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Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

The transition to a low-carbon economy has emerged as a key player in the 5 megaforces that the BlackRock Investment Institute have been outlining for us in recent episodes. But what exactly does it mean to 'invest in the transition to a low-carbon economy', how are investors seizing this opportunity, and why is this transition seen as a 'mega-force' for investors?

My guest today is Helen Lees-Jones, EMEA Head of the Sustainable & Transition Solutions group at BlackRock. Helen, will reveal the top questions investors are asking about transition investing and will highlight the particular areas in this field that are exciting investors. We'll also delve into the timing, the regional variations, and driving factors behind the transition. Helen, welcome to The Bid.

Helen Lees-Jones: Thanks so much for having me.

Oscar Pulido: So Helen, in recent episodes of The Bid, we've been discussing the five mega forces that Alex Brazier has introduced us to, and these are forces that are affecting investing both now and in the future, and creating opportunities and risks that investors can't ignore. The transition to a low carbon economy is one of those forces. So can you tell us why this is one of those mega forces?

Helen Lees-Jones: So, as you've heard, this is one of those mega forces, it's not the only one and as we think about advising investors and talking to them about what's happening in markets. We see that alongside the future of finance, the advent of digital technologies like AI, the transition to a low carbon economy is rewiring economies, sectors and businesses. And we see as a result of this transition the average investment in the energy sector increasing to $4 trillion per year over the next 30 years, that's up from only $2 trillion over the years past.

And so, as part of this rewiring of economies, that is creating both risks and opportunities for investors. And what we're seeing is that it's also channeling investment into both high carbon sectors and low carbon sectors. So, it's really a transition that is affecting the whole of finance and we are trying to put as much information into the hands of investors as possible.

When you think about this transition, there are really three key drivers behind it. You've got policy forces like the Inflation Reduction Act in the U.S. or the EU Green Deal, you've got the advent of new technologies like carbon capture, and you've got real changes in the way consumers and investors like to think about their investments. We also know that the transition to a low carbon economy, is playing out at different speeds in different regions, particularly when you look at developed markets versus emerging markets, as one example.

We see that the electrification of light vehicles is largely on track for 2050, whereas other sectors that perhaps have harder to abate emissions in the emerging markets need a significant amount of investment and or policy in order to drive that transition ahead.

Oscar Pulido: Okay, so just to reiterate, you're saying $4 trillion per year of investment in the energy sector over the next 30 years. That's a huge increase from what we're seeing now, and maybe we can take a moment to think about what does it mean to invest in the transition to a low carbon economy. In other words, what are some of the ways that investors are thinking about this opportunity?

Helen Lees-Jones: Great question! The definition of transition investing is something that continues to evolve, we're operating in a quite new space when you think about it. So, we at BlackRock have tried to put our own framework around it just to help investors think through the risks and opportunities associated with it. And we define transition investing in four ways, but the first area is around preparing for the transition. And that's where companies are investing in assets that make them better positioned for the transition, such as those improving and or leading on mitigating GHD emissions within their industry, either through their business operations, or their business models.

So, you're probably sitting there thinking, what on earth does that mean? Let's bring it to life a bit. As an investor, you're going to be thinking about companies that are outperforming their peer group, and we'd see in this category someone who is placing particular emphasis on reducing emissions intensity in their own operations and or deploying more CapEx than their competitors in that space into lower carbon solutions. So that's the first definition, those companies that are preparing for the transition.

The second is those that are aligned to investing in portfolios or assets on a decarbonization pathway that's aligned to an industry accepted low carbon scenario. So, you are an investor, you're looking at your portfolio, here, it might be an index or a portfolio that's aligned to a Paris aligned benchmark.

Thirdly, those companies that are really benefiting from the transition They're investing in assets such as those that are providing key inputs necessary for decarbonization that will benefit from the macroeconomic trends offered by the transition. Here you might think about the mining sector and a company that produces lithium. That's a key input into electric vehicles and the batteries within electric vehicles. So, a company that is leaning into lithium production, we would see as benefiting from the transition to a low carbon economy.

And then finally, those companies that are contributing to the transition. So here this might be companies who are investing in solutions or interim low carbon alternatives that are needed to mitigate emissions in the real world. So here examples might be wind farms, or grid scale batteries. So those are really the four ways in which we are defining transition investing here at BlackRock.

But when we think about investors and what's driving their preferences in transition investing, you see a range of interest from investors worldwide. Some want to look at it through a whole portfolio lens, you tend to find the big institutions who have made whole portfolio commitments seeing this as really something they want to see throughout their whole portfolio. Others who are very much focused on the thematic opportunities associated with the investment, like investing in specific sectors, minerals, materials, would want to play it thematically. But the prevailing interest that we are seeing is in the private market space because we see that the transition is driven by new technologies and new businesses that don't exist today. The real innovation that's going into this space requires an awful lot of private capital.

Oscar Pulido: That framing was very helpful that description of the various ways in which somebody can go about investing in the transition to a low carbon economy. I wonder if you could maybe give us a few real-life examples that might help someone who's learning about this investment space for the first time. You mentioned batteries. What are some of the opportunities that exist in the battery and carbon capture space?

Helen Lees-Jones: Of course, two exciting areas in which to invest. When we think about carbon capture, we have a brand-new joint venture with a US oil major on this very topic because as you will know from what I've talked about so far, traditional oil and gas producers are really key to meeting the world's growing energy. Even with the rapid build out of clean energy infrastructure, we still see that there's a space for emissions removals capabilities to come online. So, carbon capture is really there to use new technology to remove large amounts of carbon dioxide from the atmosphere and put it back into the ground.

On the battery side of things, they're essential to the transition to a low carbon economy, whether it's from powering electric vehicles or ensuring grid reliability. And we have also in our infrastructure business invested in a super battery in Australia, it's there to ensure that it stabilizes energy grids as they shift to renewable sources. When you think about it the wind only blows for a certain amount during the day, the sun only shines for a certain amount during the day, so being able to harvest that renewable energy supply, store it and then transmit it when it's needed, those grid scale batteries are critical to ensuring that we can make the most from those renewable energy sources. So those are just two examples, carbon capture, grid scale batteries.

Perhaps the third space, whilst we're talking about batteries is next generation materials that are needed. Batteries are now prevalent everywhere, whether it's in your electric car, or in other parts of your Day-to-Day life and those batteries need to become higher performing more efficient, more sustainable. So, looking at new materials and minerals that are required in order to make those batteries better, is also another interesting area for investment opportunities.

Oscar Pulido: And so, Helen going back to the numbers you referenced earlier about the investment in this space doubling, what impact will that have on opportunities for investments going forward?

Helen Lees-Jones: So obviously with that significant scale of CapEx going into new energy sources, there's an array of opportunities across the world. This transition isn't happening just in one sector or one country, this is something happening globally. I talked about, a super battery in Australia or a carbon capture facility in the U.S., there are other areas in which we are investing in transition assets. Pipelines as one example, we're looking at ways in which we can invest in building thousands of miles of critical infrastructure to help transition from oil to natural gas and clean hydrogen. So, it is about taking some of that infrastructure that exists and finding ways in which it can both continue to deliver the oil and gas that is being produced today but also be converted in the future into a way of transmitting newer energy sources like clean hydrogen.

Electric vehicles, we've made a pretty significant investment into a continental European EV charging company, which installs and manages high speed electric charging stations. Their goal is really to be the biggest charging facility provider across Europe, and they're already operating one and a half thousand chargers across the continent today. As we see wider adoption of electric vehicles coming online, those drivers are going to want the convenience of being able to charge wherever they wish. you can charge your vehicle at a petrol station wherever you like today, but the infrastructure still needs to be built out in order to charge your electric vehicle. And the goal there is to ensure that around every 150 to 200 kilometers on European highways, you can access the convenience of EV charging as you drive.

Perhaps if we look at the more renewable end of the investment opportunity set, you can think about solar power. We can see big opportunities in solar power, we have significant investments across our portfolio today, we've invested, in a renewable energy developer in the Philippines as another example of where we see global opportunity. So yes, this is happening in, developed markets, but increasingly we're seeing much more opportunity coming across in the developing markets.

And those transition assets are not only helping transition from browner sources today to greener sources tomorrow, but they're also providing resilience and security, which importantly we see as key characteristics of the transition. Yes, of course we want it to be green and lower emissions, but also it needs to be consistent, and it needs to be stable. Things like solar power and battery storage are a key component of that transition, so for investors, there's a wide array of infrastructure, assets and technologies in which to invest globally.

Oscar Pulido: So Helen, you may have recently listened to an episode we did with Portfolio Manager Charlie Wilford around electric vehicles, and he commented on some of the charging infrastructure challenges that you mentioned as well. You also mentioned policy as a driver of the transition, and you touched on the Inflation reduction Act in the us. And the EU’s Green Deal package. What impact does policy have on investment opportunities and what challenges might it present?

Helen Lees-Jones: Great question because the policy landscape is a really critical input into how you think about making investments, particularly as long-term investors. What we've seen with new policy come online, whether it's the US Inflation Reduction Act, whether it's the EU's Green Deal package, there's been a significant investment of policy and subsidy into both the US and European marketplaces, we're seeing other parts of the world also come online, Japan most recently. The policy support is huge in this space, that catalyzes investment, which is what we want to see, but it also does create risks when you think about how that policy is going to be deployed.

Things that you might want to consider are things like policy changing. So, policies are enacted normally aligned to political cycles, what happens if a different, political party comes in or the government is managed differently, will those policies endure or will they look different or be removed entirely. And so that's a risk to consider when you think about just the feasibility and long-term nature of policy.

The second thing is that huge wave of investment that it generates can also create bottlenecks, whether that's in your supply chains, getting hold of critical raw materials and minerals, that wave of demand can also generate bottlenecks in your supply chains. And then you've got the issue of permitting risk. The policy support is there, the money is there to put to work, but are you allowed to actually go ahead and build that new project? And often you require permits in order to put those infrastructure projects in place.

And that in itself comes with risk, not all projects actually end up getting the permits they expected to get, and we've seen some of that play out recently. So, policy is a great mechanism. It comes with huge opportunity, but it does come with some risks as well. And importantly investors in this space want to work with a partner who can understand and help navigate all that complexity that I just talked about.

Oscar Pulido: And do we have any data how many institutional investors are already thinking about this for the future or are they already investing in the transition?

Helen Lees-Jones: So that's a timely question, Oscar, because we recently surveyed 200 institutional investors globally over the summer, and a whopping 56% of them indicated that they plan to allocate more to the low carbon transition over the next few years. Some are looking at it through a whole portfolio lens, they want to really think through how do they hit net zero targets if they've made them, others think about it from an asset class perspective, so where can they generate the highest and best, investment return in their portfolio and or manage the risk that it generates.

Oscar Pulido: So 56%, that's a significant portion of the investors you surveyed, and I'm curious, as this is a relatively new space, how has that number changed in recent years? Is that a big shift in investor preferences into investing in the low carbon transition?

Helen Lees-Jones: We have seen a change in investor preferences particularly since three years ago. We've seen the world change around us, we've seen a shift in the geopolitical context, we've seen, unfortunate crises with energy supply, with geopolitics. That has changed to some extent the way investors think about their objectives as fiduciaries to their assets. thinking out over both a, 1, 3, 5, 10, 30-year horizon, you've got to adjust to, what's going on around you. And of course, the transition. Isn't necessarily linear. So perhaps three years ago, investors who were interested in the space would've been very much focused on things that you'd perceive to be green today.

They'd be very invested in your renewable energy sources like solar and wind, and having quite restrictive exclusions in their portfolios, they might have chosen particular sectors that they felt were not aligned to sustainable investing and excluded them from the portfolio. And as I said, today, we've seen the conversation shift quite considerably, and investors are much more interested in assets that are greening, so they're transitioning, and hence why we're so focused on the transition in all its frames.

Because when you think about what this means in a portfolio, an exclusionary approach doesn't get you to where you want to be necessarily. You understand that the biggest drivers of this transition are also perhaps the industries, sectors, companies who aren't necessarily the greenest today, they've got big plans to transition and they're putting a significant amount of time, energy, and resources into thinking through how do they get to where they'd like to be over a long horizon.

But those things can't be done overnight, and we're seeing a much bigger preference towards transition assets. And I think importantly, the dialogue is really shifting as well between investors and corporates, and we're seeing much more of a partnership approach between incumbents and disruptors.

Rather than just seeing the new technologies recast the playing field, we're seeing much more interaction between traditional sectors today in traditional companies within those sectors, partnering with the challenger technology providers, challenger companies in the same sector. And we see that coming to life in investors’ portfolios. So, whilst they'll invest in perhaps the traditional sectors today, they'll also be investing in newer technologies through their private markets allocations to almost go alongside what they have in their public markets portfolios. This is something that we see as an important part of the transition investing opportunity set that it really is a whole ecosystem opportunity and that, investing across a wide range of assets, sectors, capabilities is just a great opportunity for investors.

Oscar Pulido: So basically what you're saying is that the good news for investors is that there are a whole multitude of ways to think about investing in this transition to a low carbon economy. Helen, thank you so much for this 101 on transition investing. It really does sound like there are a lot of exciting opportunities in the space right now. And thank you so much for joining us on The Bid.

Helen Lees-Jones: Thanks so much for having me.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out our recent episode 'The Race is On For EVs' where portfolio manager, Charlie Lilford, unpacks the contribution of transport and electric vehicles in the transition to a low carbon economy.

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Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

In a world filled with financial uncertainties and rapidly changing economic landscapes, one thing remains clear. Emerging markets are becoming increasingly pivotal in shaping the global investment landscape.

This topic has been a point of great interest for us since our enlightening conversation with Emily Fletcher in London during the summer. You might remember Emily is a portfolio manager in BlackRock's fundamental equities business. Emily and I discussed the BlackRock investment institute's bullish outlook predicting that emerging market equities would significantly outperform their developed market counterparts over the next decade. But the question remains, how will this outlook play out in the near and long term?

Today I'm joined by Jeff Spiegel, US head of BlackRock, megatrend International and Sector ETFs. Jeff is going to help us explore the multitude of factors contributing to this anticipated outperformance. We'll delve into specific global trends that are paving the way for emerging markets, including the intriguing concepts of supply chain rewiring, and demographic population shifts.

Jeff, thank you so much for joining us on The bid.

Jeff Spiegel: Pleasure to be back with you.

Oscar Pulido: So, Jeff, as you know, over the summer, I spoke with Emily Fletcher. Emily's a portfolio manager in our fundamental equities business and she invests in emerging markets and was quite constructive on, the asset class. The BlackRock Investment Institute, has an outlook that of the next 10 years, emerging market equities will outperform, developed market equity, so they're quite constructive as well.¹ So how do you see, this playing out in emerging markets? What's your outlook on the asset class?

Jeff Spiegel: Oscar, as you and I have discussed in the past, one of the privileges of getting to work here at BlackRock is we work with some of the greatest investors in the world. In Emily's case, a fundamental equity investor, at the cutting edge, but it's not just our fundamental equity business or even our investment institute that's excited about the opportunity in emerging markets. It's our alternatives business, it's our systematic business, it's our index business.

Really, there's tremendous excitement all across the firm around these opportunities. There's a historical truth about emerging markets, which today has become a misconception, which is that a lot of emerging market countries are actually the smaller countries in the world. Actually, that's changed significantly.

Countries like China, India, Brazil are today some of the world's most important economies. The reason we consider them emerging markets has more to do with local equity market structure, as an example, and going forward, we actually think in the next 10 to 20 years, four out of the five largest economies in the world, markets we would consider to be emerging today. So, these are big, important economies and these emerging market countries are being driven forward by one of the things we like to talk about a lot here, which are big structural changes or mega forces we have identified five of them: digitalization and artificial intelligence, demographic divergence the transition to a low carbon economy, geopolitics and economic competition, and the future of finance.

All of these are going to play a role in propelling forward emerging markets. In particular I think we'll have the chance to talk about them today, demographics, that transition, and geopolitics because so many of these countries have favorable demographics, so many of them have access to the key resources for the climate transition and there'll be beneficiaries of increasingly, competitive geopolitics by essentially playing all sides and staying in the middle.

Oscar Pulido: You mentioned the five mega forces and one of the ones you touched on was demographic divergence. I think we read a lot about in the US in the UK, in Japan, these developed markets, how populations are getting older. So how are demographic shifts then impacting the emerging market economies? Is it the same story or is it something different?

Jeff Spiegel: It's actually quite different, so The Economist has this term I like, called 'AltAsia', like alternative Asian economies, that are really coming up in importance.² And a lot of these countries have incredibly favorable demographics, especially relative to, developed market countries or even China.

And just to put some numbers around that, AltAsia, think about Vietnam, Thailand, India, has a collective working age population, about 1.4 billion people.³ It's home to about 155 million people between age 25 and 54 who have a tertiary education.⁴ What's interesting is these are some of the only countries in the world where those stats are actually improving, year on year. They're not at the sort of peak, they're actually still in the early innings of that demographic growth and of that education trend.

Now, when you compare that to China, Western Europe and Japan, all three are actually shrinking in terms of working age population, and even the US is actually only staying about flat. There's a term we like to use here that demographics are destiny, because this is one of the big changes in the world that you can actually predict with a pretty good amount of certainty- how many people are in a country today? What does the birth rate look like and how are people going to age over time?

And looking at those things. A lot of emerging markets, particularly in this sort of Alt Asia cohort, present incredibly attractive opportunities that are going to be hugely important for economic growth in those nations.

Oscar Pulido: And so, on top of the demographic shifts that you just mentioned, we also hear a lot about geopolitical fragmentation we're seeing it in the world. We're seeing more economic competition. So how does this play into your long-term outlook for emerging markets?

