by the opening of SFOs to other family clients. Although family offices have “thousands of people and thousands of faces” and are highly customized according to the heterogeneous characteristics and needs of clients, the core functions of most family offices focus on wealth management and inheritance, which are reflected in asset allocation, portfolio management and Financial services with risk management as the main content, and non-financial services with legal, tax and inheritance as the main content.
Although the situation of each enterprise and family is different, high-level management of a family office is inseparable from a high degree of condensed investment philosophy, including core elements such as investment principles, benchmarks, methodology and values. A systematic, clear and accurate investment philosophy can form a systematic guide for internal teams and external stakeholders, set benchmarks for investment decisions and subsequent evaluations, and provide guidelines and boundaries for implementation.
The values that core family members, especially founders, have developed over their long work, study and life largely shape the family office’s investment philosophy. The chief investment officer of an interviewed FO said: “Our founder has a reverse thinking. He likes to do big things, dare to challenge, and is willing to invest in areas that others do not want to invest in, such as kitchen waste, stem cells, engines, etc. They prefer long-term investments, but they are relatively open to financial returns, and they are unwilling to make purely financial investments.” Another CEO of FO interviewed said: “We prefer innovative and aggressive investment projects. It may have something to do with the character of the founder. Our direct investment projects are all novel, high-risk (high-growth) technology companies, and the key is to invest in the future.”
When family offices set investment goals, since different family members face various needs in education, entrepreneurship, medical care, pension, and charity at different stages of their life cycle, FO should make scientific calculation and planning according to capital needs and expenditure rhythm. Due to its unique intergenerational inheritance characteristics, the investment horizon of FO often spans multiple economic cycles. This makes FO’s investment objectives and boundary conditions more complex and diverse. A family office specializing in philanthropy said: “What we pursue is not high risk and high return, but long-term charity and inheritance. Since the donation commitment of family philanthropy requires an annual expenditure intensity of more than 100 million yuan, so The asset allocation model must be able to ensure a healthy and sustainable cash flow.” The
clientele of family offices are often private entrepreneurs, and the existence of industrial enterprises further exacerbates the complexity of the asset allocation model. For many FOs, the dividend distribution and share reduction of industrial enterprises are the main sources of their capital inflows. In order to meet the needs of industrial enterprises for transformation, expansion, mergers and acquisitions, etc., FO needs to provide financial support or financing arrangements, which often brings large-scale capital outflows. Therefore, FO’s investing activities are structurally constrained by the cash flow of non-investment income and expenses. Taking into account the operational risks, industry risks, policy risks and international risks faced by industrial enterprises, FO should also design corresponding hedging plans to reduce the risk exposure of family wealth in a certain industry or region.
The family FO investment model setting for technology industries, traditional industries, and the sale of businesses varies. For technology entrepreneurs (such as the Internet, hard technology, new energy and biopharmaceuticals, etc.), their wealth is mainly reflected in the stocks of listed companies and unlisted companies. Since dividend distribution is not a routine practice for growth-stage technology companies, their wealth growth mainly comes from stock price increases rather than dividend accumulation. Considering the high-risk, high-growth, and high-return characteristics of the technology industry, such FOs tend to pay more attention to the diversification of asset types to reduce the risk exposure of a single technology industry.
For traditional entrepreneurs (manufacturing, real estate and large-scale consumption, etc.), since most of their industrial enterprises are in a mature or declining period, they have strong profitability and abundant cash flow. Such FOs prefer strategic investment projects with long investment periods, high return potential, and low liquidity. At the same time, taking into account the synergies related to the strategic transformation and industrial upgrading of industrial enterprises, the need for decentralized allocation of financial investment and the strategic development of industrial enterprises are considered. needs combined.
