Systematic investing

JEFF ROSENBERG: Hi and welcome to this quarter's Market Pulse Webcast, special systematic version in the systematic world. We call our webcast Decoding the Markets. So, I'm joined by our head of systematic, Raffaele Savi, and our special guest this week, deputy head of portfolio management group, Mike Pyle. Mike, I'm going to start with you and first say it's great to have you back. I am making reference to the fact that Mike has spent a lot of time working in Washington, and we're going to tap into some of that expertise. Mike worked at BlackRock before. We worked very closely together. Great to have you back. What I want to do for everybody's benefit here… oh, by the way, I should introduce myself. I'm Jeff Rosenberg. I'm a portfolio manager in our systematic fixed income group, run a number of our portfolios with my teammates, and I'll bring, you know, some hosting and some content as well, and it's good to all be in the same room together as opposed to doing it WebEx style. So, hopefully, you all there are getting some of that vibe. So, Mike, to start with you, I'm going to read a section from Mike's bio that I find very appropriate for the conversation. Obviously, we're going to start with some of the big macro issues around policy. So, Mike, in his prior role, acted as the president's principal negotiator with Europe, Japan, and other partners in crafting common approaches to issues such as trade, technology policy, and geopolitical competition with China, and so, Mike, I think it's the understatement of the decade to say that your successors might be taking a slightly different approach to these policy issues than you did in your prior role. So, give us your take on what's going on, your deconstruction of the events, and we'll get into it from there.

MIKE PYLE: Cool. Well, great to be with both of you. You know, I think one of the interesting things is, you know, the approaches might be different, but some of the problems are very similar, you know. So, you know, going back to my first stint in government act during President Obama's term in office, you know, issues around rebalancing the global economy, and in particular, rebalancing U.S.-China trade, that was an important dimension of conversation, you know, more than a decade ago. Then similarly, you know, the time that I spent serving in the Biden White House for President Biden, you know, issues around revitalizing American manufacturing and increasing the industrial capacity of the U.S., as we're also kind of very front of mind, top priority issues. So, I think one of the interesting things is the problems that the Trump administration has identified and are working on are not problems that are unknown to administrations, really, of both parties across the last 20 years. I do think what's different is some of the ways in which the Trump administration appears to be balancing the costs and benefits of different types of approaches to solving those problems. So, I think, when I was both in the Obama White House and the Biden White House, you know, we recognized that, or part of the way that we approached it was to say, boy, certain ways of leaning into solving these problems can bring pretty immediate disruptions, pretty immediate costs, and we need to be careful to calibrate our approach so as to take steps down the path towards making progress on solving those problems without bearing too much by way of immediate disruption, immediate economic costs. You know? So, I'd say one way in which this administration, I think has differed is their, you know, risk tolerance with respect to taking more disruptive steps in the immediate term. I think the proof will be in the pudding, you know, out over the next one year, two year, three years, four years, you know, are those disruptions, are the costs that they are bearing today going to be worthwhile, net-net, in terms of what they're able to achieve with respect to rebalancing global trade, with respect to rebuilding and reshoring American manufacturing. I guess when I look at it from a market's perspective, you know, obviously, you know, the buzzword of the moment is uncertainty, and certainly, the markets we've seen over the last couple of months have been deeply characterized by uncertainty, and in particular, the uncertainty emanating policy, but I think it's important to really get into the markets discussion, to unpack, you know, the different forms of uncertainty that we're seeing and how that can play out in terms of a timeline for giving investors

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firmer footing to make decisions moving ahead. So, I think there are at least three dimensions of uncertainty here. One is what I would describe as uncertainty around objectives. I think it's not clear from some of what we're hearing from the administration, you know, what the end objective is here. Is it to, you know, raise revenue from the tariffs on a permanent basis? Is it to put in place incentives to permanently bring manufacturing back home? Is it to use as a tool of leverage to drive better deals and better terms of trade with key partners, implicitly meaning that those tariffs are going to be much more temporary in nature and not necessarily set up a permanent signal to bring manufacturing back home and/or to raise revenue on a permanent basis? I think that's one dimension. We don't really know what's being optimized for.

JEFF ROSENBERG: And let me just interrupt for a second on this first dimension, because I've found this to be like one of the biggest issues. I've somewhat characterized it as will Trump take zero for an answer, and by zero, is it zero trade barriers and trade tariffs, or is it zero trade deficits, and if you go back to, and Raf, feel free to chime in on this part of the conversation, the big kind of aha moment for markets on liberation day was when he stood up there with the placard, and you looked at these, you know, implied non-tariff/tariff barrier, reciprocal tariff rate, and then it was discounted by 50%, we're all like, where do you come up with that number, and then, like, you know, you quickly kind of figured out it was like the net trade deficit divided by two. You're like, oh, well, that's not what we thought Reciprocal tariffs were going to be. Reciprocal tariffs were supposed to be the kind of good outcome, because they were better than a 20% across the board outcome. So, this first uncertainty objective here is really critical. So, I don't know if you have any more thoughts on, like, which way are they going?

