Top of main content

The implications of inflation for Family Offices

14/09/2021, updated 01/07/2022
Climate
Family office
Real Estate
Lending
Inflation

Family offices pay close attention to inflation dynamics. Passing on your wealth to the next generation becomes harder when rising inflation threatens to erode the value of investments over time. CPI typically understates families’ living expenses and prices of luxury items. And families’ borrowing costs could rise if central banks plan to react to higher inflation by hiking rates. 

After years of benign inflation, the recent jump in global inflation metrics (with US CPI recently reaching a peak of 5.4 per cent) puts the topic back on the agenda. So what is the inflation outlook and how should family offices adapt their strategy?

  • The good news is that inflation pressures are largely related to the post-pandemic reopening, and that global competition, automation and technology should bring inflation back down from next year. In fact, the market’s long term inflation expectations still are quite anchored, providing some comfort. There are risks to the upside, however: sustainability will come with a cost which is largely unknown, and de-globalisation could make supply chains less efficient
  • The bad news, however, is that there is no silver bullet to preserve and grow your wealth in excess of inflation, and a multi-pronged strategy is thus needed. Holding cash will continue to come at a cost, as central banks will be slow to hike rates. And inflation-linked government bonds such as TIPS carry negative real yields so will underperform inflation. A better approach is to construct a diversified portfolio with a mix of real assets such as equities, gold and real estate as this should remain a good long term hedge
  • Outside of the core portfolio, you can also align returns with specific drivers of inflation. For example, the upside inflation risks from de-globalisation and rising wages can be partially addressed by looking at our automation investment theme, or at quality companies with strong margin power. And strategies linked to carbon pricing, climate adaptation solutions or natural capital can address the risk of climate change boosting inflation
  • Finally, portfolio leverage and business loans can be tailored to match the rate outlook, earn extra yield or lock in the low current levels
  • In summary, the recent inflation spike is not a harbinger of a long term trend. But family offices nevertheless need to address the inflation topic, using a long term and multi-faceted approach 

The inflation outlook: don’t extrapolate the recent spike

Inflation has not been a major structural topic for investors in the US or Europe for many years until now. CPI has been so subdued that it has fallen short of central banks’ targets. This pushed them to pursue a very accommodative monetary policy, which has pushed up asset prices (see left). Cash rates exceeded inflation from 1980 to the great financial crisis, but real rates are now negative. The takeaway: investors have been beating inflation easily, as long as they were invested. 

Is this about to change, and should we worry about the recent inflation spike? 

We have discussed the 6-12 month outlook for inflation at length in many other publications. As our infographic shows, short term and domestic factors are currently boosting inflation. There are clear bottlenecks in restauration for example, as the economic reopening boosts demand, creating labour shortages. In manufacturing, inventories are low, and there is a shortage of some inputs, boosting inflation there too. It is not clear when exactly supply will match demand in these areas and inflation may remain elevated for several months, but it would be very surprising if supply is still lagging demand 12 months from now.
 

For several decades, inflation has not been a problem for investors, as most assets comfortably exceeded inflation

Inflation has risen from very low levels, especially in the US. We do not think this is that start of a trend

The longer term inflation outlook is still structurally low, in our view. The shift to an increasingly online economy means that workers face increased global competition, which should cap wage growth. Meanwhile advances in automation – accelerated by AI, 5G, robotics, fintech etc – should allow firms to manage their wage bills. Technological advances also allow consumers to compare prices before buying, reducing the scope for rapid price rises.

So our long term outlook for inflation is benign. We expect CPI inflation to come down from its current elevated level and average 2.3 per cent in the US (close to market expectations), 1.9 per cent in the UK and 2.1 per cent in Hong Kong in the next 10 years. 

For family offices, it is prudent to position for somewhat higher inflation, compared to recent years. Central banks do not want inflation to remain below their target forever and the Fed will tolerate an inflation overshoot as long as inflation averages 2 per cent. As for governments, they would welcome some inflation to help reduce the debt load. But while we are prudent, the recent spike should not be seen as a signal that inflation will run away, or that interest rates and bond yields will spike from here.


