Why you should invest in family business funds?

Family business has historically represented big opportunities for the investors. The reason is mainly because of their alignment of interests, with the absolute knowledge of their company and the business history that goes through the family lines. In this article, we have the collaboration of Pictet, Carmignac and Bellevue, and we will analyse the reasons why it is a good idea to invest in Family business funds.

Birgitte Olsen, Lead Portfolio Manager of the BB Entrepreneur strategies at Bellevue Asset Management

Family businesses – emerging from the crisis as winners

Family-run businesses have long stood out for their long-term planning horizons, solid balance sheets and strong competitive positions in market niches. Those distinctive qualities generate above-average returns for their shareholders too. Inditex, Bankinter, Grupo Catalana Occidente, Vidrala and Rovi all have something in common: they are classic family-run or owner-managed companies.  

Their company culture is shaped by family values and this fosters a strong sense of organizational identification among the workforce. Decision-making pathways are shorter and more efficient. Their planning horizons are conspicuously longer: family-run businesses think in generations, not quarters. Which is not surprising, since most of the family fortune is invested in their own business and entrepreneurs want to create value over time.

What’s more, their strong balance sheets and conservative financing practices make them inherently more resistant to crises than the typical company and put them in a better position to take anti-cyclical action. Equity ratios of 60% or more are not unusual among owner-managed companies. A comfortable cushion of capital gives these companies the independence they need to execute their business strategy even when times are hard. This means entrepreneurs can still invest in market-expanding activities, improve their product quality and bring relevant innovations to market even in the midst of a widespread crisis. 

Investors can also benefit by adding some stocks of family-run companies to their investment portfolio. A research report by Credit Suisse lists 920 family-run companies in 35 countries around the world that have a market capitalization of at least one billion dollars. Europe boasts more than 1,500 listed companies that qualify as entrepreneur companies. The good performance record of entrepreneur stocks is backed up by historical data. Over the past 10 years, the CS Family TR Index has significantly outperformed the MSCI World Index.

A fine touch and a wealth of experience

Bellevue Asset Management is a pioneer in the management of entrepreneur investments, having launched its first dedicated fund, BB Entrepreneur Switzerland, in 2006. Its range of Entrepreneur funds has since grown to four in total, comprising the BB Entrepreneur Europe, BB Entrepreneur Europe Small and BB Entrepreneur Swiss Small Mid funds. Our Entrepreneur investment universe consists of more than 800 stocks of companies in which a family or a company founder own at least 20% of the voting rights and play an active role in the management or supervisory boards. The highly experienced three-person BB Entrepreneur Team makes use of quantitative and qualitative analytical tools within a fundamental bottom-up investment process. They hold more than 450 physical or virtual meetings with entrepreneurs every year.

Proprietary investment research and good stock-picking skills are more vital than ever because sell-side coverage of small and mid caps has been in a steep structural decline for several years. This sometimes leads to market inefficiencies and attractive buying opportunities for investors.

Value rebound

The rollout of multiple COVID-19 vaccines has gained traction and the brighter economic outlook triggered a strong rotation into value stocks and cyclicals. As the corona situation normalizes, cyclicals are expected to benefit most from the positive economic momentum and their earnings growth might be double that of companies in more defensive sectors going forward. The slight pickup in inflation expectations from historically low levels supports this widespread shift in the stock market after years of rock-bottom interest rates and a strong investor preference for growth stocks. As a result, the team has increased its allocation to value stocks, which now represent about 37% of the BB Entrepreneur Europe Fund's total portfolio. 

Current positioning of BB Entrepreneur Europe

Bankinter and Catalana Occidente are two top-quality financial stocks in the portfolio. The banking sector should generally profit from the current environment.  The fund is heavily invested in cyclical industrial and consumer stocks, which stand to profit from the “reopening trade.” The US-Belgian beer giant Anheuser Busch-Inbev, for example, is still trading 30% below its pre-Covid level. Media stocks are attractively valued given their FCF yields of more than 10%. The TV sector in Europe is ripe for consolidation and ITV, M6, TF1 in France and Mediaset Espania are good candidates.