MIKE PYLE: I think it is genuinely unclear. I mean, certainly they have talked in trade deficit terms pretty regularly. I think the flipside of that is, you know, my own intuitions are, you know, if what we want to do is rebuild America's industrial capacity, a sort of net trade deficit notion isn't necessarily the right way to think about that compared to something like what are our gross exports, what is the competitiveness of the manufacturing and industrial exports that the rest of the world wants to consume from us. You know, in state of the world one, you know, driving the trade deficit to zero can mean imports go down and exports go down. In scenario two, you're less focused on imports, and what you're really focused on is what is the volume of exports, what is the sophistication of exports that the United States is competitive in world markets around, and I think that implies a much different type of a policy approach, you know, when push comes to shove in the one versus the other, and I don't think we're quite clear yet on which of those worlds that the administration wants to walk down, and I think that the additional dimension of uncertainty that I would just highlight before shutting up here is, you know, I think investors are looking for some timeline for these puzzle pieces to start falling in place. You know, this is a very challenging moment to be an investor, because you don't know what the objective is. You don't know what the magnitude is. You don't know what the timeline is for these puzzle pieces to fall into place. Now, I think if we can get to a place where we start to see the outlines of what the solution is going to be at some level with less import on what the solution is and more that we kind of have the makings of one, I think that gives investors the beginnings of the rules of the game to begin redeploying risk, and I think that's very important from a market's perspective.

JEFF ROSENBERG: Yeah, and I think these initial reads out of, like the meeting with Japan, for example, markets are on, you know yeah, pins and needles waiting for is it going to be a positive signal or a negative signal as a testament to that, yeah.

MIKE PYLE: I think one last one I would just add, you know, I think that the challenge is that, on one hand, I think the market, rightly, is looking for signals, is looking for a template that can be built upon and expanded. You know, you start with Japan or India. What does it mean to take that template and expand it to other of the 75 countries that are in play here? On the flipside, I can speak from some experience here, these are very complicated negotiations, you know, tariff issues in some ways, even more importantly,

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non-tariff issues, behind the border issues, get to really important political sensitivities, not just in the United States, but our trading partners, and it is not straightforward to unlock solutions to those, particularly when you're constraining yourself to a really tight timeline. So, I think I'm hopeful that we're going to see some of these pieces fall into place, but from, you know, hard experience, recognize that, kind of, if you gave me an over/under on any timeline for a trade negotiation, I will basically systematically take the over, because these are very complicated things.

JEFF ROSENBERG: Yep. Raf, let's bring you in here. We're going to pivot a bit from this kind of high-level discussion around the policy uncertainty to markets and the economics, and obviously the economics piece of this, I think by now, we've all seen economists’ consensus, Powell talking about, you know, this raises prices, it reduces growth. You've seen consensus economics marked down, growth estimates marking up, recession expectation. So, a lot of the systematic theme for today is how do we incorporate that into our process. What are some of the things that you see from our platform that's informing this outlook?

RAFFAELE SAVI: First, let me sort of leverage the analogy that, that Mike introduced, that I quite like this idea of sort of the puzzle pieces, no? I think what we're living through is desire to reconfigure the way in which global trade works and the way in which sort of important parts of the economic system in the United States, and hence, the world work, probably the biggest, most ambitious agenda in terms of reconfiguring the board that we've seen in decades, and I like this idea of, you know, as you were saying, markets are on pins and needles, trying to understand sort of where the first pieces of the puzzle will be placed down. Then I think markets are very resilient. Corporations are very resilient. We would probably be able to see very quickly winners and losers, magnitude of effects. I think we're still before that phase of the actual, trying to figure out the specific effects. So, for example, when we're looking at our data, alternative or otherwise, you're seeing a lot of movements on sort of surveys, a lot of movements on sentiment, and what you're seeing on the hard data side is a very confused picture. You might have certain sectors of the economy that, you know, might show growth, that possibly, for example, you know, some stockpiling of autos in dealership in anticipation of tariffs. Some of the growth we're seeing, it's hard to associate with immediate consumer demand, maybe, but then you're seeing in other parts of the economy, maybe, that orders have ground to a complete halt with the idea that maybe, you know, corporations and businesses can go through the inventories in this uncertainty period and then figure out how to replenish their… so, it's very hard. Usually, you know, consumer demand is the primary driver of some of these changes in inventories across sectors, and what you're seeing here, it's very hard to sort of match the magnitude of what you're seeing or the abrupt slowdown of the spikes with a change in consumer demand, right? So, I think we're going through this phase in which we're waiting for the first few pieces of the puzzle to sort of be on the board. Of course, prolonged uncertainty also drives, in and of itself, a reset of markets, and I think I was looking at it yesterday. You know, we're looking at alternative data or traditional data using magnifying lens and all the tools, you know, we have, but when you look at year-to-day performance on sectors, it’s actually, it’s a remarkably simple story. You know, it's a story where gold is the best performing asset in sector in global markets, and you're seeing defensive sectors that are at the top of the leaderboard and sort of consumer facing, more cyclical sectors at the bottom. So, I would say that the first order reaction of markets to sort of this phase has been risk off and a movement to a defensive stance. We've seen evidence in our leverage tracking data of a little bit of de-risking in the system, sharper in two waves. One, you know, first week in March, and then another one we saw after liberation day, but I think that there's not a lot of cross-sectional differentiation happening at the moment. I think the first thing that markets are present in is sort of elevated uncertainty, and everybody's waiting to sort of understand where the first piece of the board, of the puzzle will be laid down and extrapolate from there, but it's been a market where extrapolating has been very hard, right, because of the level of uncertainty, and, you know, I'm actually as you know, I'm always an optimist. I think that as soon as we start figuring out a few things, then the collective intelligence of prices and market participants will fill the board pretty quickly.

