The BID

Global institutions at the limit (Part 1)

A primeira parte de uma série de duas partes do nosso Fórum de Investimentos

O crescimento da desigualdade, as pressões ambientais, o aumento do protecionismo e a eficiência reduzida da política monetária têm colocado as instituições do mundo todo sob tensão. Mas as ferramentas e políticas do passado podem não ser eficientes para ajudar na resolução desses desafios. Com o mundo sofrendo pressão em seu limite estrutural, o que isto significa para a geopolítica, economia e mercados?

Neste episódio de “The BID”, a primeira parte de uma série de duas partes, visitaremos os bastidores do nosso Fórum de Investimentos para ouvir líderes de pensamento e investidores, incluindo Philipp Hildebrand, vice-presidente da BlackRock Investment Institute, Brian Deese, head global de investimento sustentável e Teresa O’Flynn, head global de estratégia em investimento sustentável para alternativas da BlackRock.

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  • Catherine Kress: For the past decade, as we’ve formed our year-ahead investment outlooks, we’ve been able to agree that the business cycle will keep going. That the bull market will keep running. And that’s been true year after year. And in the short term, this looks like it will continue to be the case. The global economy is still growing, interest rate cuts globally have provided a helping hand, and in the U.S., consumers are still going strong.

    But the range of outcomes is growing and unusually wide. Longer-term, structural dynamics are brimming beneath the surface, threatening to upend the global economy, markets, and society at large. The question becomes: are markets reaching their limits?

    On this episode of The Bid, we’ll try to answer this question with thought leaders behind the scenes at the BlackRock Investment Institute’s Investment Forum. In the first of a two-part series, we’ll hear from Philipp Hildebrand, Vice Chairman of BlackRock, Tom Donilon, Chairman of BII and former U.S. National Security Advisor, Brian Deese, Global Head of Sustainable Investing, and Teresa O’Flynn, Global Head of Sustainable Investing Strategy for BlackRock Alternatives. We’ll talk about what limits we see challenging markets in the year ahead, and home in on the path forward for geopolitics and sustainability. I’m your host, Catherine Kress. We hope you enjoy.

    At our recent Investment Forum in New York, more than 100 portfolio managers and strategists came together to hash out our outlook for markets in 2020. One thing quickly became clear from discussions: our global economic and geopolitical environment is hitting its limit. 

    Philipp Hildebrand: So the way we framed this discussion over the last two days is really to say on the one hand, we have a cycle that continues to be in place, it gets extended, again supported by further monetary policy easing; and at the same time, longer term, we’re seeing limits across four dimensions, which is really the theme of the whole two days.

    Catherine Kress: That’s Philipp Hildebrand, BlackRock’s Vice Chairman. Philipp notes the tension we’re facing: on one hand, easy monetary policy, like recent cuts in interest rates in the U.S., have supported economic growth. But on the other, we see limits that threaten the economic cycle. So what are these limits? I sat down with Philipp and Tom Donilon, Chairman of BII and former U.S. National Security Advisor, to find out.

    Philipp Hildebrand: The first one was in terms of inequality. Clearly, we’re getting to a point where the extreme levels of inequality are putting entire political systems, are putting the economy under stress. The second one is globalization. And it looks, when you look at the data across a number of dimensions, it looks like we’re reaching limits as to how far we can take globalization, or in fact, more and more, the data suggests we’re seeing some form, some degree of deglobalization. The third one is monetary policy, interest rates, we’re hitting rock bottom in many ways in terms of interest rates and reaching limits as to what else monetary policy can do going forward. And the fourth one, which is in many ways an overarching theme, is around sustainability. Increasingly, the data shows us that we are pushing the system to the limit when it comes to sustainability, whether it’s climate change, whether it’s other environmental factors here. It’s beginning to show up as physical risks; it’s beginning to morph into relative prices; it’s beginning to have an impact on the economy and on markets. So, these are four limit themes that we've identified to frame the entire discussion the last two days.