Some of the causes of inflation are short term in nature, and global forces are generally deflationary

 

Sources: Bloomberg, HSBC Private Banking as at 15 September 2021. Past performance is not a reliable indicator of future performance.

How good are the traditional inflation hedges?

Family offices typically look at DM and EM equities, gold, inflation linked securities and real estate to protect their portfolio against the risk of rising inflation. Recently, a very small proportion are also looking at cryptocurrencies as a potential inflation hedge in portfolios. 

 

Gold has been more closely linked to real yields than to inflation, but it is still a valuable diversifier

Equities like ‘good inflation’ – i.e. when inflation rises from a depressed to a more normal level


To test whether these are good strategies, the typical approach is to look at historical correlations of asset class performance vs inflation. For cryptocurrencies, that approach is not possible given the lack of a sufficiently long history. For other asset classes, historical averages can ignore the fact that correlations change over time, and it is important to know why they are changing. 

Gold’s correlation with inflation, for example, has moved to negative territory, causing some to question gold’s credentials as an inflation hedge. But inflation has been far below historical averages in recent years (until recently), and thus less of a driver of gold performance. Instead, gold has mainly been driven by falling real yields, resulting from quantitative easing and low structural growth. The end to QE should halt the fall in real yields, but they will still remain low due to the large debt pile (as this should weigh on growth and increase the impact of any rate hike). Other factors should take over as the main drivers of gold prices and we think gold’s correlation with inflation will progressively turn positive again. 

Meanwhile, the positive correlation between equity returns and inflation has further increased. In our view, this is due to the fact that inflation has been so low in recent years, so almost any rise is welcome. When inflation rises from depressed to more normal levels, equities tend to benefit strongly. EM equities tend to do well if the cause of higher inflation is commodity price appreciation (often linked to EM being a strong engine of global growth), as long as US monetary policy remains accommodative. 

For real estate, academic studies suggest that values continue to be strongly related to inflation. As for rental yields, some leases are linked to inflation, while long fixed leases will offer little or no protection against inflation, unless indexed with price rises. Residential property is relatively closely linked to inflation due to the high share of owners’ equivalent rent in CPI (32.7 per cent in the US). Retail property returns generally show good correlations with inflation as well, but this is somewhat lower for commercial property. In any case, real estate’s link to inflation only works in the long term, and many other drivers such as interest rates, supply and demand have an important impact. If inflation is linked to strong economic activity, real estate demand often increases with it, and higher construction costs often restrict supply.


Real estate sensitivity to inflation

Real Estate CPI Elasticities
Property type Income Value
Retail 1.02 1.07
Industrial 0.70 0.91
Apartment 0.56 0.98
Office 0.18 0.74
Real Estate CPI Elasticities
Property type Retail
Income 1.02
Value 1.07
Property type Industrial
Income 0.70
Value 0.91
Property type Apartment
Income 0.56
Value 0.98
Property type Office
Income 0.18
Value 0.74

 

Sources: Bloomberg, Massachusetts Institute of Technology study, HSBC Private Banking as at 15 September 2021. Past performance is not a reliable indicator of future performance.

How to beat inflation: stay invested and address upside risks

How can you beat inflation when one of the traditional inflation hedges – inflation linked securities – has such negative real rates? The best starting point is staying invested in a well diversified portfolio that includes real assets such as developed and EM equities, inflation-linked bonds, gold and real estate among other assets. Over medium-term and long term holding periods, a portfolio that reflects our strategic asset allocation (SAA) mix rarely underperforms inflation. The two exceptions are the credit crisis and the internet bubble, which were risk-off events, not inflation shocks. Re-weighting a standard SAA to include more real assets is possible if inflation is a family office’s primary concern, but this may move the portfolio further away from the efficient frontier. Most family offices will be able to take at least a 3-year view, and this is important, as beating inflation over shorter term periods is not as obvious and can be erratic. 
 

