Introducing the 'family firms' portfolio.
In recent years, a growing body of literature has pointed to long-term outperformance by quoted 'family firms'.
The studies use slightly different criteria for what constitutes a family firm, but in a nutshell they focus on businesses in which the founding family has a significant ownership stake and plays an active role in management.
The outperformance of such firms has been observed in stock markets across a range of economies -- including the UK, in a study (pdf file) by Dr Panikkos Poutziouris.
Most of the studies have reached similar conclusions about why family firms outperform, identifying the same key factors.
1. A long-term view
Family enterprise owners tend to feel a sense of stewardship of the company and a shared responsibility to protect the 'family silver'.
As such they are prepared to take a long-term view of their investment return, thereby gaining the significant competitive advantage of cheaper capital.
In contrast to career executives, whose goal is often to move from one plc to a bigger and better one, the owner-directors of family firms are less reactive to short-term pressures and less inclined to take actions for short-term results.
2. Solid balance sheets
In keeping with their long-term view, and the knowledge that the company will face tough economic times as well as boom periods, family firms tend to have robust balance sheets.
They invest in more tangible assets, and favour lower financial leverage and cautious accounting, a prudent approach which puts them in a stronger position to weather recessions.
They reinvest more profits, and dividend payouts tend to be at sustainable levels. Raising fresh equity is rarely on the agenda due to the dilutive impact on the family's shareholding.
3. Trust
In conventional plcs, 'governance' is largely based on external investors' distrust of management. As a result, there is a corporate bureaucracy involving elaborate rules and controls, and excessive monitoring and reporting.
In contrast, family firms operate on relationships of loyalty and trust, based on kinship and relations with other key personnel who are treated as 'family'. The minority holdings of external investors provide less scope for the bureaucratising of governance.
The trust-based structure means that people in the company get on with their jobs without others looking over their shoulders, contributing to speedy decision-making and an entrepreneurial spirit.
Private investors
Critics of family firms suggest a number of potential risks for investors: a limited pool of family members from which to draw the next generation of managers; business decisions made on sentimental rather than economic grounds; and expropriation of special benefits for the family at the expense of other shareholders.
In practice, though, the best family firms avoid these issues -- and have done so for decades and generations. These families, whose members' personal reputations and names are intimately associated with their businesses, have a strong incentive to maintain the high standards set by their predecessors.
I believe that the prudent and long-term view taken by family firms, and their long-term outperformance, makes them an attractive investment proposition for those private investors who seek to follow a long-term-buy-and-hold (LTBH) strategy.
If you're prepared to buy into the 'trust' element, then family businesses represent a near-perfect alignment of the interests of family shareholders with those of non-family LTBH private investors.
A portfolio of family firms
Within my own portfolio I have a sub-portfolio of family firms. My son, Sim, who is coming up to his 15th birthday, and whose financial education is progressing well, has a particular liking for these firms.
He already has a number of equity investments (trackers, investment trusts and a smattering of blue chips), bought by grandparents and myself, but now wants to be involved in investing some of his own hard-earned money.
Over the coming year we will be constructing a portfolio of family firms using The Motley Fool ShareBuilder service, the plan being to invest in one or two companies each month.
You'll be able to follow our progress on the Fool. Look out for the next article, which will report on Sim's first purchase.
More from G A Chester:
> Set up a regular purchase plan with The Motley Fool ShareBuilder and you can buy shares for just £1.50. Ordinary dealing account, ISA and SIPP options are also available.
