NEVER MIND STOCKS. JUST BUY THE COMPANY.
Never Mind Stocks.Just Buy the Company.
By PAUL SULLIVAN
AFTER years of litigation against the side of his family that controlled his grandfather’s coffee business, Steven D. Crowe woke up on New Year’s Day 2004 with a lot of money in the bank – $111 million, according to reports at the time. Having developed and managed real estate for decades, he said he knew little about the stock market, so he invested the money broadly for his mother and sister and his own family.
He was content with the returns of a balanced portfolio until the point in the financial crisis when 30 percent of his family’s fortune was gone. That experience changed how Mr. Crowe looked at investing, but not in an expected way.
“In 2010, I figured this could happen again and it could be not as bad or it could be worse,” said Mr. Crowe, who was living in Los Angeles where his grandfather’s company, Farmer Brothers, was based. “I harkened back to owning apartment buildings. I never worried about economic cycles.”
Today, Mr. Crowe has half of his family’s money in a fund that owns four large apartment buildings in Texas. “I felt it was a far safer investment,” he said. “Why should I worry about the stock market? It’s affected by psychology.”
A growing number of people, wealthy and less so, are investing directly in companies, projects or private equity funds instead of buying stocks and bonds on the open markets. This week, I’ll focus on how the wealthiest families make those investments; next week, I’ll look at a subset of affluent investors who are using their retirement accounts to invest in similar but smaller ways.
Ward S. McNally, managing partner of McNally Capital, which advises wealthy families on private equity investments, said that in a study of families with $500 million to $25 billion, which it will release next month, the firm found that 79 percent of them had made direct investments. That is up from 59 percent in 2010, when McNally Capital conducted a similar survey. In direct investments, the investor buys a portion, if not all, of a private company with the expectation of receiving income from it or selling it at a profit one day.
“Families have come to the conclusion that if they want to generate real wealth they have to make direct investments,” he said. He added that 49 percent of respondents wanted to have control over their investment, as opposed to 17 percent who preferred to be more passive.
According to Tiger 21, a membership organization of 250 people who have at least $10 million to invest, the shift toward allocating money to private equity has been substantial since the financial crisis. Their members had 9 percent of their money in private equity at the start of 2008; it is now 20 percent.
“After 2008 many of our members became more concerned about the public markets, which seemed more like a casino than a true weighing machine of a company’s value,” said Michael Sonnenfeldt, founder of Tiger 21. “Private equity is where long-term value has been built.”
A desire for control and a distrust of Wall Street are not uncommon sentiments today. But investing directly in companies or private equity funds is no free pass to riches. It carries risks that may be easy for even the wealthiest families to overlook.
Investing too much in any asset class is never a great idea. “Invariably the pendulum always swings too far,” said Charles Buckley, managing director and head of UBS’s global family office. “I hope everyone is looking at the balance between liquidity and illiquidity.”
In Mr. Crowe’s case, the other half of his family’s money is in equities and high-yield corporate bonds.
Buckley said many wealthy families were fed up with traditional private equity funds because of the high management fees and percentage of profits they take. While their preference to invest alone or in groups may save them fees, it may not earn them the returns they expect.
“With some of these things, if you’re wrong you may not be proven wrong for five years,” he said. “These things take a long time to play out.”
Most individuals also fall prey to investing in ideas that land in their lap. Mr. McNally said his study found that 85 percent of people were brought deals from family and friends. And 48 percent of them look at fewer than 50 deals before investing.
This may be the biggest disadvantage faced by wealthy individuals who invest in private deals on their own, in comparison to large private equity firms, which pass on hundreds of investments before making one.
Speaking at UBS’s global family office forum in New York this week, Hamilton E. James, who is known as Tony and is the president of the Blackstone Group, one of the most successful private equity firms in the world, discussed the advantages that a firm like his had over individuals.
“Our size gives us a massive, consistent advantage that drives consistently high returns,” he said, before listing off several multibillion-dollar deals the firm was able to do because of its size, like the $39 billion acquisition of offices from Sam Zell.
“What we do is buy it, fix it and sell it,” Mr. James said. “If we just buy it, we won’t make any money.”
Beyond talking up his own book of business, he discussed the seven areas he was personally investing in through his own family office. These included energy production around the world, real estate in Europe and Asia and infrastructure in Brazil. Yet Mr. James, a billionaire in his own right, said he had the ability to invest as an individual alongside Blackstone deals.
Few have an advantage like that. But where families are giving themselves the best chance of success is where they are investing in areas they know from past careers. Mr. Crowe said he learned from previous mistakes he had made as a real estate developer that it was better to invest in apartment buildings with at least 200 units and little debt. The four properties he has invested in have 1,250 units. “I knew what I wanted to invest in,” he said. “Our income has been great.”
William E. Bindley, who has sold two health care companies, Priority Healthcare and Bindley Western, for billions each, focuses his investment strategy on acquiring and building health care companies and using innovative financing techniques.
“We’re either leveraging our knowledge in a space like health care services, or we’re leveraging our capital where others can’t,” said Thomas J. Salentine, president of Bindley Capital Partners, which invests Mr. Bindley’s money. “Anyone can come in and buy a health care services company. We can leverage our knowledge.”
The more esoteric financing, however, shows the opportunities that private investors have for large returns on high-risk investments. Mr. Salentine said that during the financial crisis the firm bought out investors who no longer wanted to hold their private equity positions and others who needed to quickly liquidate hedge fund investments.
“Bill understands doing creative financings and doing deals,” Mr. Salentine said. “A lot of family offices are started by people who had an operating company and grew it organically, not through financings and deals.”
Today, he said the firm was buying judgment settlements and lending money to professional athletes against their contracts. Yet, the firm can choose to do nothing, a luxury that comes from having to report only to Mr. Bindley.
“We don’t have to do any deals,” Mr. Salentine said. “We’re only going to go forward with stuff that we really like.” That’s a type of discipline that everyone can learn from.
A version of this article appears in print on May 24, 2014, on page B5 of the New York edition with the headline: Never Mind Stocks. Just Buy the Company.