Historically, a diversified portfolio has outperformed inflation over almost any 3-year period

Our forecasts suggest that diversified portfolios should outperform inflation in the future too

Looking ahead, diversified portfolios should continue to outperform inflation. Most asset class return forecasts are above our inflation forecast, with the notable exception of TIPS, as real rates are currently negative. Apart from the lowest risk portfolio, our SAAs for the four other risk profiles should also beat inflation. Companies’ margins are currently near record levels, and inflation could pose a risk. Hence, we believe a bias towards quality stocks with strong margin power makes sense.
 

Risks to the benign inflation scenario: will the rising cost of carbon raise the cost of goods and services?


Sources: Bloomberg, HSBC Asset Management, HSBC Private Banking as at 15 September 2021. Past performance is not a reliable indicator of future performance. 

Where could inflation surprises come from?

The potential impact of climate change and sustainability on asset returns and inflation are hotly debated topics. Products and services generally do not yet incorporate their environmental cost, but this is bound to change, either through legislation or as companies will start to charge through rising carbon costs. Investors can adapt to this by looking at strategies linked to EU carbon pricing or by considering natural capital strategies, which may see more interest as investor interest in sustainability increases, and the regulatory focus intensifies. Climate change could also raise food prices, and investments in climate adaptation solutions (resilient crops, flood defences etc) should do well. Sustainable investments should address both climate mitigation and adaptation and rising carbon costs could boost investor interest in the circular economy.

Another risk is that of more durable wage inflation, if workers start to push back against the very low share of wages compared to GDP or governments see an increase of the minimum wage as a step towards a fairer society. If wage increases were to accelerate, companies will react by investing in automation, which is an investment theme of ours and should see good structural demand.

Risk disclosure on Emerging Markets 

Investment in emerging markets may involve certain, additional risks which may not be typically associated with investing in more established economies and/or securities markets. Such risks include (a) the risk of nationalization or expropriation of assets; (b) economic and political uncertainty; (c) less liquidity in so far of securities markets; (d) fluctuations in currency exchange rate; (c) higher rates of inflation; (f) less oversight by a regulator of local securities market; (g) longer settlement periods in so far as securities transactions and (h) less stringent laws in so far the duties of company officers and protection of Investors. 

Risk disclosure on FX Margin 

The price fluctuation of FX could be substantial under certain market conditions and/or occurrence of certain events, news or developments and this could pose significant risk to the Customer. Leveraged FX trading carry a high degree of risk and the Customer may suffer losses exceeding their initial margin funds. Market conditions may make it impossible to square/close-out FX contracts/options. Customers could face substantial margin calls and therefore liquidity problems if the relevant price of the currency goes against them. 

Currency risk – where product relates to other currencies 

When an investment is denominated in a currency other than your local or reporting currency, changes in exchange rates may have a negative effect on your investment. 

Chinese Yuan (“CNY”) risks 

There is a liquidity risk associated with CNY products, especially if such investments do not have an active secondary market and their prices have large bid/offer spreads.

CNY is currently not freely convertible and conversion of CNY through banks in Hong Kong and Singapore is subject to certain restrictions. CNY products are denominated and settled in CNY deliverable in Hong Kong and Singapore, which represents a market which is different from that of CNY deliverable in Mainland China. 

There is a possibility of not receiving the full amount in CNY upon settlement, if the Bank is not able to obtain sufficient amount of CNY in a timely manner due to the exchange controls and restrictions applicable to the currency. 

Illiquid markets/products 

In the case of investments for which there is no recognised market, it may be difficult for investors to sell their investments or to obtain reliable information about their value or the extent of the risk to which they are exposed. 

The following may be subject to local requirements.

 

This is a marketing communication issued by HSBC Private Banking. This document does not constitute independent investment research under the European Markets in Financial Instruments Directive (‘MiFID’), or other relevant law or regulation, and is not subject to any prohibition on dealing ahead of its distribution. HSBC Private Banking is the principal private banking business of the HSBC Group. Private Banking may be carried out internationally by different HSBC legal entities according to local regulatory requirements. Different companies within HSBC Private Banking or the HSBC Group may provide the services listed in this document. Some services are not available in certain locations. Members of the HSBC Group may trade in products mentioned in this publication.

