High-net-worth investors’ outlook on inflation for 2022

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As inflation hovers over the economy, high-net-worth investors and their advisors are looking at what strategies will best keep their portfolios safe from its ravages.

Consumer price indexes in North America and elsewhere have been rising throughout the year, and while economists and analysts still describe inflation as “transitory,” fear that inflation and rising interest rates will erode asset values and increase borrowing costs is high among wealthy investors, according to a CNBC survey of millionaire investors.

On Dec. 8, the Bank of Canada said it “continues to expect inflation to remain elevated in the first half of 2022 and ease back towards 2 per cent in the second half of the year.”

The bank added that it is “closely watching inflation expectations and labour costs to ensure that the forces pushing up prices do not become embedded in ongoing inflation.”

Will this approach succeed? “On the whole, there is confidence in central banks’ ability to manage inflation over the short to medium term,” says Chris Farkas, an advisory practice partner and national asset management leader at KPMG Canada.

That doesn’t mean inflation can be ignored, says Wayne Kozun, chief investment officer at Forthlane Partners, a multi-family office based in Toronto.

“There’s an increasing realization that inflation is not going away that quickly. It’s hard to say exactly how long it’s going to last,” he says.

Even if inflation settles back, it likely will remain above the 2-per-cent range that economists generally agree is low enough for healthy growth conditions, Kozun adds.

Portfolio challenges

Portfolios held by high-net-worth investors and managed by family offices face similar challenges from inflation to those faced by major pension funds, Farkas says.

A Goldman Sachs report surveying family offices globally last year indicated investment responses to inflation ranged from increasing allocation to equities, to increasing hard-asset investments, such as real estate. Fears of currency debasement also led to increased investment in digital assets as well as currency hedging.

While CIOs such as Kozun are watching inflation closely, a KPMG survey of 15 of the world’s largest funds finds that fund managers are not alarmed about the long term.

Inflation overall hit an 18-year high in Canada of 4.7 per cent year over year, and is showing up not only in higher consumer prices but also in higher wages in a tightening labour market.

“You see help wanted signs all the time now at fast-food places when you buy a coffee, and there’s a shortage of skilled workers, too,” Kozun says. This drives up wages and, ultimately, higher prices follow.

There is general agreement that this short-term inflation is likely to continue and cause turbulence in growth, markets and valuations in different sectors and regions. But there is also agreement that the Bank of Canada, the U.S. Federal Reserve and their counterparts should be able to manage the shockwaves.

“The fund managers do not believe a long-term inflationary paradigm shift is likely to occur. Further, they say their portfolios are built to sustain such shocks,” Farkas says.

Monitoring and protective moves

The KPMG fund managers’ survey found that, to keep an eye on inflation, most managers are carefully monitoring the stock-bond correlation for signs that the risk might move from shorter to long-term.

This correlation can be a complicated indicator, but it’s often an accurate one; historically, when stock prices move in one direction and bond yields move in the opposite direction, inflation tends to happen. The correlation has been consistently strong this year, according to an analysis published recently by Bloomberg.

One move that managers of high-net-worth portfolios can make against inflation is to allocate less to cash, keeping just enough for investment opportunities.

“For many clients we’re keeping cash to around 5 per cent, enough for liquidity and for taxes and the like,” says Brian Madden, senior vice president and portfolio manager at Goodried Investment Counsel in Toronto. Cash also leaves room for buying opportunities in markets that are volatile but still generally rising.

To keep balance, Madden looks at rate-reset preferred shares. These offer fixed dividend payments that are reset after a set period, typically five years, with the rate set at a pre-determined spread above a government bond with a similar term. This offers the security of fixed income but at better rates than the rock bottom ones government bonds are stuck in with key lending rates still at historic low levels.

Inflation strategies

Most managers of large portfolios such as pension funds or family office holdings have more than 25 per cent exposure to traditional inflation protection assets across their portfolio, Farkas says. These include assets that are relatively protected against inflation such as real estate, infrastructure, natural resources, commodities, gold and real-return bonds, which are bonds that have inflation compensation built into the principal.

Among the managers surveyed by KPMG, portfolio exposure to inflation-protection assets has increased, from 22 per cent of total net assets in 2010 to 32 per cent in 2020.

Inflation strategies are not all identical, Farkas says. A manager’s approach and choice of assets depends on how much they consider inflation to be a threat and, conversely, whether they see it as an opportunity.

With low interest rates and high demand, real estate can look attractive as a bulwark against inflation. Colliers’s just-released 2022 Global Capital Markets Investor Outlook Report notes that investors are split on whether inflation is a positive or negative attribute for real estate assets — it boosts construction costs but also makes properties go up in value.

In any case, Colliers notes that there is a “massive amount of capital sitting on the sidelines waiting to be deployed into property” across North and South America.
“We’re going to be flying with clear skies in 2022 compared to 2021,” says David Amsterdam, Colliers’s president, U.S. capital markets and northeast region.

Look forward, not back

One thing that high-net-worth investors and their managers tend to know is that it is important to analyze what is happening now with regard to inflation, not to look backward at past economic shocks, Madden says.

“Investors are often tempted to bulletproof their portfolios against the last shock or the last crisis, but that would be a mistake,” he says.

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