Some of the most respected investors including Fundsmith manager Terry Smith and asset manager Stewart Investors hold the view that family-controlled businesses can be good investments.

The logic is fairly simple – the people running family-controlled companies will have its interests at heart, because they want to ensure the business is around in 10, 50 or even 100 years’ time so their children, grandchildren and so on will still have a future running a solid company.

In theory, this means they will be more thoughtful in allocating capital and won’t make any rash decisions, which could make them safer in a downturn, enable them to provide more reliable dividends and potentially outperform over the long term.

HARD EVIDENCE

There have been studies validating this hypothesis. Research by professors at the IE Business School, looking at 2,500 European stocks between 2001 and 2010, concluded that there is ‘no room for doubt: listed European family businesses created more value for their shareholders during the period 2001-2010’.

Research by Bloomberg in 2015 showed significant outperformance in these types of companies against the FTSE All-Share and colossal outperformance against the FTSE AIM index.

In April this year, a few weeks after the low point of the big market sell-off, research firm AlphaValue identified 47 family-influenced firms in the Stoxx Europe 600 Index. Just three of these companies scrapped or cut their dividend, meaning 94% maintained their payout. By comparison, 75% of the wider index chose not to cut dividends.

INVESTMENT OPTIONS

Many family-owned firms are big household names listed on European markets including L’Oreal, Heineken, H&M and Volkswagen.

On the London market there are plenty of examples including Primark owner Associated British Foods (ABF), clothing retailer JD Sports (JD.) and fund management group Schroders (SDR).

Given the apparent benefits of family-controlled firms, a number of high-profile fund managers use family-controlled companies as one of their criteria for helping to pick stocks.

For example Richard Pease, manager of CRUX European Special Situations (BTJRQ06), mostly invests in companies where the founding family or original entrepreneur hold a large stake, while around 63% of the portfolio of Fundsmith Emerging Equity Trust (FEET) is held in family-controlled businesses.

Three characteristics of family businesses

Rania Labaki, a director from business school EDHEC, says:

1 Family businesses often prefer self-financing and have a low dividend payout rate. Excess cash flow is used primarily for long-term investments with a liquidity reserve which seems to exceed that of non-family firms.

2 Financing from banks can be relatively more accessible given the long-term and trusting relationship developed with banks that are often historically linked to the family.

3 Family businesses have a greater capacity for innovation than other businesses, but also a willingness to innovate that seems more marked in times of crisis, which they see as signs of opportunity.

FAMILY FUND

Investors seeking a fund purely focused on this theme should note the recent launch of Pictet-Family (BGY5SC0), which debuted in June and is a repositioning of what was the Pictet-Small Cap Europe fund.

Pictet thinks this approach of investing in family-controlled firms could deliver strong returns going forward, a theory supported by a back-test it conducted which showed a 56% outperformance compared to the MSCI ACWI index between 2007 and the middle of June 2020.

It defines a family business as a listed company where a person, often the founder, or a family hold a minimum of 30% of the voting rights. Pictet says this provides an investment universe of around 500 companies globally.

The family can be by blood or marriage, it says, and the stake can be held through a foundation or another vehicle. It chose 30% as the threshold as this is where a shareholder would effectively have the casting vote and thus control of the company.

RISKS TO CONSIDER

While the advantages of investing in these companies seem pretty clear, there are some risks to be aware of, such as related party transactions (where a family-owned company could buy a business from a relative at a grossly inflated price), excessive compensation or expropriation of assets.

But Pictet-Family co-manager Cyril Bernier insists there are ways to mitigate such risks.

He explains: ‘We look for bodies on the board that ensure protection for minority shareholders – independent committees like audit, remuneration, and nomination committees, to ensure the family’s interests are aligned with the interests of investors.

‘We also only invest in family companies where there has been no controversy in the family. And we look for a strong financial culture, a strong culture which supports minority investors.’

ASHMORE EXAMPLE

Among the UK stocks in Pictet’s fund is FTSE 250 fund group Ashmore (ASHM), which he describes as a leader in emerging markets with good governance and long-term growth opportunities.

Set up by chief executive Mark Coombs in 1998, Bernier says Coombs has been ‘developing a strong culture’ at the business and aligning the company with the interests of minority shareholders. He also notes that Coombs has ‘plenty’ of his personal wealth invested in the firm.

It’s worth noting that family-controlled companies tend to be more heavily weighted towards the consumer discretionary, consumer staples and communications sectors, and so don’t necessarily mirror the wider market.

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