Jeff Spiegel: So, we talked about demographics and the importance of that mega force geopolitical fragmentation, another really critical mega force that's affecting the emerging markets cohort and in a variety of different ways. So, off the bat, trade is actually growing faster between geopolitically aligned countries that have better diplomatic relationships with one another.

We are also distinct from the Cold War period, have this idea of multi-aligned states, really large economies, that are negotiating with all sides geopolitically, and they're benefiting, they're getting infrastructure support, they're getting trade deals, from some of the largest economies in the world.

To get a little more specific, you have the Gulf States. these are countries that have massive capital account surpluses and people are courting their investments. You have, Latin America, which has a lot of the most critical minerals, that are going to be really important in the transition to a low carbon economy.

So, lithium supply is really geographically concentrated. About 98% of it comes from South America, Asia, and Australia.⁵ And the bulk of that, specifically from South America. and then copper. You think about countries like Chile and Peru, they alone account for about 40% of output.⁶ And then beyond this idea of multi-line states beyond this transition, metals, you also have this sort of geopolitical battle in technology where South Korea and Taiwan are great examples of beneficiaries.

So, East Asia, particularly Taiwan, really excels in wafer fabrication and assembly, for semiconductors. Whereas actually the US and Europe and Japan tend to specialize in more of the design of chips. So, you only have a couple of countries that can actually do the fabrication and assembly, they're going to be beneficiaries as the world increasingly fights over things like semiconductors. So, this geopolitical fragmentation idea is going to benefit a range of emerging markets, but also in a range of different ways.

Oscar Pulido: So, you took us on a little bit of a tour around the world in some of your comments and you highlighted the point that these countries are cooperating. They're creating economic blocks. They're increasing their negotiating power and that's making them more powerful players on the economic stage. But we've talked about emerging markets at a high level. Maybe we can zoom in a little bit, you've touched on a few countries, but are there specific ones that in particular you think are poised to outperform?

Jeff Spiegel: If I was going to lean into one country that is potentially most poised to benefit, I would think about this as India, for a variety of reasons. They are beneficiaries of geopolitical fragmentation as well as demographics. And I'll break this down into a couple of areas. The Indian economy is now the world's fifth largest, recently overtaking the United Kingdom.⁷ Again, reinforcing this idea is that emerging markets are not the smaller countries. they're actually some of the largest economies in the world. And by the end of the decade, economists actually think that India will be the world's third largest economy, behind only the US and China.⁸

In fact, the Indian economy grew at a rate of about 7%.⁹ In 2023 and that's expected to remain strong going into 2024. in fact, India's likely over the period to be the fastest growing economy. The G 20 and the upsides are massive going forward, so manufacturing opportunities come to mind. So as supply chains rewire and the world looks to find a gateway to growing South Asian markets, India's really well positioned to benefit.

The Indian government has certainly taken note of this and it's looking to increase attractiveness, as a home for manufacturing. They've introduced production linked incentives. To encourage overseas manufacturers. that initiative alone drew about $6.5 billion in investments during 2022.¹⁰ But India's heft, it's demographic, it's demographics, it's multi aligned status.

all of these things make us think that if there's one sort of standout with maybe the biggest opportunity in emerging markets, it may very well be India.

Oscar Pulido: And it's interesting to hear how they've climbed the ranks in terms of the size of their economy and where you projected that going forward, very much among the leaders in the league table if you were looking at it on a global scale. Jeff, one of the things that, I think back over the last few years, when we think about the pandemic and we think about how the economy was getting rewired, a lot of companies realizing that they were sourcing their supplies from very far away, and we've started to hear this term of nearshoring and companies bringing their supply chains, closer to home. How does that impact. Emerging market economies, is that a positive for the space?

Jeff Spiegel: I think it's a mixed bag for the space. And this is where you have to think about, what are the more specific opportunities in emerging markets and not think about emerging markets as just a single or monolithic cohort.

Trade openness or globalization we often call it has been a one-way escalator ride since the end of World War ii. there were really two forces that drove that. So, the first was the Bretton Woods system after the Second World War championed by the United States. And the second was really around the initial rise of China, its entry into the World Trade Organization, for example, in 2000, but there's a few forces that have changed, a lot of this just in the last few years. And we've actually seen trade openness start to go into reverse for the first time in a long time.

What are those three forces? The first was the Covid19 pandemic, to your point about supply chains, it's not just that they were far away, it's that companies were really prioritizing the lowest cost production of goods. And what they learned is it can't just be about cost. You actually also have to think about resiliency, even if that might make your goods a little bit more expensive. So Covid19 changed this focus away from purely cost towards resiliency. That's the first area, rewiring supply chains. The second is really the war in Ukraine.

And here it was less industrialized goods that were affected, but a lot of commodities, be it energy, be it food, were massively disrupted by this, geopolitical event that's also leading to a rethinking of supply chains. And then lastly, and we've already talked about it a bit, is geopolitics. as geopolitics become more fraught, it means that not just reshoring is important, not even just nearshoring, which you referenced, but also something that we think of as friend shoring. now Mexico I think is actually a really good example to think about what that means.

So, Mexico is a candidate both for nearshoring and front shoring. Nearshoring is moving production, closer, to the ultimate destination of goods. Friend shoring is moving production towards areas that have really friendly relations between governments, really open trade. So, when you look at Mexico, and you poll executives, of companies around the world and you ask, why is Mexico a potential beneficiary of all this? The answer is threefold.

Qualified labor force, proximity to the US and friendly relations. But Mexico actually isn't the only story in this regard, if you think about a country like Poland in Eastern Europe and its proximity to Western Europe and its friendly relations and its qualified labor force, you actually have a very similar story.

Think about Vietnam, again, skilled labor force, strong government relations with the west, proximity to a lot of markets like India and like Japan. Mexico's not the only part of this story, even though it gets referenced the most, probably because we're sitting here in the US and it's obviously the most directly close by.

But when you start to rattle off the full list of countries who are going to benefit from this rewiring, be they in Southeast Asia, Eastern Europe, Latin America, you actually start to think about most of the actual countries in the emerging market benchmark being huge beneficiaries of these shifts.

Oscar Pulido: Right, so the shift is companies went from just seeking the lowest cost to seeking, you said, resiliency in where they source those supplies and that could be from still a low-cost location, maybe not as low, but also with countries where they have stronger diplomatic relations.

Jeff, you also touched on China. And China constitutes a large proportion of emerging markets.¹¹ China's not only large, but it also has its own opportunities, challenges and nuances. How are investors thinking about China distinctly from other emerging market countries?

Jeff Spiegel: Yeah, so this gets back to this critical point of emerging markets are not a monolith. They have different opportunities associated with them. Now, as far as China's specific role, in emerging markets or in an emerging markets benchmark, the analogy to make here is actually the United States, versus developed markets more broadly. So, people don't tend to invest in developed market equities inclusive of the us.

Instead, they tend to have a dedicated allocation to developed markets, ex-us. Alongside a dedication, a dedicated allocation to US equities. why is that? It's really a size issue. when you put all the developed market countries together, the US makes up such a huge portion that it's just critical to think about it independently.

Otherwise, it's driving your whole developed market allocation. It's a similar situation now with emerging markets in China. So more and more we're seeing investors take a modular approach that actually splits China and these other EM holdings. in fact, ETFs that are tracking, emerging market X China benchmarks might be great tools for investors who are thinking about this opportunity.

this has been a really popular trade. in fact, year to date, we've seen almost $3 billion, flow into such ETFs.¹² Now, what's important to remember is. There's no right or wrong answer, for how to access emerging markets in a portfolio. But we recognize, and we have to recognize that China is a large component of the EM universe, with its own unique characteristics, and it makes more sense today than ever before to have an EM view and a China view that are distinct from each other.

Oscar Pulido: So, Jeff, we've heard from Emily, Fletcher, we've heard from you today on your view on emerging markets and the exciting trends that are driving these countries. So, looking ahead, there's plenty of economic uncertainty and the geopolitical risks, have only escalated more recently. So, what should investors be considering when it comes to emerging markets?

Jeff Spiegel: So, the question is, how do you want to access emerging markets? Do you want to own a broad emerging markets benchmark? The traditional emerging markets benchmark holds about a dozen plus countries, and we continue to see this as the way that most investors seek EM exposure.

Or as we discussed, do you want to think distinctly about emerging markets and China emerging markets? Ex China as an index is actually outperforming that traditional EM benchmark,¹³ and critically flows into it or growing incredibly rapidly. This is a new phenomenon really just in the last few years, so it's a sea change on the part of investors to do this break.

In the emerging markets benchmark and some are actually getting even more granular still. so India and South Korea have both had tremendous performance this year.¹⁴ They've also had flows into chinaETFs that specifically track those countries.¹⁵ So we're moving from a world in which investors are thinking about emerging markets as a monolith into one where they're either breaking it into two camps or even just targeting to target these individual countries they're getting more deliberate, they're getting more targeted, and that's important because as we discussed, these are some of the most, large and important economies in the world.

So, at the end of the day, emerging markets on the whole are really set to benefit from a lot of these mega forces, demographics and geopolitical changes in particular, but whether in Asia, south America, Eastern Europe, and even within these geographic boundaries, emerging market countries will capitalize on these opportunities differently Some will succeed in policy, others won't. Some will benefit from geographic proximity to the US or Western Europe, others will profit from significant deposits of the metals that are critical to the energy transition. So, the opportunities in emerging markets are many, and they're exciting, but investors need to be deliberate in how and literally where they want to capitalize.

Oscar Pulido: It sounds like a space that is evolving a lot and the way in which investors are approaching emerging markets is also evolving, is what you're saying. So, we'll hope to have you back and hear more about how emerging markets are evolving and how this story is playing out. But Jeff, once again, thank you so much for joining us on the Bid.

Jeff Spiegel: My pleasure. Great to be back with you.

Oscar Pulido: Thank you for listening to this episode of The Bid. If you enjoyed this episode, check out the episode titled A Stock Pickers Guide to Emerging Markets with Emily Fletcher. Subscribe to The Bid wherever you get your podcasts.

Source
¹ BlackRock Investment Institute, 'Capital Market Assumptions,' 08/2023. Data as of 06/30/2023.
² The Economist, 'Global firms are eyeing Asian alternatives to Chinese manufacturing,' 02/20/2023.
³ Ibid
⁴ Ibid
⁵ McKinsey & Company. Lithium Mining: How New Production Technologies Could Fuel the Global EV Revolution, 4/12/22.
⁶ International Energy Agency. 'The role of critical minerals in clean energy transitions', May 2021.
⁷ World Economic Forum, 'This chart shows the growth of India's economy,' 09/26/2022.
⁸ The Economist, 'India likely to become third biggest economy behind US and China by FY28,' 10/16/2022.
⁹ The Economist, 'India's economy likely to grow 7% in FY23: First advance estimates,' 01/07/2023.
¹⁰ Reuters, 'India to review production incentive scheme this month-end,' 06/13/2023.
¹¹ Morningstar, MSCI. China constitutes 30% of the MSCI Emerging Markets Index as of 9/30/2023.
¹² BlackRock, as of 9/30/2023.
¹³ Morningstar. The iShares MSCI Emerging Markets ex-China ETF has a YTD total return of 6% as of 09/30/2023. The iShares Core MSCI Emerging Markets ETF has a YTD total return of 3% as of 09/30/2023.
¹⁴ Morningstar. The iShares MSCI India ETF has a YTD total return of 7% as of 09/30/2023. The iShares MSCI South Korea ETF has a YTD total return of 4% as of 09/30/2023.
¹⁵ BlackRock, as of 9/30/2023.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH1123U/M-3192519

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Electric vehicles, or EVs, have been hailed as the future of transportation. They promise cleaner air, reduced dependence on fossil fuels, and a seismic shift in how we commute.

Charlie Lilford: When I work in the office, I take my bicycle which is obviously lowering my carbon footprint significantly when I travel. Yes, we can buy electric cars and we can utilize that in an EV, but when we think about our mobility and our transportation around our daily lives, it becomes much more significant.

Oscar Pulido: But as we navigate this high-speed journey towards an electric future, there are certainly some speed bumps ahead, whether it's concerns about range anxiety, the availability of charging infrastructure, or simply the price tag of EVs.

Charlie Lilford: These cars are much cheaper, in some cases even cheaper than a lot of combustion vehicle cars today. And so the next question is then, what is the challenge today?

Oscar Pulido: Here to dive into the fast lane of EVs is Charlie Lilford, Portfolio Manager for BlackRock's Fundamental Equities business. Charlie talks with hundreds of companies across the electric vehicle and renewable energy supply chains every year. Today, he joins us to talk about the rate of adoption of electric vehicles across the world. and where he sees the most exciting investment opportunities.

<<THEME MUSIC>>

Oscar Pulido: Charlie, welcome to The Bid.

Charlie Lilford: Thanks, Oscar. It's a real pleasure to be here today.

Oscar Pulido: Maybe we can start by talking about what is driving this shift towards electric vehicles? We hear a lot about the transition to a low carbon economy, so I think these two things are related.

Charlie Lilford: Yeah, they definitely are related. I think what's really exciting right now is the fact that electric vehicles are truly accelerating. This is becoming a mass market opportunity, we're seeing more and more of these EVs proliferating in our cities, in our economies, and we've really taken a totally new step change in terms of the future of electrification and electric vehicles.

As these cars become much cheaper, much more affordable to the consumer, we will see more and more of these cars being owned and purchased in all segments of the population. Historically, people thought of electric vehicles as something that's quite exclusive, whereas now it's really democratized.

We often see Government regulations and subsidies has having been very supportive to get that initial take up of electric vehicles and that's certainly been the case in a number of markets such as in Europe and China for instance where EV penetration rates are now in excess of 20 percent in new car sales.

But that was really just the first step and now what we're seeing is this more broad and holistic adoption of EVs which I think is very exciting for the net zero transition and what it means for just our ability to reduce our impact on emissions in our cities. But also, this advancement in technology and mass market opportunity for electric vehicles

Oscar Pulido: And you talk about the net zero transition and the reduction of, carbon output, the lower reliance on fossil fuels, this is something we hear a lot about. What is the contribution that this transition to EVs is making to that transition? Because certainly there's a lot of other things that are contributing to that transition, but what's the EV contribution to that?

Charlie Lilford: There's certainly a lot of other things that contribute to this and that there has also been an evolution what it means to be able to emissions more generally. And so, it is clear that this is something which is holistic and will need to be done in variety of industries and sectors.

But transportation accounts for approximately 25 percent of global CO2 emissions today. And then road transportation, passenger vehicles and freight, that's about two thirds of that amount. It's a huge component of emissions, and yet it's hugely addressable in the sense that we can actually create change over the coming decades very effectively just from moving from mechanical to electrical transportation.

Passenger vehicles typically see that car owners own their cars for 12 years or in some cases more than that that's clearly an area where we will see electrification expanding and evolving and increasing penetration rates of electric vehicles over time.

But commercial vehicles are typically used for six to eight years on average the turnover rate of those vehicles is much higher compound that with the fact that many of these companies have net zero targets. They're trying to also reduce their costs and clearly electric vehicles do reduce your operating costs. It suggests that we will potentially see much higher acceleration and adoption of electrified vehicles in these segments than what we've seen to date. And that all comes down to the fact that it's becoming much more affordable, it's being driven by cost incentives and operating costs, and these adoption rates could accelerate.

Oscar Pulido: So, it's not the only way in which the world can transition to lower carbon, but it is a major contributor is what you're saying.

Charlie Lilford: Exactly, Oscar. But as I said before, the fact that we are seeing these vehicles becoming cheaper every year, they're democratizing into our economy so that opportunity is no longer something that we are forced to do. It's something that we will naturally choose, it's cheaper for us, it's a better solution and actually it has a much, more sustainable outcome.

Oscar Pulido: So, let's talk about the consumer, and I have to admit I'm actually one of those consumers in recent years of having purchased an electric vehicle, but what are the barriers to more mainstream adoption of electric vehicles? is it still price? You mentioned government subsidies before played a role early on, but is price the biggest barrier or are there other factors at play? Are people concerned about the range of the vehicle, maybe you can talk a little bit more about that.

Charlie Lilford: Historically it had been about price, this is changing, and this is actually changing very quickly. Now that we're seeing Not just one or two car manufacturers in the world producing electric vehicles, we're seeing many more. For instance, this year alone, there are over a hundred new designs that are being launched in Europe, close to 50 in the United States, China is even more, about 150 new designs.

So, the opportunity for us as consumers to purchase electric vehicles is expanding. And so, we are spoilt with choice, and we will be even more spoilt with choice in three, five, 10 years’ time, because these manufacturers are producing electric vehicles at scale at affordable prices. That affordability question and the price point is becoming relatively mute in the future. These cars are much cheaper in some cases even cheaper than a lot of combustion vehicle cars today. And so, the next question is, then, what is the challenge today?

There's still challenge around charging, and I think people's anxiety around range. Can I get to my destination without having to stop and charge? To some degree that's people getting used to using electric cars and being familiar with how they would utilize them day to day.

It's clearly also a factor of building more charging infrastructure. And we're seeing a lot of that being built out. So longer distance charging. A lot of work being done with automotive manufacturers to work together to find solutions so that they solve the problem for the consumer.

And then also the fact that ironically, we've over built the batteries in the cars. The average US driver drives 40 miles in a given day. And if you think about the efficiency of battery in a pack, we are effectively looking at a car that is overbuilt by a factor of four or five times in terms of battery capacity. So, there are ways that we can evolve the cars to be best suited to the use cases of the end consumer.

Oscar Pulido: And it's interesting you mentioned all the new models, new companies coming out with electric vehicles, and I've had this experience of walking on the street and seeing a car and not recognizing the manufacturer of the model and more often than not, it does appear to be an electric vehicle. So that resonated with me as you said that.

Before there were electric vehicles, we had something called hybrid vehicles, and they still exist, but there was this sort of steppingstone where people used hybrid cars before they went fully electric, and now people making that jump to just go more fully electric. So, what is that role of the hybrid vehicle these days then?

