How HNW individuals are navigating volatile times and positioning for the future
Many of the pillars underpinning the investment strategies of HNW clients have come under intense pressure in the last 12-18 months.
HNW clients are more exposed to disruption
2022 ushered in a new period of financial uncertainty around the world.
A prolonged market downturn was accompanied by runaway inflation and a ratcheting up of interest rates, leaving consumers feeling bruised and unsure where to turn. House prices have plunged, leaving some owners facing a negative equity scenario.
Investors, too, experienced their share of pain, with bonds and equities both delivering negative returns, leaving a hole in many superannuation balances, and leading many to question traditional investment wisdom.
One group of investors that has arguably experienced the most disruption in the past 12 to 18 months are the high net worth (HNW) individuals. Not just because they tend to be the most exposed to market risk, and generally have more at stake financially, but because many of the pillars underpinning their financial strategies have come under intense pressure.
Building, protecting and transferring wealth has always been complex, but now especially so. The preference of many HNW individuals to adopt a DIY approach is looking increasingly questionable.
In this article, we examine the evolving landscape for HNW individuals, looking at the challenges they currently face and how – with the help of financial advisers – they are responding and positioning themselves for 2023 and beyond.
Who are the HNW and what do they look like?
A quick search reveals a number of definitions of HNW in use in Australia, including:
- the Investopedia definition[1] – $1 million in liquid assets (family home excluded)
- the Coredata definition[2] – $1m in the share market, or earning an annual income of $450k and over (family home excluded), and even
- the ASIC sophisticated investor definition[3] (annual income over $250k or net assets of $2.5m).
To be consistent with the Australian-focused research – and because rocketing real estate prices are rendering the ASIC definition less meaningful every day – this article will use the $1m in net investable assets criterion common to both Coredata and Investopedia.
Across the globe, according to Capgemini’s 2022 World Wealth Report[4], there are around 22 and a half million HNW investors (of these, around 200k are classified as ultra-high net worth individuals, with net investable assets in excess of $30m USD).
In Australia in 2022, the HNW segment was estimated by Investment Trends[5] to comprise around 625,000 individuals, investing more than $ 2.8 trillion AUD.
The millionaire next door
As tempting as it is to think of HNW as one homogeneous group – that is perhaps largely male, middle-aged and professional – in reality, today’s HNW client is just as likely to be a female entrepreneur or a young tech firm founder. And the stereotypical signs of wealth – expensive car, luxury brands – are not always present. Today’s HNW individual could well be your neighbour.
While various studies[6] suggest the average age of a HNW investor is around 60, that average is dropping as more wealth finds its way into the hands of millennials.
Segmenting the HNW by wealth tiers reveals differences in profile and behaviours.
The rising economic power of female investors is also a standout trend around the world, and is redefining the way firms are approaching this segment.
Global analysis[7] reveals that females hold around 40% of all US wealth, and a third of Australian wealth. But they are growing their wealth around 40% faster than males, and are expected to inherit 70% of global wealth over the next two generations. By 2030, females are projected to manage two-thirds of all household wealth.
Motivations for investing
To some extent, the money motivations of HNW and ultra HNW clients mirror those of many other investors – saving for retirement, the desire to make a social impact, preserving wealth and passing it on to family members, and leaving a legacy. However, the quantum of the amounts involved increases the number – and complexity – of solutions available.
Older HNW clients, boomers and beyond, have ridden a wave of enormous asset growth over their lives, in both equity and housing markets. It is these clients who are at the very centre of the enormous intergenerational wealth transfer we will see over the next two decades.
They will be more focused on preserving wealth as opposed to chasing it, with key considerations being:
- an orderly transfer of wealth to younger family members (44% of HNW clients are worried about this) [8],
- asset protection, and
- optimising tax treatment.
As times become more challenging, their demand for advice is increasing
Wealth does not guarantee financial literacy, and while the majority of the population are not advised, this is true also true of HNW individuals. Rather than being a group of sophisticated and self-directed investors, the HNW have just as much need for expert advice as other clients.
