More Hedge Funds May Convert To Family Offices

December 3, 2013

There has been a marked increase in the hedge funds looking to convert into family offices. The key incentives driving the transition to a family office setup include the ability to avoid regulatory scrutiny that comes with legislation such as the Dodd-Frank act. Transitioning to a family office has other benefits besides the potential to substantially lower operational cost. Without the hassles of outside clients a family office fund manager enjoys far greater flexibility in the investment strategy than a pure play asset manager. While some hedge funds make the transition voluntarily to take advantage of these compelling benefits, there are also firms that are forced to make the shift to a family office due to internal difficulties such as underperformance, staff exits and other reputation damaging factors.

Prominent Family Office Hedge Funds

Image: Wall Street Journal

Well known hedge fund managers who in the recent past turned their hedge funds into family offices include George Soros, Steve Cohen, Carl Icahn and Stanley Druckenmiller. While Soros returned outside money and converted the business to a family office to avoid registering as investment adviser with the US regulator, Steve Cohen had no option but to convert to a family office after he was barred from managing outside capital on being found guilty of insider trading.

Funds such as the highly volatile Covepoint Capital Advisors couldn’t recover from steep losses and the inability to raise outside capital as a result of continued underperformance resulted in the firm going private. Covepoint Capital is run by hedge fund manager Melissa Ko who was once a star fund manager who spun out Covepoint from Bear Stearns in 2008. New York based multi strategy hedge fund Brencourt Advisors run by William Collins also had difficulty in fundraising and converted to a family office in 2013. At the time of its announcement to shift to family office, the fund managed roughly $300 million, well below its peak asset size of $2.5 billion.

Over 1,000 Family Office Hedge Funds In The US

The Dodd-Frank act provides a special exemption for family offices and since family offices don’t solicit or invest money from outside investors, the disclosure requirement of family offices are far less onerous than they are for hedge funds. As a result, the lure of family offices for hedge funds has become very compelling.

According to an estimate from the Wharton Family Office Alliance, there are now more than 1,000 family offices in the US. Many families and private investors are also investing through family foundations that are lightly regulated. Some insiders compare the current environment surrounding family offices to what hedge funds were in the early 1990s when hedge funds used investment vehicles that are lightly regulated to make big bets on markets and yet remained out of the spotlight. Stephen Martiros, a consultant to private investors and family offices says he expects the combination of family offices and family foundations to be a growing force in capital markets.

Not All Hedge Funds Can Become Family Offices

Not all hedge funds can automatically make the transition to a family office. For a hedge fund to convert to a family office, the founding family and the employees must contribute substantial portion of the fund. A hedge fund that is dependent on outside money to operate may not find the family office option viable.

Leor Landa, a partner at Davis Polk who represents hedge funds says “There aren’t that many guys with that much wealth who can just move from a hedge fund to a family office,”.  Given that family office hedge funds are a separate class and not a substitute for any category within hedge funds, its emergence as a force in capital markets will be a net positive for the hedge fund industry and could aid in new job positions being created within the hedge fund space.

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