How Family Offices Stand to Benefit From the Shift into Private Markets

Private equity and private credit are taking front row seats in family office portfolios.

Once considered adjuncts to the traditional allocations of stocks, real estate and bonds, private market investments have emerged as central to the mission of the modern family office. Long pioneers in alternative investing, family investors today stand at the forefront of key trends including private credit and direct investments.

Private Assets Take the Lead

Research conducted with The Harris Poll for BNY Wealth’s 2024 Investment Insights Report for Single Family Offices has a striking finding: for family offices, the era of private equity dominance is already here.

Private equity investments (fund, direct and venture capital combined) account for the largest single asset allocation in family office portfolios, surpassing more traditional portfolio leaders such as public equity and real estate. 

The balance between public and private credit continues to tilt in favor of the latter. Forty-three percent of professionals at family offices with AUM under $1bn and 35% of those at family offices with AUM of over $1bn report plans to increase exposure to private credit over the coming 12 months, compared to 36% and 30% respectively for public fixed income. 

Private equity also emerges as a key priority for new investments. Family offices are presently focused on going for growth as they tap into structural trends across AI, sustainable investments and healthcare. Such growth investing calls for exposure to pre-IPO start-ups that promise to become the champions of tomorrow. 

The Context: A Structural Shift

Our family office research speaks to a profound change in the broader economy. The past few decades have brought explosive growth in the universe of assets beyond public exchanges.

The number of publicly listed U.S. companies has more than halved since 2020, while the number of private equity-owned companies has surged. In the U.S., the number of private equity-backed companies surpassed the number of public companies in 2012, and the gap is only widening.

Similarly, private credit has undergone powerful growth since the 2008 global financial crisis, with the market for private credit expanding tenfold since 2007 to reach an estimated $2.38tn as of the end of 2023.¹ New regulatory requirements have caused banks to tighten credit standards, especially for lending to mid-sized and smaller companies. The resulting funding gap has created an opening for private credit funds to step up and lend on attractive terms.

How Private Assets Help Family Office Investment Programs

An important consequence of these structural shifts is that investors can no longer hope to secure broad, diversified exposure to the modern economy without a significant allocation toward private equity and private credit.

Our research reveals a particularly strong appetite for growth-oriented private equity. That testifies to a growing awareness that some of the best growth stories are no longer available on public exchanges. Since the mid-1990s, the average time that a company stays private before an initial public offering has almost doubled, from six years to 11. The stage of a companies’ growth where the most value is created is increasingly accessible only to investors who venture beyond public exchanges.

As the chart below shows, private equity and venture capital have been a powerful source of investment alpha since the 2008 financial crisis. 

Private credit has similarly proved its worth. Privately negotiated loans often enjoy stronger lender protections than comparable public instruments such as high yield corporate debt. Private credit has now been tested through several economic cycles, demonstrating better recovery rates following defaults than those typically seen in high yield corporate debt. The sector demonstrated its resilience during the most recent rate hiking cycle, recording modest overall default rates of 1.84% in the first quarter of 2024. It has also been a portfolio performance driver, with annualized total returns of 8.5%, compared to 4.2% for high-yield bonds and 1.1% for investment grade bonds.

Future performance drivers

Private assets will continue to play an important role in portfolios as the economy cools and markets adjust to structurally higher interest rates than in the 2010s - the decade preceding the pandemic.

Over the next few years, hundreds of billions of dollars of leverage loans will require refinancing, which will drive significant demand for private funds to step in as liquidity and capital providers.

While a soft landing of the U.S. economy remains our base case, a cooling economy or a future downturn will create pockets of opportunity for skilled managers working in distressed debt and private equity to acquire good businesses at attractive valuations.

The Family Office Edge

Private assets have the potential to generate market-beating returns, however choosing poor managers or underperforming investments can be a significant drag on portfolio returns.

As the chart below shows, private equity investments have far greater performance dispersion than that seen on public markets. Top-ranked private equity funds have historically outperformed bottom-ranked funds by an average of 21% on an internal rate-of-return basis.

Family offices are well-placed to emerge as winners from the general shift toward private markets. The sector enjoys many of the ingredients that are necessary to be top performers in a competitive sector. Entrepreneurial by nature, family offices are able to leverage in-house business expertise, extensive industry connections and patient capital to be successful in private investments.

Such attributes are especially useful when running direct investments, programs which see a family office negotiate directly with a private company to provide debt or equity (or provide the same through co-investment). BNY’s research shows that family offices are highly focused on this competitive strength. Seventy-one percent report planning to make six or more direct investments over the next 12 months, a 15% rise on the year before.

The appeal of direct investment is not limited to return potential. By foregoing fund management and performance fees, direct investment can also help to lower portfolio costs.

Direct and co-investment have additional advantages for risk management purposes. By allowing family offices to exercise greater control over their investments, families are able to gain much greater transparency into how their capital is being put to work.

Key Challenges

Private assets are increasingly central to family office portfolios, but there are real barriers to success. Through conversations with our industry partners, we know that taking full advantage of opportunities across private equity and private credit isn’t always easy.

For family offices that utilize funds, identifying the very best managers in a sector can be a complex and time-consuming process.

In-house direct investment programs carry great promise, but also heightened risks. Common pitfalls can include a family office misjudging its area of expertise, or committing to a company whose values are misaligned with those of key family members.

Above all, successful direct investing requires family office managers to develop a clearly defined, repeatable process for identifying genuine value. Sifting through potential deals for nuggets of alpha opportunity is a lengthy and research-intensive activity.

Building a portfolio of direct deals also requires significant patience. As any collector can tell you, acquiring and cultivating a stable of truly excellent assets cannot be done overnight. Yet it is precisely in not doing the easy thing, but that which is hard and rewarding, that family office investors are able to secure a competitive edge.

Learn more

Leveraging our extensive industry network, BNY Wealth’s experienced team is dedicated to crafting strategies that add value to your investing process.

To find out more about the fast-evolving landscape for family offices, read BNY Wealth’s 2024 Investment Insights Report for Single Family Offices.