JEFF ROSENBERG: I want to talk a little bit with both of you about this concept of sequencing, that we came in really beginning with the election anticipation and had, at the end of last year, a very strong Trump trade, and part of that was sort of like what markets were expecting from Trump 1.0, that you had kind of what I would characterize as the market-friendly or good Trump policies, and then later in 2018, as you started to get more of a focus on trade and China, kind of more market unfriendly policies. So, when we think about, you know, obviously, we talked about the focus. Liberation day is all on trade and tariff, but there are a lot of policies that potentially could be affecting outcomes. I think the anticipation at the beginning of the year is that the market friendly ones might be first: tax, deregulation. Instead, there's been a little bit of a switch, obviously, in attention and focus on trade. So, Mike, I'll start with you. In terms of thinking about the other sequencing of policies that may evolve here, you know, what else do you think we will be talking about, or is it just all going to be about trade and those other policies are just getting pushed to the back of market's attentions? Yeah, I think this questions spot on Jeff, both because exactly, as you say, the way in which the sequencing played out differently 2017 to 2021, and the way that sequencing played out, of course, was generally quite market friendly here. You know, coming out of the gate, a set of policies somewhat more unexpected in terms of magnitude, in terms of willingness to bear disruption, somewhat more generating of the uncertainty in markets that we've described. I do think, as, you know, we turn the calendar into the summer months, you know, we are going to see almost necessarily the relative share of the policy discussion moving towards other things, and I think the first most important thing that it'll shift to is around tax and fiscal policy. You know, I think that the tax and fiscal policy debate is incredibly important and perhaps has, you know, relatively differentiated impacts across market by asset class. So, I think on one side, you know, I think we're very likely to see an extension of the 2017 tax cuts and potentially some additional, you know, business and individual tax cuts thrown into the mix, you know, some additional incentives on business investments. You know, I think there really is a kind of serious push around additional tax relief for lower and working class households in the country, things around excluding tips from the tax base, and other steps like that. You know, I think that those are the types of steps that, you know, are, in the near term, growth supportive, in the near term, can take some of the staying out of the growth shock that I think we would expect to see as a result of tariff policy, and as a result, kind of I think really begin to cushion or kind of foam the economy to be sure that, as we go through 2025, that there are supports to growth in addition to some of the pullbacks that we'll see as the tariff policy plays through. You know, I think it's maybe a little different, I'd be curious as to your view on this, on the fixed income side. I think that that growth supportive policy for risk assets, for credit assets, I think, looks pretty positive or pretty constructive. I think, in some ways, it adds to uncertainty around rates, around the treasury market. You know, obviously, there are a range of puts and takes around treasuries these days, but one important dimension of additional upward pressure on the term premium is, you know, what does that U.S. fiscal trajectory look like out over, not just the next one year, but the next four, five, six, seven years, and I think everything is pointing to that deficit trajectory being higher than we expected, and as a result, that pressure on the term premium to be higher still, and when you combine that, I think, with some greater hesitation that we've seen amongst the buyers, the demand sources of treasuries, that supply-demand equation, I think, cuts in the direction of greater pressure on the term premium. So, I think that's a really important dimension of policy that's going to get increasing focus as we go deeper into the year, and I think the implications across asset classes may be somewhat differentiated. You know, on the other side, you know, I'd say there's also going to be steps on regulatory policy, and here, you know, I differentiate between places where I think they'll have relatively near-term impacts on economic behavior we. Wut here, I think, the last set of likely moves on banking deregulation that I think are moving through the system, and I would expect to really begin having impact as we get into the second half of the year. I'd contrast that to, I think, steps that are likely to happen on energy policy deregulation, where I think both the timeline of them actually having impact, I think, is going to be measured in years, not quarters, and I think moreover, when we look to the near-term trajectory on energy production, the price signals that are being sent from the market today are going to have a lot more to do with the willingness of EMP companies to invest and produce in the near-term more than the regulatory steps. So, I think it's a relatively complicated picture on the regulatory side as well. Bottom line, I think we're going to, necessarily, see a moving on from some of the tariff discussion to other dimensions of policy. I think, on balance, those are going to be more positive conversations for growth for the market, but I do think that they're differentiated in terms of asset class with respect to fiscal policy and with respect to sector when it comes to some of the deregulation.

