Wealth managers are grappling with one of their worst years in a century after high inflation and a sell-off in stocks and bonds hammered returns.
The threat of stubbornly higher inflation presents a challenge to preserving wealth in real terms that has not been faced in decades, while the pain in markets over the past 12 months has undermined conventional wisdom around balancing portfolios between equities and fixed income.
“This year is one of the most significant years of wealth destruction in nearly 100 years,” said Renaud de Planta, who leads Pictet, the 217-year-old Swiss partnership, which stewards $635bn.
“Looking at it rather simply, many private investors could have lost more than a quarter of their real inflation-adjusted wealth,” said de Planta, citing the example of a portfolio split evenly between bonds and stocks.
Standard portfolios have suffered as both stock and bonds recorded double-digit drops this year. The two asset classes normally move in opposite directions and provide a counterbalance to each other.
Stéphane Monier, chief investment officer at the $300bn Swiss private bank Lombard Odier, said 2022 was one of only three years since 1926 in which both stocks and bonds had a “significant negative return”.
The MSCI World Index tracking global stock markets is down 14 per cent since January in US dollar terms, while the Bloomberg Global Aggregate fixed income benchmark is down by a similar amount.
A typical UK wealth management client will have seen their portfolio lose nearly 20 per cent in inflation-adjusted terms in the year to December 15, according to research by Asset Risk Consultants (ARC), which tracks the returns of strategies run by more than 100 large UK wealth managers.
Setting aside inflation, typical wealth management portfolios lost 10 per cent this year, ARC said.
“With falls in almost all asset classes, the notable exceptions being energy and commodities, there have been very few opportunities for investors to avoid losses,” said Graham Harrison, managing director at ARC. “For investors accustomed to low and stable inflation, its impact on the real value of their wealth may not have been immediately apparent.”
Managers have tried to find assets that are not correlated with stocks and bonds.
Monier said hedge funds, particularly using strategies than benefit from volatility, have helped boost returns this year. Other managers say they have turned to commodities exposure and gold.
For Lombard Odier, the parallel falls in stocks and bonds have reinforced a shift away from bucketing clients into a range of boilerplate portfolios based on their tolerance for losses.
Conventional wisdom holds that bond-heavy strategies will lose less during a market downturn. However, many fixed-income dominated portfolios have done worse this year than equity-heavy options. The highest inflation in decades and the prospect of interest rates rising further is a particularly toxic combination for bonds.
Monier said his firm now prefers to design bespoke investment strategies. For example, he said, a tech entrepreneur who had just sold a company for $250mn might look for an annual income of $3mn and want to buy a multimillion dollar property in Florida. The bank could pay the income from a portfolio of government bonds, while putting some cash to work in higher-risk investments to build up to the property purchase.
If investors have a better sense of what they want from their investment strategy, managers think they will be less likely to sell assets during a downturn.
“In a financial crisis, the typical client who is not a financial professional will be disappointed at having lost 8 per cent and take their loss in cash, and miss the rebound,” Monier said.
A spell of rocky performance also requires managers to spend plenty of face time with clients to prevent panicked moves. “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,” said Peter McLean, director at Stonehage Fleming, the London-based multifamily office, successor firm to the private bank run by the Fleming dynasty, which included James Bond author Ian.
Markets tend to cover their losses over the longer run but the sudden spike in inflation presents a particular challenge, one they have not had to face in earnest in decades. The industry is based on preserving the real buying-power of assets. Inflation running close to 10 per cent means managers start the year far behind, and need to deliver much better performance just to break even.
“There is clearly a higher inflation risk that we have to contend with now compared to the decade before the pandemic,” McLean said. “It is very difficult over the shorter term to keep up.”