April 13, 2023: Adam Shapiro on investment strategy; a family-office debate on Reddit
Adam Shapiro is the managing partner of East Rock Capital, an investment adviser managing over $3 billion in assets on behalf of a select group of families. He writes about his firm’s talent-driven investment strategy and other topics in a monthly newsletter published on LinkedIn, “From Star To Founder.”
You have adopted a distinctive investment strategy that involves being laser-focused on “talent-driven” returns. Can you talk more about that?
People talk about sweat equity. Well, there’s also sweat return. The hustle, the network, the skill of a really good investor — that’s what creates the extra return, as opposed to the return that you deserve for the risk you took. We aim to find these investors or sponsors when they’re in the “sweet spot” — that moment in their career when they’ve developed an investing style and proven that it works but haven’t stayed in one place for too long or gotten too far past their peak level of ambition. If you can find someone who’s got the talent and the tools, and on top of that you catch them where they’re incredibly motivated, and on top of that you partner with them in a structure where you’re both trying to achieve the same thing, — that’s where that extra return is really optimized.
Can you talk about an example of an investor hitting the sweet spot?
We recently backed an investment firm founder who buys consumer-products companies and makes aggressive changes to improve operations. He’s in his mid-40s and launched his investment firm four years ago. His firm buys a new company every 12 to 24 months using a highly disciplined approach — they don’t go forward until they have tremendous knowledge of how they can improve the business. Before launching his firm, the founder had worked and succeeded at a wide range of places — an investment bank, a PE firm, a corporate M&A group — and ran operations of a corporate subsidiary. Normally, we like to see more years in PE than he had, but his prior accomplishments and unique investment process convinced us that we wanted to be in business with him. In our first investment together, we supported his firm in buying an energy-bar business that has been a strong early success. More recently, we invested with him in a frozen-foods business that we are very excited about.
What’s the biggest advantage you have in making investment decisions for the long term?
Our flexible time horizon is a big advantage because we can think long term, but we’re not limited to the long term. Private equity firms want to hold for a minimum of three years and generally a maximum of seven. But I think the ultimate in investing is having the incentives and the mindset that allow you to sell at exactly the optimal moment. Say you make an investment, and a month later someone wants to buy you out for 30% higher. There’s a reasonable chance you should sell there. But for a PE firm, getting $1.30 back for every dollar might look bad because it lowers their average MOIC [multiple of invested capital]. The nice thing about our setup is that we have different incentives and complete flexibility; we can hold 20 years or a month. We go into everything prepared to own it for 20 years, but the reality is that we’ve had opportunities to sell much, much sooner at prices that we couldn’t justify not selling at.
You advocate for heavily outsourced family-office setups. Why is that?
Families hire investment people and think: “There! I control my destiny.” What they often misjudge is that employees are a lot of work themselves. For starters, good chief investment officers are very hard to find. The employees’ ambitions and problems become the family’s issues to deal with. An extreme case is having to fire somebody — or even worse, they sue you for it. That’s not what the family signed up for. You don’t want surprises, headaches and other demands on your time. For most people, you want to be liberated from that. You just want someone to grow your capital and not lose it.
In our business, we want only world-class investing talent touching our clients’ money. That’s hard for a family to do without outsourcing. If you lift a PE team out of Blackstone and just put them into a family office, you’re not going to get that motivation or alignment. And you’re generally not in a position to compensate them as much as you need to in order to get a top-tier operation.
What lessons can you share with other family offices about investing strategies, multigenerational goals and philanthropy?
In my experience, “multigenerational goals” usually boils down to this: How do I promote harmony, happiness and a sense of responsibility in the younger generation?
We’re an investment shop, really, so our job is to protect and grow the pie. That helps, but it’s also important to balance the varying individual preferences that exist within a family. For example, some members may care about investment gains, others about avoiding loss. Some prioritize societal impact and/or learning; others want maximum economic gain. Even if everyone agrees on the virtues of family harmony, not everyone may agree on how to get there. So, my “lesson” would be to be very clear on what you care about, and be very purposeful in matching your setup to those goals.
Interview conducted by Darrell Hartman, a freelance journalist whose work has appeared in The Wall Street Journal, Fast Company, Bloomberg Businessweek and other publications. He is the author of Battle of Ink and Ice: A Sensational Story of News Barons, North Pole Explorers, and the Making of Modern Media (Viking, June 2023).