Charlie Lilford: Well, I think the hybrid still has a place. Particularly for those making that are using the car more frequently, want to have the opportunity to use electric, but also that range anxiety means that they want to fill their car with gas when they need it.

That being said, the progress and the advancements that are being made in EVs, pure EVs, battery electric EVs, is so significant. Really the core of the matter is hybrid is just a transition story as we move to a full electric marketplace. With the advancements in technology around electric vehicles there is the opportunity to see more and more of these EVs coming to the market. If you think about some of those step changes in technologies, the chance to have higher voltage electric batteries being able to charge faster. I mean, that’s the key right? As a consumer, you don't want to waste too much time charging your car If you're out and about you want to be able to charge it quickly.

That's one of the key changes that we see underway, and a lot of these car companies and a lot of the manufacturers are focusing on that. How do they produce batteries that have much higher energy density that can enable us to charge our cars faster?

 Then car manufacturers asking the next question, where do we find greater efficiency? Where do we improve the technology? And then it comes down to the aerodynamics. It comes down to the rolling resistance. So how much resistance is applied from using your tires or the inertia? All of these incremental improvements mean that we can find ways to be far more efficient with the electricity that we're using in our cars and enable further adoption of electric vehicles.

Oscar Pulido: Everything you've mentioned certainly highlights that there's progress for the consumer, there's more choice, and there's progress being made in terms of transitioning to lower carbon emission. For you, as somebody who comes to work and is investing in stocks and companies, it sounds like the automobile ecosystem has changed dramatically over the last couple of years. So, what does that mean in terms of investment opportunities?

Charlie Lilford: This is such a great question, Oscar, because You're getting a collision of effectively the legacy environment with this new onset of what it means to be in an environment with electrification and electric vehicles.

And so, when you take a step back and you think about the automotive sector or the transportation sector, we've seen these companies historically engineering change. The fact is that this is the first time in over a hundred years that we've actually seen a totally new power train technology. We're moving from a mechanical to an electrical world. And what that means for me and our team as investors is that you see new companies coming into the space, new technologies emerging. There's a lot of change and that as an active stock picker really represents a huge opportunity for us.

We see companies that are legacy, or companies that are incumbent, that are able to change, that will evolve, that will survive, that will succeed. That being said, some other companies that are legacies will not be able to do that. And I think that's where it gets truly exciting, this change that's underway, the emergence of new players, the emergence of new technologies, creates true opportunities for us at BlackRock as active stock pickers.

Oscar Pulido: And so, what's that one innovation that you see coming to electric vehicles that could, be a game changer in terms of performance and price and how far away is that innovation from being in mass production?

Charlie Lilford: We get this question quite often. We’re certainly looking for these game changing technologies. So, if it's advancements in battery technology, to get very technical, some of the anode technologies that we're seeing, where these companies are progressing on that front. Even just the advancements in the chemistries for the batteries, and furthermore, when you think about longer term, a lot of people talk about, solid state batteries. There is evidence that this could be very exciting and a game changer in its own right.

When I say solid state battery, what that means is there is a different technology that we can see being able to be used in cars, which is, much safer, but also has much greater performance. if we were to get into this achieving solid state status, it does unlock a lot of the issues around charging times.

But I often reflect on what is the key game changer. And the key game changer for me here is efficiency. The ability for the manufacturers, for the supply chain, for the providers of technology to find much, much more efficient solutions to the problem.

 When you think about it, how does a car company scale? How does a car company manufacture millions of vehicles very cost effectively so that it is cheaper for you and I, when we want to buy our next car. How do manufacturers of batteries, get into a position where they can produce batteries at an affordable level so that those batteries are much cheaper when going into the electric vehicles?

And so, there are a lot of really interesting game changing technologies out there, but it comes down to efficiency and the entire ecosystem to become more and more efficient, to improve day in, day out, year on year, to bring a product, which is going to be far more cost effective, far more affordable for everybody, not just a premium product.

Oscar Pulido: That's interesting because we live in a world where we want something, and we want it right away. We expect it on our doorstep. And what you're saying is there's great technology already in these vehicles. So certainly, there could be improvements. There always is, but it's just these companies getting to a point where if a lot of people actually want these vehicles right away that they can do it in an efficient and scalable manner.

Charlie Lilford: Yeah, exactly. Like you said, it's really about providing something to the consumer they want, that solves some of their problems. People want to have a car that's easy to use, cheap to run, comfortable, safe, reliable. All of these factors come into play in this sector, and I think electric vehicles do solve a lot of those issues.

Oscar Pulido: You mentioned before that one of the anxieties that potential buyers have is the range of the vehicle and where am I going to charge it? Is that the biggest obstacle right now for electric vehicles or is there something else that is precluding this industry from growing faster?

Charlie Lilford: That is the case. We've seen that costs are coming down. In fact, costs will come down even more dramatically when we think about buying our next car. Really the key factor right now is, can I charge my vehicle? And I think this is, also very interesting when you think about it, and I often use this quite flippantly, but it’s incredibly true. Electrification is all around us. If you think about electrification and the access to electricity, in many cases it's more accessible to us as urban dwellers than combustion engine or combustion fuels are.

So, if you think about where do we source our electricity to charge our cars, it's in our apartment buildings, our homes, in our offices, on our streets, and so the fact that electrification is permeating all around us is one of the key constraints which we believe is there but in fact isn't, and so it's really about changing some of the behaviors.

And very similarly to when you think about when you go home and charge your mobile phone, you charge it overnight. And then I wake up in the morning and I go to work with my phone fully charged.

When you think about electric vehicles, The best solution is to charge it slowly overnight, take eight hours, let your car charge. it's a behavioral factor that will evolve and emerge over time as people become more accustomed to using these new technologies and become accustomed to how they can optimize those technologies.

Oscar Pulido: So, imagine you wake up 10 years from now and it's the year 2033 is the adoption of electric vehicles now mainstream? Have we gotten to that point where that's what you own?

Charlie Lilford: So, ask this another way, in 2033 when you're looking for your next car to buy will you be buying an internal combustion car? That's the key here. There are obviously some very optimistic scenarios around this many people think that internal combustion cars will disappear overnight. The reality is they won't. internal combustion cars will be with us for many years to come. And that's a factor of, we as drivers of these cars own these cars typically for 12 years. So that turnover rate is relatively slow, but nonetheless, what we're seeing is a dramatic increase in escalation in EV adoption.

And you just have to look at what's happened over the last few years. this year we should have EV penetration rates close to 20%, on a global basis, forget about certain markets where we see dramatic penetration rates, but if you reflect on that a few years prior, this was barely at 3 or 4%.

So, we've seen a 5X development in this just over the last four or five years. And when you think out to 2030, given the costs that we're seeing coming down, and given the nature of the design releases that we're seeing coming out of the manufacturers, there's nothing to suggest that we will not see significantly higher penetration rates in electric vehicles by 2030.

Oscar Pulido: So, Charlie, I have to ask, I mentioned at the beginning that, I became an electric vehicle driver myself in the last couple of years, but do you practice what you preach? Do you drive an electric vehicle?

Charlie Lilford: I do, but I think it's even broader than just that. what's really interesting is that it's becoming a question of electrification in our lives. Yes, we can buy electric cars and we can utilize that in an EV, but when we think about our mobility and our transportation around our daily lives, it becomes much more significant.

When I go to London to work in the office, I take my bicycle. I use mass transportation, which is obviously lowering my carbon footprint significantly when I travel. So, it becomes far more holistic, EVs are just one piece of that puzzle in terms of, how we can address our own impact and what it means in terms of our own impact on net zero, but also how we travel more efficiently in cities. And so how can we be much more sustainable in our daily lives?

Oscar Pulido: So, I feel really charged after this discussion. I was trying to think of a witty pun to match, many of the ones that you had as you were describing this space. But, Charlie, thanks for your insights on electric vehicles and what's to come ahead. And thank you for joining us on The Bid.

Charlie Lilford: Thanks, Oscar. we will see more and more electric vehicles in the future, and it's just going to be such an exciting next couple of years.

Oscar Pulido: Thank you for listening to this episode of The Bid. If you enjoyed this episode, check out our conversation with Cristiano Amon, CEO and President of Qualcomm, where we discuss the digital transformation and how that's already affecting the electric vehicle market. Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH1023U/M-318700

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

The face of finance has evolved considerably of late. From changing financial architecture and payment applications through to regulatory developments and the impact of AI, all of which have major implications for banking’s business models. So with all of this rapid change, what should investors be considering?

In our midyear outlook we discussed a new regime of greater macro and market volatility is being shaped by five major structural forces that we’re calling megaforces. Alex Brazier, Deputy Head of the BlackRock Investment Institute joins me to talk about the first of these big forces in detail, the future of finance. Alex will explain what this big shift will entail for banks, companies and investors as we grapple with a changing economy and structural changes. Alex, welcome back to The Bid

Alex Brazier: Hello again, Oscar. Thanks for having me back.

Oscar Pulido: Alex, you introduced us to the idea of megaforces in the mid-year outlook earlier this year, but perhaps you can remind us what a megaforce is, and what are we talking about when we say the future of finance?

Alex Brazier: These megaforces, they're big structural shifts in our economies. Things like demographic change. Competition between great global powers, the development of artificial intelligence, and the transition to a low carbon economy. All these things are changing the way we produce, the way we consume, and the way we work. And they are enormous, sort of powerful forces in our economies, and they're absolutely relevant to investment. They might be forces that are here with us for very many years to come, but they're actually shaping investment. returns right now.

And this week we're talking about reshaping the financial system, the future of finance. It's a big topic, I don't pretend that what we've got to say on it right now is in any way the last word. There's loads more to explore, and we'll be exploring it. But what we're really looking at here is how the way the financial system serves savers, borrowers, how stable the financial system is, and most importantly, as it evolves, what investment opportunities does that create? And what risks does that create? That's what we're exploring in the future of finance.

Oscar Pulido: Okay, so as you said, you're thinking about these as thematic shifts. So, moving on to today's topic, the future of finance, as we're looking ahead and considering what that might look like, maybe we can start by thinking about the fact that US banks have been experiencing deposit withdrawals. At an unprecedented pace. So, can you tell us what's been happening that's led to this change? And what is the ultimate impact?

Alex Brazier: Yeah, when we talk about deposit withdrawals at an unprecedented pace, it sounds like really bad news. we're normally used to people taking deposits quickly out of banks when they 2008.

But this is actually pretty good news, because part of what's happening is just due to what the Federal Reserve has been doing with, first of all, QE - purchasing assets. Every time it purchases an asset, it puts money in someone's deposit in a bank. And now it's doing QT, Quantitative Tightening, it's, selling the assets that it had and draining deposits out of the banking system.

It's inevitable given that monetary policy, but there's something deeper going on as well, which is the good news here. Really what's happening is that savers are searching around for the best return. We're now in a very different environment, We're not in a zero-interest rate environment. And savers are looking for other options. And most importantly, they found them as well. And they found them in things like money market funds.

And we've seen around two trillion dollars’ worth of deposits over the last few years flow out of the banking system into money market funds. And, as I say, that's not largely because people have any questions about the safety of the banking system. There was a bit of that back in March, this year. But largely it's because banks have been slow to raise deposit rates as the fed has raised rates, but money market fund rates have basically followed the Fed's rate. So, people are looking to earn a higher return on their deposit. They're putting money where it earns the higher return. So, what it's telling us is that there are now credible alternatives to bank deposits. Money market funds have been substantially reformed since the financial crisis in 2008.

They put their money mainly in short term treasury bills and even on deposit at the Fed. So having this alternative to bank deposits is great news for savers. They can find the best returns. They've got choice. That's a new development, and as a result, they're looking around. Now, it's good news for savers, but it's going to be a challenge for banks. And they're going to have to face up to this more competitive market for people's savings, effectively. But broadly, big outflow of deposits, not the usual bad news story. Actually, a good news story about choice for savers.

Oscar Pulido: Certainly, sounds like a really good story for consumers, and they have better options, and sounds like banks are going to lose out if they can’t compete. So how are they going to adapt to this change?

Alex Brazier: Well, they will, over time, have to. for the bank, as we talk about in our paper, it's not really an urgent problem for the banking system as a whole. It's still pretty flush with deposits, largely thanks to the Fed's monetary policy actions. But what this is revealing is that banks can't rely on continually paying rates on deposits that are much bigger.

So, they're going to have to compete more aggressively for deposits over time. Now, there will come a point over the next few years where that. they really have to do that. And for some banks, they really have to do that now. We're particularly seeing that with smaller banks who perhaps aren't so flush with deposits.

And they've been repricing their deposits. That's a sign of what's going to happen in the system more broadly. What does that mean for them? Well, for banks, it means two things. It means squeezing of their profits, their so-called net interest margin, the difference between their lending rates and the rates they pay on their deposits.

And it also means they're going to be trying to pass through some of that higher cost of deposits. into lending rates, into the rates that borrowers pay them. And that means that over time, bank credit is probably going to get a bit more expensive relative to other forms of finance. That sounds like bad news as well. But actually, it creates an opportunity for reshaping or reinforcing a trend in the financial system that's been going on for many years actually, which is diversification in the sources of finance, particularly for companies.

So over time, companies have come to rely less on banks. They've been reliant more on using public markets in particular. Now this change, bank credit becoming a bit more expensive is actually going to encourage companies to continue to look for other sources of finance from outside the banking system. And ultimately, it's going to mean a financial system where companies have more choice as well. They've got more options, they've got a more diversified system to finance growth and jobs, in the economy. and that to us is one of the more exciting things of this, this tectonic shift we see going on.

Oscar Pulido: And if we think about the public sector for a moment, what are regulators proposing and what's that going to mean for this, change in bank lending?

Alex Brazier: Yeah, regulation is clearly in motion here and bank regulators, particularly in the u. S., are likely to make changes. They've made some proposals, and those proposals, could change, over time. But the thrust is that they're probably going to expect banks to fund more of their lending with shareholders cap their own shareholders capital. Now, that's great for the stability of the system, because it means banks are funded more with something that can absorb losses. if they take losses on those loans. but it also means that for banks, funding themselves in the mix the regulators want is going to be more expensive. if these proposals go through, it's likely going to reinforce this trend to make bank credit relatively a bit more expensive than other forms of, credit. And there's one other aspect to the proposals as well, which is, in large part, u. S. regulators are responding to global agreements reached a few years back,

But they're also responding to what happened back in, in March, and the failures of some mid-sized banks, in the u. S. And what they're proposing to do is to extend some of the more stringent regulations. that apply to the biggest banks Down to some of those mid-sized banks as well.

So that's going to be a particular tightening for that segment of the banking system in the U.S. it's going to take away some of the advantages to being middle sized rather than big which as a result we think is going to encourage some consolidation in the industry but it's also going to add to

This sort of tightening of supply of bank credit, because these mid-sized banks have actually been pretty important in the supply of credit to the U.S. economy over the last few years. they've been playing an outsized role. So, for all these reasons, regulation we think is a kind of added factor, added to competition for deposits, that means bank credit is going to become relatively a bit more expensive.

Oscar Pulido: So overall banks are raising rates, regulators are making proposals for more regulations and stricter regulation I should say. So, what does this mean, perhaps, for the broader economy and maybe what opportunities do you think this is going to create?

Alex Brazier: Yeah, we've talked about how it's good news for savers. It's probably good for the stability of the financial system as well. But it does mean slightly more expensive bank credit.

So, what does that mean we're going to see? we're likely to see some innovation in the way finance works. We're probably going to see growth of non-bank forms of finance. and for many years, we've seen companies diversify finance away from banks towards public markets by issuing bonds. This is going to reinforce that trend. And it's also going to broaden it out a bit as well. Because many companies want smaller deal sizes than the public markets can serve them with. And so maybe we're going to see partnerships between banks and other parts of the financial system where the banks do the lending, but the loans are held outside the banks on other balance sheets. But we're also probably going to see the growth of things like private credit. by which we mean loans that are directly negotiated between a borrower and a non-bank lender like an asset manager. And they're held in funds financed directly by investors. Now, this market's still pretty small relative to public debt markets and bank lending. But we think we're likely to see it grow. And that's going to be good for diversifying the sources of finance that companies have to drive growth and drive, drive job creation.

But it also potentially creates a pretty big, investment opportunity over the long term, and we actually see some opportunities in private credit over the long term because as banks step back, we're Probably going to see more demand from borrowers for these alternative forms of credit. That's going to keep interest rates pretty high.

And that's what creates the potential opportunity, but we think we need to be pretty discerning here because private credit loans are not immune from credit losses in a higher interest rate environment. So, we focus on companies that are better placed to navigate that as borrowers. And it's really important to recall that much of the kind of interest rate premium, the extra return on private credit, reflects the so-called illiquidity of those loans. The fact that it's difficult to sell them quickly at a good price.

So, these are not investments suitable for all investors and investors who do hold them need to be able to manage their cash needs pretty effectively using other assets. But if they can do that, then actually there's a premium. To be harvested, and that's why we see the appeal in things like private credit, particularly in longer term, strategic, portfolios.

Oscar Pulido: So, Alex, it sounds like there's a lot to consider. and I'm just wondering, there's a lot of things happening in the world at the moment. Why are we considering the future of finance such an important megaforce?

Alex Brazier: Yeah, it's particularly important, I think, for the way our economies are going to function. In the same way that many of the other megaforces are as well. It's a big structural shift in the way a core part of our economy, the financial system, works. And we're not just interested in this because it's, close to home for us. We're interested in this because it reaches a lot of different parts of the economy. It's changing the way savers save. It's changing the way borrowers borrow. It's changing the way our financial system interacts with our economy. And in the process, potentially creating some investment risks, but also very importantly, investment opportunities. And that's our focus on this. So, it's a big force with big structural effects that's going to be at play for many years yet, but it's already having an effect on investment returns.