RAFFAELE SAVI: One point on this one that I find interesting, we've done some work, as you know, trying to figure out, you know, what's the mix of policies that the administration is talking about. Of course, there's a huge amount of motions in the U.S. and globally around the agenda of the administration, and what we found useful is sort of trying to… so, you can't really look at Twitter feed in general, because the amplification of emotions and views on both sides of a particular argument is all time high, but what we're trying to do is we try to look at sort of official acts of the administration and, you know, you can start with executive orders, and you can also start with sort of, you know, President Trump and sort of elected officials’ comments on it, and when you do it this way actually the data shows an interesting pattern, that, you know, brought some clarity, and I think it supports Mike's sort of description and expectation of events, and in a nutshell, it says that sort of pre-election and in the first month post the election victory, the dominant topic was, by far, immigration. So, it was almost 90% of the actual sort of President Trump and close collaborators’ official pronunciation and acts were around the topic of immigration and border. Then, you know, we had a transition, maybe in December or early January, where sort of social and cultural issues became the dominant part, and then trade and tariffs became a dominant part in in sort of the February-March timeframe, and now, you are actually seeing, to Mike's point, tax and regulation that, in the official pronunciation, are becoming a more important component, and I thought it was interesting, because sort of living through this, especially as a market participant, trying to figure out and extrapolate and interpolate, it does seem that there's a lot going on, but when you actually look at like a simple sort of count of topics with some topic modeling behind and a little bit of quant smoothing over it, it shows a more orderly picture. So, I do think, to Mike's point that we might be, you know, we might be moving into a slightly different phase, where the topic du jour might be different. Now, I go back to what I was saying earlier, that this practical implications of sort of this phase around trade and tariffs that markets need to get a grip on and understand, but I do think, you know, I do think unlikely that this will be the only issue that we'll be talking about for the remainder of the year, and that, to a certain extent, I think is also what makes it hard having an ultralong time horizon in your investment decision, and why it's sort of we try to stay nimble, neutral, on a lot of big dimensions, whether it's beta, whether it's duration, whether it's factor, try to sort of trade a little bit more tactically around the neutral position, because, you know, the steps to sort of some reduction of uncertainty, you know, seem to be many ahead of us.

JEFF ROSENBERG: Many indeed. All right, Raf, let's stay with you and go a little bit deeper. I will come back to the fixed income conversations and the fiscal stuff. We'll maybe take some of that in the Q&A, but I want go a little bit deeper on the systematic side, and Raf, I'll ask you a question I get often asked as a systematic portfolio manager, which is, you know, we're talking about some incredibly new, untested kinds of shocks to the economy, and we're talking about rewiring the whole global trading system, and so, as systematic investors, a lot of the kind of skepticism and pushback is, oh, well, you know, how could your models possibly handle this kind of environment. You know, if you're doing machine learning on historical data, there's nothing in the historical data that can tell you about this kind of environment. Well, that's a challenge, but I think, you know, rise to that challenge, and so, I want you to talk a little bit about that and a little bit of a preview, a little bit of advertising. This is our 40th year anniversary of being systematic investors. Raf, I think you've been here for around 20 of that.

RAFFAELE SAVI: That's right.

JEFF ROSENBERG: I have been, as part of the systematic team, going on year eight, but there's a long history here of process and evolution, and so, I think if we start framing it from there, that might be interesting to move us into the conversation of what we're doing right now around this particular period of uncertainty.

