Thought Leadership Content

Family Office Network Launches Los Angeles Family Office Association as Networking Resource for Wealthy Families

Los Angeles, CA - May 31, 2017 - Family Office Networks announced today the launch of a new division in Los Angeles led by local resident James R. (Jim) Hedges, IV. Family offices, high net worth individuals and the top advisors who serve them are invited to join the Los Angeles Family Office Association, which will host events on a regular basis across Los Angeles. The group will celebrate its local kick off with an exclusive, invitation-only networking event this summer at the Beverly Hills Hotel.

 The Los Angeles Family Office Association (losangelesfoa.org) will serve one of the most intellectually astute family office regions in the country. The group is designed to serve the extremely accomplished single and multi-family office community by creating an environment in which to share intellectual capital, leverage their years of industry expertise, and bring unique industry-generated deal flow and opportunities.

 "Our organization is dedicated to providing information, opportunities and investment resources to affluent families and individuals. We provide multi-generational support to family structures in order to ensure continued success and wealth preservation. We will offer our Los Angeles members exceptional news, information, and other resources to help ensure that they are well-positioned for future success," said Andrew Schneider, Founder and President of Family Office Networks.

Local Managing Director James R. Hedges, IV was one of the early leaders in the hedge fund and alternative investments industry and is the author of Hedges on Hedge Funds. He was the Founder and Chief Investment Officer of LJH Global Investments, LLC, an alternative investment firm which advised on the placement of over $5 billion of assets. Following the sale of LJH, in 2010, he founded Montage Finance, to make asset-backed loans secured by contemporary art and is also Managing Member of Hedges-Projects, a family entity created to oversee principal investments and art activities. Hedges has been an active investor throughout his 25-year career, representing the interests of both substantial investors and entrepreneurs. In 2017, Hedges founded HEDGES COMPANY (www.hedges.company), an Expert Network to marshal resources for its clients' investing, growth and business development needs.

 The Los Angeles Family Office Association is open to any family office operating in the local market. There will be numerous events, seminars, and special functions that take place throughout the year engineered to deliver the most pertinent information to assist family offices in reaching their goals. 

For information about joining the Los Angeles Family Office Association or to be invited to the kick-off event, please contact Jim Hedges at 1-212--671-0522 or jim@losangelesfoa.org.

About Family Office Networks 

 Family Office Networks is the premier global community for families to share information and intelligence. The team works with a select group of top tier investment managers and sponsors who offer substantial families access to stellar investment opportunities in areas such as real estate, venture capital, private equity, and hedge funds. In addition, Family Office Networks shares timely thought leadership on topics related to portfolio management, philanthropy, multi-generational wealth management, compliance and regulation, risk management, insurance, training and education. The website is the hub of Family Office Networks with 40,000 users, including 9,000 family offices, and is a go-to resource for news related to family offices.

An Investor’s Due Diligence Lessons in Marketplace Lending- Published by Lend Academy

http://www.lendacademy.com/investors-due-diligence-marketplace-lending/

When I began working in the family office and hedge fund worlds in 1992, private investors were looking, foremost, for return enhancement and, secondarily, for diversification. Fast forward 25 years, investors are still looking for return enhancement, but less on the equity side, and rather more for current income. In the early 1990’s, hedge funds were a secretive, largely unregulated landscape with virtually no disclosure and very little educational information available for those looking to allocate capital to the space. As a result, investors often did not know how to differentiate fund managers and tell the difference between an A- player and a C- player. There was a profound lack of thought leadership, and those charged with advising new entrants in the market had to do a great deal of educational missionary work and lay out a thoughtful path of insights.

In today’s marketplace lending sector, it is a similar story. There is a proliferation of funds in the space, and assets are flowing in to funds to the tune of hundreds of millions of dollars per quarter. There are ample industry-focused conferences and e-publications, but there remains precious little in the way of independent research and insight for private investors, institutions and the consultants who serve both groups. Product differentiation is difficult, and there is still not a robust set of data analytic tools or benchmarking indices.

In terms of the landscape, on one side of the field, we have a universe of loan originator platforms. Best known names like Lending Club, Prosper and SoFi have dominated the press, but there are, in my estimation, well over 100 unique specialty finance loan origination platforms, and within that group, loans are being originated in an ever-increasingly diverse set of sectors, such as:

  • Unsecured consumer credit for debt consolidation and emergency expenditures
  • Real estate lending (often secured by real property)
  • Small business credit
    • Merchant Cash Advance
    • Equipment Financing
    • Factoring
  • Retail installment contracts (RIC’s)
  • Solar equipment financing
  • Education financing
  • Automotive repair financing

Each of these segments has unique drivers impacting customer acquisition costs, underwriting procedures, and borrower behavior. Consequently, many of the segments offer differing yields, default rates and durations.

