Podcast: An Adviser's Point of View – The cost of living crisis
Inflation, the cost of living crisis and how it impacts clients is being dissected in our latest podcast for financial advisers, featuring Simon Cooper, Head of DFM Relationship Management, and Portfolio Director Richard Gould.
Simon and Richard look at what we can learn about inflation from the 1970s, how clients can lower their exposure to inflationary risks, our response to these events and how advisers can help and reassure their clients.
Listen to the podcast to find out more.
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Simon Cooper: Hello and welcome to the latest Cazenove Capital podcast in the ‘Ask an Adviser’ series. I'm your host, Simon Cooper, the Head of DFM Relationship Management at Cazenove Capital. You can find us by searching on your podcast app and looking for the name ‘Lens On’, in order to subscribe. Or go to www.cazenovecapital.com, where you'll be able to download all the content. With all that's going on in the world at the moment, we've made a slight change to the format to this podcast, and we've decided to concentrate on the inflationary environment, or what is being more commonly referred to as the cost of living crisis. Therefore, we've drafted in this month one of our senior portfolio directors at Cazenove Capital, Richard Gould, who's going to relay some of his and the company's thoughts on the current situation and where we might be headed. Welcome, Richard.
Richard Gould: Hi Simon, thank you very much for having me.
Simon: Pleasure, I say we dive straight in, Richard. There's quite a lot to get through. There's a lot of headlines about the cost of living crisis at the moment, what's worrying your clients? Is it the actual effects of inflation on their spending or do they worry about the knock-on effects to their investments, or is it a combination of both?
Richard: Yes, I mean, absolutely. Clients are understandably concerned, you know, there's a lot going on in the world at the moment, and there's a lot that they're worrying about. And clearly, the inflationary pressures are impacting everyday lives, and this is being made worse by the question of how long is this really going to last. And I think this is one of the main reasons why the negative sentiment regarding inflation is so prominent. Because, when you, kind of, look at it, inflation has not really been a cause for concern for many years now, with the latest or last experienced back in 2008 during the credit crunch. And, if you look at our views going into 2021 and coming into 2022, we expected inflation to rise and potentially peak in and around April to then gradually fall and become transitory over the course of the year. Now, I use the word transitory because that's the word the Fed used, and this was mainly driven by things like supply chain and demand factors largely associated with the pandemic.
Simon: So, you no longer believe that inflation is going to be transitory?
Richard: No, I'm afraid that word has now been almost officially retired. And with the Ukraine crisis dominating news, there really is now an acceptance that price pressures are going to continue for a while. You know, we witnessed household energy bills rising dramatically since October 2021 and that's clearly hurting disposable incomes. And we've also seen an acceleration in interest rate hikes to try and combat these inflationary pressures. This is all adding up and is weighing on people's minds as well as markets and you can clearly see that with, you know, even by looking at the MSCI World Index, that's, as of yesterday, or close of business yesterday, was down approximately 14.5% since the beginning of the year. And it's adding to that negative sentiment we're experiencing. So, yes, clients are therefore, understandably, concerned, not just about the inflationary pressures but also the effect it is having on their investments.
Simon: And history is often something that we can potentially learn from. The last time inflation was this high, Margaret Thatcher was in power and I was still in nursery school. What, you know, clients, some for the first time ever are experiencing double-digit inflation, but what can we learn from history here?
Richard: Yes, I mean, it's a good question, it's a question I get asked quite a lot. And I think, first of all, is it's best if we just first look at what did actually happen in the 1970s. And, when you look at it, in summary, we effectively saw an unsuccessful military invasion, that then sparked a global energy crisis and that then caused inflation to jump from already high levels. Now the effect back then was that we saw US inflation at around 6% at the start of the decade. Which, when you look at it today, it's a little lower than where we are today.