RAFFAELE SAVI: Yes. Well, you know, I think, in a way, and this is, by necessity, a little bit simplified and, you know, forgive me for generalizing a little bit too much maybe here, but I'd say a systematic investment process is sort of built around the idea of a lot of sort of checks and balances, and, you know, I talk about sort of safety engineering using a car analogy there. There's a lot of that. What's been working in different regimes, what's been working in different magnitudes, how do we build portfolios that have maximum exposure to insights that we feel are persistent, consistent, and we minimize the exposures to all sorts of risks that might be in markets and might be not rewarded in the long term. Right? So, when you were doing this many, many years ago, you didn't have the granularity, the frequency of the measurements you have today, and so, the risks that these portfolios wanted to be immune to would be like market direction, large versus small cap, value versus growth, and sort of momentum, and this was sort of what you would try to either intentionally gain exposure to or sort of minimize unintended exposures, and that does a pretty good job, but we also know that there's a part that these factors don’t capture, and that, to me, is the interesting part. Right? In normal times, that part is benign, if you want. You know, you can try and take advantage of those misalignment, knowing that by and large, they tend to revert, and so, there's a lot of opportunity and just sort of, hey, maybe the market has gotten too excited about it. Let's take the other side of it. Or maybe people are too pessimistic on this thing relative to some long-term valuation. Let's… now, there are also moments, like the moment we're living now or COVID, where it's not quite clear that those residuals are all mistakes, that they're all sort of excessive reaction of markets. Maybe there's some genuine elements. A colleague sent me last night this sort of, this chart where we were showing how big the movement around the exporter versus domestic in Japan have been in the cross-section in the last month and a half. That is also, you know, a period where, of course, you got tariffs, you got the yen moving versus the dollar in a significant manner, and what happened, the real change in the last 15 years is that we got so much more data, and so, we can now do the same intentional, deliberate constructional portfolios on the standard factors, also, on some of these emerging, you know, emerging factors that might be really relevant one or two months, and then they kind of, you know, disappear and get absorbed by crisis, and so, we're doing a lot of work these days on, you know, you have to do an extra shift these days if you want to keep your portfolio immune and neutral to some of these factors. The objective is always the same. The objective is always to sort of have exposure to ideas that we think will be rewarded and minimizing risks that sort of are not compensated, and it's just that, if 15 years ago, 20 years ago, where it started, maybe we had ten or twelve of these risks we were measuring. Today, we have 1,000, and there's a much more dynamic composition of those ones. I like to say, you know, you heard me saying this. There's a quote from our original founder. You mentioned 40 years for BlackRock Systematic, and so, that made me think about Richard Grinold, that was the founder of this group, founders of Barra, very storied. So, one of the founders of systematic investing, and he used to say the best way not to gain 20 pounds is not to gain five pounds, and the way I interpreted his cryptic saying was that, you know, one, you're more likely to sort of take a better decision if you are, you know, in a good position in terms of you can live with the swings in returns, in your funds, you're happy with, you know, the trailing performance, and also I interpret that way of saying as, if you can control some of these big exposures that can move your portfolio away from its intended goals significantly, you're going to be in a much better position to get to where you want to be, where you want to go with your journey, and so, I think one of the reasons why these portfolios are performing reasonably well in this environment is this idea of safety engineering, car with brakes, and they might not be the most exciting portfolios in a, you know, rates at zero, central banks, very supportive, clarity on the direction of global economy, where, you know, more thematic, aggressive strategies might take more advantage of a stable environment, but in environments that move around quite a bit, I think this type of investment styles, actually, are well equipped to navigate that.

JEFF ROSENBERG: Awesome. I want to pick up on something you said around safety engineering and the engineering aspect, and so, talk to us a little bit about the kind of need and the evolution in that safety engineering. I think it goes back to some things that you learned during the COVID period, how you're seeing the application of that, you know, comparing two periods of very heightened uncertainty that we had never seen before, and so, there were some innovations done during COVID and then compare that to what's going on now.

RAFFAELE SAVI: Yeah, I mean, I think the way we always thought about our team was, you know, we want to have best people with the best insights and intuitions about market dynamics, but with a shared understanding and discipline to sort of quantify, measure, and systematize and automate as much of those insights as we can. My friend and colleague, Tom Parker, calls this the ghost in the machine, now, this idea that every piece of insight that anyone in this team for 40 years had, could be around the way your currency a payer is moving. It could be around sort of what are the drivers in a particular environment or the long term of the curve versus inflation. It could be dynamic between two sectors or many other ideas. It’s still there, and it’s still tracked, and what did change over time is the ability with, you know, I think we started with regressions, and now, we're at large language models, you know? Like, the ability of answer some of the questions you're asking has gone up tremendously in these last 40 years, and one thing that I am always amazed by is how the systems become more proficient the more data you feed them. So, one thing that is really interesting there is that, you know, if you have an objective of consistent performance and of limiting influence of factors you don't understand, things you don't have an edge in predicting, right, models where you have a limited number of factors. They limit your ability to do that effectively, and as you're adding more and more data, more and more granular information, you know more and more things about what's driving asset prices, and then your ability to sort of engineer some safety in this portfolio grows. It's never going to be perfect, because active investing, you know, is about trying to figure out what's going to happen in the future, but you can sort of build portfolios that are closer and closer to being, taking risk on things you know a lot about and minimizing risks that you think are not worth answering, and so, I think that this quantity of data becomes quality of portfolio is a very interesting concept that is happening, and interestingly, it's not just happening in finance, you know. We know there's a paper that, you know, as you know, I posted on our team's chat. It's a two-page paper that I think is really interesting. It's called The Bitter Lesson, and it's a paper that made quite a splash in the machine learning community that says, hey, how interesting it is that sort of data almost always wins, that larger models tend to perform better, and that you should never look at this as a competition between human insights versus a fully automated solution. It actually is the ability of leveraging human insight with an increasing quantity of data that tends to outperform in a lot of fields, from translation, gaming, to sort of sequential decision making, and I think that there's an element of that in investing as well. You were asking, you know, when you were mentioning COVID, I think that this is a similar phase in markets, where, when I'm looking at how much of our signal base is things that we've been trading for a long, long time versus how much is recent, we're seeing a surge in new signals, new factors, new ideas, similar to the one we saw during COIVD, and I think it speaks about this rewiring of the economy, this large scale rewiring of the economy that that we've been discussing so far.