    Catherine Kress: I want to pick up on the second limit you mentioned, which is globalization. Over the course of this year, we as the BlackRock Investment Institute and our investors have been thinking a lot about geopolitics and geopolitical risk, globalization being one of the key themes that we've discussed. So Tom, turning to you, in thinking out over the next 12 months or so, what are the geopolitical risks or perhaps the one geopolitical risk that you're most worried about?                                                                                                                                 

    Tom Donilon: Well in general, it’s our view at the BlackRock Investment Institute that the biggest threat to the ongoing cycle as Philipp was describing is geopolitical conflict and in particular trade policy, and that’s really been at the center of a lot of what has been going on in the markets over the last year or so. There is a trade negotiation obviously underway with China. We had the 13th round of negotiations recently in Washington and there’s movement towards some sort of very limited deal. But more generally, there are ongoing structural issues that need to be worked out between China and the United States on the economic front, but also on the technology front and on a number of other fronts. We've made some progress we hope on the trade front, but it’s of a limited nature, and I think trade will continue to be at the center of the risks that we’re going to be looking at going forward.

    Catherine Kress: So, you mentioned trade and technology, what are some of the other dimensions that you're thinking about?

    Tom Donilon: Well, let’s stop on technology for just a second.

    Catherine Kress: Sure.

    Tom Donilon: There really is a pretty robust competition underway between the United States and China with respect to technology leadership. And you’ve seen that in the goals that have been set forth by China. We've seen that by the number of steps that have been taken in the United States, for example, to provide some fairness in technology competition in the views of the United States, to ensure the United States maintains an edge in some of these key technologies going forward. We’re looking at much more rigorous review of investments in the United States around technology, through the so-called CFIUS process. In the next couple of months, I think we’ll see more rigorous export controls on technology leaving the country. You know, there’s some tension around students and researchers coming back and forth between the United States and China. So, there is a robust competition underway in the technology field that is going to continue for a long time, I think. In general, Catherine, we're in a new era of U.S.-China relations. The focus has been on trade, but that’s not the only or even main focus over the long haul, and we’re going to have to develop a new set of rules of the road. The contours of the relationship as it goes forward, I think are still being developed.

    Catherine Kress: If you were to look at some of our indicators measuring geopolitical risk, whether it be global trade tensions or U.S.-China competition, it’s clear these are issues that markets are paying attention to. So, to each of you, I’m curious what your thoughts are on the some of the risks that we might not be paying enough attention to, that you’re worried about that perhaps markets may not be sufficiently.

    Philipp Hildebrand: Well, I think the reason things have worked out pretty well in market terms, despite all these things that Tom has just mentioned, is because we’ve had this extraordinary underpinning of asset prices through continued and persistent monetary policy support. So I think the biggest risk in a sense relative to what we've now seen over the last ten years – really the entire post-Crisis era – is if indeed we are reaching limits as to what monetary policy can do, that’s, I think, an underappreciated risk, because it has been in my view the main underpinning of the extraordinary performance of most financial asset categories. Most financial securities have performed on the whole very well over the last ten years – supported by this nearly endless, repetitive, over and over again, support from monetary policy. If indeed we are reaching limits, which is one of our concerns here, around that tool, then the question becomes what comes next? So we can either diffuse the tensions that Tom talked about, which as he said, it might be the case in some areas, but presumably not broadly, or we can find other ways to support and underpin markets and the economy, and that gets harder and harder as we run out of space on the monetary side. Now there are some answers to this. Fiscal policy is one obvious answer, that is where the discussion is going, but for many reasons, that is a much harder tool to implement, and so I think to me that’s the perhaps the most underappreciated risk: what happens if we need more stimulus given that we are reaching limits? We have reached limits arguably around monetary policy.

    Catherine Kress: So, you mentioned fiscal policy was one potential route forward, do you think that is likely or does this still remain very uncertain?

    Philipp Hildebrand: Well, I think at the margin, if we step away from the U.S. for a second, in Europe, there is a renewed debate around this, which is not surprising given that we have reached a limit there certainly, pervasive negative rates already in Europe certainly. So there is a change in tone, there is a change in even official statements, but it is still pretty marginal. And it’s going to be hard to activate fiscal policy in the same coordinated large-scale sense that we have been able to activate monetary policy. It’s certainly not a full, let alone a perfect substitute to what monetary policy has been. So, I think it has to be a combination of diffusing the conflicts, diffusing the sources of tension, fiscal policy where appropriate and where possible, and continued focus on structural reforms to make economies more competitive fundamentally. I think those are the three elements to how we deal with this next phase.

    CATHERINE: And Tom, turning to you, what risks are you most worried about that perhaps markets might not be paying attention to?

