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Five ways to preserve wealth in a risky and volatile world

A proper mix of assets in a portfolio can help minimize risk and preserve capital

For many ultra-high-net-worth individuals (UHNWIs), investing is not all about maximizing the rate of return. UHNWIs already have sufficient wealth for their lifestyles, estates and charities. Investing for them is more about minimizing risk and preserving capital.

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Here are five ways to protect wealth without sacrificing returns too much.

1. Diversified portfolios

A proper mix of assets in a portfolio can do the job of minimizing volatility and the risk of capital loss. When the prices of some assets are down, others will be up.

As Jeff Hales, a partner and portfolio manager at Toronto-based Focus Asset Management, recently told the Financial Post: “If you have a diversified portfolio of assets that have a relatively low level of correlation with each other, you can deliver an attractive rate of return at substantially less volatility and risk.”

One example is the “permanent portfolio,” as set out in Harry Browne’s book, Fail-Safe Investing. It was designed to husband capital though different economic scenarios, and consists of four asset classes: stocks for prosperity, bonds for deflation, gold for inflation, and cash for recessions and depressions.

Despite low yields, bonds can still play a role as a safe haven, as pointed out by Eric Olson, chief investment officer at New York-based Olson Capital Management. “Any portfolio that had a significant allocation to U.S. treasury bonds when COVID-19 hit saw a great benefit in the rally in U.S. treasuries,” he said at the Respada CIO Summit in May.

The epic stimulus unleashed by governments and central banks during COVID-19 raises concerns. Olsen thus sees value in holding gold for the inflation risk (but also for rising geopolitical tensions in the world). He also likes short-term treasuries (a form of cash) because they roll over faster into market rates, keeping up better with rising interest rates and inflation.

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2. Private market assets

There have since been other developments in the diversification of portfolios. One is the addition of private assets, which do not trade on public exchanges. Included are the shares and debt securities of private companies, as well as tangible assets such as real property, infrastructure and farmland, which generate income (rents) and provide inflation hedges.

“Private assets are not as easy to trade and require long holding periods – but the compensation for this lack of liquidity is a higher rate of return,” Hales reports. “Since UHNWIs have wealth that doesn’t need to be tapped for long periods, most are comfortable with this illiquid asset.”

He adds, “Private assets do not have their prices updated or published as frequently as those on public markets, and are not subject as much to the whims of buyers and sellers.” That creates less of the volatility that can stir investors’ emotions and lead to bad decisions. Overall, this adds a greater sense of stability to a portfolio.

3. Socially aware investing

Beside the financial risks of inflation, interest rates, recessions and so forth, UHNWIs face increasing political and social risks in today’s world. Spurred on by the writings of authors such as French economist Thomas Piketty (who argues for high inheritance taxes), growth in wealth inequality is leading to greater demands for curbs on wealth. Meanwhile, whistleblower programs at government tax agencies and the increased capacity for hacking and publishing financial records (as highlighted by the Panama Papers), is making it more difficult to maintain privacy.

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Some UHNWIs are attempting to adapt to these evolving realities by diversifying into new wealth-management approaches that are more transparent, socially aware and community-based.

“There are some UHNWIs who are pulling back from secrecy and undeclared money in favour of investing with the community and organizations dealing with social issues such as climate change,” commented David Friedman, o-founder of New York-based wealth-management advisory WealthQuotient. “For these wealthy families, it’s not just about maximizing profit – it’s also about winning the hearts and minds of their fellow citizens.”

4. Calculating the required rate of return

Portfolios can be further de-risked by tallying up a family’s financial goals and calculating the rate of return needed to achieve them. “When we take people through this process, we find that about eight times out of 10, they discover the required rate of return is lower than expected,” said James Stellick, managing director at Focus Asset Management.

This means that less risky investments can be made when growing and safeguarding a family’s wealth. Targeting the required rate of return will be less of an emotional roller coaster and so provide more certainty of staying the course, compared to taking aggressive risks to outperform a market index or benchmark.

5. Mindset

Financial markets and assets are naturally prone to fluctuations and there may be times when even all-season portfolios slip into the red. UHNWIs need to be mentally prepared to wait out such reversals: History shows that over the long run, steadfastness is rewarded.

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There are financial vehicles that can hedge against the dips, for example market-neutral hedge funds and derivatives such as stock options and futures contracts. But they often come with high fees, greater sacrifice to long-run returns and execution risks.

“If you look at the stock-market crash in March of 2020, short-dated options were a fantastic place to be but if you were carrying that position for years as a hedge, you took a big hit to your returns,” observed Hales. As for market-neutral hedge funds, they short-sell stocks – which can result in unlimited losses, as was seen earlier this year during the short squeezes on GameStop and other meme stocks.

Also, there will always be financial innovations and fads, many of which can lead to capital losses. A current example may be cryptocurrencies. They challenge the monopoly of governments and central banks over currency issuance, so it is not surprising there are signs regulators are beginning to clamp down. As well, there are serious environmental concerns in the inordinate amount of power – whether eco-friendly or not – required to mint digital coins.