Real wealth preservation faces a challenge from inflation that hasn’t existed in recent memory.
High inflation, a sell-off in equities and bonds, and poor profits have left wealth managers facing one of their worst years in a century.
While the recent market turmoil has cast doubt on conventional wisdom regarding portfolio balance between equities and fixed income, the danger of persistently higher inflation offers a challenge to retaining wealth in real terms that have not been faced in decades.
According to Renaud de Planta, the head of Pictet, a 217-year-old Swiss partnership that manages $635 billion, “this year is one of the most dramatic years of asset destruction in nearly 100 years.”
De Planta used the example of a portfolio evenly split between bonds and equities to illustrate how many individual investors could have lost more than a quarter of their actual inflation-adjusted worth.
Standard portfolios have suffered as a result of this year’s double-digit declines in both Treasuries and stocks. The two asset groups typically move in different directions and balance one another out.
One of just three years since 1926, according to Stéphane Monier, chief investment director at the $300 billion Swiss private bank Lombard Odier, 2022 would see a “substantial negative return” on both equities and bonds.
In US currency terms, the MSCI World index, which tracks international stock markets, is down 14% since January, while the Bloomberg Global Aggregate fixed-income benchmark is also down 14% since January. According to data by Asset Risk Consultants, which monitors the returns of strategies operated by more than 100 major UK wealth managers, a typical UK wealth management client will have seen their portfolio lose roughly 20% in inflation-adjusted terms in the year to December 15.
Inflation apart, most asset management portfolios lost 10% this year, according to ARC.
“With decreases in almost all asset groups, the notable exceptions being energy and commodities,” said Graham Harrison, managing director at ARC. “There have been very few options for investors to avoid losses.” “Its influence on the real value of their wealth may not have been immediately obvious” for investors used to low and stable inflation.
Assets that are not connected with equities and bonds have been sought after by managers.
Monier claimed that this year’s gains have been boosted by hedge funds, particularly those that employ methods that profit from volatility. Some managers claim to have started investing in gold and commodities.
The concurrent declines in stocks and bonds for Lombard Odier have strengthened a move away from grouping clients into various template portfolios based on their tolerance for losses.
The conventional thinking is that strategies that focus heavily on bonds will suffer less during a market slump. However, many portfolios that are heavily weighted in fixed income have performed worse than equity-heavy options this year. Bonds are particularly vulnerable to the combination of the worst inflation in decades and the possibility of higher interest rates.
According to Monier, his company now favours creating customised investing strategies. He gave the example of a software entrepreneur who had recently sold a company for $250 million and was looking for a $3 million annual income to purchase a multimillion-dollar home in Florida. The bank might pay a portfolio of government bonds’ interest while also investing some money in higher-risk ventures in the run-up to the property purchase.
Managers believe that investors will be less likely to sell assets during a downturn if they have a clearer understanding of what they hope to get out of their investment strategy.
The normal client, who is not a financial expert, will be dissatisfied at having lost 8% and take their loss in cash, missing the comeback, according to Monier.
To avoid frantic actions during a period of shaky performance, managers must spend a lot of time in person with their clients. According to Peter McLean, director at Stonehage Fleming, the London-based multi-family office that succeeded the private bank run by the Fleming dynasty, which included James Bond author Ian, “there is a lot more engagement with clients and a lot more explanation about what’s happened, why it’s happened, and what changes we’ll make when it’s appropriate.”
Over the long term, markets typically recover their losses, but the abrupt increase in inflation offers a unique problem that they have not had to deal with seriously in decades. The industry is built on keeping assets’ actual purchasing power. With inflation hovering around 10%, managers must start the year considerably behind and produce significantly better results just to break even.
When compared to the ten years before the coronavirus epidemic, there is unquestionably a bigger inflation risk that we must manage, McLean added. “Over the shorter term, it is exceedingly difficult to keep up.”