For some first-generation entrepreneurs who cannot achieve transformation and upgrading on their own or who do not have the conditions for succession, they often choose to sell their controlling stakes in industrial enterprises. Since such families no longer own industrial enterprises but only financial assets, FO pays more attention to wealth security and asset preservation, emphasizing a sound asset allocation model and a complete risk control system to achieve risk-adjusted investment returns. A FO founder who has sold an industrial enterprise said: “Our FO investment philosophy is safety and stability, long-term layout and value investment. The family shareholders have sold the industrial enterprise and have a lot of cash in their hands, but because there is no wealth creation Therefore, stable and controllable returns are the most important. We do not deliberately pursue high returns on a single asset class or single investment project.”
Asset Allocation Strategies for Family Offices
In the realm of asset allocation practice, the Yale Endowment is known worldwide for its cyclical investment returns. The Yale Endowment attaches great importance to asset allocation and alternative investments, and rebalances various asset allocations in response to changes in the external environment. Over-allocation of alternative assets (especially PE/VC funds) is one of its most important features, exchanging poor liquidity for excess returns. The asset allocation model of the Yale Endowment Fund has strong reference significance for FOs who are also long-term investors.
The asset allocation model of most of the interviewed FOs refers to the university endowment model, with an over-allocation of alternative assets. An interviewed FO clearly stated that the asset allocation model is derived from the Yale endowment and adjusted according to its own situation: “Over the past few years, our average performance has surpassed the performance of the Yale or Stanford endowments, mainly due to emerging market risks. Higher exposure, and more positions in the medical industry.” Another interviewed FO developed an investment model similar to the characteristics of the expenditure flow of university endowments based on the family’s charitable cash flow expenditure needs, and calculated the family’s future cash flow by measuring the family’s future cash flow. It can not only ensure the preservation and appreciation of assets, but also meet the expenditure needs of charitable cash flow.
Looking at the asset allocation of the surveyed family offices, more than 90% of the FOs have allocated private equity assets. However, in recent years, due to the inversion of primary and secondary markets, poor liquidity, and fluctuations in Chinese concept stocks, the allocation ratio of private equity assets has declined. Most of the FOs have increased the allocation of stock assets and fixed income assets in the secondary market. Such standardized securities assets have high liquidity and their proportion has increased significantly. With the rapid development of domestic quantitative funds, some FOs have begun to allocate such assets. Real estate, gold, art and other physical assets are used by some FOs as a necessary asset allocation category. It is worth noting that digital assets are receiving more and more attention from FOs. Most of the FOs in this survey indicated that they have allocated a small amount or are ready to allocate digital assets.
In terms of investment style, the surveyed family offices have both active and passive management, as well as a mix of both. Actively managed FO pays more attention to excess returns and is committed to finding undervalued assets in the market, while passively managed FO hopes to achieve risk-adjusted steady returns through asset allocation.
The goal of passive investment is to obtain the long-term value growth brought about by the market over time, and usually choose a “buy + hold” long-term investment strategy, uphold the belief in market effectiveness. Passive managers seek to capture the average return of an asset class in the market, investing broadly in a variety of investment targets within the target asset class. A typical passive investing method is “index investing”, which involves buying all the securities it contains against the weights of a stock market benchmark index. The investment style of an interviewed FO tends to be passive management, and adopts the plan of stock/debt = 40/60, that is, 40% is invested in equity assets and 60% is invested in debt assets.
Active investment hopes to beat the market (or relevant benchmarks) by means of timing and stock selection, and build a portfolio different from the market through in-depth analysis and research, and strive to achieve the goal of outperforming the market. Timing strategies make investment decisions by predicting the future trend of the market; stock picking strategies try to find assets that are mispriced by the market and will generate profits based on self-correction. Contrary to the asset allocation ideas of passive managers, active managers tend to “concentrate bets” in order to beat benchmarks – holding large amounts of assets that are expected to generate excess returns.
A FO who adopts an active management method has formulated a clear investment strategy, including: (1) Contrarian investment strategy – looking for undervalued companies to be contrarian investors; (2) Turnaround strategy – focusing on investing in a few profitable companies. (3) Second player strategy – focus on the second players that are undervalued in the market but are expected to become industry leaders; (4) Portfolio strategy – combine the companies in the portfolio according to The shareholding level is divided into “core investment”, large investment and small investment, holding 10%-15% of “core investment”, and improving the operation status by participating in corporate governance and decision-making. Another FO that prefers active management adopts a timing strategy: “Based on our judgment on the market, we will increase our positions when we need to increase our positions, and we will reduce our positions when we need to reduce our positions. After the epidemic, the market volatility will increase, and our adjustment actions will be even greater. Higher frequency, such as a significant reduction in secondary market positions in 2021.”