Oscar Pulido: Alex, as always, thank you so much for your time. we very much appreciate your insight leading the way in the first of these megaforces that we're considering. And I very much look forward to speaking with you about the upcoming outlook for 2024.

Alex Brazier: Great, thanks for having me, Oscar. See you soon.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH1023U/M-3181415

Oscar Pulido: Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I’m your host, Oscar Pulido.

How do you feel about your own retirement during uncertain market conditions? In periods of volatility, investors can often be short sighted when considering the outlook ahead. And your retirement is a journey that's not only personal, but also profoundly influenced by external factors.

These forces can make or break your retirement dreams and understanding them is crucial for anyone looking to secure their financial future. So, what should investors be thinking about today when planning for tomorrow? Here with me today is Anne Ackerley, head of BlackRock's retirement group. Anne will help us consider the current market conditions from a retirement lens and will walk us through the five major forces that are shaping the retirement outlook. Anne, welcome to The Bid.

Anne Ackerley: Thank you so much for having me.

Oscar Pulido: Anne you're a frequent guest on the podcast, so it's good to have you back. And when you've been on in the past, you've talked about the retirement challenges that women investors have, you've talked about the need for more resilience in retirement plans. And today you're here to give more of a State of the Union address about the retirement industry. I know you released a paper earlier this summer, so what are some of the things that are going on that you want people to know about?

Anne Ackerley: Well, I’m excited to be back here talking about my favorite subject, retirement, and I'm glad that you called it, the State of the Union. that's really what we had in mind when we wrote the paper, and it's about the five forces that are impacting retirement in the United States. It's probably no surprise to you that retirement today is kind of a mixed bag. There are a lot of things that are really quite challenging, but there are things that are working, and we wanted to really focus on that as well. The five trends that really stick out to us are the following:

So, one, Americans are living longer.

Two, there's been this move from defined benefit to defined contribution.

Three, there's Millions of Americans actually don't have access to a workplace retirement plan.

Four, there's a really great need and a great desire for, lifetime income.

And then finally, the racial and gender, disparities continue to exist in retirement. Before I go through all of these, or I hope we get to all of these today.

Oscar Pulido: We definitely will.

Anne Ackerley: I did want to double down on maybe the first two and just do that as scene setting for the rest of the conversation.

So, longevity, Americans are living longer and actually, in the 20th century, we added 30 years of life. We went from 49 years to 79 years in just that short amount of time. And when you think about historically, people have been around for thousands and thousands of years, and it's just been this massive change in longevity.

Now, one thing I do want to just point out, we talk about average longevity in the United States. It is not the same for everybody, and we do need to be aware of the differences. It differs by race, by ethnicity, by gender, by socioeconomic status. And actually, over the last couple of years, longevity has actually been on the decline in the U. S.

But generally, overall, Americans are living longer, and it should be a good thing. Now at the same time that Americans are living longer, our society is also aging. We are going to have more and more people over 65. In fact, within the next couple of years, there'll be 15 million Americans over 65, and that is unprecedented. It's also unprecedented math. All these people are going to have to find a way to pay for these longer more expensive retirements. And interestingly, the one thing that hasn't changed in that time frame has actually been the retirement age. So, while we're living longer, people are still retiring right about the same age, 62, 63, on average, that they were, 40, 50 years ago.

The last thing I'll say, is that the tools that people have to save have also changed during this time period. And there's been this kind of massive shift from defined benefit to defined contribution. I think for most people listening to the podcast, probably very few of them will have guaranteed pensions. Maybe some of the lucky ones, maybe some of the people who are working in the public sector. But for the most part, people will have, defined contribution of 401K plans, which really means the onus is on the individual now, not the company, for people to save and invest and then ultimately figure out how to spend their money in retirement.

Now, it sounds like, whoa, is that a good thing that we've moved from defined benefit to defined contribution? There are some good things about that in a lot of ways.

Oscar Pulido: So just taking a step back, you mentioned, living longer is a good thing, but it requires more planning and you're right about that retirement age point because I can think about my parents. Both have retired in that mid 60s, but yet, their life expectancy has gone up relative to history. So, let's just go back though to define benefit, define contribution. Defined benefit, a company is responsible for a pension that an employee gets after they retire. But there's been a shift towards defined contribution where that employee now is responsible for making their own investments, and they dictate what their retirement pot's going to look like at retirement. So why is that move to defined contribution so impactful to the industry?

Anne Ackerley: You know, 401k plans have helped millions of Americans be better prepared for retirement. and there are two things that have happened with the rise of 401k that have helped that. And we call them the autos, like automobile, but they, actually automatic enrollment.

And automatic escalation, so the autos, and also the rise of the target date fund. So those two things have actually helped more and more people be prepared. So, what is, auto enrollment?

You start at a company; you're automatically put into the 401k plan. money is taken out of your paycheck. And it gets invested into the plan. You don't have to do anything. And in this way, inertia works for you. You're just put into it. Auto escalation means you start out at an initial contribution, and generally every year that contribution might increase by half a percent or a percentage up to a maximum amount. often, it's timed with when people get raises and the concept of auto escalation is that people might not even notice that they're saving even more money. both those things have helped people be more prepared. the second thing, I would just say target date funds, I'm sure we'll talk a lot about them, but they have also been a major, I'd say revolutionary transformation that has happened over the last 30 years in retirement.

Oscar Pulido: The auto part is, it's interesting to me, it would seem like somebody should just do that on their own, but there's also a behavioral aspect of sometimes people need that nudge, you use the word inertia that once it's done for them, they're not tending to reverse that, right?

Anne Ackerley: Absolutely. Look, people are busy. People are out there living their lives, they're working, maybe they're having families, they're volunteering, they're just doing so many things. And the idea that you have to remember to sign up for something, and I will just use my 30-year-old son as an example, because he's in a school that they actually don't have auto enrollment.

And just yesterday I asked him. Did you enroll? And he's like, 'Oh, I need to go check.' You know, people are busy. And all these autos, the doing it for you, and these nudges have really helped. And just on auto enrollment, we know that when people are automatically enrolled, it's something like 98 percent of people or 95 percent of people stay enrolled in the plan. When you have to do it yourself. The number is something like 28%. People are busy, and they think they're going to get to it, and they don't get to it.

Oscar Pulido: So, it's in their best interest,

Anne Ackerley: A hundred percent.

Oscar Pulido: So, your son is 30 years old. It turns out that Target Date Funds, at least the ones at BlackRock, are also celebrating 30 years this year. You've talked about the importance of Target Date Funds within the retirement ecosystem, so maybe take us back, why was it important that Target Date Funds came of age 30 years ago? What's the state of them today? When you look ahead, are some of the evolutions coming to Target date Funds?

Anne Ackerley: This is the 30th anniversary of the Target Date Fund, and BlackRock did pioneer it, 30 years ago. Really, what a Target Date Fund does is take the complex job of trying to figure out how you should invest over your career, and it does it for you. Target date funds are basically a mixture of equity and bonds and that mixture changes over the course of your career. It's more in equities when you're young and then target date funds take risk off the table as you get closer to retirement.

And really the only decision that you need to make is, quote unquote, the target date. What is the year that you think you will retire? You pick that and then you're put into it, and it does all the investing for you, both, what we call the glide path, the mix of stocks and bonds, as well as the asset allocation within that.

Really revolutionary just transformed. What happened with 401k plans. Today, something like 36 million Americans use a target date fund, and they are the primary default vehicle, in over 90 percent of 401k plans. So, this is just a way that we've made it easier and simpler for people to be invested appropriately during the course of their life, and I'm just really proud that BlackRock pioneered this amazing vehicle.

Oscar Pulido: I'm thinking about how you said it and people are busy. within the retirement ecosystem, this concept of enrolling them automatically escalating their savings, and then within the target date fund, it sounds like making adjustments in the portfolio is also happening automatically. So, all of this creates, hopefully, a better long-term experience for the person in 30, 40 years or whenever it is that they're retiring.

Anne Ackerley: You know, if you put yourself in a 401k plan, let's say you put yourself in a certain non target date fund, you get busy in life, you forget about it, maybe you're not changing your asset allocation often enough, maybe you started in cash. And you're young, you shouldn't be in cash, as you get older, you probably shouldn't be in all equities. it does it for you, and you really don't need to think about it as you're busy living your life and doing the things you want to do.

Oscar Pulido: And then one day you retire, and you have this pool of money that ideally, you've been very diligent about and saving and so you've talked about then the need for that person to have retirement income or at least the concept of retirement income becomes important to that individual because now I have this pool of money. I'm no longer working. how do I consume and how do I maintain that day to day that I was accustomed to having? So, maybe talk a little bit about this concept of then retirement income and why it's so important.

Anne Ackerley: Absolutely. The number one financial fear in the United States is the fear of outliving your savings. And it's actually, it does make sense if you think about it. as you said, you retire, you no longer have income coming in, and you've got this pool of assets. And, in the United States now, because we're in 401k plans, it's really up to you to figure out how to spend that money and spend it so that you won't run out of it. And yet, you don't know how long you're going to live. You don't know what the markets are going to do, and you probably don't really know what your expenses are going to be, particularly if you're going to have some sort of larger medical expense or some unforeseen expense, and yet we say, everybody, hey, go figure this out.

Bill Sharp, the Nobel Laureate, has called this the nastiest, toughest problem in finance. Particularly as people are aging, more and more people are retiring, people are getting very focused on retirement income. The question of how do I spend my money so I can continue to live the life I want, but not run out.

And we've looked at surveys, 98 percent of employees want help with this, or over 90 percent of employees want help with this. 98 percent of employers I think they should be helping people with it. If you look back, people were very focused on that accumulation phase, the saving phase, now people are really starting to think about, how do I generate this income stream? at BlackRock, we've been very focused on this. we've taken the concept of the target date, and we've extended it. And we have come up with a strategy that embeds annuities into the target date strategy so that when a person gets to retirement, they would have the option of perhaps annuitizing and getting some form of guaranteed income.

And all embedded within a target date, which people know, and now we've put a guaranteed, piece into that as well. So, they're trying to bring back some of the defined benefit aspects. But still within the confines of a defined contribution plan. it's industry innovation, I think, at its best. There's just, the fact that people are living longer, the fact that they want help, employers wanted help, we've really pulled together to come up with something that we think can give people real help in figuring out how to spend in their retirement years.

Oscar Pulido: And so, everything you've talked about is around, if you have a retirement plan, if you work somewhere that offers you target date funds or a company has a 401k plan, right? The economy's changed a lot over the years and I think there's a lot of companies that don’t necessarily offer target date funds or a worker that doesn't have access to a good retirement plan. And I think your report actually maybe even touches on it and shares some data on this, but what does that person do? Like how do they get set up for success if they don't have access to all the wonderful, 'we'll do it for you' sort of features that you've talked about?

Anne Ackerley: So, this is a great question, and it is something I'm extremely passionate about. It goes without saying that all these good things that I've talked about, all the innovation, is only available if you, in fact, have access to a workplace plan where you work.

And today, 57 million Americans do not have access to a workplace plan. That's about 48 percent of private sector workers, so think about that, almost half of the people who work in the private sector don't have access to a workplace plan. Now a lot of that is small to medium sized businesses. Historically, small business has found it costly, hard to administer. they may not have HR departments who are able to do this. And so, the industry has really tried to work on how can we get more people plans, because we know that when you get, a plan at work, you're 15 to 20 times more likely to save.

You ask me, what do people do if they don't? They've got to go and probably set up some kind of IRA. And then they have to remember to take money out of their paycheck and invest. They've got to figure out their investments. And it's just shown that people will save 15 to 20 times more if they have access at their workplace plan.

And so, the industry's been focused on how do you increase access. And one of the things that has really changed over the last few years is technology. Technology is making it easier and simpler and cheaper for small businesses to offer plans. Today there are companies where in two clicks, an employer can sign up, and in two more clicks, an employee can sign up. And so, technology, I think, is going to help. there's some policy that's helping, in a policy called Secure 2. 0. There are tax credits available to businesses to try to encourage them to offer the plans. And then finally, some states have gotten involved. I think it's about 12 states have said if you work in this state, the company needs to provide a plan.

 So, we've got a whole bunch of different things working to try to increase the number of people, in the United States who have access, because there is no, federal requirement that a company provide these benefits.

Oscar Pulido: I'm almost thinking if a company has a gym in their building, you probably get more of the employees that exercise versus if a company doesn't. and therefore, the statistic around 15 to 20 times. more likely to save if there's a workplace plan. it makes sense. It's the people who don't have access to the workplace plan are also busy, and therefore, if it requires extra work for them to find how to do it, it's going to be more challenging.

Anne Ackerley: For sure.

Oscar Pulido:  That 57 million, those people who don't have access to that workplace plan, talk a little bit more about that. I think there's also some demographics, challenges in, in, in terms of what we see, access to retirement, the retirement outcomes that we see among different genders and demographics that I know you've done some work on that is, is interesting to touch on.

Anne Ackerley: The who doesn't have access are, people who tend to work in, certain sectors, the retail sector, maybe the hospitality sector.

I'd also say, gig workers don't. People who work for smaller businesses often don't. this might be surprising, there's 600,000 401k plans in the United States, but there's 6 million employers who have more than one employee.

So, there's a lot of plans, but then there's a lot of companies that don't offer it. And women and people of color disproportionately are affected by the lack of access. It's the sectors they work in. It might be part time workers, particularly for women. Often part time workers are not eligible to participate in plans. And the ultimate impact on retirement savings if we look at women, what we find is that women's balances at retirement are often 30 percent less than men's. This is in part due to access; they often don't have access. it's also due to the gender pay gap, the fact that women make 84 cents on the dollar. even if they're saving the same amount as men.

It's less amount of money, and that less amount of money compounds over time. Women are often, I think they provide almost, 80 percent of caregiving in the United States, whether that's childcare or elder care, and are often in and out of the workplace, which, again, impacts, their ability to save.

And for women of color, these numbers are even far, far greater. And again, I think the impact, is pretty devastating on people who don’t have access. and again, particularly women and people of color.

Oscar Pulido: So, this is a topic that I imagine we're going to be talking about for some time, but I get the sense that there's a lot of positive trends in the retirement space, particularly, I keep coming back to the person who's busy and how the ecosystem around them is developing to try and put in some good behaviors. There's still those 57 million Americans, though, that lack access that we need to help. we will probably have you on more than a few more times, Anne, to hear about how we're trying to close that gap. I want to thank you, though, for joining us today on the Bid.

Anne Ackerley: Thank you so much for having me.

if you've enjoyed today's episode, check out 'How to Solve the Emergency Savings Crisis', where I speak to Claire Chamberlain, BlackRock's Global Head of Social Impact, about what both the private and public sector is doing and what more still needs to be done to help resolve this crisis. Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH1023U/M-3146522

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Artificial intelligence can be described as the simulation of human intelligence by machines. As we heard in the previous episode in this two-part look at AI, we heard how AI has been evolving for decades. Today we're going to take a look at the implications of AI for the investing landscape. Here with me today is Brad Betts, global equity researcher for BlackRock Systematic, an investment team that emphasizes the use of data-driven insights and cutting-edge technology in their approach.

Brad focuses his research efforts on using artificial intelligence, machine learning, and natural language processing to generate alpha. In other words, he uses AI to attempt to outperform the markets, and he's been researching these technologies for decades from his time as a scientist at NASA to the pivotal role he's played in bringing AI innovations to BlackRock. Brad will help us understand what AI means for investing and the opportunities that lie ahead.

Brad thank you so much for joining us on The Bid.

Brad Betts: Thanks for having me.

Oscar Pulido: So, Brad AI is seemingly everywhere right now. We're hearing about it on company earnings calls. We're hearing about it in news headlines, but you've been researching and using these technologies, really throughout your career. So, I'd love to hear more about the evolution of AI in terms of how you've seen it and how it pertains to the investment management industry.

Brad Betts: Yeah, my pleasure. I was an intern in the summer of 1989. I was working in a military research lab and one of the senior members of the lab had gone to a conference and came back and gave us all a briefing, and it was the first time that I had heard about artificial neural networks. And these neural networks are the key architecture behind things like ChatGPT. it was a particular demonstration. of a truck, a big rig, you know, an 18-wheeler being backed up.

Here I was seeing a computer learning how to do it. It wasn't being instructed explicitly by humans. It was learning how to do it, and this fascinated me. and it could do it even from a position that you called jackknifing a big rig, which is a really tricky position to get a truck out of. And it was riveting and so that was my first exposure.

Back in those days, we had nowhere near the computing power, nowhere near the volume of data, nowhere near the accelerated computing hardware that we have now, and nowhere near the sophistication of the algorithms. But it captivated me and it in no small part led to the great fortune I had in that next step of my career, which was to do my doctorate in something called the information systems lab at Stanford.

That lab was buzzing with ideas of information theory and signal processing, and cryptography and optimization and compression and medical imaging. It was just a wonderful time and there were giants of the 20th century, that were there. But there was another powerful force in this information Systems lab at Stanford, and it was a gentleman named Bernie Widrow - Bernard Widrow. And Bernie Widrow, had developed the first practical use of a neural network. If you made a phone call for many decades in the US you were using artificial neural networks, it was being used behind the scenes to do things like cancel echoes on the line.

Anybody that remembers older phone calls and you could sometimes get a really annoying echo. Well, that was technology that had been developed by Professor Widrow and others, something called Adeline. Professor Widrow, and others, built Adeline in 1960 before I was born, so that history of this goes well back into the 1950s. And it was the first practical use of a neural network. And again, these neural networks are what are underpinning so much of the progress and excitement.

I then had the good fortune to use what I had been trained and taught at places like NASA, at startups in Silicon Valley, and then close to 16 years ago now at BlackRock. The evolution has been for me, one of extraordinary excitement and privilege to see the changes in these technologies, to see the advent of more data, of more computation, of increased sophistication and algorithms, has led to this remarkable excitement that we're seeing now.

