Two sectors where the ultra-wealthy are putting their money

Family offices are channeling ever more capital directly into companies over investing in private-market funds.

Last year, these investors—institution-size organizations that manage investments for wealthy families—boosted the value of their direct investments in private companies by 123.3% from a year earlier to nearly $13 billion, according to S&P Global Market Intelligence.

These investments offer more transparency into the companies getting their money, and sometimes, they offer families more control. By investing directly, families also avoid the high fees charged by private-equity firms, typically a 2% annual management fee on assets and 20% of profits above an agreed-upon threshold.

“If you think about a family office and why a family would set up a family office, [direct] investing is right in their wheelhouse,” Dino De Vita, president of the Global Family Office at Northern Trust, said in an interview. “They want to be able to fully customize. They want to be able to avoid certain sectors. They want the flexibility of sometimes not investing in public equities.”

Historically, private equity has been a big part of family offices and it has been growing from about 25%-35% a decade ago to more like 50% for some family offices today, De Vita says. “Direct investing is a natural evolution of what’s been happening.”

In a survey from Citi Wealth published this past fall, 70% of family office respondents said they were “engaged with direct investments.” And of those, 40% increased their activity in the past year. In a separate survey of family offices published by Bank of America Private Bank, also in the fall, 40% of respondents said direct investment was “one of the greatest opportunities to create wealth for the family office in the future.”

Families believe direct investing offers them a competitive advantage “because they can deploy patient capital and they can hold it for a long time or a very long time…after all, most of them created their wealth owning businesses sometimes for a few generations,” Alexandre Monnier, head of Family Office Advisory at Citi Wealth, said in an interview.

Increasingly, these families are gaining direct access to these deals through nimbler independent wealth management firms and RIAs, according to Joshua Becker, co-leader of law firm Pillsbury’s Private Client & Family Office practice.

As family office wealth has grown, a number of registered investment advisors and smaller wealth management firms that make investments on their own balance sheets are enabling family offices to invest alongside them, Becker told Barron’s.

“As a result, you have family offices that are suddenly getting these deals that historically you would have gained access through private-equity funds now coming through these investment boutiques,” Becker says.

One of these firms, Gideon Strategic Partners, finds family offices are “not only a source of deal flow, but also a source of due diligence,” Erik Oros, Gideon’s chief investment officer. “It’s a big reason why we can win the transactions.”

Family offices also can make a meaningful difference for companies through partnerships, sales contacts, board representation, and other meaningful contributions, Oros says. “It creates a great network flywheel.”

One reason this works is family offices are often sophisticated investors, and they don’t want to be in a blind-pool fund where managers can drift from a thematic mandate. “They want to underwrite on a deal by deal basis, they want to understand what they are investing in,” he says.

An advantage of working with a larger bank could be it’s wider scope. Daniel O’Donnell, head of Alternatives & Investment Manager Solutions at Citi Wealth explained in an interview that “we are able to channel deals from the investment bank or other parts of Citi to help drive connectivity…those deals can have a slightly different look and feel, but the goal here is to provide appropriate breadth and depth of opportunities because different family offices are looking for different things.”

Unsurprisingly, a lot of family offices have been interested in investing in growth-oriented tech companies, O’Donnell says. “It’s the names that you would think of, the higher profile names that are out there.”

Last year, families invested more than $3 billion into 36 technology, media, and telecommunications deals, according to S&P Global Market Intelligence—the most deals of any other sector. The largest tech-related transaction was an $860 million investment in Stoke Space Technologies, a rocket company founded by former employees of Blue Origin and SpaceX.

The sector attracting the most capital was materials, with five deals valued at a total of $4.8 billion. That was largely because of the $4.5 billion acquisition of the glass packaging manufacturer Verallia Société Anonyme by BW Gestão de Investimentos, the office of Brazil’s Moreira Salles family.

Most of the interest Becker sees in materials is in rare earths mining and related infrastructure. Unlike other sectors, however, most families interested in investing in rare earths don’t have expertise in mining. But they know these minerals are critical to advancing technology so they are looking for guidance from other families or outside advisors.

A reason almost every family office De Vita speaks with about why they are moving to co-investing or direct investing is to avoid the fees charged by a typical private-equity fund manager. That’s true for Becker’s clients as well.

But Monnier at Citi Wealth argues that the pendulum is swinging back a bit as families realize that doing their own due diligence on a company is a lot of work.

“It takes time, it takes a team, it takes talent. At the end of the day, there’s a reason why you’d pay the 2-and-20,” Monnier says. “The difference is one of them is easy to measure—the 2-and-20, and the other is sometimes a cost that families don’t fully appreciate because it’s buried within the cost of running their family office.”

Write to Abby Schultz at abby.schultz@barrons.com