There has never been a more important time for us to understand what our clients’ longer-term aspirations really are. As the ‘Great Wealth Transfer’ gains momentum, it is expected to result in $30- $70 billion of assets being passed down to the next generation over the next 20 years. As this new generation of beneficiaries take over their family wealth, is there a risk that past decisions come under more scrutiny and how do we protect ourselves against this?
Since the Global Financial Crisis (GFC), when failures of multiple large financial institutions in the United States brought about the most severe economic crisis since the Great Depression, risk management has been at the forefront of investors’ minds. In 2008 the GFC saw global equity markets fall -37.4% wiping $2 trillion from the global economy.
It was not just equities that faltered at this time, as market contagion saw default rates in fixed income jump and less liquid investments close their doors for clients to get their money back. The pain was felt widely, impacting large multinational institutions to private individuals with investments, pensions or even just savings or a mortgage.
These ‘black swan’ events, named due to their historical rarity, are becoming more common. However, in the case of the COVID-19 crash in 2020 and the market declines in 2022 due to aggressive monetary tightening, these market events have seemingly become shorter and sharper but have, importantly, bounced back more quickly.
This has, quite understandably, led to a shift in focus for many in the industry to ways of mitigating these adverse market moves. We have, to some extent become more risk managers and less asset managers, as investment portfolios have increasingly more commonly become managed to a volatility profile or a risk matrix. This, in turn, has seen individually tailored solutions being replaced by off the shelf risk-controlled model portfolios, striving for conformity over character and hiding behind the average.
Risk management is and must be a key consideration when managing a client’s assets. Equally though, we must remember that every individual, every family, every structure is different and so should be treated with the same level of specialisation that we as fiduciaries would wish for ourselves.
of assets being passed down to the next generation over the next 20 years.
In a multigenerational client scenario is this good enough?
How can we consider a trust’s requirements without considering each individual’s requirement in their own right? What amount of income will each individual involved require to live their lives? Are they self-sufficient or to what level are they reliant on the fund? What life events are on the horizon? What are their own ESG preferences? Are there any experiences from their past that might affect the type of investments they hold?
With the appropriate level of planning, financial investigation and modelling we can answer all these questions. We can now look at each individual and accurately map out their financial future, incorporating life styling to adjust the expected requirements based on their stage of life.
The levels of income needed now versus the income needed in later life can be very different. People typically move from a more active phase of life, potentially with their own income streams, into retirement and considerations for later life care, during which there is a requirement to draw on their, or the structures’, assets. These costs may increase and potentially erode the capital value, leaving less behind for the next generation.
We can also look for any potential pinch points or red flags. We talk about investment time horizons as a way of understanding the level of volatility a client can take but in a family or multigenerational structure, the time horizon we should be considering is much longer.
By identifying these red flags early on, we can put in place plans in advance, building a tailored solution specifically designed for them. This solution can be risk aligned but outcome driven, significantly reducing the risk of being caught short in 20 years’ time and having to draw on the next generation’s legacy to plug the hole.
Investing to meet these outcomes
In the years following the GFC, investors have enjoyed a prolonged period of relatively benign economic conditions. Between 2009 and 2019, low inflation, near zero interest rates and a very supportive mentality from central banks, which opened the taps of quantitative easing, saw global equities rally +215.9% (Source: LSEG).
This dynamic came to an end due to the spectre of high inflation, caused by a number of factors, such as the massive monetary and fiscal stimulus in response to the COVID-19 pandemic, economies returning to normal more swiftly than many expected and a surge in commodity prices following the Russian invasion of Ukraine. As a result, interest rates were raised rapidly to levels not seen since before the GFC in an attempt to bring inflation back under control.
The impact of these hikes was significant on most portfolios, especially if you did not have the flexibility to shorten duration (reduce sensitivity to adverse interest rate movements) within fixed income exposure or rotate from growth to value stocks.
Bond yields, despite being off their peak, are still yielding circa 4.5% for a high investment grade issue. Equity markets have enjoyed a good run with headline inflation back toward central bank target levels. Once again, we can now build an efficient investment strategy generating meaningful returns from both fixed income and equity investments.
The sell off in growth stocks meant that more inflation-sensitive technology companies fell sharply, as more cyclical commodity and financial companies outperformed.
To put this into context, technology is a sector that delivered six times better performance than the wider market, between 2009 and 2019 (Source: LSEG). It has become an integral part of US stock benchmarks and therefore is a main constituent of a diversified portfolio. This is not without risks though and between November 2021 and January 2022 the sector fell 35%.
So, if the GFC reminded us of the importance of better risk management, recent years have reaffirmed the added value that active management can play. With the right forward looking approach to planning and investing, with regular reviews, we can not only move clients out of average outcomes but towards something good. Delivering a solution that will protect longer-term financial security.
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