Oscar Pulido: Well, it's interesting because for many of us, common folk we think of AI as a recent development but I think you started your story with an internship back in 1989, this really has been an evolution over multiple decades, and you mentioned a couple terms, by the way, you mentioned neural networks, machine learning. I know we talk about like large language models, natural language processing, how do you think about those terms? What do they mean? How do they apply to the investment industry? Maybe we can go there.

Brad Betts: The field is definitely filled with jargon acronyms and terminology. Artificial intelligence, is a very broad and ambitious field of endeavor, which is obviously looking to try to mimic human levels of intelligence.

Machine learning is another term, and you can think of it perhaps as a sort of a subset of artificial intelligence. that tends to be more focused on performing a particular task. It's using computers to learn from historical data to take advantage of a historical data to make predictions about the future. That's a common use of machine learning. And its roots are in the signal processing and computer science and applied mathematics, the applied mathematics of optimization community.

You mentioned natural language processing, another term that people will use for that is also 'text analysis' but text analysis, natural language processing, NLP, is trying to have computers understand and take advantage to perform some task, human speech, human writing.

You mentioned large language models, ChatGPT is an example of a large language model. We call them large language models because they as rule of thumb, are trained with large amounts of text data, and also they have a very large number of parameters. you can just think of them as dials. you have one dial on your thermostat at home, imagine having billions of dials. So how you set those dials is critically important. The last one, you asked about, Neural networks, the, maybe the slightly more correct people usually just shorten it to neural network. we really say artificial neural network to distinguish it from the biological neural networks in our own human brains. These artificial neural networks we're meant to be very crude, of approximations of our human brains, of the neurons and synaptic connections and it turns out that these techniques pioneered by people like Bernie Widrow and many others have proven, over many decades now to be staggeringly successful.

Under all of those terms you've mentioned, natural language processing, machine learning, artificial intelligence, large language models. Under all of it is large amounts of data. Large amounts of computing power to take advantage of that data. And then also this accelerated computing. It's not just the standard computers people tend to have at home. There's specialized hardware that is well-suited to machine learning, natural language processing, artificial intelligence tasks in particular. It actually grew out of graphics processing, but it turns out it was well suited to the mathematics of this of this area.  So, I hope that gives a flavor and we've only touched some of it.

Oscar Pulido: Well, one of the added terms that comes to mind when you think of Ai, and you mentioned it, one of the most widely publicized headlines around AI when ChatGPT was released at the end of 2022, and I think you put it in the category of Large Language Models. So how does the large language model that ChatGPT uses compare to what you would use in investment analysis?

Brad Betts: We use large language models for investment at BlackRock, but we use them very differently. So, we take these large language models and we tune them to make forecasts for the returns that companies will generate in their stock. So, in effect, you can think of this model being tuned and becoming a real specialist. This a big piece of computer code powered by massive amounts of data and computation and becomes a specialist in making forecasts of, what will the return be to Apple over the next week, over the next quarter, over the next month.

And the process by which we do that is one called fine tuning. So, when people are interfacing with something like ChatGPT, they tend to be putting in text and they get out text. Whereas when we use them for investment, we tend to be putting in lots of text, and what comes out are numbers, forecasts of returns, and we use those forecasts of returns to conduct trading.

Oscar Pulido: Brad, one of the criticisms perhaps of ChatGPT is you put in text and. The text, you get back may or may not be accurate, it might have provided a lot of convenience, there's a bit of like, how do we know what it's telling me is true?

How do you then, assess that with the fine tuning that you described when you put in text and it gives you numbers, and do you know how believable that data is in order to make your forecast?

Brad Betts: You put your finger, of course, on a very difficult and challenging part of our job, which is exactly what you said. how do you trust, how do you tune the neural network properly, appropriately to do what it is that you want it to do?

So, this fine tuning process, think of it as, as, picking up an initial base model, that sort of understands a language, say English, it understands English very well. It can generate tokens, maybe not quite as well as ChatGPT but it can do it pretty well.

And then what we do is we feed in new text and we give this text a label. And this label is used by the neural net to understand if it's done something well or poorly.

Say you take the transcript of an earnings call, or say you take a broker report from some sell-side firm, this is the phase where you're training your neural net, then you're going to use the neural net for new data. But initially what you're doing during this fine tuning is using history to make the net much more specialized. And so you put in a piece of text and you give it this label. you can use the future returns that a company will receive over some horizon.

Then the neural net takes that information, feeds it forward through its architecture, and it produces a forecast of what the return it thinks will be achieved. We reward or penalize the neural network on how well it does. And then the neural network, the algorithm I'm describing it so I'm personifying it, of course it's just math and code, computer code, but what happens is the neural network then adjusts its weights.

I mentioned earlier that notion of like maybe having a billion dials, how do you set those? This part of the algorithm is now called back-propagating. The neural net says, 'okay, I took that piece of text. I think that the firm in the future, over the next say month or so, isn't going to do very well. Oh, but you're actually telling me it did do very well. Thanks for giving me that feedback via that label. I'm now going to go and adjust my weight slightly to try to close that gap.'

But you're doing this with huge amounts of information and you're doing it very rapidly. And it's not just one piece of text. It's taking in billions of these items and it becomes very skilled at matching what happened. And now what you can do once you have trained it in this fashion now you can use new pieces of information that it hasn't seen, so nobody knows because now you're talking about a real prediction, you're talking about the future, the neural net can take that piece of text and say, based on everything that I've learned, that I've been trained with, I think that this firm is going to do well. and again, it's not using any one piece of text.

By the way, Oscar, one of the things that allows us to do this fine tuning so powerfully is a brilliant algorithm called ADMM, the alternating direction method of multipliers. Under the covers, a lot of this comes down to doing optimization well, and this ADMM technique, was brilliant. And we have developed and tuned an ADMM implementation for so many years. that under the covers allows us to do this fine tuning because I described it as it's just matching returns. we actually get it to match exactly the investment problem or as close as we can make it to what we are really going to do.

So that is to say we want the neural network to learn to maximize returns while minimizing risk and minimizing transaction costs and minimizing borrow costs. And we're able to do this because of the brilliance of ADMM.

Oscar Pulido: Can I go back to something you mentioned, and that was fascinating how you painted that, image of the neural network learning being given feedback. Isn't the data that you are providing, historical data, and we're in a new investment regime, the great moderation is over, that period of low interest rates and low inflation and growth being more stable and predictable. Well, now we're in a new investment regime, of more volatility, so how do you think about the predictive nature of these models when maybe we're at an inflection point and some of the real-time data that you are feeding, it, it might not be trained for that. or does the data go back so far that it has plenty of history to have picked up on various economic cycles?

Brad Betts: Yeah, a huge change was the pandemic. As humans, we hadn't roughly seen a pandemic at this scale for, around a hundred years. Think back to March of 2020, how many of us really predicted how sharp the rebound would be in markets. And whether you are a computer, Or whether you're a human, A shift of that kind of magnitude is an incredible challenge.

The markets are a very dynamic system. And the nature of a dynamic system is It keeps changing. it will continue to be true. algorithms, humans have to be nimble, they have to be able to take advantage of what information they have available to do the best job that they can for prediction.

And we'll see, it is a fascinating time to, to be alive, to see, who is able to adapt more effectively to these changes that that will always be there in the markets.

Oscar Pulido: That race between man and machine, brings up something that we touched on in our previous episode, which are some of the ethical concerns, that arise from artificial intelligence, and what the impact is going to be on industries and society. And there seems to be two, schools of thought here. One is very fearful about the rise of these technologies and there's another side of the camp that's a little bit more I reverent. So, what's your view in terms of the business impact, the impact on society from artificial intelligence?

Brad Betts: It's my life's work. I don't go to bed worrying at night around a machine takeover. The opposite for me. I'm excited by the opportunities that these present the opportunities. You know, I,I feel that sometimes the conversation gets a bit focused on the risk and that's human. but sometimes it misses the extraordinary opportunity, the opportunity that will come, you look at algorithms like alpha fold. a neural network that learned the 3D folding structure of proteins, the opportunity that will afford for drug discovery is wonderful.

I fall in the camp of being more excited. I think that the impact businesses will see is around, automation. I think a lot of the ways initially and unsurprisingly businesses will see these impact will be, in productivity enhancing tools, for example, on things like email, in code generation, in the translation of old computer code into more modern languages to reduce operational risks, to put them into a more modern, framework.

How many of us really go to bed at night achieving inbox zero? Imagine if you had an agent that was sitting there that was summarizing the emails for you, was summarizing presentations, was drawing your attention over time to the ones that it's starting to learn, that you're more interested in that it feels are more worthy of your attention, that are able to summarize.

I think that is a way, and firms like Microsoft are working very hard and highly incentivized, of course to bring those kind of capabilities, to many enterprises. So I think these opportunities for automation are a path where we're going to see, a flurry of activity around the adoption of these technologies.

Oscar Pulido: I think the term inbox zero would resonate with a lot of people. I know it resonates with me. It seems like an impossibility unless I delete everything and then surely I'll have missed a lot of important things. But while you work in the investment industry, it sounds like a lot of the examples you gave were actually just about productivity, automation you mentioned healthcare as well. Are there other opportunities for artificial intelligence in in other industries or other, just, parts of our life that we're not thinking about, that you think about when it comes to artificial intelligence?

Brad Betts: You see them more and more in things like, chip design, the layout of chips on silicon, on car aircraft, spacecraft design, improvements in advancements in simulation, environments that, that come from these technologies.

There's a lot. And I don't want to give short shrift to investment, my goodness, there's so much opportunity that we have taken advantage of at BlackRock and will continue to take advantage of at BlackRock through these technologies. Our allegiance, Oscar, is to whatever is efficacious. Our mission at BlackRock is to do right by our clients. It's to do right and to bring them those investment results that they want and need.

 What it really excites me, the opportunity for these technologies in an investment context is that opportunity to continue to improve the outcome ultimately for our clients to execute the mission.

And also quickly, I mentioned that it feels very personal for me. my mom grew up one of seven kids. They were of modest means and she put herself through high school and she put herself through nursing school and. And she raised three boys. And she and my dad built a home for us and, saved their money and bought me and my brothers, our first computer, a Commodore 64 that took savings from them, that took effort. And I've been obsessed with computers and math since I was a little boy. And Oscar, if II can put, my life's study of math and computer science, if I can put that to use, to help our clients to, then for me that's a life well lived. That, that idea that maybe I can try to help a family that has never had a vacation. there's an extra basketball. It as a birthday gift or something, all the things that, that my mom never had. and for me that's, that's a life well lived.

Oscar Pulido: I love that story. I'm sure a lot of our listeners will say the same. Brad, I know you're based in San Francisco. I'm just thinking about your comments. I've been through the office but there's a quote somewhere that says something like 'the art of investing has become the science of investing.' I'm wondering whether you put that up there when you first joined?

Brad Betts: Well done, Oscar. Good for you for remembering. That comes from one of the most brilliant, researchers I've had the privilege to work with, Ron and Richard Grinold.

Oscar Pulido: Brad, thanks for all the insights and, most importantly, thanks for joining us on The Bid.

Brad Betts: Thanks for having me, Oscar. It was a real privilege.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out part one where we took a look into AI's history and its inflection points for investing. Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0923U/M-3069965

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Artificial intelligence, or AI, is more than just a buzzword. It's a transformative force that has revolutionized industries and reshaped the way we live, work, and interact with technology. But before the age of self-driving cars, virtual assistants and smart homes, there is a fascinating history of research, trials and tribulations that laid the foundation for the AI driven world we inhabit today.

In this episode, we'll delve deep into the origins of AI, tracing back to its theoretical beginnings and early aspirations. We'll uncover the pivotal moments that triggered significant shifts in investment sentiment, and we'll analyze the turning points in AI's history that propelled the technology from mere possibilities to tangible investment realities.

Here with me today is Jeff Shen Co-CIO, and Co-head of Systematic Active Equity at BlackRock, an investment team that emphasizes the use of data-driven insights and cutting-edge technology in their approach. Jeff and his team have been at the forefront of innovation in AI for decades from their role in helping to start BlackRock's AI labs several years ago to the strides that his team is making in leveraging the latest AI advancements in their investment process today.

Jeff, thank you so much for joining us on The Bid.

Jeff Shen: Thanks for having me.

Oscar Pulido: So, Jeff, I'd like to start by asking you to talk a little bit how you got started in this field of systematic investing and then what is your interpretation of some of the most recent developments in artificial intelligence?

Jeff Shen: Absolutely. So, I started in graduate school, got a PhD in finance and had been in the investment world for the last, 25- 30 years. I'll say that it's certainly been extraordinarily exciting to see some of the most recent developments. Some people like to call it the age of AI, the age of big data, the age of machine learning, and we're going to get into a little bit of what all of these things mean. I'll say, given what's going on in the world, this is certainly a bit of a golden age. We've also never seen so many developments in different algorithms to interpret this interesting data. And then eventually relative to the investors I think the most important thing is how do you make sense of all of this data and what you can do with this data and eventually lead to a better investment outcome?

Clearly, we're going to get into Generative AI, large language models, If I have to step back a little bit, we've been looking at numbers for the last 40, 50 years. And large language model or natural language processing in general certainly allows us to be really smart readers of any of the texts out there. Whether it's earning transcript, whether it's a broker calls, whether it's news articles. Now we can read smartly as an investor. And I think that's a revolutionary step that can impact how AI can be applied in the investment world.

Oscar Pulido: And that's interesting that you use the term, golden age for data, for technology and how it's maybe helping you do your job. But maybe if we could just, take a step back and tell us a little bit about maybe some of the technology milestones that led to the development of artificial intelligence. Just wind the clock back and help us understand where we've come from.

Jeff Shen: Now we can wind back the clock a lot if we want, because when you think about artificial intelligence it is really a field that encompasses many different subfields, if you go back to logic, go back to Aristotle, or if you go back to normal distribution, At the same time, the artificial intelligence field as we know it today probably can date Back a bit around 1940s and about 80 plus years of research and development. When we think about in 1969, Marvin Minsky and John McCarthy were given Turin award. A big part of it is actually about how do we think about representation? How do we think about reasoning in a machine intelligence way? And when we say machine intelligence, essentially you can really think about an intelligent agent would get a bunch of inputs and then the agent would go through a rational set of calculation- what we call algorithm. And the output will be a set of rational actions and behaviors that is actually desirable in a particular type of environment or context.

The development here is about better input, meaning better representation, better sensing technology, better algorithm, how do you process this information better? And also, how you measure the success is really to think about the output or the behavior coming from this kind of, intelligent agent, whether that can learn in a new environment, whether it can adapt to a new environment, so how good the output is. So, it is really about better sensing, better processing, or better algorithm, and then eventually leading to better output.

Oscar Pulido: I didn't realize you would take us back to Greek philosophers in winding the clock back, but you also made the point that a lot of the research and development has been taking place over the last 80 years. Certainly, a long period of time there've been advancements in this field. Have there been certain breakthroughs or milestones that triggered a shift in the investment trends in artificial intelligence where it started to get the attention of those who wanted to again, invest in this field and weren't just observing it from afar.

Jeff Shen: Yeah, I think the investors', attitude towards this field certainly have gone through I call it a potential three phases. Initially, there's always a sense of skepticism. How can an intelligent system be better than humans in behaving or delivering certain output?

So, there's a certainly a phase of skepticism, which is normal for any type of new technology. Then I think it can go through a bit of a period of hype. There's a lot of excitement, maybe sometimes too much excitement, and then that may eventually lead to a bit of a crash of excitement in any type of new technology.

And I think for AI, I'll say that back in 1950 s, there was a prediction that AI system would beat the world champion in chess in about 10 years. So, you're thinking late 1970s AI would be able to beat the world champion. That did not happen until 30 years later. we all know the story of Deep Blue and Gary Kasparov in 1997.

So initially there was certainly a bit of hype then in the 1980s there was certainly a bit of an AI winter and that caused a lack of enthusiasm in the sector. And then clearly, given some of the latest development, I think right now we're certainly seeing quite a bit of excitement, quite a bit of hype. So, I think, from an investment perspective I would like to think a thoughtful approach in any of these technologies, it's important, because there could be hype, there could be skepticism, there could be crash. It's always important to think about what is really going to impact, the future, what is really going to survive some of the hype, and I think the thoughtful approach is certainly an approach that BlackRock likes to take.

Oscar Pulido: And presumably this cycle that you highlighted, and I'd never heard the term AI winter, but I get the sense, of course those are periods where there was more pessimism towards this technology, but a lot of technology goes through that cycle, perhaps that you've described the hype, the pessimism so with respect to artificial intelligence, why is it that it has reemerged as a viable investment opportunity? I think it's safe to say we're out of an AI winter.

Jeff Shen: Yes, the 1980s is quite behind us. I want to take us back a little bit to think about some of the games that AI has actually delivered. I talked about the 1997 chess match. Deep Blue won over Gary Kasparov the World Champion back in that day. People also may remember that 2011, the IBM Watson system actually end up winning Jeopardy. and we thought Jeopardy's a very human type of endeavor and, for folks in Asia, the game Go has been around for a couple thousand years.

And the Google DeepMind developed this algorithm called AlphaGo. And that essentially, it is an AI system, that actually defeated Lee Sedol who was the world champion back in 2016.

If you don't know what the game Go is, it's a game with a board and you put black and white pebbles on top of it. And the whole objective of the game is to occupy as much territory on the board as possible. The difficulty of the game is that the number of possibilities of the moves is more than the atoms in the universe.

What Google DeepMind did was trying to use essentially what we call is machine learning. It is actually learning, along the way. So to a certain extent, the chess, what they did was a bit of a brute force. They imagined all the possibilities and they went for it. The game of goal, the issue is that you cannot get to the end by imagining all the possibilities.