The oil price spiked, the economy was in the grip of what they call a wage price spiral and to, kind of, put that in perspective, that is where wages increased in line with the cost of living. Companies then had to raise prices to cover their costs, which then ultimately meant another round of pay increases ensued. So, on top of that, consumer confidence then plunged and, clearly, many businesses struggled. So, unsurprisingly, stock markets around the world were very volatile in the '70s. And that was seen by the S&P falling, where the S&P 500 falling by almost 40% or so. Now, when I talk about that, although, you know, there are some, and there is an emphasis on ‘some here’ similarities, between the 1970s and where we are today, there are also quite a lot of important differences to bear in mind.
Simon: Which are?
Richard: Well, for one thing, central bankers have learnt from the experiences of the 1970s and they're now taking the threat of inflation a lot more seriously. And this really, unfortunately, was not the case when inflation started to rise at the end of the '60s. There are also several other factors suggesting that the global economy should hopefully be able to avoid a replay of the 70s. And, firstly, what I would say is the way to look at it is firstly look at the pandemic and at least some of the inflationary pressures we have experienced over the past few years is explained by the pandemic. I should, kind of, caveat here that China's most recent draconian measures against this latest wave of COVID could cause further future disruption. However, the lockdowns we experienced caused many people to actually build up their savings, which has put consumers in a much stronger position to absorb these higher costs.
Secondly, we are in a very different labour market. I mean, today's labour markets look a lot less conducive to the kind of wage price spiral that I was talking about before that we saw in the '70s. And this is one of the key differences. We have much lower levels of unionisation, nowadays, and, you know, to put some figures into that, in the US, 30% of the workforce or the workers belonged to a union in the '70s whereas, today, it's closer to 10%. Similar figures for the UK with around half in the '70s now falling to around a quarter of the labour force. And what that really means is wages are now less likely to automatically move in line with prices. But, you know, there are other factors to bear in mind, we've got things like technology. Technology has massively weakened workers' bargaining power. It's now a lot easier for companies to outsource or offshore work. We've seen it in every industry, we've seen it in every sector and, with rapid advances in robotics and artificial intelligence, it also means automation is going to be a greater threat to many industries than before.
And, you know, kind of the final thing I would almost say is the last element is really down to things like oil prices. And, when you look at the '70s, oil tripled in both 1973 and 1979, so when you put that in perspective and then you compare that to the rise of around 50% since the invasion of Ukraine, it does look somewhat modest in comparison. So, you know, to cut a long story short, and I know I've rabbited on a bit here but, when you put all this together, the good news is that the global economy is much less energy-intensive than it used to be, this is clearly being reflected by changes in how we generate power, changes in our consumption patterns and, as I've said just now, technological developments. And I think this ultimately means that, even if we see oil prices spike again, there should hopefully be less of an enduring economic impact.
Simon: That's interesting, so I suppose that naturally leads on to client portfolios and how an individual client can lower their exposure to these risks. What are your, sort of, thoughts on that area?
Richard: Well, there are a number of ways clients can potentially reduce exposure, not only to the risks posed by rising inflation but also the crisis in Ukraine. It's something that is dominating review meetings that we have now and, in general, kind of, conversations we have with clients. And I'd say, first and foremost, I believe one of the most effective ways is really to ensure that a client's portfolio has a very strong level of effective diversification across the full asset class spectrum. Now, when I say that, what I don't mean is the traditional ways of investing whereby one utilises a range of equities, bonds and cash. What I really mean is, yes, having exposure to those assets but actually complementing that with additional exposure to a range of alternative investments. And, you know, these alternative investments, they're great because they offer very attractive diversification characteristics compared to equities and bonds.
They also form a really key part of our investment philosophy here at Cazenove Capital. And when you look under the bonnet, they comprise different ranges of assets and you have things like targeted absolute return funds. They have the ability to deliver less correlated returns. You know, that is great, we want that in a volatile environment like we're in now. You have things like liquid private real assets, these are able to offer long-dated revenue streams and income and, when you dig deeper within this space, we're seeing some really good opportunities in areas such as digital infrastructure, specialist property and also exposure to private companies.
And, finally, I know we talked about oil and things like that before, but commodities in general, it can really be seen as a good hedge against further rises in inflation. And we are principally looking at areas such as gold, we think gold is very attractive.