On the other side of the marketplace lending landscape, once the loans are originated, there are many different asset management structures through which capital inflows are being allocated, including:

  • Managed Accounts for institutional investors
  • Hedge Fund Vehicles (i.e. private partnerships: funded all at once with shorter lock-ups)
  • Private Equity Vehicles (i.e. private partnerships with investment drawdown periods and long-term lock-ups)
  • Fund of Funds investing across a spectrum of originator strategies
  • UK-listed Funds (i.e. closed end funds, most of which trade at meaningful discounts to their NAV)
  • Luxembourg SICAV’s
  • 40 Act Funds (interval funds which mostly have staggeringly high fee burdens)
  • Notes and Variable Life Insurance wrappers for tax efficiency

With gross current yields ranging from high single digits to the upper 20’s (and in some cases, even higher), it’s easy to see the appeal for family offices, under-funded pensions and insurance companies. Even with potentially high default rates, these loans can provide a very strong current income stream, and with average loan durations typically under 2.5 years, there is very little comparable in the traditional investment market, making this space the holy grail for today’s investors.

Over the past year, I’ve had the opportunity to engage in diligence discussions and meetings with approximately 40 origination platforms which have originated over $18 billion of new debt in 2016 and 50 investment vehicles, managing in aggregate over $10 billion of capital. I’ve seen a great deal of opportunity, but I’ve also found numerous reasons for investors to have great concern and proceed with great care.

Once prepared to allocate capital to the space, an investor in this space must first establish one’s point of view on:

  • Segment (-s)
  • Duration of assets
  • Rate thresholds
  • True Lender requirements
  • Appropriate entity structure
  • Tax implications of entity structure
  • Allocation size (multi-manager or single focus)

Establishing these sorts of goals and parameters is the fundamental bedrock of beginning an investment allocation process.

As ever in the alternative investment landscape, manager due diligence is paramount, and this new field is populated with portfolio managers who are more likely to have worked at Capital One on a credit desk than on the trading floor of Goldman, Sachs. The lack of a traditional investment pedigree and track record in this field makes it more difficult for one to assess a manager’s relevant skills and experience. Likewise, the use of leverage in this field is not confined to swaps and broker/dealer leverage, but is more analogous to the leverage debt fund markets (i.e. CDO’s, CLO’s, etc.). Moreover, these factors, when combined, (less portfolio management expertise and unique leveraged assets) highlights a risky dynamic. It’s also true to state that many funds in the space have added little value or even created their own problems through portfolio management errors and mistakes on deploying leverage. To wit, many of the niche segments in the marketplace lending landscape are somewhat new to direct lending, and as such, historic performance of borrowers’ behaviors is less understood. The result is that financial modeling and risk management at many funds has been reliant on incomplete data.

I want to shine a light on something we should all be terribly concerned about. Valuation practices in this space have lacked consistent methodologies. Managers frequently accrue for loan losses using differing standards. The result is that performance can be overstated or that returns appear to be smoother than they would be using different methodologies. For instance, I offer the following excerpt from the performance report of a very large fund in the space.

 

When I first saw these returns, I instinctively thought of Madoff. The narrow band of returns is, in my experience, highly unusual and inconsistent with the returns of investments being marked-to-market. To be clear, I am not saying that this fund is a fraud. I am stating that the performance they’ve reported is, in my experience, unlikely indicative of a valuation methodology that accurately reflects the month-to-month performance of the underlying assets. What this could mean is that investors could be disadvantaged when they come in or leave the fund.

As stated earlier, there is a wide spectrum of investment vehicle structures with varied liquidity terms. What is abundantly clear is that the majority of funds appear to offer liquidity terms which could be inconsistent with the underlying duration of the investments in their portfolios. By example, an alarming number of funds offered annual liquidity (some with gates, others not) where the underlying assets were 36 and 60 month stated duration. When a manager tells you that current income and all the new investor in-flows of capital should be sufficient to meet any redemption requests, one should take pause. It’s critical to keep in mind that the instruments in these funds are not liquid. There is no formalized primary securities market or secondary trading platform with any establish volume.

