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Inflation a headscratcher for investors

Whether cost increases are temporary or the new normal, high-net-worth investors have options

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As the world economy starts to shake off the effects of the pandemic, there is a growing focus on inflation. Whether it is a quick burst or a sustained rise costs across sectors, experts say that now is the time for high-net-worth (HNW) investors to prepare.

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“It’s the No. 1 question that everyone is asking. There’s a tug of war over inflation between the markets and central bankers. The markets are getting nervous about inflation rising, and the central bankers are telling us not to worry, it’s only temporary,” says Benjamin Tal, deputy chief economist, CIBC Capital Markets.

“A lot of our high-net-worth clients are watching this closely. We’re going to see a lot of volatility in inflation numbers and a lot of head scratching,” says Robert Janson, president and chief investment officer at Westcourt Capital Corp. in Toronto.

“We’re seeing the economy come back, people getting back to work, and the inflation numbers are going up. Some analysts say this is transient, that it may last a year or two, but we can’t be sure,” he says.

We’re going to see a lot of volatility in inflation numbers and a lot of head scratching.

Robert Janson, Westcourt Capital Corp.

Statistics Canada reported that in May, inflation rose 3.6 per cent over a year, up from a 3.4-per-cent year-over-year increase in the consumer price index in April and a 2.2 per-cent YOY increase in March. The boost was the largest yearly increase since May 2011; central bankers usually seek to keep inflation tamed to within a 2-per-cent rise year-over-year.
Janson says that even as inflation rises rapidly now, it is not clear yet whether it can be moderated to 2 per cent, because the COVID-19 economy has created unprecedented conditions.

“We had a massive economic contraction, yet at the same time Canadians have managed to save up $250 billion [since the lockdowns began in March, 2020],” Janson says. Supply chains have been pinched and disrupted, and as the economy opens up, it is expected that consumers will spend, putting pressure on goods and services and driving up demand — and prices, he explains.

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“We’re still keeping an eye on whether inflation will be mild, medium or spicy,” Janson adds.

Inflation is not necessarily a problem for very- and ultra-high-net-worth investors who hold assets such as property or — for now, at least — stocks and funds that are rising fast.

Assets will rise

“They’ll see their assets continue to rise even with inflation,” Janson says.

Anyone who holds real estate or land does well in inflationary times because their property is rising in value faster than inflation, but very- and ultra-high-net-worth investors have built-in advantages, says Earl Davis, Head of Fixed Income and Money Markets, BMO Global Asset Management.

“If you’re a middle-class person who owns a house, the question is whether to cash in, but it’s almost impossible to time the market. For a the high-net-worth person, the equation is different — this person is asking, what else can I buy that will go up in value,” he says.

The other difference HNW investors enjoy is that in an inflationary environment, they can take on debt, Davis adds.

“In an inflationary environment, you actually want to hold debt if you’re able to,” he says. The money you owe will be less valuable if inflation causes the price of everything to go up, and you have used what you borrowed to buy assets that are going up, he explains.

Yannick Archambault, who leads the family office practice in Canada for KPMG LLP, says most people tend to be hypersensitive about inflation if they remember the early 1980s, when it reached double digits, or they read about places where people needed wheelbarrows full of money to buy bread.

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Not super-inflation

Today, HNW investors likely understand the difference between super-inflation and what appears to be happening now as they plan their strategies.

“It comes down to direction and magnitude. We’re seeing positive economic growth, but short-term magnitude when it comes to inflation,” he says.

Even the current 3.6-per-cent year-over-year inflation is deceptive, Archambault says. “If you leave out the rises in the price of oil and fuel, it’s about 1.9 per cent. Also, remember that interest rates are very low, and the Fed [the U.S. Federal Reserve, whose rate-setting leads the way for others] has indicated that it’s not until about 2023 that they’re looking at raising rates.”

While hard assets such as land and buildings look like safe from inflation, the markets, which are still reaching record highs every week, may be another story.

“There’s lots of euphoria right now,” he says. If inflation sticks at 3 or 4 per cent into next year and interest rates are boosted, corporate profits will be affected and the markets could bounce, Archambault says.

“At this point it’s a safe assumption that inflation will go back to normal, but there’s still a risk,” Tal says. To minimize this, central bankers are keeping an eye on what he calls the “velocity” of money — the pent-up energy of people who have been sitting at home and are now ready to spend.

If spending goes wild, bankers will tighten the money supply, making it harder to borrow and spend — though tightening too much, too fast can trigger a recession.

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HNW and ultra-high investors have options, though, in addition to hard assets such as property.

“They can buy gold, or TIPS [Treasury inflation-protected securities], for example — inflation-protected bonds,” Tal says. TIPs are an American product — bonds in which the principal increases with inflation and decreases with deflation, as measured by the Consumer Price Index. (In Canada we have Real Return Bonds.)

“Overall, the strategy should be to allocate some money to investments that protect against inflation and to be careful with the [current] bull market, which will react negatively if long-term interest rates go up,” he says.

Perhaps the biggest advantage that HNW investors have is not just having more wealth, Janson says.

“They have the luxury of time — they don’t have to use their money all the time for everyday needs, so they can put it into investments that grow,” he says.

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