The seismic changes of the last two years have generated significant headwinds for investors. Inflation has spiralled to multi-decade highs thanks to the one-two combination of unprecedented fiscal and monetary policies in response to the pandemic, followed by supply chain and energy price-shocks caused by the conflict in Ukraine. This has implications for many aspects of portfolio performance, from return generation to risk management and beyond. Family offices clearly recognise this threat: ‘high inflation’ topped their list of concerns in the recent UBS Global Family Office Report 2022.
Return generation remains the top priority for family offices. And, in pursuing this goal in an environment where real returns are eroded by persistently high inflation, they have become increasingly open to moving into riskier assets. The UBS survey confirms a continuation of the recent shift towards private equity/alternatives. But while these assets can provide attractive returns, they come with health warnings. BlackRock Investment Institute highlighted in its 2022 mid-year outlook that “private market valuations are not immune in this new regime of higher volatility…we see a tougher … environment for some private assets...” The risks are not just limited to returns; investors are often required to sacrifice liquidity in order to share in the potential rewards. Furthermore, a 2020 BlackRock Global Family Office Survey found that, in relation to their private equity allocations: “Family Offices …are increasingly concerned about correlations with other asset classes.”
Diversification remains a challenge
Inflation not only has implications for the performance of both equities and fixed income; it can also undermine the negative correlation between the two. Although their primary focus is on achieving target returns, diversification and appropriate risk management remain key priorities for family offices. And according to the UBS survey, most respondents think that diversification and uncorrelated returns are hard to find. They express doubts as to the ability of bonds to provide appropriate levels of diversification, with 63% of respondents no longer feeling that high-quality fixed income can help reduce portfolio risk.
Amid the backdrop of high inflation, lower central bank liquidity and higher interest rates, we believe that gold may be able to play a part in helping family offices balance the need for higher real returns with appropriate risk management.
Gold is a proven diversifier…
While many assets become increasingly correlated as market uncertainty rises, gold’s negative correlation to equities and other risk assets increases during market downturns. Historically, gold has been particularly effective during times of systemic risk, delivering positive returns and reducing overall portfolio losses. Importantly too, it allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell. But gold’s correlation does not just work for investors during periods of turmoil. It can also deliver positive correlation with equities and other risk assets in constructive markets, making gold a well-rounded and efficient risk hedge.
And gold is able to provide its diversification benefits while needing less oversight compared to some alternative assets, such as private equity.
…and a liquid hedge against inflation
Analysis we have conducted shows that while gold alone may be a blunt tool
in protecting against inflation, it can form a valuable part of an inflation-hedging basket of assets. Gold is often considered a hedge against CPI. But as a global asset it is more than that; it is a hedge against the broader erosion of purchasing power – be that against property, collectibles or financial assets that are excluded from CPI indices. It is also a hedge against the debasement of a currency, should the value of that currency be slowly eaten away as supply is increased.
In addition, gold as a small but meaningful part of any portfolio may help offset concerns about liquidity that might arise from investing in private markets. The gold market is large, global, and highly liquid – trading volumes averaged approximately US$131bn per day in 2021 – which highlights that the market can support large buy and sell orders even during times of market duress.
Wealth generation and preservation strategies can go hand-in-hand. This suggests that gold could play a multi-faceted role in family office portfolios as they reposition for the uncertain outlook. Gold is not only a highly liquid, proven store of value, it is an asset whose correlation to risk assets in both good times and bad can improve portfolio resilience. As such, an allocation to gold can serve as ballast to family office portfolios, providing confidence when strategically planning for generations.