JEFF ROSENBERG: Excellent. Let me bring Mike back into the conversation. Talking about safety engineering, talk a little bit about what you're seeing across the platform in terms of switching to the other topic as deputy head of the broad portfolio management group. You know, what are you seeing from client interest, what are you seeing in terms of portfolios, opportunities for navigating this high policy and uncertain environment?

MIKE PYLE: Sure. I mean, what I'm going to end up doing is echoing, you know, a lot of what Raf has said and, and what you have as well. You know, the first thing I would observe is, you know, this is, just to restate it, a period of heightened uncertainty, not just in terms of policy, but also, in terms of how big parts of the market are moving versus one another. You know, we came into 2025 with a really significant conviction, when I say we, I mean that we in the market sense, around U.S. exceptionalism, you know, underpinned by ongoing U.S. outperformance, underpinned by the tech sector, in particular, the portions of the tech sector at the leading edge of AI, accompanying that, a historically strong dollar, at least over the last, you know, 15 to 20 years and, you know, very stably pinned rates, and I think all of those things have come under challenge over the last handful of months, and in particular, you know, as I know you both have been tracking closely, you know, risk has sold off. U.S. exceptionalism, inequity markets has sold off, but we haven't seen the type of behavior that we typically expect to see around growth scares, around risk off environments in terms of the treasury curve rally and rallying in terms of investors fleeing into the dollar as a safe haven. Instead, we've seen rates sell off and the dollar sell off alongside U.S. equity markets and equity markets more broadly, and I think what that highlights to me is, boy, there's some big tectonic plates moving. To what extent are the market moves and the relation of one market move to the other just an unwind of sentiment that we saw build up around the U.S. in ways that, perhaps was, necessarily, going to come off the boil at some point, and to what extent are we seeing something much more fundamental in terms of how equities versus rates versus currencies are going to move in relation to one another, rolling the clock ahead? That's a big question. That's a question that I'm probably not prepared to take a view on definitively at this point, and I don't think, frankly, investors should want to take a view definitively on that question, and so, what does that mean? It means I want to take a step back from those big unanswerable and focus on what does it mean to run a portfolio that delivers alpha, delivers diversification, does so in ways that are liquid, that is safety engineered to ensure that, you know, we're not seeing big drawdowns in the face of historic uncertainty and volatility. I think that's the order of the day, in some ways, to kind of shrink the field of vision away from some of the big imponderables and really focus on, you know, what does it mean to deliver strategies that are market neutral, that are factor neutral, that are thoughtfully constructed in terms of taking a high breadth of risk and risk that can be, you know, that can be controlled in terms of the risk of drawdowns. That's the type of, I think, strategy that's really getting a lot of attention from clients right now, and I think frankly, when we look both in the firm and across the industry, the types of strategies that are performing.

RAFFAELE SAVI: Yeah, if I may add to this one, again, I'm very much in agreement with Mike. We very often are. I don't think, you know, I don't think what we're seeing now is… I know that it's a deeply fascinating subject for people who do what we do for a living, and, you know, are we on the verge of a structural change where sort of, for example, market valuation inequities between U.S. and the rest of the world we'll close a gap that has been there and growing for 25 years. You know, are we on the verge of like an epical change in terms of… I don't think that that's an answerable question, and I don't think that what we're seeing in markets tells us much about that. I think what you are seeing in market, and we're seeing it on our platform, is, you know, little bit of client shifting towards international rest of the world versus the U.S. It's not in the size that makes me think that people have changed their strategic asset allocation, but I think at the margin, probably, surveys say that our data says that, you know, clients, in general, clients' portfolios were overweight the U.S. in a variety of ways. Maybe some of those overweights are being trimmed, are getting close to neutral. I don't think you're seeing the magnitude of going the other ways and going overweight Europe or Japan, but I do think that you're seeing some of these adjustments or combination of beta and alpha in investors' portfolio. Again, at the margin you're seeing that some of our alternative products, absolute returns, hedge fund, liquid alternatives have been the ones where we've seen more flows on our own platform, but also, in the industry from what we're tracking, and when I look in magnitude, it does seem to me that in this period of high uncertainty, there's a little bit of adjustment of portfolios, but I don't think that, you know, markets are taking this viewpoint, and I don't think they should. There's not enough data at the moment to sort of do that. So, I think it's a very interesting question, very hard to answer with the data we have, and I do think that sort of market moves that have brought a lot of these variables, if you want, somewhere, you know, mid-2024. So, we're not really talking about moves that unwind half of the 20 years of outperform [PH 00:44:11] or moved and unwind two quarters, and that, to me, is sort of portfolio adjustments. I'd also say on this topic, that is very interesting in our BlackRock Investment Institute, we call example one, and the team there started talking about immutables, and I like this concept, you know, this idea of, well, what are boundaries, what are constraints on how these pieces can be configured. You know, we don't know where the first piece of the puzzle will go down. We don't know what's going to be around it, but, you know, there are constraints. There's still a board that has to be filled, and there are some rules, you know, in which these puzzles can connect or not. He talks about the macro side, of course, you know, budget deficits and risk premia. I think there's interesting sort of equivalence at the portfolio level and, you know, for an equity investor at the company level, and so, I think I like to think all these all this uncertainty, like what is it going to do to company margins, and what is it going to do to productivity in different countries, right, what is it going to do to propensity to consume in different countries, right? Those were also big parts of the story of U.S. exceptionalism, and, you know, are we ready to say that some of these, or all of these tenants are impaired. I would take a very cautious view. As a proud European, I have to say that sort of, you know, that there's a reason why margins and productivity and propensity to consume in the U.S. have been stronger than in Europe in the last sort of two-three decades, right? The other immutable that I think a lot about is the portfolio level immutable, now also, in terms of, for example, when we think about treasuries, and you're thinking about, okay, alternatives, you know, Asian bond markets, China, they have their own specific characteristics, just thinking about Europe. So, when you are an institution with the time horizon or an individual with the time horizon of 20-30-40 years, and you're trying to diversify your savings across assets that, you know, hopefully have a certain ability to deliver return on income and add the ability to sort of offset each other's shock, like, how big is that palette really in terms of size, liquidity, and so, I think what we're seeing today, and maybe I go back at what has been the [PH 00:46:50] field rouge in my comments is that there's a lot of uncertainty. There's a lot of emotions around this uncertainty, but we also live in a world where there's constraints, and there's a lot of parts that cannot really be easily reconfigured and fit in an infinity of ways. I think sort of there's some rationality in the way that the economic system is built that will play out in the next few quarters.

