Over the last four years, McNally Capital has acquired companies for itself and for other family offices with a combined enterprise value of more than $700 million. Is interest in direct investments growing of late?
The amount we’ve deployed over the last two years is a disproportionate share of the $700 million. Interest among families in direct investing is rapidly accelerating. We’ve seen many indicators of that, both qualitative and quantitative. We conducted a survey in 2014 of family offices focused on their private equity investments and we conducted a similar survey in 2010. In 2010, 59 percent preferred direct investments over private equity funds. In the 2014 survey, 77 percent of the respondents preferred direct investments over private equity funds. The survey compiled results from 100 families with median investible net assets of $1 billion each. Our observations are drawn from families with between $500 million and $30 billion in investible net assets.
What are the big pluses of direct investments rather than fund investments?
The two primary advantages families have are their industry knowledge and their indefinite hold period. Our perspective is that all forces of nature resist the perpetuation of wealth — taxes, spending, inflation, family dilution, divorce. And very few things make wealth come in other than smart investment decisions. Historically, the most effective mechanism for creating and extending wealth has been ownership of private companies.
An advantage that families enjoy really plays out when a seller rolls over substantial equity. If this seller partners with a private equity fund, they can be certain that they will get that call in 3.8 years — the median hold period for a private equity fund — that the company is now for sale, regardless of whether it’s the best time. Selling to a family leaves a roll-over investor with the comfort that an exit won’t be rushed for reasons having nothing to do with the company itself.
What about negatives of direct investments?
The two primary disadvantages families have are that finding and buying companies is hard and expensive, and you lose some of the protections of portfolio risk management. When you invest in a fund, your risk is spread over a collection of risks, and these risks offset each other, thus limiting your downside but limiting your upside as well. But when you invest directly, you make a series of bets rather than a collection of bets. This does expose you to more downside risk, but also makes it possible for you to profit enormously if you’re able to win those bets.
Any type of fund right now that seems to be in favor with your clients?
These days, families are looking for yield, which has led to an increased interest in credit-related funds, such as mezzanine or venture debt. They’ve also shown an increased interest in direct credit investments. In addition, families also favor sector-specific funds.
Will we see more family offices setting up their own direct investment shops in the vein of the Pritzker Group?
Yes. We have seen an increase in the number of families seeking to build in-house teams in the fashion of the Pritzker Group, and this has been made easier by the dislocation on Wall Street. But not many families have the dedication and resources of the Pritzkers, so I would not expect this trend to continue. No investor, fund or family, should allow their investment infrastructure to drive their investment decisions.
Edited by Steve Gelsi