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As fear of downturn looms, a look at playbooks of high-net-worth investors

Investors in real estate and other private assets could be in for a rougher ride, and others are holding cash


Joel Schlesinger • Jul 12, 2023

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Sooner or later the other shoe is going to drop. That’s the feeling among many Canadian family offices and their clients regarding the markets and the economy.


After more than a decade of mostly rising equity prices — aside from the bear-market blip in April 2020 as COVID-19 spread — fear of a recession and slump in the markets seems to be reaching a fever pitch.


“We’ve had a very long economic and market cycle over the last 10 to 12 years, and our clients, including family offices, are becoming a lot more risk-aware,” says Thane Stenner, senior portfolio manager with CG (Canaccord Genuity) Wealth Management in Vancouver.


“All the economic indicators we’re seeing point to at least a moderate recession by the end of this year or Q1 next year.”


A recent report from BDO lists a number of economic headwinds, including less discretionary income as consumers face higher interest rates on mortgages and other loans. Furthermore, rising interest rates mean consumers and businesses will borrow less, slowing economic growth.


Borrowing costs will remain elevated for the foreseeable future, the report states, and demographic speed bumps — including a lack of skilled labour and a greying population — will further hamper growth and hold up wage inflation. Also, companies face tighter regulation and added costs to meet ESG (environmental, social and governance) commitments.


Arguably, however, the downturn in the markets has already come and largely gone, says Arthur C. Salzer, Toronto-based CEO and CIO of Northland Wealth Management, a multi-family office.


“What people forget about public markets is that they don’t discount the same situation twice, so last year, when the market declined, it discounted this year’s recession.”

In turn, the markets today are pricing in rate cuts coming in 2024, he adds.


Still, risks remain, particularly in private assets. Many owners of office properties, for instance, have yet to write down the impact of declining economic prospects, Salzer says, and performance might be worse than expected. Family office portfolios with direct holdings in the office category, for example, could see income decline as more tenants reduce their office footprint as leases expire, he says.


At the same time, owners could see borrowing costs rise as they renew debt at higher rates, while asset values are marked down in light of higher yields from risk-free government debt and cash, he says.


All the economic indicators we’re seeing point to at least a moderate recession by the end of this year or Q1 next year. – Thane Stenner, CG Wealth Management


Further knock-on effects could hit banks and other lenders, especially with respect to commercial real estate loans that are non-recourse, Salzer says. (Non-recourse means the lender cannot pursue more than the collateral originally offered to recoup their losses.)


“So the borrower can walk away,” Salzer says, and lenders are left holding depreciated assets. “All of this means that you don’t want to overweight the financial sector, either.” A lot of the damage that we’re seeing, he says, is from “the interest rate increases that are trying to correct the original problem” of too-loose monetary policy that led to stretching for yield, speculation and high debt levels.

Most family offices run diversified portfolios designed to mitigate these risks, says Patrick O’Connor, the Winnipeg-based CEO of Blackwood Family Enterprise Services, which serves ultra-high-worth families.


“They typically have pretty disciplined investment policy statements,” he says. “Anytime there is a significant upturn or downturn, it’s an opportunity for families to check in on their investment thesis to make sure what they were comfortable with a few years ago, when they set the policy up, still applies.”


A lot of families have been working with their advisors to position their portfolios and ready their business holdings in advance of market volatility, he adds.


That has been the case at Northland, which has reduced clients’ exposure to assets in the portfolio negatively affected by higher inflation and interest rates.


“We started changing portfolios in 2017 and 2018 because we thought we were getting to a secular low with inflation — which we actually saw in April 2020 during the lockdown,” Salzer says.

In some respects, preparation for a downturn has meant keeping larger cash allocations.


Stenner says, “We found that clients have increased their cash weightings so they’re getting ready for opportunities and getting paid fairly well — around 5 per cent — on U.S. and Canadian deposits while they wait.”


Even now, some opportunities are at hand in the public markets, including among REITs (real estate investment trusts).


“It’s one of those rare times in the cycle where public REITs are trading at a much bigger discount than the private market REITs,” Stenner adds, noting that some are trading at 50 per cent below net asset value.


“Currently, the public market REITs already have investors panicked to some level.”


The private market is offering opportunities too, including real estate whereby some asset owners in a cash crunch must sell at depressed prices.


“When others need to rebalance, we will be able to take advantage of lower prices,” Salzer says.

Still, ultra-high-net-worth families with businesses in certain areas may inevitably be exposed to downturns, and while they likely will be able to weather the storm better than other investors, they may face unique challenges.


“A lot of clients have a distribution policy to beneficiaries within the family,” O’Connor says. “To the extent that you have got someone who is relying on that distribution to help them with their mortgage payments or whatever it is, if the economy falters and markets are down, that might mean distributions are down.”


Here, communication with clients becomes critical, ideally involving everyone in family council meetings to discuss economic and market risks.


“If the family council is meeting on a quarterly basis, which is often what we recommend as best practice, then what is often on the agenda are things that could impact the distribution,” O’Connor says. “So they’re getting out in front of it.”

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