 

This document is provided to you for your information purposes only and should not be relied upon as investment advice. The information contained within this document is intended for general circulation to HSBC Private Banking clients and it has not been prepared in light of your personal circumstances (including your specific investment objectives, financial situation or particular needs) and does not constitute a personal recommendation, nor should it be relied upon as a substitute for the exercise of independent judgement. This document does not constitute and should not be construed as legal, tax or investment advice or a solicitation and/or recommendation of any kind from the Bank to you, nor as an offer or invitation from the Bank to you to subscribe to, purchase, redeem or sell any financial instruments, or to enter into any transaction with respect to such instruments. The content of this document may not be suitable for your financial situation, investment experience and investment objectives, and the Bank does not make any representation with respect to the suitability or appropriateness to you of any financial instrument or investment strategy presented in this document.

 

If you have concerns about any investment or are uncertain about the suitability of an investment decision, you should contact your Relationship Manager or seek such financial, legal or tax advice from your professional advisers as appropriate.

 

Market data in this document is sourced from Bloomberg unless otherwise stated. While this information has been prepared in good faith including information from sources believed to be reliable, no representation or warranty, expressed or implied, is or will be made by HSBC Private Banking or any part of the HSBC Group or by any of their respective officers, employees or agents as to or in relation to the accuracy or completeness of this document.

 

It is important to note that the capital value of, and income from, any investment may go down as well as up and you may not get back the original amount invested. Past performance is not a guide to future performance. Forward-looking statements, views and opinions expressed and estimates given constitute HSBC Private Banking’s best judgement at the time of publication, are solely expressed as general commentary and do not constitute investment advice or a guarantee of returns and do not necessarily reflect the views and opinions of other market participants and are subject to change without notice. Actual results may differ materially from the forecasts/estimates.  When an investment is denominated in a currency other than your local or reporting currency, changes in exchange rates may have an adverse effect on the value of that investment. There is no guarantee of positive trading performance.

 

Foreign securities carry particular risks, such as exposure to currency fluctuations, less developed or less efficient trading markets, political instability, a lack of company information, differing auditing and legal standards, volatility and, potentially, less liquidity.

 

Investment in emerging markets may involve certain additional risks, which may not be typically associated with investing in more established economies and/or securities markets. Such risks include (a) the risk of nationalization or expropriation of assets; (b) economic and political uncertainty; (c) less liquidity in so far of securities markets; (d) fluctuations in currency exchange rate; (e) higher rates of inflation; (f) less oversight by a regulator of local securities market; (g) longer settlement periods in so far as securities transactions and (h) less stringent laws in so far the duties of company officers and protection of Investors.

 

You should contact your Relationship Manager if you wish to enter into a transaction for an investment product. You should not make any investment decision based solely on the content of any document.

 

Some HSBC Offices listed may act only as representatives of HSBC Private Banking, and are therefore not permitted to sell products and services, or offer advice to customers. They serve as points of contact only. Further details are available on request.

 

In the United Kingdom, this document has been approved for distribution by HSBC UK Bank plc whose Private Banking office is located at 8 Cork Street, London W1S 3LJ and whose registered office is at 1 Centenary Square, Birmingham, B1 1HQ. HSBC UK Bank plc is registered in England under number 09928412.  Clients should be aware that the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors, including the protection of the Financial Services Compensation Scheme, do not apply to investment business undertaken with the non-UK offices of the HSBC Group. This publication is a Financial Promotion for the purposes of Section 21 of the Financial Services & Markets Act 2000 and has been approved for distribution in the United Kingdom in accordance with the Financial Promotion Rules by HSBC UK Bank plc, which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

 

In Guernsey, this material is distributed by HSBC Private Banking (C.I.) a division of HSBC Bank plc, Guernsey Branch which is licensed by the Guernsey Financial Services Commission for Banking, Insurance Intermediary and Investment Business. In Jersey, this material is issued by HSBC Private Banking (Jersey) which is a division of HSBC Bank plc, Jersey Branch: HSBC House, Esplanade, St. Helier, Jersey, JE1 1HS. HSBC Bank plc, Jersey Branch is regulated by the Jersey Financial Services Commission for Banking, General Insurance Mediation, Fund Services and Investment Business. HSBC Bank plc is registered in England and Wales, number 14259. Registered office 8 Canada Square, London, E14 5HQ. HSBC Bank plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