Given the current rate environment and lack of performance in mainstream alternatives, there is no doubt that the landscape of direct lending is entering an explosive growth phase. However, there are many factors that could derail its progress:

  • Increased bank regulation
  • Shocks to the consumer credit cycle and rate environment
  • Fund blow ups due to:
    • sloppy valuation
    • poor liquidity management
    • unexperienced portfolio management
    • ineffective use of leverage

Expect a rapidly changing environment. The coming years will surely see billions of dollars of investor capital flow into this asset class, and there will be a wave of new products, intermediaries and experts. My experience evaluating a broad array of originator platforms and investment vehicles has only highlighted the increasing complexity and systematic risks. In spite of a cautionary message to move carefully into these waters, the sector offers some very appealing uncorrelated returns and current income for those who execute superior due diligence.

PEER-TO-PEER LENDING AND DIRECT LOAN FUNDS DUE DILIGENCE: An Investor's Guide to Opportunities & Risks

Let’s be candid.  The hedge fund landscape is a wreck.  Mediocre performance for years.  Heavy fee burdens.  Limited disclosure.  No real asset flows in years (except for performance increases).  Finally, uncorrelated alpha seems to be a thing of the past. 

However, in the past few years, there is a new industry emerging offering the promise of uncorrelated alpha, and, the holy grail:  current income.  It’s not exactly a hedge fund, but it falls under the alternative investment banner that families and institutions rely on to enhance performance and meet funding goals.  Peer-to-peer or marketplace lending is a relatively new segment of the alternative investment landscape, one grown out of the ashes of the 2008 financial crisis.  As banks were slapped with increased regulatory oversight, they exited many segments of the direct lending market, most notably unsecured consumer credit and small business credit.  The result created a void of lending solutions which have now been gradually replaced by fin-tech powered platforms focused on loan origination.   

The peer-to-peer or market place lending space includes a broad array of segments which include:

            Unsecured consumer credit for debt consolidation and emergency expenditures

            Real estate lending (often secured by real property)

            Small business credit

           Merchant Cash Advance

            Retail installment contracts (RIC’s)

            Solar equipment financing

            Education financing

            Automotive repair financing

            Factoring

            Equipment Financing

Each of these segments has unique drivers and underwriting procedures, and consequently, many of the segments offer differing yields, default rates and durations. 

With current yields ranging from high single digits to the upper 20’s (and in some cases, even higher), it’s easy to see the appeal for family offices and under-funded pensions and insurance companies.  Even with high default rates, these loans can provide a very strong current income stream, and with average loan durations typically under 2.5 years, there is very little comparable in the traditional investment market.

As an investor in this space, it’s critical to first establish one’s point of view on:

            Segment

            Duration of assets

            Rate thresholds

            True Lender requirements

Investing in this space can be done using both active managers and passive managers. 

Active Management includes investment funds dedicated to a single segment or a diversified group of segments.  Investors can also establish managed accounts by entering into forward flow agreements with lending platforms, provided they have sufficient scale to meet high minimum requirements.  Finally, there is a small group of fund of funds dedicated to the space, though it seems their fee structures could pose problems for exposure to lower return segments.    

As ever in the alternative investment landscape, manager due diligence is paramount, and this new field is populated with portfolio managers who are more likely to have worked at Capital One on a credit desk than on the trading floor of Goldman, Sachs.  The lack of a traditional pedigree and track record in this field makes it more difficult for one to assess a manager’s relevant skills and experience.  Likewise, the use of leverage in this field is not confined to swaps and broker/dealer leverage, but is more analogous to the leverage debt fund markets (i.e. CDO’s, CLO’s, etc.).  Finally, many of the niche segments in the marketplace lending landscape are somewhat new to direct lending, and as such, historic performance of borrowers’ behaviors is less understood. 

Passive Management

In order to meet its funding offer obligations, an originator platform must rely on a steady demand for its loans, and one way to insure ample demand is to sponsor a captive asset management vehicle.  Many of these companies have registered vehicles available to accredited investors, but most of them are seeking to sponsor private partnerships offering a passive exposure to all the loans issued off the platform.  With low- or no-fee funds, originator platforms offer an efficient way to gain access to the asset class on an unlevered basis, but the compromise is the lack of professional risk management and investment criteria. 

Now, the cautionary tale……

First, I want to shine a light on something we should all be terribly concerned about.  Valuation practices in this space have lacked consistent methodologies.  Managers frequently accrue for loan losses using differing standards.  The result is that performance can be overstated or that returns appear to be smoother than they would be using different methodologies.  For instance, I offer the following excerpt from the performance report of a very large fund in the space. 