JEFF ROSENBERG: Awesome. I'm going to pick up on that theme. I'm going to remind you out there to ask questions. I've got my little device here that will send me those questions, and while you're thinking about questions to put into the chat, I'm going to start back with some of my own questions that we hinted at. On the immutables, there is a current account deficit, and the mere image of that is the capital account surplus, and so, if you're going to go back to that first uncertainty, you know, if you're going for zero deficits, well, the flipside would be then zero capital account surpluses, and it would seem that the role of the dollar and treasuries in that kind of environment may look a bit different, but I want to go back to the fiscal side, because that was another piece of this. So, what were you expecting in terms of the deficit amount, and is there any significance to, you know, the fact that with the adoption of current policy baseline as opposed to current law baseline, that we magically wiped away, you know, $5 trillion of deficit impact, seemingly, you know, with the stroke of the pen?

MIKE PYLE: No, we haven't.

JEFF ROSENBERG: Good answer.

MIKE PYLE: No, I mean, I think that it's some of the current policy, current law discussion is all kind of inside the beltway accounting, and like, basically the types of constraints that Washington policymakers either put to themselves or don't in terms of what the legislative outputs end up being, but the thing we should care about, as investors, is what does that fiscal trajectory look like, in fact, and I think that, you know, in fact, it's not going to look much different in one way or the other. You know, the thing I would highlight, again, about fiscal policies, in some ways what I've said is, from the start of the administration, the least uncertain elements of policy as we came into President Trump's term was fiscal policy. You know, we know that the 2017 tax cuts are going to be extended. That is the single most important fiscal policy decision this administration and this congress will take, and that implies a deficit trajectory of, call it, 6.5% out over the next four years. That's a historically high deficit to be running in an economic expansion at a time of peace, etc. You know, I think the incremental news that we've gotten over the last couple of months in particular around the tariff shock suggests that there's going to be a focus on making that fiscal policy package more growth supportive rather than less, and so, I would expect, on the margins, to see, as I said earlier, more tax cuts rather than more government spending reduction, a mix of both, but I'd say, on balance, we're going to see more on the tax cuts and less on the government spending reduction, and that, I think, suggests that, you know, like I said, the kind of incremental deficit is going to be probably a little bit higher than what we were already tracking, and, you know, on balance, that means probably more growth support in the near term and more pressure on those term premia and treasury markets at the same time. That's, you know, a mixed picture from an asset allocator's perspective, but I think that's probably what we're going to end up with as we roll the clock forward.

JEFF ROSENBERG: We're getting some questions in here. I just want to echo, I think it is challenging to the term premia. We've seen, you know, traditional relationships break down in a risk off environment. So, the dollar being lower. The curve steeper is usual, but usually, it's a bull steepening as opposed to steepening. So, higher long-term rates, lower short-term rates, and I really think the hedge asset here has been lost, and so, the biggest hedge asset is fixed income, and it's losing some of its hedge efficacy. Where you do see some hedging efficacy stills in the shorter end. So, you see a little bit of this flight to the short end. We've shortened up in anticipation of that in some of our portfolios, but the bigger issue is really the loss of confidence in the role of the treasury asset as a risk producer. So, Raffaele, I'll turn this question to you, and I want you to maybe just amplify a bit more about market beta factor neutrality and really about alpha in the role of a portfolio and how our systematic process fits in that.