    Tom Donilon: Well, I think it flows from what Philipp has said. One of the biggest trends we've seen in the world has been the revival of great power competition, and we talked about that earlier with respect to trade and technology competition between the United States and China. But another one of the big themes, the big trends in the world over the last few years has been really dissatisfaction in the democracies. We’ve seen populist moves particularly in the Western democracies across the globe that put pressure on the ability of governments to perform. And we've seen of late a large number of protests in the world. And that flows from a lot of things, some of the things that Philipp talked about: inequality, the perceived inability of government to be responsive, and other individual factors, but those are important factors. And I think that one of the unappreciated risks is if governments can’t become more responsive to these trends, what happens in the next downturn? We’ll have a risk in terms of the response that Philipp talked about, in terms of the limits of what central banks can do, but I think it’s a bigger political risk of what do these dynamics look like in a downturn if they are this dynamic, and there is this level of dissatisfaction in an economy that’s not in a downturn.

    Catherine Kress: Right, we've talked about how this rising populist or anti-establishment wave has taken place amid incredible economic growth or economic strength, and so the question indeed is what happens in the downturn if many of these concerns or anti-establishment sentiment is in fact driven in some way by economic anxiety.

    Philipp Hildebrand: I think one of the things we should not forget, it’s true of course that the overall climate has been a very positive one. But when you look at income distributions, when you look at even broad segments of the middle class, in many ways, large sections of the populations all over the world have not really benefited from this period, certainly in terms of real wages. This experience of a good decade in many ways in terms of just if you look at headline growth numbers in GDP and markets, of course has not translated down into the lives of many ordinary people, which is exactly why I think we’re seeing this extraordinary frustration around ultimately an inequality issue which has been exacerbated by the crisis and sadly, to some extent at least, by the response to the crisis over the last ten years.

    Catherine Kress: Overall, as we think about some of these risks that markets may or may not be paying attention to, how do you think investors should actually be building some of these insights and how should they be thinking about geopolitics as they invest and as they manage their portfolios?

    Philipp Hildebrand: I think we have to recognize that we are still in a world where consumption has been very strong, the cycle continues, and it’s underpinned by very supportive financial conditions. For those reasons, I think near-term recession is very unlikely. I suspect we will continue to see significant underpinning of financial markets. And so the challenge really for investors is to think about these short-term, constructive dynamics, and how do they match up with some of the longer-term limits that we’ve talked about, and at what point do the two time horizons collide? That’s a very difficult thing to do for investors. I think they have no choice but to focus on quality investments, trying to focus on portfolio construction that leads you to a resilient portfolio, so that you can partake in this extended cycle while being aware that some of these longer-term trends, if left unaddressed, could become real challenges. But it’s a very hard one because you are dealing with almost two-time horizons here.

    Tom Donilon: You know, in general, Catherine, I think if you’re an investor and you look at the list of geopolitical issues in the world, it’s a very daunting list. We could spend a lot of time here making a list of situations that, if they went to worst-case scenarios in every case, could be paralyzing for an investor to look at that. So I think the important thing to understand is that each of these has to be looked at individually. And you do a deep analysis as to which of these are likely to move to less positive case scenarios and what the impact is going to be. Every geopolitical situation in the world that may go to a worst-case scenario is not going to have a market impact. So, it’s two things, it’s doing the deep kind of work on each of these to understand what the trajectory might be, and then the second piece is looking carefully at what the actual market impact would be under various scenarios.

    Catherine Kress: Tom mentioned two ways to think about incorporating geopolitical risk in portfolios: understanding the trajectory and likelihood of individual risks and analyzing the impact those risks might have on global markets. As the economic backdrop weakens, this analysis becomes all the more important – geopolitical shocks can have a bigger impact when markets are vulnerable.

    Geopolitics and globalization is just one of the limits we’re keeping our eye on. Philipp outlined three other long-term issues he’s worried about: inequality, monetary policy and sustainability. To get a better sense of this last issue, I sat down with Brian Deese, Global Head of Sustainable Investing, and Teresa O’Flynn, Global Head of Sustainable Investing Strategy for BlackRock Alternatives, to talk about the future of sustainability and what makes right now a critical moment to incorporate sustainable insights into our investment views.

    But first, a level set: what exactly do we mean by sustainable investing?

