Now is a good time for a portfolio risk audit
While markets and global economic and geopolitical conditions are an obvious focus, don’t forget cyber-risk and ESG, experts suggest
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Experienced investors and their advisors know that conducting a risk audit of their holdings is important, and given what is going on in the world, the best time to do one may be right now.
“People are starting to realize that there is risk in the market and this is a good time to reassess,” says Dan Riverso, Chief Investment Officer at Jesselton Capital Management Inc., a firm in Thornhill, Ont., that serves high-net-worth individual investors and families.
After a strong start in January, markets around the world started dipping through the winter, even before the Russians invaded Ukraine on February 24.
“It didn’t meet the technical definition of a market correction in January, because markets didn’t fall by more than 10 per cent. But it certainly felt like it was going in that direction, which makes a reassessment worthwhile,” Riverso says.
In March, U.S. markets did enter “correction territory,” according to Trading Economics. Then, both U.S. and Canadian markets started an upward, if volatile, trajectory.
While looking at risk in terms of markets is similar for high-net-worth as well as average portfolios, the former entails more intricacies.
“The main principles are the same in terms of process, but there are likely to be more complexities with wealthier investors and, of course, the stakes can be higher,” says John De Goey, financial author and advisor and portfolio manager at Wellington-Altus Private Wealth in Toronto.
Complexities can include the need to analyze the risk involved in holdings that are tied up in wealthy investors’ privately held corporations as economic conditions change, as well as issues such as international tax and regulations, De Goey explains.
Riverso adds, “Ultra-high-net-worth families, say those with more than $20 million in investible assets, often have different holdings than individuals or families with smaller holdings, even those who have several million dollars,” he explains.
In some cases, ultra-high-net-worth families’ holdings are more diversified rather than simply a portfolio of stocks, bonds and funds. In other cases, a family’s wealth may come mostly from one sector or industry, which can change the way risk is assessed.
“For example, one family we have worked with had about 75 per cent of its wealth invested in real estate. When we did a risk audit of their entire wealth, we asked whether we should look at all of their holdings together or look at the real estate in isolation,” Riverso says.
“In early 2020, when the pandemic began, the markets fell, but the family’s entire portfolio [including real estate] was down only 4 per cent, because it was hedged with real estate and other holdings such as gold,” he explains.
Family office clients will differ from one another on how much risk they want to be exposed to, but De Goey says the main, most important elements of a risk audit tend to involve being able to expect the unexpected.
“There are many things that can go wrong in the economy that need to be considered; the best approach lies in being prepared to respond to changes as they happen rather than mitigating them after,” he says.
The biggest current concerns are valuations, continuing pandemic effects such as the lockdowns in China, and geopolitical instability caused by Russia’s invasion of Ukraine including its effect on commodities. Meanwhile, longer-term issues that a risk audit must consider remain the same as they were several months ago – concerns about possible runaway inflation and the side effects of central banks jacking up interest rates (from borrowing costs, to labour and repercussions on real estate).
Last month, the Bank of Canada began to raise rates, increasing its key lending rate by 25 basis points to 0.5 per cent and is widely expected to raise it half a point today. Both Canada’s and the United States’ central banks are expected to continue raising rates aggressively to combat inflation.
Inflation is well above the 2-per-cent annual target considered acceptable by the Bank. Its governor, Tiff Macklem, has noted that higher interest rates can tamp down inflation but many analysts are concerned that if borrowing costs get too steep, the result may be stagflation, a combination of sluggish growth and higher prices and business costs.
Other long-term risks that a family office or high-net-worth audit needs to consider include looking at whether a portfolio is cyber-safe. KPMG Canada’s Family Office services note that managing cybersecurity risk is critical to both the business and personal side managing family wealth. The risks that need to be addressed include protecting against identity theft, data leaks and reputational risk that can come from social media.
As part of risk management, high-net-worth families also need to look at whether holdings are meeting environmental, social and governance (ESG) standards that institutional investors, corporate boards and consumers now demand.
“ESG is becoming more important and there’s more attention being paid to it,” Riverso says.
De Goey agrees, saying that, “the general consensus is that the world is moving toward a serious effort to meet [United Nations] objectives on climate and that green energy and infrastructure will be a major theme for the coming generation.”
Investors who downplay the environment and also social and governance issues such as diversity increasingly do so at their peril, the experts agree.
Even the most comprehensive risk audit isn’t perfect, though, De Goey warns.
“What if we experience a decline that is deeper and lasts longer than anything we have experienced before. We cannot really know how we’ll react if we’ve never been in that situation,” he says.