Fund management has its roots in the safeguarding of private family assets. Wealthy families traditionally relied on their accountants, solicitors or bankers to invest their capital. From these small beginnings grew many big financial empires.
Only later did the fund management sector expand to encompass the mass market and the corporate pension fund industry. As it did, it changed out of all recognition. Going retail meant the need to build up expensive marketing expertise and distribution networks.
That put upward pressure on fees. The pursuit of pension funds had the opposite effect on fees but led to the development of the consultant industry, the use of measurement tools and eventually the tyranny of the index.
Quietly, however, some fund managers have continued to specialise in the wealthy family sector. It is an area where word of mouth and reputation can be very important and where the big banks, in spite of their desire to target “high net worth individuals”, do not always get their own way. Some individual families have even lured away stars of the fund management industry, solely to look after their accounts.
But now there may be a new threat to the cottage industry of private family wealth management. At least that is the view of Fleming Family & Partners.
The business was founded to look after the wealth of the Fleming family after Robert Fleming was sold to Chase in 2000. It has since expanded to look after the wealth of 17 families, with some £2.4bn of assets.
The Fleming family made its money from a long-term commitment to the equity market and thus has had no interest in owning bonds.
However, many wealthy families have traditionally used bonds as a means of safeguarding their capital. FF&P has used hedge funds to create the bond-like safety net in its asset allocation.
This may come as a surprise to those who associate hedge funds with the high-profile bets of George Soros or the collapse of Long-Term Capital Management.
But in recent years hedge funds have tended to play up their “safe” characteristics, their ability to make money in both good and bad markets.
With the rich disillusioned by equities since the 2000-02 bear market, and with bond yields so low that future returns look unattractive, FF&P believes that more families will turn to the hedge fund sector. But this will be a problem for the single family managers or even the small groups. They will not have the ability to research the sector sufficiently nor will they have the asset base to get access to the best managers.
Another asset base that FF&P favours is private equity and, here again, there may be research and access problems for the smaller players in the sector.
However, this process, like consolidation elsewhere in the fund management sector, seems likely to be slow.
First, even if FF&P is right and hedge funds and private equity are the right assets for the wealthy, the thesis is at the mercy of random events. A blow-up in either sector could set the cause back by several years.
Secondly, equities had good years in both 2003 and 2004. Hedge funds struggled in the first few months of last year. Add the effect of the higher fees that can occur in fund-of-funds or manager of managers structures, and there must be a few investors out there who wish they had stuck with traditional asset classes. The word-of-mouth effect may no longer be working in the favour of hedge funds.
Third, it can be hard, even for those with knowledge of the hedge fund industry, to select the best managers. Nearly half of all funds close within five years.
Academic studies have tended to show that funds of funds do not add value, once their fees have been accounted for.
But FF&P may have a point in that private wealth probably needs to be diversified. The shining example among college endowments is Yale which, under David Swensen, has built up a diversified portfolio (including hedge funds and private equity).
Yale's record has been outstanding, illustrating that excellent returns can be achieved without sticking rigidly to conventional asset classes. Managing private wealth these days needs an equally flexible mindset.