 

When I first saw these returns, I instinctively thought of Madoff.  The narrow band of returns is, in my experience, highly unusual and inconsistent with the returns of investments being marked-to-market.  To be clear, I am not saying that this fund is a fraud.  I am stating that the performance they’ve reported is, in my experience, unlikely indicative of a valuation methodology that accurately reflects the month-to-month performance of the underlying assets.  What this could mean is that investors could be disadvantaged when they come in or leave the fund. 

Duration mismatching & liquidity

Over the past year, I’ve met with and, to varying degrees, evaluated nearly 50 funds in the peer-to-peer space.  Some funds are structured as registered vehicles, but most are private placement entities with a broad spectrum of liquidity terms.  Certain funds look more like traditional hedge funds, while others are more like long-term drawdown private equity funds.  What is abundantly clear is that the majority of funds appear to offer liquidity terms which could be inconsistent with the underlying duration of the investments in their portfolios.  By example, an alarming number of funds offered annual liquidity (some with gates, others not) where the underlying assets were 36 and 60 month stated duration.  When a manager tells you that current income and all the new investor in-flows of capital should be sufficient to meet any redemption requests, one should take pause. 

Given the current rate environment and lack of performance in mainstream alternatives, there is no doubt that the landscape of direct lending is entering an explosive growth phase.  Two factors could derail its progress:  increased bank regulation and fund blow ups rooted in sloppy valuation and liquidity management.  The coming years will surely see billions of dollars of investor capital flow into this asset class, and there will naturally be a wave of new products, intermediaries and experts.  In spite of a cautionary message to move carefully into these waters, the sector offers some very appealing uncorrelated returns and current income for those who execute superior due diligence. 

 

 

 

 

 

LESSONS FOR ALTERNATIVE INVESTMENT MANAGERS FROM GONE WITH THE WIND

Having been born on Lookout Mountain, Tennessee, I was raised on Southern folklore, literature and films. In particular, GONE WITH THE WIND has become something of a touchstone for life’s lessons. 

As I survey the current alternative investment landscape, we are closing the first act of Gone with the Wind. The Yankees have burned Atlanta, Tara has been occupied, there is no food, Pa’s gone crazy and Mother is dead. What better analogy for an alternative investment landscape that has essentially delivered poor performance on a relative and absolute basis for over a half dozen years, if not a decade? 

On top of that, there are too many mouths to feed: thousands of fund of funds, hundreds of third party marketers, a proliferation of advisors and consultants. When coupled with the backdrop of pension funding short-falls, fee compression and increased costs of regulatory compliance, the landscape looks barren and fraught with peril. 

An honest assessment of our landscape warrants “brains and courage” lest we “be winnowed out.”   Said another way, we in the alternative investment landscape need a period of Creative Destruction: doing away with old practices and looking for innovative solutions to our current state.  

And when you’ve got a problem, just like in marriage, you’d better start talking it out!

The hedge fund and private equity space has always been heavily shrouded in secrecy. Managers often site concerns over general solicitation, but in fact, it’s often attributable to laziness and arrogance. In periods of strong performance, managers think they don’t need to talk to their investors and constituents. In periods of poor performance, managers often abdicate direct engagement, thereby exacerbating withdrawals. Another approach for managers has been to rely on external story tellers: the third-party marketers. 

Let’s begin with the manager who wants to hire a third party marketer to solve his fund-raising and, sometimes, investor relations management, issues. I was recently told by a leading third-party marketer that his company has the definitive database of 16,000 hedge fund investors in the world, as though that were enough to build a business for someone else. Databases do not sell investment products. Guns-for-hire may be able to get someone to the table, but they will not keep them engaged and confident in the relationship through thick and thin. 

We know that managers must create a relationship with their investors. No one else can do it for them, and in fact, when the relationship foundation has been set by an external party, who goes away after raising the assets, those investors typically leave first. 

My theory is very simple. Third-party marketing rarely works, and it equates to managers abdicating their personal responsibility for building investor relationships. 

Managers have got to start talking it out, not just when in fund raising mode, but all the time. Here are my three rules for success in today’s environment. 

(1) Investors want to hear about opportunity. 

(2) Investors want to be educated. 

(3) Investors want, what I call, “consistent programmatic excitement.” 

Managers have to learn how to build a real communications and marketing team and implement a strategy. This is not done by third-party marketers, and it’s not done by junior guys pitching names from a database. 

Explaining and identifying opportunities for investors creates both excitement and engagement. Education creates inquiry. Consistency creates a relationship. I want to impress upon the reader that these are fundamental to the firm’s long term success and could even prove equally valuable in times of growth or tumult. 

Get visible. Create content. Stay engaged. Lest you “get winnowed out!”

 

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