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Family offices are diving into new markets
A TRANSACTION occurred on Wednesday that should give investors pause. Two hours before the US Federal Reserve announced a 25 basis point interest rate cut, Pegasus Investments said that it had arranged the sale of Water Tower Place, a 270,000 sq ft shopping centre in Des Moines, Iowa, to a "California- based family office". Sadly, the buyer's name and the price were kept secret, although Pegasus said that it was "the second highest price ever paid for a shopping centre in Iowa history " and - strikingly - was paid entirely in cash.
However, the motive is easy to guess. Once, property advisers mainly sold malls to developers, retail groups or banks. Now, however, there is rising demand from family offices. The new owner of Water Tower Place was said to have experience acquiring and managing other "trophy quality, grocery-anchored shopping centres" in the US.
As the Fed and other central banks loosen monetary policy, private pools of capital are searching for ever-more innovative ways to earn returns. Thus, if you want to understand the impact of Wednesday's rate cut, don't just watch bond and equity prices, track what is happening with assets such as Water Tower Place as well.
It is not easy to monitor such financial flows with precision, since the family office sector - which is estimated to control almost US$6 trillion in assets - is highly secretive. However, financiers say that a shift is under way.
A few decades ago, the sector (like most asset managers) put most of its money in public bond and equity markets, with a smaller allocation to real estate.
Then investing in hedge funds became all the rage. But a survey conducted late last year by UBS bank and Campden Wealth suggests just 5.7 per cent of family office assets now sit in hedge funds, sharply down from recent years. Meanwhile, the allocation to public markets is also falling, with just 28 per cent in equities and 16 per cent in bonds.
At the same time, investments in private equity and real estate have risen to account for 22 per cent and 17 per cent respectively. This trend seems set to intensify. After all, holding cash is unattractive, as banks such as UBS start charging for large deposits, and the rally in equity and bond prices looks at odds with many fundamentals. Indeed, public markets as a whole now seem dangerously hostage to the whims of unfathomable politicians and central banks - as shown by Wednesday's market swings.
While the traditional asset classes "generated average negative returns" in 2018, private equity "generated expected double-digit returns", the Family Office Exchange pointed out in a recent report. "Family offices continue to re-evaluate traditional approaches to investing accelerating interest in making direct investments in real estate and operating businesses."
This means that family offices are no longer just investing in private equity funds (which are already bloated with cash), but increasingly cutting direct deals. Moreover, 73 per cent are doing this in what the exchange calls an "opportunistic way", up from 54 per cent last year. That is, they are grabbing unorthodox avenues for higher returns, whenever they materialise.
"It is the hardest investing climate I have ever seen in my career in public markets now," explained a luminary of one of America's largest family offices. "So it's all about real assets now, and being creative." Indeed, this particular investor has recently started buying and running data centres and converting multifamily residences to Airbnb-style rental units.
Is this good for the economy? Classic economic theory suggests yes. Loose monetary policy is supposed to boost economic activity partly by forcing capital to embrace investment risk - and fund growth. In that sense, it is good news when family offices back "real" commercial projects such as data centres rather than putting all of their money in safe assets such as government bonds.
But there is also a US$6 trillion catch. The more that elite private pools of capital find juicy returns outside public markets, the more this risks fuelling wealth gaps. After all, most non-elite investors remain stuck in public markets and bank deposits, exposed to the vagaries of low interest rates.
This return gap may be going largely unnoticed now, because private markets are so opaque. However, the difference is likely to grow. Therein lies another mostly unnoticed consequence of central bank easing; and another reason why the 20th century vision of democratic capitalism based around public markets is under political attack. FT