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A New Wave of Hedge Funds Emerge

Recently, we’ve come across more and more family offices converting their structure to model a hedge fund. The shift in family offices’ infrastructure enables them to reduce costs and attract and retain talent, while providing new business opportunities. More importantly, they’re actively and successfully capitalizing on these opportunities.

Finding a more effective management approach

For the asset manager, managing one comingled structure is far less tedious than managing 80 individual portfolios. Even with the single structure, customization and individual goals and objectives are still attainable, similar to a mutual fund. But why would a family office create a hedge fund-like structure as opposed to investing with one?

Creating the comingled fund maintains the control for the family office – it provides them with the opportunity to influence the strategy of the asset manager and provide assurance that their goals and objectives are being considered when the investments are being made.

Because an internal hedge fund structure does provide the family with the opportunity to influence asset allocations, they are reducing the risk profile of the investment strategy while creating transparency.

Ultimately, all of these factors contribute to a more investment-friendly environment for the family as well as the manager by simplifying the operational aspects for the asset manager.

Chris Bekmessian, Partner and Co-Chair of the Financial Services Group at EisnerAmper, has already seen this trend occur among half a dozen of his clients. “Family offices are doing this for a combination of reasons and we’ve seen this happening for a while now. You have a family office whose money is professionally managed; doing so in a hedge fund style/structure has a lot of benefits in terms of ease for the manager – making one decision for the comingled vehicle vs. making decisions per portfolio.”

Family offices are developing more sophisticated infrastructures, which in turn, present new opportunities

As family offices are exposed to the vast opportunities and benefits of building out their own infrastructure and teams, including front and back office employees, they are changing the way they operate. Seasoned professionals are managing their money, they’re hiring CIOs and marketing employees to help attract third-party investors, they are co-investing when appropriate and, ultimately, redistributing costs.

Reorganizing the fund in this manner allows the family office to compensate their staff generously, while providing them the opportunity to invest in more interesting and varied deals. In a society where talent retention is a concern to some of the largest institutions, it is crucial for traditional fund structures to be aware of this changing family office landscape in order to retain top talent.

The business opportunity that the money manager and family offices are realizing is with a robust infrastructure in place, these offices can take one of two routes: 1) Open the ‘fund’ to third-party investors or 2) Co-invest with another family office with similar goals and objectives. These strategies help to reduce the fee bourne by the family offices by redistributing the cost amongst the two offices or multiple investors.

As these opportunities are recognized, family offices are sponsoring hedge funds. “The hedge fund manager could be managing $600-700M for the family office, but now both parties have agreed that they will sponsor a hedge fund in which the family office will invest some of the initial capital. They will then set up a profit-sharing arrangement moving forward. They’re really trying to build a business and share profits,” Bekmessian explains.

So what does this mean for investors?

While this trend has been occurring for a few years, it is just now beginning to pick up momentum. When evaluating this new fund structure, investors should evaluate these funds like any other:

  • What are the family’s goals and objectives? As the majority investor, the family will have preference as it relates to the investment strategy, asset allocations and risk profile.
  • What are the terms, in detail? If families are looking for third-party investors, the funds should have a private placement memorandum with well-balanced terms.
  • How long will the investment be locked up? As many institutional investors have longer time horizons than wealthy individuals, a family office sponsored-hedge fund may lock up the investment for several years – which could create a well-balanced fit for the two entities.
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