With the US Federal Reserve flooding the market with liquidity keeping short term rates near zero, high net wealth clients are on an quest to increase the return on their portfolios without trying to take additional risks. Higher returns are out there as money, punished if it remains on deposit or in short term money markets is almost forced into long maturity bonds and bond funds, equities, gold and other commodities, hedge funds and private equity driving up prices and therefore returns.
The problem with higher returns is that they always go hand in hand with higher risk. There is no free lunch is true in life and in the financial markets. Clients are taking more risk at a time when the Fed is conducting the riskiest operation in history in an attempt to restart the US economy. With the second round of quantitative easing now underway, (QE2), the amount of freshly printed money being forced into the system is expected to approach $2.0 Trillion. Never has the so much liquidity been driven into the system and we simply have no idea what might happen.
In the past, increasing the supply of money on a more modest scale has lead to increasing inflationary expectations that has driven up interest rates and increased the cost of living. High inflation is about the worst scenario for the large demographic group of Baby Boomers that are starting to retire. It reduces both the value of client savings and their standard of living.
With all of this money flooding into the system, why we are only seeing limited price pressures, outside of food, has a number of possible explanations. The key appears to be confidence. Once that returns the money held in reserve by banks will be lent, houses will be bought and the consumer spending will ramp up again. More and more money will chase after a finite supply of goods. The problem with emotional events as they tend not to be linear and do not change slowly over time as economists would like. They tend to fully off then fully on, with little warning.
Economist Nassim Taleb, author of the book, The Black Swan I think describes what will happen next best. Think of a kid with a plate of french fries and a full ketchup bottle. He holds the bottle upside down over his plate and hits the side. Nothing happens. He does it again. Same result. Finally he hits it a third time and you can’t stop the flow of ketchup, it is everywhere. The Fed has got the bottle upside down, with low rates, and have now hit it twice with quantitative easing. I think we should be prepared for a similar result.
So if inflation is a highly probable event how to we protect ourselves? The key is to take less risk than normal and make sure what risky assets you do hold are well diversified. This is what we are recommending to our clients.
- Hold more cash than normal. I know it is painful but rising rates will create an opportunities that you will need cash to take advantage of.
- Hold only bonds with maturities earlier than 2013. You pick up about 1% yield by buying high quality corporate bonds in this area of the curve without taking too much interest rate risk
- Hold a globally diversified portfolio of equities. Shares of large companies that are not highly leveraged and have great global brands that allow them to increase prices easily do well in an inflationary environment. Hold shares in emerging market companies where inflation is already high so prices have adjusted to it.
- Hold shares of companies that produce commodities. Commodity prices are already reacting to the increased money supply and will do well wit h increasing inflation. Gold is the traditional safe haven for inflation and should be helpful in a portfolio. There is a lot of speculation in gold so in the short term a correction is likely.
- Hold hard assets. Real estate as long as the leverage is low, performs best in an inflationary environment. Farmland is in demand by large pension plans.
- Hold a portfolio of conservative hedge funds, ones that are really hedged and use low leverage. In a sudden move hedge funds should protect your downside.
Transitions in economies are always difficult to predict and the range of potential outcomes is wide. This is not the time to blindly reach for higher yields, but it is the time to put together a well diversified portfolio that will give you higher returns and can preserve your capital in the event of adverse market conditions.
Founded in 1993 by its co-managing directors Bill Messer and Scott Elphinstone and in conjunction with N.M. Rothschild, Five Continents Financial Limited is located in the Cayman Islands and was privately held until 2009, when Scotiabank acquired a controlling interest in the firm. “Scotiabank has been long-recognized as a leading player in the Caribbean and Central America, particularly in the Cayman Islands.” said Bill Messer, Managing Director of Five Continents Financial Limited.
Scott Elphinstone and William Messer continue to be Managing Directors and minority shareholders. Five Continents Financial Limited has assets under management of US$458.3 million. Five Continents Financial Limited’s discretionary asset management services are focused on managing conservative global investment portfolios for private clients, corporations, insurance companies, pension plans, trusts and third-party investment funds.
The firm also offers treasury management and captive insurance portfolio management. The firm extends their services to offer a variety of corporate services, including offshore company incorporation, administration and custodial services. Five Continents Financial Limited employs a conservative investment style, focusing on globally diversified portfolios with core positions in high quality fixed income investments.
Five Continents provides complementary solutions to the International Scotia Private Client Group Centres as well as to other partners within International Wealth Management.
Asset Management Services
The asset management services offered are focused primarily on globally diversified portfolios with core positions in high quality fixed income investments managed on behalf of high net worth individuals, corporations, insurance companies, pension plans, trusts and third-party investment funds.
Client portfolios include specialist advisory services in the areas of global equity and hedge fund investments.
Five Continents also manages client portfolios in conjunction with a select group of trusted external advisory firms with which we have long-term relationships with senior management/portfolio managers.
In addition to asset management services, we provide additional advisory services to clients as appropriate to their individual situations, which include the following areas:
- Fund Management Administration
- Offshore Mutual Fund Incorporation and Administration
- Company Formation & Corporate Administration Services
- Provision of registered office, secretary, directors and shareholders
- Registration and licensing administration
- Nominee shareholder, director and officer services
- Facilitation of active business management
Scotiabank has been part of the Caribbean and Central America since 1889. It is now the leading bank in the region, with operations in 27 countries, including affiliates. The Bank has 12,117 employees in the region, including affiliates, serving more than two million customers, with 593 branches, kiosks and other offices, plus about 932 automated banking machines.
Scotiabank is one of North America’s premier financial institutions and Canada’s most international bank. With more than 69,000 employees, Scotiabank Group and its affiliates serve approximately 12.8 million customers in some 50 countries around the world. Scotiabank offers a diverse range of products and services including personal, commercial, corporate and investment banking. With more than $509 billion in assets (as at January 31, 2009), Scotiabank trades on the Toronto (BNS) and New York Exchanges (BNS). For more information please visit www.scotiabank.com.