 

In France, this material is distributed by HSBC Europe Continental. HSBC Private Banking is the private banking department of the HSBC Group in France. HSBC Europe Continental is subject to approval and control by the Autorité de Contrôle Prudentiel et de Résolution [Prudential Control and Resolution Authority] as a credit entity. HSBC Private Banking department of HSBC Continental Europe, Public Limited Company with share capital of 491,155,980.00 €- SIREN 775 670 284 Trade and Companies Register of Paris Bank and Insurance Intermediary registered with the Organisme pour le Registre des Intermédiaires en Assurances [Organisation for the Register of Insurance Intermediaries] under no. 07 005 894 (www.orias.fr) - Intra-community VAT number: FR 707 756 702 84. HSBC Private Banking - HSBC Europe Continental – Registered office: 38, avenue Kléber 75116 Paris- FRANCE- Tel. +33 (0) 1 49 52 20 00.

  

In Switzerland, this material is distributed by HSBC Private Bank (Suisse) SA, a bank regulated by the Swiss Financial Market Supervisory Authority FINMA, whose office is located at Quai des Bergues 9-17, 1201 Genève, Switzerland. This document does not constitute independent financial research, and has not been prepared in accordance with the Swiss Bankers Association’s “Directive on the Independence of Financial Research”, or any other relevant body of law.

 

In Abu Dhabi Global Markets (ADGM) by HSBC Bank Middle East Limited, ADGM Branch, 3526, Al Maqam Tower, ADGM, Abu Dhabi, is regulated by the ADGM Financial Services Regulatory Authority (FSRA). Content in this material is directed at Professional Clients only as defined by the FSRA and should not be acted upon by any other person.

 

In Dubai International Financial Center (DIFC) by HSBC Private Bank (Suisse) S.A., DIFC Branch, P.O. Box 506553 Dubai, United Arab Emirates, which is regulated by the Dubai Financial Services Authority (DFSA) and is permitted to only deal with  Professional Clients as defined by the DFSA.

 

In South Africa, this material is distributed by HSBC Private Bank (Suisse) SA’s Representative Office approved by the South African Reserve Board (SARB) under registration no. 00252 and authorized as a financial services provider (FSP) for the provision of Advice and Intermediary Services by the Financial Sector Conduct Authority of South Africa (FSCA) under registration no. 49434. The Representative Office has its registered address at 2 Exchange Square, 85 Maude Street, Sandown, Sandton.

 

In Bahrain and Qatar, this material is distributed by the respective branches of HSBC Bank Middle East Limited, which is locally regulated by the respective local country Central Banks and lead regulated by the Dubai Financial Services Authority.

 

In Lebanon, this material is handed out by HSBC Financial Services (Lebanon) S.A.L. (“HFLB”), licensed by the Capital Markets Authority as a financial intermediation company Sub N°12/8/18 to carry out Advising and Arranging activities, having its registered address at Centre Ville 1341 Building, 4th floor, Patriarche Howayek Street, Beirut, Lebanon, P.O.Box Riad El Solh 9597.

 

In Hong Kong and Singapore, THE CONTENTS OF THIS DOCUMENT HAVE NOT BEEN REVIEWED OR ENDORSED BY ANY REGULATORY AUTHORITY IN HONG KONG OR SINGAPORE. HSBC Private Banking is a division of Hongkong and Shanghai Banking Corporation Limited. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business. In Singapore, the document is distributed by the Singapore Branch of The Hongkong and Shanghai Banking Corporation Limited. Both Hongkong and Shanghai Banking Corporation Limited and Singapore Branch of Hongkong and Shanghai Banking Corporation Limited are part of the HSBC Group. This document is not intended for and must not be distributed to retail investors in Hong Kong and Singapore. The recipient(s) should qualify as professional investor(s) as defined under the Securities and Futures Ordinance in Hong Kong or accredited investor(s) or institutional investor(s) or other relevant person(s) as defined under the Securities and Futures Act in Singapore. Please contact a representative of The Hong Kong and Shanghai Banking Corporation Limited or the Singapore Branch of The Hong Kong and Shanghai Banking Corporation Limited respectively in respect of any matters arising from, or in connection with this report.

