This bird’s-eye view affords us an elevated perspective that makes it evident that, since the 1980s, we’ve been living through a becalmed period of US domination, globalisation, minimal geopolitical tension, and a surge in technology and innovation which, together, have translated into a long period of capital market strength that has been largely devoid of price inflation. This cocktail of factors has combined to dampen investment risk and has produced a welcomed – but unusual – period of enormous prosperity and low volatility for investors. But the world doesn’t always look like this, and you don’t have to go too far back in history to be reminded of the other side of the coin.

Without being congratulatory of our position and critical of all other stances, it would be difficult not to acknowledge that the writing has been on the wall around current market challenges for some time. Unfortunately, not all managers of wealth have been paying attention to the warning signs, possibly because their primary motivation is based on growing assets under management by showcasing recent performance and not accepting the challenge of the primary mandate of investment, which starts with the long-term protection of capital as the foundation for growing capital. This requires independent thought and the conviction to stand apart from the madding crowd – no matter the shorter-term consequences.

In this instance, it didn’t take much for us to start beating the drum about the risk of unexpectedly high inflation all the way back in 2020 when inflation averaged just 1.2% in the US, but the monetary taps were gushing. Then, our alarm bells began ringing especially shrilly when it became apparent that the US Federal Reserve’s (Fed’s) policy was increasingly lagging the data – with the result that a widening gap, caused by providing liquidity irrespective of bulging debt levels, would require an almost impossible balancing act to close. Central banks appeared confident that they could repeat the “rabbit out of the hat” trick that was implemented post the global financial crisis of 2008. And while the initial market reaction agreed, the chickens are now coming home to roost.

As Milton Friedman famously observed: “Inflation is always and everywhere a monetary phenomenon.” With central banks pumping money into capital markets and governments spending wildly, it was only a matter of “when” inflation would arrive, and in “what size” – which is entirely at odds with the market story of the past two years that inflation would be “transitory”.

As is now well documented, consumer price inflation in the US and in other developed economies is at its highest levels in 40 years. And the Fed is increasing interest rates at an accelerated rate to try to keep these pressures in check. However, rising interest rates, elevated inflation, and high levels of debt are a toxic mix, slowing down economies and potentially pushing them into recession. The risk of stagflation – a cocktail of economic stagnation and high inflation – as experienced in the 1970s, is once more uncomfortably high and will leave vast parts of the asset management industry vulnerable to significant real capital losses.

World equity markets have lost in the order of US$25 trillion year to date, with global equity market capitalisation falling from US$121 trillion at the start of the year to US$96 trillion at the end of June – a loss of 20% in nominal terms. Bonds, which are supposed to defend portfolios in times of stress, have come under similar pressure, with the world bond market shedding US$19 trillion in value since January 2022 – a loss of 15% in nominal terms. This is a spectacular collapse in wealth by any measure, with traditionally decorrelated asset classes shedding value at the same time.

As history teaches us, stagflationary periods are a particularly challenging environment in which to protect capital. As the recent market experience shows, traditional investment approaches of long-only equity and the widely used “60/40” approach, comprising 60% equities and 40% bonds, are poorly suited to the current environment. As we have long argued, this approach is based on a limited view of the last 40 years and will be inadequate to protect and grow capital in a world with materially different economic drivers and changed market circumstance.

The problem with not learning the lessons of the longer-term past is that fundamentals can become detached from reality for long periods of time, and this can create the false impression that the investment world has entered a “new normal”. In this instance, the inevitable pain must arise from the reversal of decades of the “Greenspan put”, the buoying up of the system by central banks through quantitative easing and the creation of money, as well as abundant debt creation and fiscal stimulus packages. From elevated points, small ruptures can have amplified consequences. This period of deleveraging is particularly painful for speculators who find themselves adrift as they cling to shattered models. At the more extreme level, it is difficult and painful to witness the implosion of intangible assets such as cryptocurrencies and various mystifying derivatives. As easy money evaporates, so do past returns.

A well-structured portfolio in today’s market must include alternatives to the 60/40 model, such as inflation-linked bonds; precious metals, including gold; and commodities – all of which have performed a shock-absorber role during more turbulent inflationary periods, including the past 12 months. Our exposure to portfolio protection through longvolatility and other tail-risk positions is another increasingly important way of providing a convex return stream to offset the losses being recorded by growth assets. These positions have served us well, and we believe our core thesis remains set to play out further with hard yards still ahead for capital markets, central bankers, and investors.

Without putting too dramatic a point on it, we could be witnessing a decoupling of the world as we’ve known it. The last 40 years have rewarded “economic growth risk” but become complacent to “inflation risk”. Now we face a stark reality where the reward might be taken off the table, leaving only the risk. As a fundamental case in point, “safe haven” counter-cyclical bonds do not offer protection in the face of elevated inflation and rising yields – in real terms they are down the better part of 25% this year.

While it is impossible to predict the future, we do know that it’s mathematically foolish to expect returns to mirror those of the past 40 years. We also know that 80% of the volatility in a portfolio can be explained by asset classes. Therefore, for investors seeking to protect capital and dampen volatility, the only free lunch remains embracing a strategy of true diversification.

This is where patient money comes into its own, by recognising that an effectively diversified portfolio holding truly offsetting asset classes may lag during halcyon days. But when cycles turn – which they ultimately always do – this portfolio comes into its own. Our approach has highlighted three key takeaways. For significantly less risk, you can still achieve an equity-like return. Investment success is tipped in favour of patient capital. And wealth will continue to whisper while the world rages.

