Diversify assets to mitigate financial risks
Investment advisors are steering clients onto the road to recovery and growth despite an economy facing rising inflation, continued supply disruptions, labor issues and the Russian-Ukraine war that could extend some of the problems into 2023.
While soaring inflation is one of the biggest risk factors to a client’s recovery efforts, experts told Advisors Magazine inflation will fall to acceptable levels in 2023.
The U.S. inflation rate currently stands at 7.9%, the highest in 40 years, according to Statista, a German-based company that specializes in market and consumer data.
"All of these changes will reverse over the next one to two years, and we expect inflation returning to the trend we witnessed pre-pandemic, where demographic changes and productivity enhancements kept inflation around the 2% level," said Eswar Menon, founder and chief investment officer at California-based Harper Capital Management, LLC.
With over two decades of experience managing portfolio’s, Menon’s firm manages assets and acts as a fiduciary for institutional and private clients.
His inflation estimate is in line with recent projections the US Federal Reserve outlined in a policy statement. Inflation will return to 2% while the labor market remains strong. The median inflation projections from the Federal Open Market Committee (FOMC) participants are 4.3% this year and falling to 2.7% in 2023 and 2.3% in 2024, according to the March 16 statement.
As if the risk of rising inflation wasn’t enough, whispers of a possible recession are growing louder, a scenario that currently doesn’t hold with Jerome Powell, chairman of the US Federal Reserve.
The U.S. economy isn’t headed for a recession because of the strong demand for goods and services, strong labor market, payroll job growth as well as strong balance sheets from household and businesses, Chairman Powell outlined in a press briefing on March 16.
But experts at one of the nation’s largest financial institutions think otherwise.
In a survey of global fund managers released in March, experts at Bank of America, the second largest bank in the U.S., found that fund managers are holding onto cash as concerns about the ongoing war in Ukraine and rising inflation push them to be more cautious.
“Cash levels are recessionary. Economic growth and profit expectations are recessionary,” Michael Hartnett, Bank of America’s chief investment strategist, wrote in a survey note.
Cash holdings in March stood at 5.9% – previously it was at 5.3%, according to the BofA global manager survey. Cash levels haven’t been this high since April 2020 the beginning of the Covid-19 pandemic.
Diversify assets to mitigate financial risks
The key to financial risk management is in constructing durable or anti-fragile portfolios, according to Menon.
"We advise clients to invest in a diverse group of assets, like real estate and gold, besides equity and bonds, which will provide protection in a scenario where inflation remains elevated for longer than we currently expect," Menon said.
Harper Capital Management's approach to building diversified multi-asset portfolios starts with understanding the client's long-term goals and current financial cash flow and balance sheet.
For long-term investors, Menon’s firm views risk as a permanent loss of capital and not the volatility that's inherent in markets. To avoid the permanent loss of capital requires rigorous research and a disciplined approach to investing, according to Menon.
"In the long run, we believe this risk management method is the best way to protect and grow capital for our investors. We think volatility is more likely to be an opportunity than a risk for such portfolios," he said.
As experts encourage clients to focus on risk management in the post-Covid 19 pandemic economy, Peter Newman, president, and founder of Illinois-based Peak Wealth Planning, LLC, says liquidity is key to managing portfolios during times of market stress.
Newman’s firm specializes in helping clients invest and sustain their income for the long haul. His advice to clients is to have at least six months of emergency cash. If the client is a business owner or real estate investor, Newman advises they have sufficient liquidity to work through any collection issues or in the event of recession created opportunities.
With the Federal Reserve raising rates, Newman thinks his clients are well-positioned to benefit.
"For long-term inflation hedges (at least a decade), we believe in the staying power of equities and real estate exposure consistent with each client's risk tolerance and objectives," Newman said. "We have a modest value and mid-cap tilt in portfolios to diversify large-cap indexes top-heavy with technology."
The Fed raised interest rates for the first time since 2018 by 0.25% and may raise rates six more times in 2022.
