Family offices hedge risk, focus on recession-proof industries to fight inflation
BY BAILEY MCCANN
Life has gotten much more expensive for everyone, including family offices, and inflation is to blame.
As of the end of June, the U.S. consumer price index had risen to 9.1% from 8.6% in May. According to the U.S. Department of Labor, inflation is rising at the fastest pace since November 1981.
Inflation is also putting additional pressure on stocks and bonds, companies struggling with declining consumer demand, and higher interest rates.
Family offices, which tend to have larger allocations in private markets than public markets, are often able to skate around market volatility. But this time it’s different. M&A activity is slowing down, labor costs are up, and supply chain problems are still hurting companies. These factors are causing families to reassess, to make sure that their portfolios will be able to withstand headwinds.
“We’re making a lot of adjustments to family investment and estate plans right now,” says Jaleigh White, the Sarasota, Florida-based director of Baird Family Wealth, the family-office group within the investment bank Robert W. Baird & Co. “Families are taking a closer look at cash flow needs and setting aside cash to cover years of expenses so that they aren’t forced to sell into a downturn to unlock cash.
“We’re also seeing families look at different aspects of estate planning and gifting. When we see declines in asset value, it can be a good time to do things that would otherwise come with a large tax bill.”
Families are also looking at strategic asset allocations and finding ways to pare back risk and hedge inflation. White notes that for younger generations within family offices, elevated inflation is providing a bit of a learning experience.
“If you are 30 or 40 years old,” she says, “high inflation has been more of a theoretical risk calculation than an actual one.”
Private credit and real estate are emerging as two asset classes that families are using as an inflation hedge, White says.
- Private credit can provide higher yields and less volatility than traditional fixed income.
- With real estate, rents typically increase with inflation, which means those investments are less likely to lose value if inflation remains elevated.
“Private credit tends to be secured, which can limit some of the risk,” says Jack Ablin, chief investment officer and founding partner at Cresset Capital, a Chicago-based multifamily office. “And within real estate, housing demand is likely to remain elevated, so we may see the value of those assets continue to appreciate despite rising inflation.”
The private-equity secondaries market is another area in which families are investing in an effort to diversify their private-market exposure, Ablin says.
“There is a lot of rebalancing happening in the market,” he says. “It’s hard to say that it is strictly inflation-related, but secondaries can be a way for families to build up an allocation to private equity tactically.”
OPERATORS UNDER PRESSURE
For families with operating companies, inflation is having a bigger impact. Labor costs are increasing, as are input costs overall. Supply chain pressure can make it difficult to acquire the material necessary for inventory and production. Industries with significant commodities exposure or that offer luxury products have felt the impact of inflation acutely.
Katherine Hill Ritchie, director of strategic development at Nottingham Spirk, a Cleveland-based family office, says that for her, the key is to look for “recession-proof industries.”
Nottingham Spirk focuses on product development in the consumer, health care and business product sectors, both as an investor and a product developer. “We’re looking really closely at pricing,” Hill Ritchie says.
“We made a spin toothbrush that retails for $5. There are more expensive spin brushes on the market, but $5 is something most people aren’t going to think about. We’re working on an ice cream product right now that retails for $3. Even in a bad economy, most people are going to spend $3 on an ice cream; it gives you a little lift.
“Since we started, we’ve been focused on products and industries like that—things that have durable demand that can be priced well.”
Although input costs have gone up, Hill Ritchie says, Nottingham Spirk has been able to onshore some manufacturing and supplier relationships, which ended up being cheaper than expected. Even if costs remain elevated compared with where they were pre-pandemic, she expects inflation to level off eventually.
“If you look at historical patterns, it’s unlikely we remain at the current rate of inflation,” Hill Ritchie says. “That said, we are having a lot of conversations internally about risk. We often invest alongside others, so we want to make sure our goals are aligned. We don’t want to get to a place where we can’t take a product over the finish line.
\ “The key to our longevity has been focusing on products and industries that are countercyclical.”
VISUALIZED: THE SPECTER OF INFLATION
The S&P 500 index had negative real returns from 1972 to 1976 and 1977 to 1981, when annualized inflation was 7.3% and 10%, respectively. The only other period in which a negative real return occurred in the past 50 years was 2007 to 2011, during the Great Recession
With inflation so persistent, some economists and market strategists wonder whether economy could return to a 1970s-like era of stagflation and potentially fall into a recession. From Pensions & Investments.