More than half recognise they need financial advice, and recent Australian research found a strong and growing demand amongst those seeking to use advisers to get a second opinion, and for access to a wider range of investment opportunities than would otherwise be available to them.
According to Investment Trends[9], between late 2019 and late 2020, the percentage of HNW individuals seeking to ‘validate’ their ideas with a financial adviser rose from 40% to 56%. Over the same period, there was a corresponding fall in self-directed HNW individuals, from 49% to 34%.
In the same way the demand for advice went up in line with the Covid-induced market volatility of 2020, it is fair to assume the events of 2022 have similarly decreased the appeal of DIY, driving up the demand for advice even further.
Conservative and calm investors
In contrast to the stereotypical notion that all HNW investors are frequent traders chasing higher returns through complex and risky investments, research suggests the opposite.
In Australia, the 2021 Crestone State of Wealth Report[10] found the top 3 investments held by HNW and Ultra HNW individuals to be:
- Australian equities (73.4%)
- Cash (72.4%)
- Direct residential property (43.4%).
As a group, they tend to stick with a strategy and asset allocation even during the most challenging times.
Indeed, according to Investment Trends, under two in five HNW investors (37 per cent) reported making substantial asset allocation changes to their portfolio in the year through ended 30 June 2022, down from 41 per cent in 2021 and 50 per cent in 2020 (a record high)[11].
Of course, taking the aggregate view can mask critical behavioural differences, for example by age group. Crestone found that Gen Y was most likely to have a broad range of asset classes, including Australian bonds and alternative and/or emerging investments (both held by 26.2% of wealthy Gen Y investors)[12].
One possible reason for this could be their willingness to adopt new technology and mobile trading platforms. These typically offer ready access not just to shares but to exchange-traded funds (ETFs) covering a wide range of asset classes and geographic locations.
Older investors on the other hand may have already established their investment preferences and behaviour:
“Overseas shares, I don’t know, okay you hear about the bigger companies but all these other ones … at my late stage in life, I thought no, I’m not going to bother.” 63 y.o. male HNW.[13]
What are they thinking about in 2023?
Decades-high levels of inflation and associated interest rate movements are without doubt the dominant economic themes around much of the world right now. And evidence suggests the silent wealth-eroding effects of inflation are weighing more heavily on the minds of HNW investors than market volatility.
Australian research found that military conflict (55%) and inflation (48%) to be the two biggest investment concerns for HNW investors[14]. This was consistent with US research[15] by The Wall St Journal and Barrons, which found that inflation, political uncertainty and taxation (rather than market volatility) were the top 3 concerns amongst HNW and ultra HNW investors.
A UK survey[16] of 200 HNW investors, conducted by the Charles Stanley Group, also found inflationary fears to be paramount. 59% of those surveyed said they were concerned about the threat of recession and high inflation, a figure which rose to 69% for the over 55s.
They aren’t panicking in the face of uncertainty
Despite the reality of an inflation rate that equates to the largest wealth erosion rate seen in decades, many HNW investors are slow to move. A survey[17] released by Standard Chartered in late 2022 found caution remains the foremost sentiment:
- 30% said they were spending less
- 31% said they were prioritising the protection of their wealth rather than chasing growth
- only 25% said they were looking to make new decisions around their portfolio.
Additionally, 86% of respondents to the Charles Stanley survey said they planned to invest and save in the same way as they always have
They are contemplating some asset allocation changes
The spectre of inflation has shone the spotlight on asset classes proven to respond well to inflationary times, including:
- commodities
- gold
- alternatives, and
- infrastructure.
In terms of how HNW investors are responding to inflation, the Standard Chartered study mentioned above found that 61% were looking to reduce their cash holdings (despite rising interest rates), 37% said they had invested in gold, and 22% were investing in a recovering bond market. More than half were also looking to increase their holdings of sustainable investments.
On the equity front, a degree of pessimism remains, with the majority of those with an equity exposure indicating they would reduce it (‘buying the dip’ seems to have lost its lustre).
67% of US advisers[18] surveyed in 2022 expect HNW demand for alternatives to increase over the coming years as investors look for uncorrelated returns.