    Brian Deese: So, it’s the right question to start with because this is a space that there’s a lot of terms, there’s a lot of confusion. So, we start with a very simple definition, which is sustainable investing is combining the best of traditional investing approaches with insights, ideas, data on sustainability-related issues in order to improve long term outcomes. So, there are a couple of things that are important about that definition. First, this is about delivering on our fiduciary obligation. This is about finding ways to integrate sustainability consistent with driving long term financial performance. So, there has been a long tension to say do you have to trade off financial value for your values? Our objective is to try to find ways to actually enhance traditional investing approaches. The second is that it drives you toward an understanding of how can you actually measure and integrate those sustainability-related issues? And that is where we hear a lot about ESG – environmental, social, governance – that basically characterizes a whole set of issues that might be relevant in terms of how a company or an asset is performing across time. And we’re seeing across the world in all sorts of ways – whether it’s climate change or social movements or social media or cultural changes – that these issues that have been traditionally thought of as non-financial are increasingly central to how companies or assets are going to perform over the long term.

    Catherine Kress: You mentioned environmental social governance, we hear about environmental/climate related issues all the time. What are some examples of some of the social and governance issues that you’re thinking about?

    Brian Deese: Sure. So, when you hear social, it’s about how a company manages its internal stakeholders, so think its employees. So human capital. Are you creating an inclusive workforce? We know that workforces where people feel more empowered, there is more diversity, actually there is better decision making. They generate better profitability over the long term, and they're also less subject to the kind of idiosyncratic crises that we’ve seen when you mismanage your human capital and all of a sudden, you can lose your social license to operate, and your employees go out into the street and protest you. That’s the kind of thing you think about when you think about the “S” bucket. “G” is actually in some ways the most well-understood. Basic governance principles, there’s a long and established link between good governance and financial performance. But in the world we operate in, we try to look specifically at governance-related issues on new and emerging issues in this space. So, for example, what’s your governance of your data security and privacy? Do you have a governance structure to manage risks associated with cyber-attacks? Those are the types of things that are more difficult to measure, newer in some ways, but test the governance of a company and are the kinds of things we want to be able to measure, we want to be able to integrate.

    Catherine Kress: Brian, one of the themes that we’ve been exploring at the forum this week is sustainability at the limit. How do you view this theme, and what are some of the underpinnings or core issues that you’re thinking about?

    Brian Deese: I think this concept of the limit is really fascinating when it comes to sustainability because there are sort of two lenses. One is there’s a set of things that are changing in the world, that may force a set of limits. So, climate change is a good example, right, we have had multiple once-in-500-years weather events in the last couple of years. So, at some point, the impact of rising global average temperatures is going to force a set of physical limits, whether that be extreme flooding in the middle of this country, the wildfires we’ve seen out west, or the frequency and severity of hurricanes. And there are limits associated with that that we need to understand as investors and we need to make sure that we’re factoring in. There is another which is societal, which is this increasing societal expectation and pressure is going to force limits. It’s going to force limits on how companies are allowed to operate, when companies Iose their social license to operate. And so, as investors, we also have to understand and anticipate where those trends start to go from interesting and important to actually changing or putting pressure on business models, including the financial sector.

    Teresa O'flynn: I definitely would like to pick up on the point Brian mentioned around physical limits, and this is particularly important when we’re investing in infrastructure and real estate in local economies. Today, I don’t think the market is quite there in terms of thinking about how climate change is affecting vulnerable properties or infrastructure, and this is a particularly important topic because I think the signs around how our weather patterns are changing, the facts are undeniable. So ultimately, I think in order to fulfill our fiduciary responsibilities, we need to be factoring these considerations in when we’re deploying our clients’ capital.

    Catherine Kress: What comes next for sustainable investing? After recognizing some of the key issues, starting to integrate them, what are you working on or starting to think about moving forward?

    Teresa O'flynn: I think when it comes to sustainable investing, where the market is going, it’s simply going to be mainstream investing. In years to come, I don’t even think we'll talk about sustainable investing as being a thing because I think increasingly people are recognizing that it is at the core of sound risk management. It’s particularly true for us in private markets where we are investing for a 10, 15, 20-year horizon. And thinking about how sustainability trends will affect your cash flows is, quite simply, wise investing.

    Catherine Kress: To follow up on that, you mentioned that the next thing is that we won’t even have to think about it, it’ll become traditional investing. Do you see any kind of regional differences in that, or do you expect that outcome globally?