RAFFAELE SAVI: You know, on this specific topic, again, I don't know, and I try to do what I consider a positive feature of our models, the ability to say, I don't know, you know, sometimes when you run a regression or you know, you have a… you set up this beautiful deep neural network, you'll get an answer no matter what. Right? One of the most difficult things is having a model telling you I don't know, which is part of sort of the whole concept of AI safety and something we try to do especially in our field. One thing I do know is that we tend to get better answer when, again, we stay as close as possible to the data, and again. So, for example, I think that, to me, it's a sensible assertion, this idea that if you have a world that trades a little bit less with each other, there's also a little bit less foreign reserves that that will be held, and I don't think that that is necessarily an adversarial, someone is selling, you know, is selling treasuries as a competitive or out of spite. I think that the way that, to me, is interesting to think about is, again, if you reconfigure the system in a different way, and you go back at periods where sort of bilateral trade with certain countries were was lower, what were the treasury reserves held by those countries? There's a lot that data can tell you, even in this particular environment. You know, I think that the question you ask and, and I know that this is a bit of a passion of yours, and it's an endless pursuit, is this idea of how do you build diversification. Now, we know that, over a very long term, it's quite sensible, and that's why 60/40 is a thing, and that's why people build portfolio that way, that makes sense, that you have equities or a growth asset, you have fixed income. That is a beautiful hedging property. Some of these tensions and trade-offs in public finance, in growth versus inflation, they're very well handled in most times with, and I think that this might be true for most of the next 20, 30, 40 years, but we also know that there are periods where something specific happens, and those correlations break down, right, and we are in the middle of one of these periods. I, again, I think we'll go back to an environment where these correlations will work, but it's quite interesting, as you were hinting, Jeff, analyzing why are they breaking down now and what could be the alternative, right? So, there, again, you know, another way in which, you know, one can think about what we try to do with systematic strategies to engineer return streams and, you know, the fund that you're lead portfolio manager of is one of the funds that is built on that premise, right? So, I think that no matter the environment you find yourselves in, you can try and engineer a return stream that gives that diversification property to your portfolio. So, some of the ideas that we've been looking at, for example, our defensive posturing inequities. This has been a bit of a sort of a longstanding idea that we mix with our long equity exposures. Those strategies have done very well year to date, with a little bit of a rising uncertainty focusing on the most defensive part of equity markets, and both in absolute and in the cross section has been something that's very useful. Another one I would mention that is a mainstay of our hedge fund strategies is sort of liquidity provision and reversal in a world that sort of reacts violently to a lot of news, but then these news keep coming and, you know, the classic example is harsh tariff rates, and some get suspended, and markets try to adjust, and, you know, providing liquidity to some of these trades, again, with the granular information to make sure you're not providing liquidity, you know, in an unconditional way, but you try to do it in an informed way, that also has been very effective, and I suspect it can work in a period of persistent elevated uncertainty, right? So, another way to think about this, this big library with all the signal and strategies we have is if we just… this isn't just about outperforming markets, but what is helpful in a portfolio at the moment, right, and which shelves we can go and pick ideas from that help us sort of build that diversification that, momentarily, is less available in sort of main asset markets, and other areas, you know, that I've been quite excited about, In macro land, we lived decade where there was no interest rate differentials among major currencies. Carry was not a thing, and it seemed that every GDP cycle was highly synchronized. Central bank behavior was extremely synchronized. So, if I go back to the 80s, the 90s, where the macro world seemed messier than today, than the 2000-2010s, there were strategies that did pretty well in those decades. I always like to say, well, the first hedge fund managers were macro managers, and actually, the current treasury secretary made his name by being one of the best ones in space. So, that was what the industry was in the 80s and 90s, and then somewhat in the 2000s, this became much more, you know, an equity long-short driven kind of industry with sort of more stable company prospects and more stable macroenvironment. Are we moving towards a world where sort of macro risk is going to be more prevalent and the ability to price it correctly in a world where maybe central banks would be less eager to intervene and smooth out this micro risk, right? So, again, you're going at some of these shelves are filled with the latest and greatest large language models, but some of these are simply saying, hey, maybe we're going back to a world that is not going to be like 50 years ago, but maybe there will be certain characteristics that we can sort of go back and learn from, from experiences in history, and this sort of patchwork, hopefully, will get us back to the level of diversification in our portfolios that we desire to have.

JEFF ROSENBERG: Excellent, excellent. Thank you all for joining me. Great discussion. Clearly, the macro piece is very uncertain. The implications for portfolios is the loss of diversification. The solutions you went through, a number of them here, but a lot of ways of systematically engineering defensive outcomes, going back to the old macro playbook, looking at defensive equity positioning. Those are a few of the good highlights from Raf. Mike, thank you for joining us, and we'll see you again for the next Decoding the Markets, Systematic, or the Market Pulse Webcast. Thanks again.

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