Their appetite for ESG remains strong despite recent underperformance
HNW individuals typically have a higher propensity to seek socially responsible investment options than average.
The Capgemini 2022 World Wealth Report[19] found that 55% of HNW and ultra HNW investors said investing in causes with positive ESG impact is a critical wealth management objective.
Interestingly, that same report found in APAC, 55% rose to 69%.
In Australia, an Investment Trends study[20] reported that 69% of HNW and ultra HNW investors said advice around ethical investing was an ongoing requirement.
And despite many ESG slanted funds underperforming in 2022 – as energy stocks soared – the appetite remains strong and is likely to grow further in 2023:
- a 2022 survey by PWC[21] found that 42% of US HNW investors planned to increase their exposure to ESG
- in the UK, the Saltus Wealth Index[22] research found HNW intentions to invest in green and social impact funds were higher in December 2022 than they were 6 months earlier (73% versus 64%).
SMSFs are becoming less popular
SMSFs have been a popular vehicle with HNW and UHNW investors for decades, especially those looking to drive down costs, or seeking more control over how their superannuation was invested.
ATO figures show there were around 603,000 SMSFs – worth $868 billion – in Australia as of 30 June 2022. The median assets per member at this time were $472, 824, many multiples greater than the median assets held by superannuation members generally[23].
But recently released figures show the popularity of SMSFs may be waning, with new SMSF establishments for the September 2022 quarter at the lowest level seen in more than a decade[24].
Experts believe there are several reasons for this.
Firstly, the perfect storm of 2022 led many would-be trustees to realise just how complex and challenging investment markets really are. The self-belief possessed by many individuals that they could do better than professional managers has undoubtedly been dented by seas of red ink in portfolios everywhere.
And secondly, many industry and retail funds have developed offerings specifically to appeal to those investors seeking more control and a greater array of options. Meaning much of what could once only be achieved via an SMSF is now possible within a professionally managed – industry or retail fund – framework.
As one adviser told the Financial Review:
“When you can do all the things you want to do with your super in a public offer fund in terms of investments, running pensions, estate planning etc, then why take on the responsibilities and duties, and hassle of having your own fund?”[25]
While there is no doubt that for the ultra-wealthy, and those with complex estate planning needs, SMSFs can be appropriate, their appeal at the lower tiers of HNW is much lower (as per table 1 above), and seems likely to get weaker over time.
They are starting to bring forward intergenerational wealth transfer
While increasing life expectancies will generally see inheritances occur at older and older ages, HNW individuals are in a much stronger position to transfer wealth at much younger ages, and several aspects of the current economic climate are encouraging them to do so.
With increasing interest rates putting home buying increasingly out of reach for many young Australians, and making existing mortgages unaffordable for others, many older HNW individuals are deciding it may be better to transfer wealth sooner rather than later (tax and estate planning considerations notwithstanding).
As one expert[26] told the AFR, “Wealth transfers on death are now too late to meet intergenerational needs when they occur”.
Hence the appeal of gifting. Typically, smaller than the inheritance (ATO data[27] from 2018 suggested the average gift was $8,000, while the average inheritance was $125,000), gifting is about transferring wealth to younger generations when it is most needed.
And, anecdotally at least, it seems HNW clients are increasingly choosing to purchase homes, make mortgage repayments, put money into mortgage offset accounts, pay private school fees and clear HECs debts for their children and grandchildren. At higher wealth tiers, this early wealth transfer is likely to involve more complex strategies and structures such as trusts.
In summary
While the perfect storm that continues to consume investment markets has seen many investors frantically changing their plans and running for cover, true HNW and ultra HNW individuals have – with the help of their financial advisers – remained calm and focused.
Enabled by their wealth to take a longer-term perspective, current market volatility barely registers as a risk, with concerns around inflation and geopolitical instability being more top of mind.
Whilst not panicking, several trends suggest they are certainly responding to the current environment and repositioning themselves for the future. These trends are evident in the way they are making portfolio adjustments, reducing their use of SMSFs, and bringing forward family wealth transfers.