Ciryl Benier, Co-Fund Manager Pictet Family

Misconceptions about family businesses

It is common to consider that family businesses have a weak governance structures, but in reality, their return on invested capital is higher, with less leverage relative to the world index. But the ESG rating agencies tend to score family businesses lower in governance relative to the index, although with less exposure to environmental and social disputes.  This is probably because families are especially protective of their brands -often named after them- and make exceptional efforts to avoid incidents.  Anyhow, there is lack of data consistency, many of the past, with weights varying by agency, so larger companies and developed markets receive higher ESG ratings.

So we have created our own family business governance score.  The key is the stability, whether the founder is in charge or it is in the hands of the younger generation, the succession planning, continuity policy and whether it is reflected in voting rights.  We delve in the way in which control is exercised, whether it is prone to abuse or there are extreme divergences between voting and economic rights and we consider whether the CEO participation is consistent with the long-term vision and if the Board of Directors remuneration includes payments contingent with long-term profitability.

It should be noted that agencies argue that a mostly independent Board is crucial.  However, in family businesses, the lack of independence of the Board may indicate stability of ownership and facilitate long-term leadership, financial discipline and capital preservation.  Moreover, for the protection of minority shareholders, more than the independence of the Board, it is crucial the independence of the remuneration, audit and appointment committees.  In addition, agencies have difficulty assessing family structures, which, although may carry risks of private benefits, have advantages of stability.  Moreover, a lower degree of independence generated from 2011 to 2020 higher returns (source: ISS, Refinitiv, Exane, Pictet AM). It can be attributed to the presence of a major, more conservative shareholder, whose objective is the success of the company and not the quarterly accounts.

Also, agencies focus on risks of power, including directors being disproportionately paid.  Large traded companies minimize this with attractive fixed salaries and stocks or options.  These schemes are an attempt to reproduce the alignment that already exists in family businesses, which appoint their CEO of the family, who already has a significant stake.  In addition, agencies consider family businesses to be less transparent about directors' salaries.  But family-run business directors tend to hold significant stakes and their wages are a smaller part of their total wealth, being motivated to emphasize shareholder value.  Directors compensated through stock options have no downside risks, but significant benefits it objectives are achieved and they may want to take significant risks. However, family businesses have a preference for wealth preservation and are reluctant for dilutive effects for its shareholders.

Family businesses that make up our investment universe are listed companies in which a person or family owns at least 30% of voting rights. 500 listed companies worldwide meet this requirement, in addition to a minimum daily stock market liquidity of five million dollars.

Mark Denham, Fund Manager at Carmignac Portfolio Family Governed

Family Businesses's resilience and “skin in the game”

At Carmignac we strongly believe in the “skin in the game” effect. This has to do with the drive behind family businesses’ resilience and commitment to long-term success – less pressure to please short-term investors – and ability to adapt to changing environments so to navigate short-term turbulences. We have seen that family businesses tend to have better resilience during periods of economic volatility mainly thanks to two key characteristics:

1) they use less leverage or are less reliant on debt to generate economic growth and

2) tend to focus on the longer term rather than quarter by quarter reporting cycle.

Both characteristics mean more broadly that they’re less cyclical/sensitive to the gyrations of the economy. Additionally, we have found that family businesses with higher levels of control have seen much higher levels of profits growth and during a period where profits growth was scare this was rewarded. In order to position ourselves, we have looked into 15 years of historical data and found control is a major determinant of business success. Therefore, at Carmignac, we focus on control vs. ownership as we target companies where the controlling interest can shape and influence the future direction of the business.

For our Fund, Carmignac Portfolio Family Governed, we created “Carmignac Family 500” database, a global database of stocks where the aggregate controlling stake is greater than 10%.

Our definition of founder or family control extends not only to family members but to individuals/founders/foundations and trusts, essentially anyone deemed to be a longer-term investor in the business that is not on the institutional side. There are numerous studies sighting risks around investing in family companies, and often on traditional metrics they are marked down on governance factors and criteria. This is why we carry out our own specific governance analysis on each of our holdings focusing on both Corporate Governance (board independence, management committees, skills & experience, minority shareholders treatment, remuneration) and Corporate Behavior (accounting practices, bribery & corruption, tax, corporate culture and human capital).

This process helps us to make sure that the board and management team aligns their long-term objectives with the interest of various stakeholders, including minority shareholders. Traditionally the focus of those looking to invest in family businesses has been in the European area and more specifically the mid and smaller cap landscape. This as a result has meant US opportunities have been overlooked and somewhat neglected. With our global universe, we believe we are well positioned to find successful stories others might have missed.

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