Not only is it diversified but also as an asset that can also provide portfolio insurance in the event of a meaningful equity market correction or economic growth shock.
Simon: There are many ways to peel an onion, Richard. I mean, what about investment stars, given the current environment? What are clients looking for in the way that you and the firm manages money?
Richard: Good point. I genuinely believe that having an active management style is key, and especially when you consider the environment, we're in now. With the changes I mentioned before in monetary policy, the effect inflation is having and the supply chain dynamic, it is so incredibly important to have an active management style. And, when you look under the bonnet, you know, prime examples of this have been things that we've been doing within our equity allocation, you know, we've been reducing our exposure to Europe. We've been reducing our exposure to the smaller medium-sized companies.
At the same time, we've tilted portfolios towards the higher-quality end of the spectrum. Companies with strong balance sheets and those companies that are able to pass on the inflationary pressures that they're experiencing onto consumers whilst maintaining their profit margins. You know, within bonds, for example, we've been increasing defensiveness of our fixed income holdings, we've been reducing emerging market exposure. We've been slightly increasing our allocations of shorter dated UK bonds. And these are all, you know, prime examples of ensuring that we have a very flexible and agile investment philosophy and, you know, one that we believe will help not only control risk within portfolios but hopefully capitalize on opportunities being presented at the same time. So yes, active management is key.
Simon: Okay, interesting. Interesting, I was thinking the other day, I was nearly crying when I was filling up my car at the service station, due to how much it was costing me. And it made me think about the sort of, broader expenditure across my household and my investments. Do you think that the cost of living crisis and the inflation could lead to more people seeking financial advice? And actually, does this create an opportunity for advisers in the market?
Richard: Yes, I mean, absolutely. Yes, I mean, financial advice is so imperative when managing investment portfolios. Given the changes in monetary policy, you know, inflationary pressures are persisting, there has been a huge focus on income versus expenditure for individuals. And with that in mind, we've been seeing more and more clients looking to revisit cash flow planning or cash flow modelling, which I think is so important. And you put that into perspective, when it comes to our client bank, we manage a very wide range of clients and there might be some clients sitting on a lot of cash who are worried about it getting eroded with high inflation, and they're seeking out investment opportunities to hedge against it.
But then, maybe other clients who need to focus on whether their current cash flow position is sustainable to maintain their standard of living. And we're seeing a squeeze on disposable income, and this is potentially meaning that they could look at potentially trimming some of the non-essential spending in the short term as an example. And then you have some clients who, historically, may have not actually received advice or never received advice. And I think what we've seen in the current environment and with lockdown, it's proven to be a bit of a reality check and we've seen a big increase in those seeking out financial advice to help them guide or to help guide them through what is clearly quite an uncertain time. So, absolutely, financial advice is key and this is really being reflected in a lot of additional activity over the past few years which has been great to see.
Simon: I actually had an interesting conversation with somebody who was close to retirement last week. And actually, given the current crisis and where their own investments stand, they think they were going to have to give themselves another five years before they pulled the trigger. Are clients depending more on their investments to provide income at the moment?
Richard: Income is clearly a very important source of return within portfolios. And, depending on the structure, we typically focus on something called a total return strategy. So, natural income alongside capital growth to try and offer a more consistent risk adjustable return profile over the long term. But, I mean, what I would say is that it really does ultimately depend on the underlying clients. And, when I say that, what I mean is many clients, during lockdown, this is something I mentioned earlier, they actually saved money. You know, or saved more than they were spending, and this is, when you put it in perspective and figured it's quite interesting because, in the US, we estimate that consumers added around $2 trillion to their savings, we think a similar figure in Europe, as well. So as such, clients who were in that kind of position were actually contacting us to reduce or indeed temporarily cease their regular drawdown plans.
But then, again, every client is different, we had a client who then carried out, for example, house renovations because they were at home more and more, had time to complete these tasks, you know, tasks they'd been putting off for years. And so those clients did indeed draw more on their portfolios to fund these projects. So ultimately, this, kind of, reinforces why our approach has to be so flexible to ensure we continue to meet the objectives of our clients but also to ensure that the strategy evolves with their evolving circumstances.
