Family businesses have a long-standing history in the GCC and are one of the key pillars of the economy, accounting for a large segment of the region’s non-oil gross domestic product. Many of these companies have established successful partnerships with international brands, generating considerable wealth for themselves and providing consumers with greater choice. The rise of family businesses in the region is a result of the entrepreneurial spirit of the founding generation, the strong international relationships that they nurtured and economic conditions during the 20th Century that were conducive to doing business.
However, the regional business landscape is changing with weaker oil prices, the introduction of VAT, workforce localisation and the gradual withdrawal of subsidies among some of the causes. Collectively, these factors are leading family businesses to re-evaluate their portfolio management strategies to protect value, mitigate risks and ensure sustainable growth.
As regional economies adapt to this new business environment, GCC family businesses have had to face two realities: they must now play a more proactive role in the management of their portfolios and diversify their holdings across global rather than regional assets. Traditionally, family business owners had a more passive role as shareholders in operating companies. They did not take an active role in monitoring the performance of their portfolio companies or a hands-on approach towards value creation. In today’s new economic reality, family businesses are also realising that by concentrating their portfolio in one geography and illiquid asset classes, they are exposing themselves to a high level of concentration risk.
To generate sustainable returns, family businesses in the GCC must play a more active role in preserving and growing the value of their portfolios — especially when working with direct investments. Business owners must carefully monitor the performance of portfolio companies against annual targets and business plans.
Additionally, they must stay ahead of market developments in areas where the portfolio companies operate, potentially leading to investments in adjacent and value-additive investments. Some are going a step further by creating a venture capital investment arm to identify such opportunities. Finally, they need to dedicate more attention to the selection and appointment of board members and management teams. In this respect, businesses often seek expert advice to enhance the holding-subsidiary governance agenda and identify suitable board member candidates.
The lower performance of the local, direct investments coupled with current geopolitical challenges have made many regional family businesses realise the importance of diversifying their assets across geographies and asset classes. However, diversifying these portfolios into more liquid, international assets is a major undertaking and requires a change in set-up, skill set and mode of operation. In other words, it is about transforming part of the family business into a family office — an entity that invests across geographies and asset classes, often with the assistance of External Fund Managers.
To do this, the family office must carefully assess how assets are managed, starting with the asset classes it wishes to invest in; equities, fixed income, private equity, real estate or money market instruments. It must decide how capital is deployed by adopting a strategic asset allocation and by setting the limits and constraints. The international portfolio should be subject to risk management purposes, for example to avoid concentration risks. These decisions are critical in setting the expected return of the international portfolio and the family office should be comfortable with this implied objective.
When evaluating asset management, the family office must also decide how asset classes will be accessed. This can be done using EFMs to invest in listed instruments or using the services of a third party to buy and sell listed securities, for example stocks and bonds, directly on international capital markets. It is important to understand and assess the trade-off between the management fees paid to EFMs and the skills they bring in managing assets — skills which might be too difficult or expensive to build in-house.
The family office must also determine the skill set needed in the team to support the investment objectives and create a governance framework which is open to external council. It is important to build a core team of experienced investment professionals able to understand the superiority of an EFM's investment strategy, its due diligence and the appropriateness of its investment operations and infrastructure. The family office also needs to recognise that supplementary skills from an ecosystem of trusted advisers (legal counsel, investment consultants, strategy consultants, et cetera) are needed on an ad hoc basis to make the most informed decisions and improve its operations on a continuous basis.
Family businesses are a key component of the GCC economy. If they are more proactive in managing their portfolios and invest in more liquid, global assets, then they will be better equipped to protect the overall value of their portfolio and mitigate risks while embracing investment management best practice. However, these changes need to be carefully navigated and thoroughly understood prior to implementation. In this regard, family businesses greatly benefit from working with partners who can help identify value-preservation/ creation levers in their portfolios, as well as design and plan a well-governed, cost-effective transition into a more international, liquid portfolio.
Damien Balmet is the investment governance and portfolio management leader for Mercer Investments
