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4 Ways for Your Family Office to Hedge Against Inflation and Recession

Inflation and the Rising Risk of a Recession

Inflation is everywhere and has become unavoidable for Americans. It is flooding headlines with 40-year records. You see it at the gas pump with all-time highs. But, as a savvy family office investor, have you thought of inflation’s impact on your investments and how you can hedge against inflation?

Ray Dalio famously said, “cash is trash,” and with just cause. Even with positive returns, the debasing dollar can put a damper on preserving generational wealth, let alone growth. 

For perspective, over the last 50 years, your portfolio needed an annual average return exceeding 3.4% to keep up with the pace of U.S. inflation. From 2011 to 2021, a classic 60/40 (equities/fixed) portfolio generated an 11.1% annual return or 9.1% after being adjusted for inflation. In the previous decade, from 2000 to 2009, the same portfolio generated a 2.3% annual return or -0.3% after adjusting for inflation. 

And to add to existing market pressure from inflation and geopolitical struggles, U.S. short-term bond yields recently spiked to 2.2%. With the long-term bonds only 0.2% higher, at 2.4%, we are at risk of an inverted yield curve. Clearly, we have some interesting times ahead, to say the least. 

While there is no perfect asset class to hedge against inflation and recessions, here are 4 excellent vehicles to help your family office hedge for inflation. 

Gold’s Performance History

Gold is arguably the oldest store of value, with use as a commodity dating back thousands of years. It is not surprising that gold is a favored asset class to hedge against inflation, even more so due to the historical inverse correlation between money and gold scarcity. But how has it performed during recessions?

Since 2000, gold has averaged annual returns of almost 9.5%, while inflation has averaged 2.4%, and the S&P has an average annual return of 6.88% What about during a recession? Since the dollar was taken off the gold standard in 1971, the value of gold increased in 75% of the recessions. 

One of the two recessions when gold underperformed, was 1980-1982. Why is it important to highlight that recession? Because preceding that recession, gold grew by an astonishing 2,300% from 1970 to 1980, during its largest bull market run in history.

Also, during two of the largest equity market drops in the last 50 years, the price of gold rose. While the S&P dropped 49% during the dot-com bubble, from 2000 to 2002, gold rose 12.4%. Again, during the Great Recession from 2007 to 2009, the S&P dropped 56.8%, while gold jumped 25.5%.

There are several ways to invest in gold, from physical to ETFs to digital.

Click here to learn the best way to add gold to investment strategy to hedge against inflation.

The Time Is Now to Consider Securities

Inflationary periods can lead to a stock market correction, as we have seen over the last several months. The general train of thought is that inflation leads to a decline in purchasing power, reducing company profits.

However, that’s not always the case. In fact, when inflation is below 3% and rising, equities outperform inflation 90% of the time. When inflation is falling (even when rates are above 3%), equities still outperform inflation at least 76% of the time. The only time equities, in general, underperform is in high and rising inflation environments, meaning in certain situations, securities can be a solid hedge against inflation.

But remember, not all sectors are equal. Three resilient sectors offer stability during inflationary periods and bear markets: consumer staples, discount retailers, and healthcare.

It makes sense. These sectors are noncyclical, and the demand is inelastic. Rising prices from inflation and reduced budgets during a recession caused consumers to think more frugally and get more out of every dollar, turning to stores like Walmart and Dollar Tree to manage their daily needs. And we cannot defer healthcare costs because illnesses do not take a break during less favorable market conditions.

During the 2008 recession, there were only 25 stocks that generated positive returns. In the top 10, 6 of the best-performing stocks during the recession were consumer staples, discounts retailers, and healthcare: Dollar Tree (DLTR) 60.8%, Vertex Pharmaceuticals (VRTX) 30.8%, Amgen (AMGN) 24.3%, Walmart (WMT) 20.0%, Edwards Lifesciences (EW) 19.5%, and Ross Stores (ROST) 17.6%. 

Consider Real-Estate

Real estate is a common class of choice for inflation-averse family offices. Real estate allocation for family offices has grown 67% in the last 5 years. This can be credited to the learning lessons from missed opportunities during the Great Recession. Most family offices were “sitting on the sideline,” according to DJ Van Keuren of Evergreen Property Partners, who specialize in family office real estate investments. 

But now, more and more family offices are investing in real estate to maintain generational wealth, hedge against inflation, and avoid losses by the second and third generations. In fact, for some family offices, up to “90% [of family’s wealth] is lost by the third generation,” said Van Keuren.

What are the best real estate investments to combat inflation amid a recession? According to the MIT Real Trends study, retail properties are the best real estate investment to beat inflation, followed by multi-family and industrial properties. 

Shopping centers anchored by grocery stores or lifestyle businesses, like gyms, typically offer stability during economic contractions. Other retail centers with convenience stores, pharmacies, gas stations, and consumer staples (think Dollar Store and CVS), often offer a fair amount of certainty during economic distress. These retail centers offer staples in personal budgets that are the last to get cut. 

Multi-family residential real estate offers similar stability. Even during a recession, people need a place to live. There are three key benefits of multi-family properties. With multiple units in a single property, you have multiple revenue streams and a balanced risk, but only a single property to maintain, making it more cost-efficient. 

Of course, as with all asset classes, real estate is not foolproof. Vacant units or spaces or tenants facing hard times can quickly put a damper on an otherwise cash flow positive asset and erode your family office’s cash reserves. Unlike equities or gold, it may be difficult to exit a position in real estate on short notice to rebalance your holdings or generate liquidity. 

Treasury Inflation-Protected Securities (TIPS)

Treasury inflation-protected securities (TIPS) are the government’s answer to combat inflation. The government-issued bonds are indexed against inflation and rise as the dollar sinks to maintain its real value. Like Treasury bonds, TIPS are backed by the federal government and pay annual interest, but TIPS differ in that the face value adjusts according to the consumer price index.

The concept is simple and straightforward. If the CPI increases, the value of TIPS increases. In turn, if the value increases, the interest payments increase along with inflation. The perceived safety and risk-return tradeoff TIPS to fight inflation make them a popular go-to asset when inflation fears rise. Based on this, generally speaking, TIPS are a good hedge against inflation.

Like we said at the beginning of this article, TIPS are not void of risk. The first and most obvious risk is deflation. Reduced economic activity leads to a drop in demand. Prices fall, and the dollar strengthens, and when this happens, TIPS lose value.

Conclusion

There are several vehicles for your family office to hedge against inflation and a recession. But they all have their relative strength and risks The decision ultimately comes down to your investment strategy and risk tolerance. Whichever method you choose, knowing what to look for is key to ensuring you get the most out of your investment.