 

Some of the products are only available to professional investors as defined under the Securities and Futures Ordinance in Hong Kong / accredited investor(s), institutional investor(s) or other relevant person(s) as defined under the Securities and Futures Act in Singapore. Please contact your Relationship Manager for more details.

 

The specific investment objectives, personal situation and particular needs of any specific persons were not taken into consideration in the writing of this document. To the extent we are required to conduct a suitability assessment in Hong Kong where this is permitted by cross border rules depending on your place of domicile or incorporation, we will take reasonable steps to ensure the suitability of the solicitation and/or recommendation. In all other cases, you are responsible for assessing and satisfying yourself that any investment or other dealing to be entered into is in your best interest and is suitable for you.

 

In all cases, we recommend that you make investment decisions only after having carefully reviewed the relevant investment product and offering documentation, HSBC’s Standard Terms and Conditions, the “Risk Disclosure Statement” detailed in the Account Opening Booklet, and all notices, risk warnings and disclaimers contained in or accompanying such documents and having understood and accepted the nature, risks of and the terms and conditions governing the relevant transaction and any associated margin requirements. In addition to any suitability assessment made in Hong Kong by HSBC (if any), you should exercise your own judgment in deciding whether or not a particular product is appropriate for you, taking into account your own circumstances (including, without limitation, the possible tax consequences, legal requirements and any foreign exchange restrictions or exchange control requirements which you may encounter under the laws of the countries of your citizenship, residence or domicile and which may be relevant to the subscription, holding or disposal of any investment) and, where appropriate, you should consider taking professional advice including as to your legal, tax or accounting position. Please note that this information is neither intended to aid in decision making for legal or other consulting questions, nor should it be the basis of any such decision. If you require further information on any product or product class or the definition of Financial Products, please contact your Relationship Manager.

 

In Luxembourg, this material is distributed by HSBC Private Banking (Luxembourg) SA, which is located at 16, boulevard d’Avranches, L-1160 Luxembourg and is regulated by the Commission de Surveillance du Secteur Financier (“CSSF”).

 

In the United States, HSBC Private Banking offers banking products and services through HSBC Bank USA, N.A. – Member FDIC and provides securities and brokerage products and services through HSBC Securities (USA) Inc., member NYSE/ FINRA/SIPC, and an affiliate of HSBC Bank USA, N.A.

 

Investment products are: Not a deposit or other obligation of the bank or any affiliates; Not FDIC insured or insured by any federal government agency of the United States; Not guaranteed by the bank or any of its affiliates; and are subject to investment risk, including possible loss of principal invested.

 

Australia

If you are receiving this document in Australia, the products and services are provided by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for “wholesale” customers (as defined in the Corporations Act 2001). Any information provided is general in nature only and does not take into account your personal needs and objectives nor whether any investment is appropriate. The Hongkong and Shanghai Banking Corporation Limited is not a registered tax agent. It does not purport to, nor does it, give or provide any taxation advice or services whatsoever. You should not rely on the information provided in the documents for ascertaining your tax liabilities, obligations or entitlements and should consult with a registered tax agent to determine your personal tax obligations.

 

Where your location of residence differs from that of the HSBC entity where your account is held, please refer to the disclaimer at https://www.privatebanking.hsbc.com/disclaimer/cross-border-disclosure for disclosure of cross-border considerations regarding your location of residence.

 

No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of HSBC UK Bank plc.

 

A complete list of private banking entities is available on our website, https://www.privatebanking.hsbc.com.

 

©Copyright HSBC 2022

ALL RIGHTS RESERVED

This insight is only available when you're logged on.  

 

It is restricted to HSBC customers with the appropriate account details or transaction history.

Unfortunately, this content isn't available based on your account details. 

 

However there's still a wealth of information here for you.