Simon: So, it's likely to impact the retirement plans of the client, I suppose. I mean, how can advisers best support those clients who have already retired and what pitfalls do you think they should be aware of in this current environment?
Richard: Yes, I mean, it could well impact retirement, plans of retirement, but again, I think it really comes down, or the question really comes down to clients making sure that they are having regular meetings with their financial adviser as well as their investment manager. I can't stress enough, the benefits are so important, it enables the adviser to run, as I've mentioned earlier, an updated cash flow planning model. And, you know, from speaking to clients who have already gone through this with their advisers, they have been so grateful for this, it's provided an awful lot of reassurance, it's helped them continue building that level of trust, which again, in this industry, it's so important as well. And regular meetings are key, and I think the last couple of years, we've seen a real big increase in the level of activity and communication between a client and his or her adviser. Which, again, is great to see.
Simon: I mean, speaking of the last couple of years, it's been rather surreal, going from lockdown, Covid, to, you know, war in Ukraine and this unbelievable inflationary environment. I'm assuming that communication with clients, which I know we're always a company that put a lot of effort into, yes, but how do you go about best reassuring clients through these particular times? And what are the key topics that you're looking to discuss and address for them?
Richard: Communication really has been and still is a key area of focus for us as a company, as you said. And I definitely think, with the onset of lockdown, it was very important to maintain a regular communication channel with our clients and our advisers. And, as such, you know, we initiated a series of regular webinars, these webinars are hosted by our chief investment officer, Caspar Rock. We also had a range of topical speakers, and this really did prove to be invaluable with many of our clients and our advisers and we received a lot of positive feedback from that.
You know, the last thing I think clients want is, they don't want to be left in the dark. You know, they need to have an idea of what is happening with their investments, so having these regular dialogues on top of things like our monthly update reports, we're really great at maintaining that level of trust and also offering them much needed reassurance as, what is our strategy, how are we navigating our way through the turmoil? And, you know, additionally, we saw a huge increased reliance on our e-services facility which is, e-services is our online portal and it became very apparent very quickly that, during lockdown, clients were keen to follow their portfolios more closely. So again, having this facility was very useful indeed in keeping clients up to date with how portfolios were performing but also how our strategy was being reflected from, for example, from an asset allocation perspective.
Simon: And, leading on from that, you know, what about meeting clients virtually? It was obviously something that was vital for the continuation of business during the pandemic. Do you think that that's now something of the past or is that something that's going to continue to be part of business moving forward forever?
Richard: I mean, I think it's an absolutely game changer. You having the ability to have the closest thing to a face-to-face discussion with clients and their advisers when we couldn't meet, it was so important, it helped strengthen these distant relationships, it helped address any concerns that they may have, and indeed it's proven to be such a successful communication channel that I could probably go out on a limb and say, I'd say about half of my client base still prefer that form of correspondence for review meetings or ad-hoc updates.
And, you know, for those clients who prefer the face-to-face meetings, it's been really nice to see them, you know, I see a marked increase in the number of meetings we're hosting in our offices as well as us travelling to see the client, whether it'd be in their adviser's office, whether it'd be over lunch or whether it'd be in their house. Again, it ultimately just comes back to the concept that every client is different. So having that flexible and active investment strategy along with a tailored and flexible, personalised service, it's so important, it's so vital to ensure we communicate effectively as we can with our existing and prospective clients and advisers. And it's exactly what we've been doing.
Simon: That's great, Richard. I really appreciate your time on the podcast today, it's been really interesting hearing some of your thoughts and those of the company. So, thank you very much for your time.
Richard: I appreciate that, thank you Simon.
Simon: All that leaves me with is to thank you all for listening and to remind you that, if you want to download the podcast then you can go onto your podcast app and look for the name ‘Lens On’ or go to www.cazenovecapital.com, where you'll be able to download the content. Thank you.
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