    Teresa O'flynn: I think, as we stand here today, we’re definitely seeing regional differences. The European market is, I would say, more advanced in terms of how it thinks about sustainable investing but other regions are catching up. More and more of our conversations with clients outside of Europe increasingly feature sustainable investing as well.

    Brian Deese: Well I like Teresa’s answer because it’s basically, she wants to put us out of business. As I think forward, the two big areas of next big issues to me are one, sustainable benchmarks; so previously, we didn’t have enough data, enough conviction, to actually say you can make core allocations in a portfolio and be aware or actually improve the sustainability attributes of those core allocations. We've come a long distance on that, and when you are able to do that, you can open up the aperture of how sustainability gets incorporated, not just in the decision to allocate to a particular fund, but in your original asset allocation and portfolio construction. The second is that the revolution in data that has come to the economy writ large and to the financial services industry is coming to sustainable investing in a big way. And so the proliferation of data – not just about what a company is saying to the market (so if a company has a sustainability report or otherwise) – but what the market is saying about a company. We talked about human capital; increasingly the best ways to understand whether a company is effectively managing its human capital are not what a company is saying, but what its employees are saying through social media or otherwise. Harnessing that type of information, applying it in increasingly sophisticated ways – that’s the big next opportunity in this sustainable space.

    Catherine Kress: Those are both really exciting answers. Shifting into what worries you, as you think about the future outlook, what keeps you up at night when you think about sustainable investing and how it’s going to evolve moving forward?

    Teresa O'flynn: I think in terms of some of the regulatory interventions that we’re seeing in the marketplace at the moment, and again I go back to Europe, there’s a tremendous focus on financial regulation around the space and ultimately with a very good objective to protect the end investor from green-washing, defining what we mean by ESG integration. And ultimately, I believe we are moving to a place in Europe where it’s going to be a legal requirement. That’s all good; we welcome that. I think what is missing though is more coordinated regulatory intervention that is focused on what sustainability means for the real economy. So, what do I mean by that? In the real economy, we’re talking about infrastructure projects; we’re talking about real estate. If sustainability considerations are not factored in upfront when projects are being planned and developed, often by the time we get involved as a source of capital that often gets involved at the construction or operating phase, it’s too late for us to try and influence the outcome. And this is where I think, if we take a step back and see what Europe did in a renewable energy context back in 2009, it was pretty fundamental. We set long term 2020 targets requiring the EU to have 20 percent renewable energy in the mix by 2020; we’re getting close to that. But what that very specific and deliberate regulatory initiative did was it spurred a renewable energy market. Initially on the back of subsidies in order to get wind and solar built, but now we’re at a stage where free market forces have taken over. So when I think about sustainability more broadly and the need to think about responsible resource consumption, the need to think about with all this wind and solar getting built around the world, how we modernize our power grids, how we think about encouraging innovation around broader climate infrastructure, I think we need regulatory signals that can encourage the market to respond, so that ultimately we as financial investors can invest in more and exciting sustainable investing opportunities.

    Catherine Kress: And Brian, anything you’re worried about?

    Brian Deese: How long do you have? At core, very similar to Teresa. I think as exciting and as fast moving as this space is, my biggest concern is that collectively we’re not moving fast enough to solve these big global challenges, whether it’s inequality within and between countries, or it’s climate change. And fundamentally in order to accelerate progress, you’re going to need a combination of increasing innovation in the financial sector, but also long-term price signals. The increasing uncertainty and lack of effective ability to govern around really core issues, societal issues like these and send those long-term price signals is a challenge to the kind of speed that we’re going to need if we’re going to get in front of these issues. So, I am both optimistic about the role that finance can play in helping be a catalyst for positive change, but the speed at which that happens keeps me up at night because it’s going to require this combination of public policy and private sector innovation working together if we’re actually going to get ahead of some of these big forces.

    Catherine Kress: As Brian and Teresa mentioned, sustainability is at its limit – both from a physical and societal standpoint. But as Philipp and Tom discussed, our world is up against a number of other limits. Inequality is rising across the globe, contributing to populism and anti-establishment sentiment. This rising inequality, coupled with great power competition and protectionism among countries, means decades of globalization may be coming to an end. This is happening as policymakers — central banks, specifically — have exhausted their options for dealing with the next downturn. With these limits in mind, how can we prepare to invest for the year ahead? On our next episode, we’ll continue our conversation from the Investment Forum and explore the path forward for markets.

    Thanks for joining us today on The Bid. We’ll see you next time.