The beautiful thing here is really that the machine came out with some of the moves that the human Lee Sedol in particular thought was pretty dumb moves, but it turned out to be brilliant moves10 minutes into the game. so, that was a surprise in a sense that it won without mimicking human. It won because it went with a machine way of thinking about what's most rational move under the circumstance and it was adaptive along the way. So, I think that was probably the most surprising part when we see artificial intelligence, that was probably the manifestation of the artificial intelligence because it had nothing to do with human intelligence.

Just to dwell on this, they developed another system called Alpha Zero, which did not even know the rules of the game and essentially self-simulated, so it was playing against itself try to learn the game. That was a major breakthrough because it did not rely on any of the prior human knowledge and it basically self-simulated, so played against itself such that it knows the objective eventually want to occupy as much territory as possible. Other than that, it did not know anything and, it ends up actually winning, against some of the world champions. so that's the part that's most exciting.

So, I would say that some of these big triumphs of AI systems that actually defeat, human or world champion in particular games certainly has been an extraordinary excitement, both in terms of thinking not only what AI can do, but also, the potential for AI system to surpass human capabilities.

That's certainly creates a lot of excitement, but also creates some level of anxiety. And I would say that leads both towards potential opportunities, but also there's quite a bit of a risk that people are considering.

Oscar Pulido: And so just bringing it back to the investment landscape, what are some of the types of companies in the AI space that are attracting the attention of investors?

Jeff Shen: I think, right now generative AI, especially, related to large language model is certainly all the excitement. Language is so central to our civilization, to our culture, and if you have a AI system that can have language, essentially at its own disposal and being able to not only mimic a human, but also, in a lot of tests, you can see that it's actually, whether it's a AP test for some of the high school graduates or some of the GMAT or GRE type of test, it certainly has demonstrated very strong capabilities. That part is actually generating a lot of excitement.

I think the second part is also if you're providing tools for the AI revolution whether it's chips or whether it's systems, whether it's cloud computing. So, the tools companies are also benefiting, from this overall AI trend.

That's probably the two big ones. Clearly, the outlook for this space is there will be certainly a few winners, but I think there's also could be quite a few losers because this is a very competitive space.

Oscar Pulido: And on the generative AI, side of it that you mentioned, as artificial intelligence becomes more mainstream and more people talking about it, one of the things that gets raised, and I think you touched on this, there's ethical concerns, there's questions around the biases that might exist in the data that AI is processing, there's data privacy concerns. So how do you see these generative AI companies dealing with those issues, or are they waiting for public policy to step in and regulate this in their own way?

Jeff Shen: Yeah, I'll come back. regulation second. I think just looking at the state of the world I’ll make a couple of observations.

One is that biased data will lead to biased output. Data integrity is very important and making sure that the data is covering all different aspects of the world so that we can get a more balanced output. So, I think the integrity of data is certainly critical for the success of the AI system.

The second part is some of these algorithms that's been run are extraordinarily powerful. Millions and billions of parameters that's actually being put into the system. The challenge there is really that the transparency aspect of it is actually very difficult to achieve just given how complex these systems can be. Probably some people may have heard about the neuro network that is underlying a lot of these generative AI systems. When you get into the billions of parameters, it's very difficult to figure out how the decisions is actually being made, that level of transparency can be of concern.

So come to the regulation. I think this is also the field that the industry, the technology is certainly ahead of where the government policies are. And this is actually where education for the policy makers, making sure that people really understand not only the power, but also the risk associated with the systems are very critical.

I think it's also a competitive game whether it's a competition within the industry, competition around the globe, it’s also forcing industry to need to go very fast. On one hand, this is a very powerful tool that can be transformational in a lot of industries, certainly in the investment industry. At the same time, the regulation is one or two steps behind, so I think that's the conundrum that we face.

Oscar Pulido: And so, Jeff, you took us back many years in terms of the history and some of the milestones that we've seen that have helped the development of artificial intelligence. You're using this in your day-to-day job as a systematic investor in present day. So, take us forward into the future. What are some of the developments that you see happening in AI and what are the investment opportunities for investors?

Jeff Shen: I would call out three things that I think for people to think about. I'll say that big data. Big model and big crowd on the big data front there's certainly a lot more data available and from an investment perspective, this is certainly about how do you take as much data as possible in your decision making. And it's a scale game, it's a bit of a race, on how much data you can absorb, how much data you can process. But I think the race is on, and I think that's also where the excitement can be because if you can measure things, you can make better decisions. And data is really the new oil for the AI system.

On the big model front, we talk about generative AI, we talk about large language model. These models are getting to be more and more powerful, also more and more flexible. I'll give you one specific example today we can measure many things; we can also combine them in a way that is actually optimal. So, it is not only about measure many different things in the economy in the world, but it's also combining them so that you can form a holistic decision through a big model by combining features together. So, I think from that perspective the big model not only allows you to combine different things in efficient fashion, but also allow you to tackle multiple objectives. You may care about, the investment outcome you may care about, draw down characteristics. You may care about the climate impact. So, this kind of big model really allows you to combine things in efficient way, but also allow for considering different objectives.

And the big crowd aspect of it. If you think about how generative AI is actually coming from. The human input is becoming more and more important in getting the AI system to be better. So, it is interesting that even though we call it artificial intelligence, human intelligence is actually quite important element of artificial intelligence. So, I think this idea of human in the loop is certainly something that I think is here to stay. We are making the system better and to allow the system to produce more rational response.

The new world it's not only about generating new ideas, we can see that from a generative AI perspective we can generate a lot more. But I think the human input here is also really allows us to think about how we judge these things. How do we discriminate the good output in relation to mediocre output? So, I think the human, aspect of it is actually also evolved from going from purely at a job of generating things to one that's also about discriminating different outcome. So, I'll see that big data, big model, and big crowd, are some of the exciting things as we look forward.

Oscar Pulido: Well, that's an easy way to remember your outlook and that last point, is a good example of just as technology evolves and it appears to be displacing humans in, what they do, humans adapt and humans contribute to that technology and work alongside, that technology. So, I'm going to go out on a limb, Jeff, and say, this is not the last time we're going to talk about artificial intelligence on the podcast. So, we look forward to having you back at some point in the future. And thanks so much for joining us today.

Jeff Shen: Thank you so much, Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, be sure to check back next week for part two of our deep dive into AI, where I chat with Brad Betts, former NASA scientist and global equity researcher for BlackRock's systematic investment team, where we look to the future of this technology and explore the potential applications for AI in the investment world.

Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0923U/M-3103566

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Neurological diseases and disorders are among the world's most prevalent health conditions. The need to address them is mounting amid an aging global population and as the world grapples with mental health challenges that were exacerbated by the pandemic. A combination of public and private investments, government grants and charitable donations are helping accelerate a wave of advancements and opportunities in the field of neuroscience.

Recent clinical trial success for the second significant disease modifying drug to treat Alzheimer's is a critical milestone and a positive sign for the future of neuroscience. So, what does this mean for the healthcare investment landscape?

Jeff Spiegel, US Head of BlackRock, Megatrend International and Sector ETFs, joins me to talk about these latest breakthroughs in neuroscience and why it demands a closer look when considering healthcare opportunities in your portfolio.

Jeff, welcome back to The Bid.

Jeff Spiegel: Thanks for having me back.

Oscar Pulido: So, Jeff, today we're talking about the brain, and I'm not a neuroscientist or a neurologist, but I do know that it is a very important organ and I also know that it's a bit of a mystery. I don't think there's been much progress in terms of treating neurological issues. So, what are some of the catalysts that are now bringing neuroscience to center stage?

Jeff Spiegel: So, I'm not a neuroscientist either, I just get to play one on The Bid. my wife though, actually is both a neurologist and a psychiatrist, so we had a little bit of a conversation about this last night, and she was very excited to hear today's discussion once it comes out.

The fundamental issue when I think about neuroscience is aging populations. And really, I think about this as an issue for lots of areas of medical innovation and medical breakthrough. Just to throw a couple of stats out there, I'll start maybe with my favorite, by the end of this decade, there'll be more grandparents than grandchildren in this country.¹ So that's more people over the age of 65 than under the age of 18. And about five years or so after that, the same phenomenon will be true all around the world.²

And there's some things we can predict as a result of that. We know that older populations are much more likely to suffer from a range of neurodegenerative conditions, in particular like Alzheimer's, which is a subset of dementia The good news about this is obviously people are living longer, the challenge is on us to make those years more fulfilling, more productive and healthier. Again, good news over the last 20 years we made more progress in genomics than anyone could have ever imagined. 20 years ago, we had a very limited understanding of the human genome, I would say today we seem to have a very limited understanding of the brain, and the next 20 years are going to be the story of us really getting that understanding and big leaps forward in mental health and in neuroscience. And just to set the stage, there's really three main areas that are relevant.

The first is neurodegenerative, things like dementia. The second is neuro traumatic, think traumatic brain injuries, there's a physical issue, or moment that's involved. And then traditional mental health, a lot of the conditions that affect so many people around the world, like depression, anxiety, and all of this fits into this bucket, of neurology, of neuroscience and I'm incredibly excited about the progress that we're seeing.

Oscar Pulido: Let's talk about that progress. We have seen some treatments for neurological diseases and disorders. In fact, there's been a few FDA approvals recently. So, can you go into a little bit more detail about what some of these advances are?

Jeff Spiegel: Sure. So, we have read about that and it's incredibly heartening, to see the amount of progress that we're making, especially because there's been virtually no progress over the course of the last 20 or 30 years. Consistently for a long time, we've been using cholinesterase inhibitors. These effectively are a performance booster for the brain, they're chemicals that allow the transmission of thoughts across neurons and we can use them to amp up the brain's capabilities in the short term, but we're not actually warding off the sort of degeneration that happens over time from some of these conditions.

But a lot of what you've read about, and it's so exciting in the field, is monoclonal antibodies. A lot of people first heard about these during the covid pandemic, and effectively what you're talking about is taking antibodies that exist within us, to fight various conditions, and inserting them from the outside. So, inserting very powerful antibodies that can come from you, that can come from another person who has particularly strong antibodies, and they're designed to fight particular issues in the body. One of the issues with Alzheimer's specifically is a form of dementia is we know that plaque, otherwise known as beta amyloid, builds up in the brain. Two drugs that have recently gotten approvals, Aducanumab and Leqembi, are monoclonal antibody treatments.

You can think of them as almost preventing and cleaning off this plaque that we see in Alzheimer's, they can slow the decline of the condition of Alzheimer's by about 35%.³ So, if you think about the expected survival rate of someone who's diagnosed with Alzheimer's, it's about eight years.

If you can get two or three more years that are really high quality with your family, where you're getting to engage and have that end of life, even if ultimately this condition is going to be a part of the rest of your life, if we can stretch out that period where you're still really engaged in the world, that's a game changer. Not just for the people who are afflicted, but really for their families. Because we know it's such a difficult disease, for loved ones.

So, if we think more broadly beyond just Alzheimer's, there are about 50 phase two drugs looking at neurodegenerative conditions.⁴ There's about a hundred phase three drugs.⁵ And think about across things like ALS, Parkinson's, Multiple Sclerosis and what's also heartening that we haven't made quite enough progress here yet, I think it bodes really well.

About 70% of cases of a lot of these conditions are linked to genetic factors.⁶ So, to go back to where I started the last 20 years of amazing breakthroughs in areas like genomics, that's also going to pay off as we can use some of that to better understand these neurogenerative conditions. And to give you a sense of the size of the market, it's about $40 billion in sales of these sorts of drugs today.⁷ That's a lot. It's expected to grow at a CAGR of 7.5% a year until 2031.⁸ So, this is a big market with a lot of hope ahead.

Oscar Pulido: You've mentioned Alzheimer's and you touched on this term neurodegenerative. So, these are afflictions of the brain that are more progressive and more chronic. But then you also said, something around neuro traumatic, conditions for the brain, which I think is more something caused by a trauma event, an impact. So, are there similar advances in treatments for those types of conditions?

Jeff Spiegel: Different advances, but no less exciting. This has gotten a lot of press recently in places like the NFL or children's sports, where we're hearing about so much more care and focus than there used to be around things like concussions.

I got a concussion when I was a kid playing sports, and I was basically just sent home and told to rest. That is not how we think of these conditions today, we think of them as very serious, we think of them as potentially having long-term devastating consequences. It doesn't just have to be a physical hit of the type you might get in sports- blood clots, strokes- these things can all cause brain injury. And interestingly, brain injuries are one of the leading deaths of young people. Diseases don't tend to afflict younger people in as great a portion, but traumatic injuries do because they're more active, sports obviously being a big part of that.

What can this cause? It can cause diminished cognitive capabilities, diminished motor capabilities, behavioral problems, sometimes things like paralysis, and a lot of secondary conditions that come on later or eventually like dementia, like depression.

And here one of the most important areas of breakthrough is actually less on the treatment and more in the diagnostics. Better, more advanced CT scanners and MRI machines so that immediately after a trauma we can have a much better sense of what's going on and be a lot more active in diagnosing some of these conditions.

Beyond that, when you think about the treatment, there's a lot of new tools, minimally invasive cranial surgeries, spinal tools that allow us to get in there with that better understanding from better diagnostics and actually have more of an impact on preventing bad outcomes.

And then a little further ahead, but we're starting to see it already, things like robotic neurosurgery, computers and monitoring, and I think we'll talk about AI a little bit later, but this is also playing a role here. And the last category that's exciting, is digital stimulation. So, if you're paralyzed, being able to control your limbs through digital stimulation even if you can't get back the traditional motion and regenerative cell therapies. So actually, getting to regenerate parts of the body that are impacted by these conditions. just to put some numbers around it, we think this is a $200 billion market by roughly 2029.⁹

Oscar Pulido: There was a third category which was mental health. I can't help but just think back through the pandemic this is a topic that, really seemed to rise in prominence in people discussing it and really trying to de-stigmatize it. You see a lot of companies that are making mental health treatment a comprehensive part of the benefits that they offer to their employees. So how is the healthcare industry trying to address it, and then how does it impact the investment landscape?

Jeff Spiegel: So, there's estimated to be about a billion people in the world who live with mental health challenges.¹⁰ And actually, one of the reasons I'm proud to work at BlackRock, is that is a big focus of our benefits, and the firm does take it really seriously.

I'm actually a mental health ambassador, here at the firm, which is a program that we have so that you have people to talk to. and a lot of that is about de-stigmatizing, to your point, I think a lot of companies are really starting to take this a lot more seriously, but stigma is a huge piece of it.

There was so much sudden onset of issues like depression and anxiety during the pandemic that it was more talked about. A lot of celebrities came out and really talked extensively, about their challenges in this space. One of the things that's different from the two areas we were talking about before that gives me a lot of hope, is more people seeking treatment period.

Treatment with a lot of existing drugs, existing antidepressants, existing anti-anxiety drugs. A lot of them were very effective, but people just hadn't been getting them because they weren't willing to come out and have this conversation. Look, this is true in developed markets, it's even more true in a lot of emerging markets, where the stigma is even larger. So, this market for these sorts of drugs and the ability of people to get help is really going to grow significantly.

One drug that I think is really interesting on a forward-looking basis is zuranolone.¹¹ so new generations of antidepressants tend to just be minor adjustments. And those minor adjustments are usually focused on side effects. This is really a new class of antidepressants, we're already in phase three trials, and the really interesting innovation is for anyone who's taken antidepressant drugs, you get told, okay, you've been diagnosed, here's a pill, in four to six weeks, it'll start to have an impact. That's a long time. This drug actually has shown to reduce symptoms of depression in a matter of days. That's a massive breakthrough especially if you think about the very strong link between depression and other behaviors, be it drug and alcohol use, be it suicide, being able to have a faster intervention, is really going to be a huge differentiator.

Oscar Pulido: So, you've highlighted across a number of these different dimensions of neurodegenerative disease, neuro traumatic, mental health. There's a lot of progress being made. I have to ask you about artificial intelligence, partly because you came on The Bid early in the year and were telling us about how you used ChatGPT over the holidays and now artificial intelligence is everything we talk about. How is AI advancing the neuroscience field, if at all?

Jeff Spiegel: AI is advancing so many fields, and I think a lot of investors have focused to begin with, on tools like ChatGPT these large language models, on the benefits to software companies that produce them, to semiconductor companies responsible for the hardware that goes into enabling them. But when you start to think about the downstream implications, there's a lot of industries that are impacted. And healthcare, I would argue, in an incredibly positive way.

It's not just that, artificial intelligence is helping us do better research on the brain, the way that artificial intelligence is developing is actually teaching us directly about the brain. So, what exactly do I mean by that, because it's a little bit hard to unpack.

Artificial neural networks, the way that they interpret visual stimuli, neuron by neuron, works very much the same way that humans do it. you've got something in front of you and I start to think about the shapes in my brain, then the colors, and I could piece it together until eventually I say, okay, that's a car. That's a dog or that's a banana. Interestingly though, these artificial neural networks aren't designed to mimic the brain, they follow that same sequential process, which is fascinating because we're actually learning about how there are some natural ways that neurons process that information is processed, they're actually being replicated by artificial intelligence without any input in that way. I would also note that, maybe that makes things a little less scary. AI kind of thinks like we do. Hopefully that's a good sign for us getting along well into the future. But even on how artificial intelligence works itself and how it's evolving and developing, we're learning more about how our own brains work.

Let me give you another example, smarter drug discovery and development. A lot of drug discovery is fundamentally trial and error. Machine learning is way faster at assessing that trial-and-error process that's going to allow people to move forward much faster with various drugs.