One of Genera Capital's key focus areas is helping its investors avoid the so-called "third-generation curse", the oft-quoted aphorism that wealthy families typically lose their wealth within three generations. A study of 3,200 families by US wealth consultancy Williams Group found that 70% of high-net-worth families lose their wealth by the second generation and 90% lose it by the third.

Gold’s name has common roots with the Afrikaans and German geld (money), and Dutch gulden (currency), which reveals something about gold’s attribute as a monetary asset. However, gold differs from printable currency (“paper money”) in that it cannot be created by fiat but must be mined from the earth. Gold has a fixed supply compared to easily printable fiat currency. To the extent that there is a demand for gold as a hard backing for money, the limited supply will ensure its price is well supported, at least far better than that of overprinted fiat.

Physical gold hedges the exposure that other assets have to monetary inflations, which are not limited to price inflation, and include supply disruptions because an unstable medium of exchange makes it harder to do business. The extent of gold’s power is evidence by central banks holding the precious metal to back their currency, discipline their ability to print money and, in so doing, serve as a hedge against deteriorating monetary conditions.

This summarises the conceptual case for gold: it is not necessarily a sure thing, but a “maybe” thing that may be just about the only thing – alongside inflation-linked bonds – that can protect against a serious bout of stagflation.

Here, however, challenges quickly emerge, with one of the most common being to compare gold’s returns to realised inflation. A regression of monthly gold returns on consumer price inflation for the United States (US) over 25 years shows virtually no relation. This readily supports the complaint that gold is a feeble inflation hedge.

The first impression is that gold is a poor inflation hedge. Grander versions of this faulty analysis, including more elaborate statistical methods, level the same complaint against gold being a poor hedge. But this conclusion misses a key point. If we apply the same method to US inflation-linked bonds over the same period, we are led to the same strange conclusion: even though inflation-linked bond coupons are directly linked to inflation, they have no relation to inflation. This sounds wrong because it is wrong!

A different – and corrected view – of gold and inflation-linked bonds is that they help manage the risk of changes to inflation and economic growth expectations going forward, and not backwardlooking realised results. That is because markets price assets based on expectations. From this, one would expect gold and inflation-linked bonds to at least have some (even if imperfect) similarity to one another. This is exactly the case, as shown over the past 20 years. Even more important, and returning to the diversification point, they behave different to US equities (S&P500) and produce a better return over the measured period. This is the free lunch of diversification which is earned by viewing gold’s relationship with inflation through the correct lens.

The real glory of stagflation assets – such as gold – is how they can be combined with disinflationary boom assets – like equities – to create a risk balanced portfolio that is better than either asset class in isolation. This is evidenced by the zig-zag pattern between equities and gold is caused by the fundamentally juxtaposed exposures to monetary and real economic supply and demand conditions (consider the early 2000s or 2015 to present). When held together in a diversified portfolio, the basket produces growth that is more reliable, just as rapid and with much lower real risk of loss. This is the power of diversification.

The above shows what is possible with two fundamentally different exposures that are risk balanced with one another. More can and should be done (by including more asset classes across a greater spread of geographic-economic blocs) to not place at needless risk the wealth saved up today, to meet the needs of the future to the extent that they can attained with financial wealth. Gold is not perfect, but that is the wrong standard anyway. The important point is that a portfolio is radically improved by including some of it, and that is the pragmatic, even central, point to take away. Some call it portfolio construction, Harry Markowitz called it a free lunch.

One of Genera Capital's key focus areas is helping its investors avoid the so-called "third-generation curse", the oft-quoted aphorism that wealthy families typically lose their wealth within three generations. A study of 3,200 families by US wealth consultancy Williams Group found that 70% of high-net-worth families lose their wealth by the second generation and 90% lose it by the third.

While that's often due to poor stewardship, it's also a symptom of protecting wealth from the impact of seminal historical events being no easy feat. From the French Revolution to Weimar Germany, wealth has ebbed and flowed with the shifting tides of socioeconomic and political history.

Goss cites the example of Zimbabwe and recalls the comment of someone whose wealth was affected by the country's economic collapse in the wake of its disastrous land seizures in the early 2000s.

To illustrate his point, Goss reveals a diagram on risk-balanced asset allocation across four quadrants depicting various combinations of future economic growth and inflation surprises (see diagram). The top left quadrant indicates stagflation, the uncomfortable mix of high inflation and low economic growth. The lower left quadrant shows the recessionary conditions of lower growth and lower inflation, while higher inflation and higher growth are characteristic of a boom. Benign economic conditions are marked by higher growth and lower than-expected inflation.

Goss says that's where careful asset allocation and diversification become critical to wealth preservation, a strategy he says must go beyond the typical split of 70% equity positioning with the remaining 30% of portfolios allocated to real estate, credit, bonds and cash. To protect against stagflation or hyperinflation, one has to incorporate meaningful allocations to assets like physical gold, commodities and real return hedges such as inflation-linked bonds.

Saville has been a successful entrepreneur and investment manager in the financial services sector for over 25 years. His passion for financial markets and the development of people, as demonstrated by his professorship at the Gordon Institute of Business Science, are well placed to make him an integral part of the Genera Capital team. He has been a positive voice for development in South Africa which is evident in his media activity, research and engagement in public policy.

During her career, Kathleen has gained significant global alternative investment experience. Kathleen will deliver and monitor suitable alternative investments and separately managed accounts for the families we partner. This is a natural continuation of our holistic investment offering where we have successfully provided access to several select opportunities alongside our risk-balanced portfolios. We believe that the targeted alpha from these opportunities offers a valuable uncorrelated return stream. As always, the careful selection of the right opportunities requires focus and a depth of expertise and plays perfectly to Kathleen’s experience in this regard.