To start a family office … or not? Question sparks debate on Reddit
The surge in growth of family offices in recent years has generated heated debate among ultra-high-net-worth people over the pros and cons of starting their own office. Such discussions have even spilled over into Reddit, the social media platform better known as a hangout for conspiracy theorists and other obsessives.
This past weekend, one user inquired about the level of wealth needed to start a family office: “how fat do I need to be?” They wondered: “I suspect once you factor in cost of staff, operations, etc. you might need to be in the $200M range.”
The responses ranged from the pithy to the philosophical and included a few revealing insights into the usually discreet world of family offices. When one user suggested that those on the lower end (less than $10 million) might be interested in a multifamily office, another responded:
“So hiring any ‘money manager’ to manage your assets is like playing Russian Roulette with 99 bullets in the gun and 1 open chamber. My friends have been swindled out of so much money this way. It's millions of dollars lost. I've never heard ONE positive story yet.”
That pessimistic attitude was dismissed by a user claiming to work for a major bank in Canada, which offers family-office services at $30 million for a 0.5% fee and includes lawyers, accountants, estate planning, private banking and portfolio management. “And you’re likely getting much better investment, tax & legal advice than you could hire yourself,” the user wrote. “It makes very little sense to do it yourself these days unless you simply want maximum control. But it’s hardly ever cost efficient.”
Another user chimed in with a more nuanced response:
“I'm the 3rd generation of a wealthy family that has a single family office. While I'm absolutely not an expert I feel like I'm somewhat qualified to answer this question… Ours is based in Western Europe and relatively small, it has ~10 employees: CEO, CIO, CFO and then the rest are accountants and admin staff. There are no investment analysts, the CIO is solely responsible for the investment decisions. Our family office was set up in the 90s and has expanded gradually over time. It's more about wealth preservation than capital growth so we're not overly aggressive in how we invest. At the beginning most of the wealth was tied up in one stake in a publicly listed company. Over the years it has become more diversified as windfalls were reinvested. There is still one relatively large stake in a name brand, publicly listed American company (it's only a small cap but it's well known). The rest has been reinvested into various different areas. Most of it is allocated into PE and VC funds. We also do some direct investments into real estate and private businesses. We invest a small amount directly into startups but that is more rare. There are some other smaller stakes in publicly listed companies but we're not stockpickers and tend to avoid doing stuff like that.
"I can't say exactly how much it costs to run it because I don't know the employees' exact salaries but if I had to guess I'd say it's probably ~€2mn, so not far off what your estimate. Like I said, I'm not some family office expert but I do have some direct experience with one so I can offer some insight.”
That prompted a reader to quip:
“Your family office has 10 employees but only one that analyzes investments? That sounds insane to me. What does your CEO do?”
The European family-office member replied:
“The CEO is more of a tax person and which takes up a considerable amount of time but to be fair I think the CIO and CEO both work on investment decisions, even though the CIO obviously spends more time on it. I could have worded it better. Also most of the investment analysis is outsourced since we mainly invest in funds and do a much smaller amount of direct investments. I'd also like to stress that I don't oversee the day to day operations so I can't comment on the exact functions of every employee, I'm simply one member of a large family.”
When another user suggested that CIOs could be hired for $400K, a reader replied:
“Do you think CIO only makes 200k more than [an] analyst? CIO jobs are all 1mn above. Believe me, I work in this industry. Analyst jobs can have a wider range of pay but maybe 100k for 22 year old and go up from there. Other considerations are how much you want to do in terms of private/alternative investments. Investing in mutual funds cost 0 to do essentially, but if you want to invest in private equity funds, review LPA, negotiate side letter, and do it correctly legally, then there is really no budget you can set for legal fees. It just depends on the GP and how long is the back and forth between the lawyers. Lastly, investment and operational due diligence cost money. Travel can be a huge piece. ODD is likely outsourced and run about 10k per fund. So much cost, but variable. If you have scale, like a multi billion dollars, a typical endowment is run by 25 bps of AUM. If you have less than 1bn, then that bps will look a lot higher because there is a minimum level of cost is required.”
And the debate continues …