Also, one thing that's great about modern AI is it's great at spotting patterns. In particular, it's better than people at spotting patterns, so being able to look at a large set of sample data and have artificial intelligence analyze it for those patterns and what's actually happening to people who are being monitored for underlying conditions, also going to be a really significant push forward, We estimate that it's possible that the artificial intelligence application in medical innovation writ large, this isn't specific to neuroscience, could reduce time to drug discovery by roughly 90%. And I started with this idea of how little we know about the brain to begin with. Part of the reason we know so little about the brain is just because it's incredibly complicated. Again, the modeling and the mapping capabilities of artificial intelligence are going to help us improve that understanding.

Actually, mass General Hospital up in Boston has been using artificial intelligence in MRIs to spot Alzheimer's. So, to sort of look for those telltale signs in the brain like plaque and successfully identify it, which can be challenging, especially in early cases. The AI is 90% accurate at this, approaching the success rate of humans and it's only going to get better.

So, drug discovery, better monitoring, just a better fundamental understanding of how the brain works through modeling, is really going to be a major push forward in how fast we can bring drugs to market, how fast we can do the research.

Oscar Pulido: And the important thing is it's not only helping get the right drugs to market, or better drugs to market. You mentioned the trial-and-error element, being able to be done quicker, more efficiently, but it’s helping doctors understand this very complicated organ in a way that humans alone can't do.

Jeff Spiegel: Exactly.

Oscar Pulido: Jeff, you’ve mentioned there's a number of really positive advancements going on in this space, but when you look ahead, what's your near term and longer-term outlook on this space?

Jeff Spiegel: Bullish, would be to put it mildly. I'm thinking specifically about areas like biopharmaceuticals and medical devices. Aside from everything we've discussed, there's just a lot of great tailwinds that are happening. And again, to go back to this fundamental problem of how we're going to treat and care for aging populations in which we know what diseases are going to be more prevalent. Faster approval of drugs this is actually a positive legacy of the COVID 19 pandemic. The idea that for drugs in which there really is no better solution, getting earlier in the phase trial process that available to people, 65% of novel drugs are actually taking advantage of FDA programs to do exactly that.¹²

So, you're going to see things getting to market more quickly, you're going to see those faster approvals. And then, from a market's perspective, just thinking about performance, everyone has been focused on how do you capitalize on this artificial intelligence opportunity in your portfolios? And I talked about some of the traditional software and hardware that's really been the focus of that conversation. But again, these second order beneficiaries just aren't being recognized. If you look at themes like neuroscience, themes like genomics this year, biotechnology, the performance has massively lagged technology and even massively lagged the broader market. I think investors really should be focused on where are these major breakthroughs going to come from? What's AI going to enable? And I actually think that neuroscience is going to be one of the most exciting spaces for that.

Oscar Pulido: Jeff, as usual, you've come on and enlightened us on a topic that I thought I knew a little bit about, but you've made me realize I actually didn't know that much. You get an A plus from me. I think your toughest critic is going to be your wife who you said is a neurologist. So let us know how she grades you.

Jeff Spiegel: Hopefully gently, but she's a trained mental health professional, so I'm sure she can deliver whatever the news is appropriately.

Oscar Pulido: Great. And thank you again for joining us on The Bid.

Jeff Spiegel: Thanks. Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out last year's episode on healthcare investing featuring MIT Professor Andrew Lo, discussing the funding of new drug development as he works to accelerate the pace of change in biomedicine.

And don't forget to subscribe to The Bid wherever you get your podcasts.

Sources

¹ United States Census Bureau, Older People Projected to Outnumber Children for First Time in U.S. History, March 13, 2018.
² United Nations, 2022 Revision of World Population Prospects, 2022. 
³ Eli Lilly, Lilly's Donanemab Significantly Slowed Cognitive and Functional Decline in Phase 3 Study of Early Alzheimer's Disease, May 3, 2023.
⁴ FactSet, Springer Adis Insight, 2022; BlackRock analysis.
⁵ Ibid.
⁶ Alzheimer’s Association, 2023 Alzheimer’s disease facts and figures, April 19, 2023.
⁷ Allied Market Research, 2023 Neurodegenerative Drugs Market, March 2023. 
⁸ Ibid.
⁹ Data Bridge Market Research, Global Traumatic Brain Injuries Treatment Market – Industry Trends and Forecast to 2029, February 2022.
¹⁰ Kuehn, Bridget M. WHO: Pandemic Sparked a Push for Global Mental Health Transformation. JAMA 328.1 (2022): 5-7.
¹¹ Biogen, FDA Approves ZURZUVAE™ (zuranolone), the First and Only Oral Treatment Approved for Women with Postpartum Depression, and Issues a Complete Response Letter for Major Depressive Disorder, August 4, 2023.
¹² U.S. Food and Drug Administration, New Drug Therapy Approvals 2022, January 2023.

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MKTGSH0823U/M-3056188

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Private debt, private credit, direct lending. Why are these asset classes capturing investors' imaginations around the world? Are they a viable option for individual investors or restricted only to the large institutional investors?

In this episode. I'm joined by Jimmy Keenan, chief Investment Officer and global head of private debt for BlackRock. We'll dive into the enigmatic world of private debt. Ask why it's having a resurgence in these particular market conditions and explore the risks and opportunities that are inherent from this alternative asset class. Jimmy, welcome to The Bid.

Jimmy Keenan: Thanks for having me, Oscar.

Oscar Pulido: So, Jimmy, we're here to talk about, private credit and I'd like to hear more about what is this asset class, but also private credit, private debt, sometimes I hear the term direct lending. Are these all different asset classes or are they the same thing?

Jimmy Keenan: Thanks Oscar. Yeah, I would say when you think about private debt in general, it’s as simple as it is. They are debt instruments that are done in the private market and most of the world is used to seeing the public equity markets or, public debt. Think about Investment grade market or the broadly syndicated loans or the high yield market, those are all securities or loans that trade publicly, and dynamically where you can get information on those borrowers.

The private market is really just referring to a similar type of loan or risk, but it is done in, I would call it more of a bilateral private negotiation between one or a few lenders, with a borrower.

So, the terms of that contract or that loan may not be available to the broad public, as well as the information of that borrower or company may not be as public. And so that is a private, negotiation with that, and that's essentially all that means. The evolution of the private debt space, is continuing to grow and I would say it incorporates a lot, but it’s as simple as that - it's a loan that is done that is not done through a bank, and the information associated to it is privately placed and not well known.

Oscar Pulido: So, the information is known by fewer parties. that's one difference. The similarity is that it's a loan, in this case less a bank involved and more a private lender. And so, it sounds like there's, a premium that is earned by that lender. And so, talk a little bit about like the risks and return differences with this asset class.

Jimmy Keenan: If you think about it, if you're a company, if you are a real estate developer, you're going to look and say, how do I finance my company? Or how do I finance this building? And there are different ways you can do that. You can go to a bank and the bank may. put together a financing package, and they may go to the public markets to syndicate that out. And that's typically what you see in the public markets.

The borrower may look at that and say there are positives associated to that but in many cases, they may look at it and say, what are my other options? And they may seek out a private debt provider as somebody like a BlackRock that might step in and say we'll offer you directly something that will give you a different package, meaning a different way to finance that real estate project or a different way to finance that company.

In that situation, that borrower or that corporate may opt in to having a direct relationship with BlackRock or any other private debt and provider, as opposed to going through a bank which might get syndicated out and there might be 50, a hundred plus people that are in that capital structure. And so there are a lot of different reasons why a borrower might choose one or the other it's just a marketplace that exists.

Oscar Pulido: I think it used to be, and correct me if I'm wrong, but particularly maybe before 2008, banks were the primary lender, right? But then the financial crisis hit, and I'm also thinking about even more recently, some of the recent bank failures that we've seen in the US and abroad that, that this development of the private debt ecosystem has been going on for a number of years, but that 2008 was an inflection point. Is that the right way to think about why this market has grown?

Jimmy Keenan: Absolutely. and that's a well-known fact and quantitatively you can look through that just with regards to the size of the banking systems. And even today, you mentioned it before with regards to some of the bank volatility, you've seen deposit flights of up to a trillion dollars coming out of the banking system. You're seeing risk management change, in which case it's reducing the size and scope of the banks that's changing regulatory environments, risk management and so, for a company or a real estate developer or an infrastructure project, finance, that doesn't mean that they don't need the capital.

It just might mean that their traditional lender or somebody at the bank, that relationship they might have, might not be there. So, what you said back in 2008, we saw a huge gap in financing post

the Lehman crisis, in which case credit dried up completely. And so, if you are a corporation, a middle market company, a real estate developer, like your ability to access capital, dried up.

That ultimately built in the fact that the ecosystem changed, I would call it private debt providers started to build infrastructure on how to face sponsors, corporates in a different way, directly. In the same way most of them set up shops that they can call it up. So instead of in the early two thousands, if you wanted to borrow money for an M&A deal or making an acquisition, you generally called the bank that you had that relationship with. Now you might look at a handful of options It doesn't mean that banks aren't significant and probably the biggest providers of capital and credit, but it means there are other options that you can look through and again, goes back to, the last comment, the reason somebody might, do a floating rate loan or a public high yield bond or private, direct loan may vary based off of the situations and circumstances, both for that company, but also where we are in the

Oscar Pulido: And maybe you can expand on that a little bit. You've alluded to where the financing might be utilized for, you mentioned like a toll road and real estate, but who are these borrowers? and what are the trade-offs they're evaluating between whether to use the public markets or whether to go through the private markets?

Jimmy Keenan: And it's not just price, right? often you can sit and say, why would somebody pay a higher price? At the end of the day in some cases, pricing looks fairly similar, right? And some of the premium that you get in the private market is reducing the fees that might be paid, if going through a bank process and ultimately syndicating it out, so that is generally an earned premium that private debt investors might get. But there are a lot of other reasons why, if you're a middle market company, in order to think about operating their business, dealing with a publicly syndicated loan or a high yield bond, means that you have to engage with a variety of different investors that are in your capital stack. And in some cases, if there are periods of volatility or you're going to be active with acquisitions that may be more complex in managing your business.

And those small companies typically have smaller teams, and so in some ways that might be easier and better for them from a long-term perspective to have a single or handful of lenders that might be in that capital structure.

Another example might be companies that are going through transition. they might be in a late-stage development project that have yet to kind of see more stable earnings. They might be transitioning different contracts or parts of their businesses, in which case they prefer to either have, show that concentration or that shift in the private markets as opposed to in the public domain.

So are strategic reasons beyond. I would call it pricing or structural reasons, in order to do that. And so, the bigger companies, you'll see more of that opportunity where sometimes they might issue a public deal and then, yeah, at other times they might move that and shift that to the private market. And you've seen more larger capitalized companies that might either go public and private and there'll be some pretty big headlines this year on that.

Oscar Pulido: Okay, so you've defined the asset class a bit and we've talked a little bit about, why it's come of age, particularly over the last sort of 15 years post 2008. You've talked about some of the different types of borrowers. But in your position, you're sort of the lender, right? You're the one

providing the capital and you're the investor. So where do you see the best opportunities? Is it across the entire asset class or there are subsets of the asset class that you find interesting?

Jimmy Keenan: I think all investors should look at it, at the end of the day, every investor's going to be a little bit different between how they think about their own risk reward and that includes liquidity.

But you think about the private debt markets as a whole, this is something that, for all the reasons that we just talked about, was not necessarily as broadly available of an asset class to invest as somebody might want to build their portfolio.

And now that for all those reasons, that supply that's been unlocked and based off of what's gone on this year, is only going to grow substantially over the next several years is going to provide an opportunity for people to build their portfolios in a different way. And you think about the risk reward or even the risk characteristics of some of these and how they fit in somebody's personal strategy, that they should be looking across all of this, because it is something that they can get a premium.

I think there are a couple things that are really interesting today because of the supply dynamic. Obviously, that banking system turmoil was met with some policy response in there and liquidity that was provided.

And so, there's not a fire sale per se that is going on, but you do have a shift in how those regulatory and risk management have. And so, over the next several years, you're going to see balance sheet downsizing, and we see a significant amount in the trillions of assets that are going to have to be reduced from the banking system.

And what that means is, as that balance sheet is reduced. There are really good deals that are coming at a very nice spread per unit of risk, meaning the yield that you can get relative to that underlying risk is going to look very attractive. And so, the stable income type products based off of that supply dynamic, I think are really interesting across the entire ecosystem.

Oscar Pulido: Right. So, some of the investment opportunities are because of regulatory shifts that impact the banks and therefore mean, some of what's coming off of their balance sheet is now available to investors like you. And then some of it is just the last 12, 18 months of interest rate increases have exposed some companies.

You touched on institutional investors and also individual investors now both have ways to access this private debt market, but there's probably a lot of investors who are approaching this for the first time. So, what are the things they need to know?

Jimmy Keenan: Private debt is a very wide-ranging term, when you're entering the space or even viewing the public and private markets where are you trying to anchor your risk? What types of risk you're looking for? And if you think about. private debt being a core part of your portfolio. Then you have to think about any private assets, which is what's your ability, to have illiquidity in your portfolio?

How much illiquidity are you willing to have in order to garner those either differentiated risks or that extra premium that you might get in the private market. And then you go to the private debt strategies of which one do I want which one fits in?

So, liquidity is a big portion of that again, balancing what you need and what you're trying to accomplish with what is the strategy? And then what's the vehicle.

That's probably the first thing somebody should be looking for of matching what they're trying to accomplish and what they're ultimately doing. I think the other things then fall down into those strategies of what are you trying to accomplish in that?

Then you start to realize, okay, alright. I'm going to look for the certain product, now I got to look for the manager. There's a lot of different products, there's a lot of different managers. But trying to find a product that you can kind of look through that it has a history, you want to look through that track record of that team, that product, to understand, has this historically acted in the manner that I'm thinking about investing or underwriting to and is the future of that consistent with how I want to invest?

Because at the end of the day, like if you're going to make that investment, you're in that product or in that manager you want that output to have a similar, return profile and potentially volatility profile that you're looking for in your portfolio. So those are like the two main things that I would recommend people try to dive into.

Oscar Pulido: Jimmy, you've been associated with the fixed income markets, your whole career and, particularly in credit and both public and private markets. you've, you're obviously very excited about the opportunity in private markets. So, take us five years ahead. What is, what does this space look like or beyond, maybe, if you can see that part? ahead?

Jimmy Keenan: I think it's something that has become far more of a common name associated to how people think about it, private equity 30, 40 years ago might not have been thought of the same way it is today.

So, I think, five years from now, people are just going to view this as part of their allocation in the institutional and the retail markets. I think from today's standpoint, like 2008. It's hard not to get excited, at the end of the day you have both a supply, a significant supply shift that is going on because of what's happened and what we just talked about in the banks, where trillions are going to come out, and a lot of those trillions are actually good deals, but the funding source of that from a banking system is changed, in which case they're now going to make their way to probably both the public and the private markets. That's a huge supply that it's going to ultimately come. That's going to grow demand, right? At the end of the day, it's going to create capital formation because you'll step into good deals and good financing and stuff like that.

So, from a business perspective, this is a huge opportunity that is going to be multi-years. and I think that because policy shifted, and we've seen this since the financial crisis where most central banks and governments around the world are acting quickly to try to continue to mitigate that risk of a significant credit crunch that dries up in economic activity.

So, I view this as something that is going to be significant for our clients and our investors, it's an opportunity to grow a strategy that they can ultimately get outsized returns relative to the risk profile. So, it's hard not to get excited about.

Oscar Pulido: Well, it's been a couple years since we had you on the podcast. We'll try to, not have it be that long of a gap this next time and that way we can. See whether your predictions are coming true So Jimmy, thank you for joining us on The Bid.

Jimmy Keenan: Thanks for having me, Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out the episode, 'Are you leaving Cash on the table?' Featuring Beccy Milchem, where she provides the top three things to consider when thinking about cash and volatile markets. Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0823U/M-3067972

Claire Chamberlain: 39% of all Americans could not afford a $400 unexpected emergency expense and when you break it down further by gender and by racial demographics. The numbers are even more stark.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host Oscar Pulido. In an era of economic challenges and uncertainties, having an emergency savings fund is a financial lifeline that can provide peace of mind. During turbulent times, yet statistics reveal a startling reality.

66% of the US population lives paycheck to paycheck. And lacks adequate savings to weather, unexpected storms. The problem is not limited to the US, and it seems to only be getting worse. Is there light at the end of the tunnel to find out the answer to that question and how both the private and public sectors are trying to resolve the lack of emergency savings?

I'm pleased to welcome Claire Chamberlain, global Head of Social Impact at BlackRock. Claire, thank you so much for joining us on The Bid.

Claire Chamberlain: I am delighted to be here, Oscar, it is a pleasure.

Oscar Pulido: Well, Claire, in your role as Global Head of Social Impact at BlackRock, you come across a wide range of social and economic issues. So, tell us why emergency savings is so important to you.

Claire Chamberlain: Well, when we think about our work, we start with the core purpose of BlackRock, which as you know, is to help people build financial wellbeing and security over a lifetime. And with that as the going in philosophy, we said to ourselves, how can we advance that purpose? And building financial wellbeing is aspirational for far too many people because if you're living day to day paycheck to paycheck, that is something that is very hard to come by.

And so, in thinking about how do we help people get closer to that aspiration, emergency savings is a topic and a focus that really has emerged over the last couple of years.

Oscar Pulido: How big of a problem is this or are there any numbers that would allow us to quantify when we think of what an emergency savings pot looks like?

Claire Chamberlain: So, in 2017, for the first time, the Federal Reserve published a report which outlined the financial precarity of American households. In that report there was a statistic that was really a wakeup call for many people. And the statistic was 39% of all Americans could not afford a $400 unexpected emergency expense.

And that was not just people living under the poverty line, but all Americans. And in fact, that number, when you break out people living on low and moderate incomes was 58%. It's a big number affecting a lot of working families and it was much larger than people anticipated.