Some family offices try to integrate passive management and active management, and adopt mixed management by taking advantage of their strengths and circumventing weaknesses. For example, a certain FO adopts different strategies in the primary/secondary market and emerging/developed markets: “When we see a good track or company in the primary market, we will make a single bet; but in the secondary market, We will diversify investment, such as focusing on 50-100 companies, and investing in small sums. Different markets have different growth attributes. In the Chinese market, we prefer to invest in growing companies; in the European and American markets, we are looking for special opportunities. , do contrarian investments, such as investing in distressed companies or unpopular companies, to hunt for the bottom.”
Family Offices Help Innovation Drive Growth
China’s economy has entered a period of transformation and upgrading in recent years, ushering in an economic structural transformation from factor-driven growth to innovation-driven growth. As traditional industries gradually move towards digitization, intelligence and greening, and new economies such as new energy, hard technology, and biopharmaceuticals are booming, China’s core assets have become “must-haves” for Chinese FOs.
Among the interviewed FOs, the U.S. asset allocation ratio ranks second only to China. More than a third of the FOs surveyed have European assets. In addition to the above three regions, some family offices are also optimistic about the growth opportunities in Asia-Pacific regions such as Hong Kong, Japan, Singapore, and New Zealand, as well as regions such as Canada and South America. A Hong Kong FO mentioned: “Our current US allocation is slightly higher, but we are making adjustments to increase investment in mainland China. We are more optimistic about the long-term development of China’s economy – after all, capital must pursue higher returns. The direct investment industries that the
interviewed FOs are keen on are concentrated in biopharmaceuticals, digital technology, large consumption, new energy, etc., and some FOs also involve investments in carbon neutrality, high-end manufacturing, agriculture and animal husbandry, and finance. A FO said: “One of our core investment concepts is to support industries that are beneficial to social progress, such as new energy, big health, carbon neutrality, etc. An agricultural project we invested in early, making non-polluting catalyst fertilizers, can make Yield from barren land has increased by 300%.”
Intergenerational inheritance is the most important feature that distinguishes family offices from other types of institutional investors. Unlike other investment institutions that set short-term investment goals such as annual, quarterly, and monthly, FO’s investment period can be as long as decades or even spans multiple generations.
Since FOs are essentially the most innovative, creative, and wealth-creating entrepreneurial groups, especially founders from the new economy and high-tech fields, they often have a strong passion for investing in cutting-edge technology and innovation, and can provide benefits that are conducive to innovation. Long-term “patient capital” for entrepreneurship, dedicated to “investing in the future”. Because of this, family offices have important value that cannot be replaced by other institutional investors, driving a country’s technological innovation, industrial upgrading and social progress.
The intergenerational ultra-long-term characteristics endow family offices with different risk appetites, investment horizons, technology orientations and entrepreneurial spirits from other types of institutional investors, providing extremely valuable initial investment support for highly uncertain disruptive innovations, and thus forming a promising future. Long-term “patient capital” conducive to innovation and entrepreneurship. Similar classic investment cases have repeatedly appeared in the world’s most successful science and technology companies, such as the Swedish Wallenberg family’s A-round investment in Alibaba, Ellison’s early investment in Tesla, Li Ka-shing’s early investment in Facebook, and Li Zekai’s early investment in Facebook. Investing in Tencent, etc., FO has provided crucial and critical support for technology companies that were not known to the outside world or were controversial at the time.
Therefore, the positive externalities of family offices are also worthy of the attention of policy makers, because as an important inheritance infrastructure, they can play a role in resisting the “barrier lake” risk of concentrated large-scale intergenerational inheritance of private enterprises, and at the same time, they are often in a country’s technological innovation. play an irreplaceable and important role.