Unfortunately, while there had certainly been improvements in the labor markets since 2017, there was a report released this past May where the number showed some improvement, now 37%, but again, this is of all Americans and when you break it down further by gender and by racial demographics.

The numbers are even more stark. for low- and middle-income families, who are Hispanic is over 70%. And for black families it's 72%.

Oscar Pulido: So, the numbers are surprising because the percentages are high, covers a pretty meaningful part of the population, but also the emergency expense that you outline $400. It doesn't feel like a lot has to go wrong for all of a sudden somebody to have a $400 bill. So now what is the impact on individuals, businesses and then the economy? because it's not just affecting the individual who has that unexpected expense, it must reverberate even broader?

Claire Chamberlain: Absolutely. You can think about it top down or bottom up and either way it's, currently a pretty grim situation. $400 is not a lot for a hiccup, an unexpected expense, whether it's a car breaking down, an unexpected medical bill, increasingly in our country, natural disasters and when you don't have that cash cushion readily accessible on the sidelines, you have to resort to really costly alternatives like payday loans, or even dipping into your 401K retirement account.

And we know that not only comes with penalties, but it means then you've diminished the body of investible assets, which hits you down the road as well as in the near term.

That's the individual level, in addition to families it also impacts employers. And we know that the productivity loss due to financial stress is as much as 15 hours per week per employee, which turns out to be an estimated $5 billion to employers in this country on a weekly basis.

So, the numbers are big and they're numbers, frankly, that employers have started to acknowledge and take action to try and remediate.

Oscar Pulido: And I know BlackRock has been doing some research on this topic, maybe you could share a little bit of what are the findings of that research?

Claire Chamberlain: So, the BlackRock Foundation, is focused on, financial security. During COVID there was a pretty unique opportunity to study the impact of that material economic disruption on individuals and families. So, working with one of our nonprofit partners, Commonwealth, we were able to do some research around how did having liquid savings, impact your ability to weather the disruption of the pandemic? One of the findings that emerged is that people that had less than $2,000 of liquid savings available to them were twice as likely to tap into their retirement account prematurely. So that described a pretty direct connection between liquidity and being able to build for the long term.

Oscar Pulido: And you've mentioned that twice now it's an important thing, which is people have the money to draw now, but they're now foregoing a more comfortable retirement so they're just trading off one problem for the next. Is this a US issue only then? Because as you're describing this, I'm wondering if there are other countries that are also experiencing something similar with a lack of emergency savings.

Claire Chamberlain: Well, I'd love to tell you this is isolated to the United States. It is not. And in fact, we have been working with partners in the UK, Nest Insight in particular, which is the research arm of the Nest Pension Scheme, which is Britain's Public Pension Program and the stats over in the UK in some ways are starker than the stats here, Nest Insight did research that showed one in four citizens in the UK could not come up with a hundred pounds fund for an unexpected expense. So, the UK and the US among the wealthiest countries in the world, there was further research done again coming out of Covid that has shown that countries that are lower- and middle-income countries, the implications of economic disruption of interruption in wages, for instance, people have far less to fall back on. And so, the problem we've described here in this country is by no means unique.

Oscar Pulido: That's interesting, you said a hundred pounds or a hundred sterling. That's a lot less than even $400, which you mentioned in the US. So, the bar's even lower to an individual in the UK for, that lack of emergency savings to really hit them.

You've painted this problem that is clearly prevalent in some pretty major economies. When you look ahead, what's that light at the end of the tunnel that you're seeing?

Claire Chamberlain: Well, there is light at the end of the tunnel, because there is an endless amount of innovation that as humans that we are capable of and it's happening, in trying to address, this financial precarity. One of the things that we found, with our research and with the people who were interested in partnering with us, is that the workplace was a very receptive arena for exploring how do we address this financial stress and vulnerability that workers feel. And employers and those that support them, like record keepers and payroll providers and other financial institutions, they have a lot to gain from trying to crack this I mentioned $5 billion a week in lost productivity, well that turns out to over 250 billion a year.

So, the incentive to try and not just chip away, but to pivot in a meaningful way is definitely there. And shortly after those early Fed numbers were published, BlackRock founded the BlackRock Emergency Savings Initiative to try to begin to address the problem and to encourage and spur innovation. And we really wanted that innovation to take place across channels, meaning we wanted to see it with large scale employers and with record keepers, fintechs and payroll providers because we didn't know enough to pick the horse but we thought our hypothesis was the more demonstrations and pilots we could get out into the marketplace with workers, the greater our chances of making a difference and taking friction out of that effort to build short-term savings.

Oscar Pulido: And this BlackRock initiative that you mentioned, the emergency, savings initiative was 2019, I think is when it started. It's four years later we've lived through a pandemic during that period. So how would you say it's going, and can you give some examples? You said a couple of things, record keepers, payroll providers. Are there some examples of some of these stakeholders that you've worked with and things that they're doing?

Claire Chamberlain: So, a couple of things. The initiative, at the end of last year marked its completion of phase one, and we published a learnings report in June of this year. I'll share a little bit more about that later. but in the report we do highlight case studies of partners that we worked with among them are Voya, who was the first record keeper to join the BlackRock Emergency Savings Initiative, and they were working on making available an after tax liquid savings account that people could, when they set up their retirement plan contributions, could also indicate that they wanted to build some short term savings where they could, access it whenever they wanted to without penalty.

UPS also came on board, and they did a whole internal marketing refresh on their emergency savings account and as a result of that using some insights that we have gathered from behavioral economists, they were able to increase usage by 40% of people who were offered that opportunity to build short-term savings.

Another key partner, ADP is a payroll provider, they provide payroll services for one in six Americans, and they created a savings sleeve on their pay card app and that resulted in $1.5 billion dollars of new savings, so pretty significant adjustment to an existing product that had meaningful uptake.

And then finally, another partner was AutoNation which employs over 20,000 people across the country. As an employer, they recognized they have a very diverse workforce they didn't want to just put one offering in front of their employees so they are in the process of testing three different offerings you could do a split deposit right from your paycheck. Or you could build this liquid savings on a payroll card, or you could do the savings sleeve that's adjacent to the retirement product.

They're going to let you decide as an employee and you could pick some or all of those offerings. We've really had the privilege to see this take hold directly with workers, but as provided by employers or, companies that support those employers.

Oscar Pulido: And all these examples you mentioned. It's not that people can't save, but sometimes you just have to make it easy for them. You have to provide some convenient method to do it. We all have good intentions, but sometimes we just need somebody to point us in the right direction. And that, that seemed to be like a commonality and all these examples that you just discussed.

Claire Chamberlain: Absolutely. Ideally, it's set it and forget it, or it's have it set for you and forget it and watch it build. But that's exactly right. One of the key learnings from the Emergency savings Initiative is that people even, who are living on low and moderate incomes they can save if you give them the right tools at the right time, like the point of payroll, they can save money and that even saving small dollar amounts can have really significant benefits for individuals and families. And that kind of goes back to that notion of, gosh, if you only had $400 more and you need a car repair so that you can keep going to work so you can keep earning money because you're an hourly worker, it's that either virtuous or counterproductive cycle. And building up that small dollar savings is super important to people.

Oscar Pulido: And that story you just gave is very real, the hourly worker whose car breaks down. And boy, you said if they just have that $400, it really changes their day-to-day pretty significantly.

Claire Chamberlain: And probably the child that they're dropping off at daycare as well.

Oscar Pulido: Voya, ADP, you mentioned some of these partners along the way with the Emergency Savings Initiative. Those are private sector companies, but let's talk about the public sector. In the US there's been some legislation, the Secure 2.0 Act, how does that influence this emergency savings topic that we've been talking about?

Claire Chamberlain: The legislation secured 2.0 that you mentioned was passed in December with bipartisan support which is terrific. The thrust, the primary thrust of Secure 2.0 is to encourage more and more employers to offer retirement plan programs to their employees and to encourage employees to take advantage of those programs. As relevant to the conversation that we're having here today, there are provisions in Secure 2.0 to make it easier for employers to offer an emergency savings options to their employees.

So, there are two non-mandated options that employers now have to help employees build emergency savings. The first is a $1,000 emergency withdrawal that they can make in a year from their 401K or equivalent retirement account, and they can make this without penalty. The second option is a $2,500 emergency savings account, which is linked to the retirement account and has automatic enrollment option, meaning the employer can set that up so it just automatically funds from payroll go into this $2,500 emergency savings account, which then sits alongside the retirement account.

The auto enrollment feature is the first time we've seen this in use with respect to this liquid savings, and we think it really has, a lot of incredible upsides because we know from auto enrollment participation that we've seen with retirement accounts it makes all the difference in terms of, really amplifying usage among participants.

Oscar Pulido: And it just goes back to encouraging good behavior, people want to do it, but you need to almost set it up and then we're off to the races,

Claire Chamberlain: And just let it build. And then, having this account that you can use as necessary without penalty. And that's really the secret here. We think there is a lot more innovation still to be done because Secure 2.0 is set up with this account being in plan, meaning it's linked to the retirement plan, but we know that there's an opportunity down the road to set up something similar for employees that are not saving in their retirement account but still have those needs to build emergency savings.

Oscar Pulido: So that'll be one of the many next steps that is coming from this. So, you've touched on the private sector, now the public sector in terms of how it's trying to address the issue. How should an investor be thinking about this issue when it relates to their portfolio and they're putting money to work in the market?

Claire Chamberlain: I think one of the things that's been so exciting about this work are the results but through, our partners we're able to reach 10 million Americans and build $2 billion in incremental new liquid savings which is a fairly unprecedented impact metrics from a philanthropic endeavor and so we're very proud of that.

But back to your question, I think what that shows is there's real appetite for building liquid savings and there is real ability to do that if employees are offered, back to right product at the right time. And as an investor, I would think about, are the companies I'm investing in, what kind of prioritization are they making of the financial health of their employees, and emergency savings is a part of that. So, if you're an employer like AutoNation really thinking in a very 360 way about your commitment to your workforce, that’s the way I would take this perspective and translate it to my portfolio.

Oscar Pulido: All else equal, a happier workforce is more productive, more productive business is more profitable, and you can then put yourself in the mind of that investor. And I want to be invested in companies like that.

Claire Chamberlain: And sustainable over time!

Oscar Pulido: Claire, what brought you into this field of social impact? Hearing you talk about this topic, it's obviously a passion of yours, but where did this passion start?

Claire Chamberlain: I have always, gravitated towards important work, and I've always gravitated towards organizations that I think have the standing in our world to really drive important work.

I first started my career in finance and over time, had opportunities to get involved in philanthropy and into venture philanthropy and from that came, here to BlackRock and have been involved in the setup of our strategic philanthropy commitments and program and how we support our employees and how we show up in our communities. So, I feel very fortunate for the opportunities I've had.

Oscar Pulido: well, we're, fortunate to have learned a lot about emergency savings, the issue that it is, and how we're trying to fix it. Thank you for joining us on The. Bid.

Claire Chamberlain: Thank you, Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out our retirement miniseries featuring Anne Ackerley, discussing how to plan your roadmap to retirement. Subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0823U/M-3056091

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

When big events happen in the markets, or even in history, analysts, economists and journalists set out to discover what led to those events, often working backwards, organizing a chain of events into a logical timeline. But on the flip side, accurate forecasting is a far harder skill to master, and our guest today suggests that the same deciding factors we see so easily in hindsight could in fact be easier to see in the present if only we looked through the right lens.

Peter Atwater is a behavioral economics pioneer and professor of confidence driven decision making at William and Mary and the University of Delaware. His latest book, the Confidence Map examines the hidden role of confidence in the choices we make and why events described as being unprecedented are often entirely predictable.

Peter, welcome to The Bid.

Peter Atwater: Thanks so much, Oscar. Glad to be here.

Oscar Pulido: So, Peter, congratulations on publishing your book, the Confidence Map. It's your second book, if I'm not mistaken. So, in this book you mentioned control and certainty as these two variables and you describe a visual graph of four different sectors, so can you walk us through what that graph is and what it's intended to show?

Peter Atwater: As I was trying to write this book on confidence, I discovered that to most people they know what confidence looks like when they see it, but they have a hard time explaining it, and it becomes this random word cloud.

And as I did more research, what I found was that the feelings of certainty and control that we have are really what drive our behavior. That confidence is how we see ourselves faring in the future, we need there to be a sense of predictability and certainty to what's ahead, and we need to have a feeling that we're prepared for it, that we have a sense of control. What I did was to develop a relatively simple framework, it's a two-by-two box chart, a quadrant that looks at the different, magnitudes of certainty and control that we experience. So, the four boxes, there's the comfort zone where we have both certainty and control and the stress center where we lack both of them. And those are what we think of when we think about confidence.

The other boxes are hybrid environments. you'd be familiar with what I call the passenger seat, where we have certainty, but no control. Anytime we're on an airplane or in a cab that's the environment that we're in. And then the fourth environment is what I call the launchpad. Where we have control, but the outcome's unclear to us and in the world of financial services, every decision that we make, whether it's to lend, to borrow, to invest, are all made in that environment where we have to imagine what's ahead as we're making the choice today to enter into a transaction.

Oscar Pulido: Well, I'm taking an airplane later this week so I, I will definitely be in that passenger seat part of the quadrant. But maybe as you describe those four quadrants, how do people make decisions when they're in each one of those quadrants? You described it well but take us through the decision-making process for individuals in those four boxes.

Peter Atwater: So, no matter what box we're in, we have to recognize that we're making decisions where we're imagining the future and that imagination becomes critical. It involves the stories we tell and then the outcomes that we imagine based on the choices that we're making.

When we're in the stress center though, where we have a sense of vulnerability, and we don't think of it this way, but vulnerability is the opposite of confidence. We crave familiarity, we need things to be certain. When we feel vulnerable, something's wrong.

And so, what happens in that lower left box where we are in the stress center, is that our decision making takes a very narrow focus. I focus on myself. I focus on right here, and I focus on right now. I don't care about the future, I don't care about others, and I don't care about the places that are distant from me. If there's turbulence on your airplane flight later this week, the only person you're going to care about is you in that moment.

And this has a big bearing then on the choices we make, we see this in the investment world where people out of nowhere suddenly decide they want to hoard cash. They're craving that certainty. We saw the same thing during the early days of Covid where people were hoarding water and wipes and the things that we needed to address the, the vulnerability that we were experiencing. And so that focus alters what we want and in turn what we do.

At the other end of the spectrum, we're a very different person. There we tend to be focused on, what I say is 'us, everywhere, forever'. Where we're generous, we're cooperative, we explore, we're interested in the future, and we're planning for the future. And you can see this in the investment world with the kinds of things that we invest in when confidence is really high, they’re oozing with abstraction. We saw this in 2021 with the whole focus on eVs, space and, NFTs and crypto.

And today I think we're seeing a similar phenomenon with AI where we're so interested in opportunity and that's the antithesis of what we think about in terms of possibility versus familiarity.

Oscar Pulido: That stress zone you described certainly sounds like not a great place to be in, at least not for an extended period of time. But I can't help but think that if you're in that upper right quadrant, that high confidence, high certainty, it sounds really compelling, but could you be overconfident? Isn't there something healthy about, maybe a little bit of uncertainty that keeps you somewhat cynical, keeps you asking questions, keeps you intensely curious. How do you think about that upper right quadrant not becoming also a hindrance to the decision maker?

Peter Atwater: So, when we're in that upper right-hand box, we forget that scrutiny and confidence are inversely related. The more confident we are, the less we pay attention because we don't think we have to. And so, our cognitive processes are inherently lazy, and that laziness is a disservice to us when we're really confident because we're not paying the kind of attention that we should be. The result is that we take too much risk in too great a size while at the same time paying the least amount of attention. And as you imagine, those three things together often are what precipitate a crisis that then follows.

Oscar Pulido: So how does somebody then, who finds themself in a certain quadrant, what changes do they need to make in their decision making to migrate from one box to the next or what have been your observations of how people adeptly move across these four quadrants?

Peter Atwater: The first thing is to recognize that confidence isn't a one and done experience. The self-help world would like you to believe that once you have confidence, you're going to always have it. And so, we're constantly moving around, and I think it's always helpful for us to pause before we're making a decision to step back and say, so where am I?

Am I feeling certain and in control, am I feeling vulnerable? Because that's then going to give me clues in terms of what things I should do better. For example, in the stress center, we're as likely to be under confident there as we are overconfident in the comfort zone, and so we need to be careful and to take more risk rather than less risk when we are feeling vulnerable.

And that's very counterintuitive, that really fights against our gut, particularly in the finance world. But panic tends to be an experience that should lead us to be more optimistic than we are. Panic tends to be a behavior that reflects that the worst is behind us, not ahead of us like we imagine it to be. So that's one of the things we need to do.

In the launchpad, we need to be careful about our imagination of the future because if I have control, but no uncertainty, I'm likely to make a choice based on what I imagine. And particularly in the finance world, we need to be open to both sides of the potential outcome that's ahead.

And if you are certain of an outcome, that's God's way of telling you, you're either being too pessimistic or too optimistic about what's ahead.

Oscar Pulido: When you think about like high performing individuals or some of the people that you've come across, do they rotate across all four of these quadrants and that's okay. or do like high performing individuals, people in leadership positions, whether that's in the public or private sector, do they typically operate in only one or two of these?

Peter Atwater: No, so what I find is people who are resilient recognize that all four of these boxes are going to happen. So, it's not about avoiding a box, it's more about recognizing that I'm going to be in the stress center, I'm going to be in the passenger seat, I'm going to be in the launchpad. That those are a natural part of a business cycle of a life experience.

And so, their focus isn't on avoiding those, but getting comfortable in those boxes. And to appreciate that they're not going to be there forever. I think one of the mistakes a lot of inexperienced leaders make is that they get themselves in the stress center and they become paralyzed, they feel like it's never going to end.

Somebody who's resilient recognizes as oh no, this is today. and what I'm going to do when I'm in that box, and this is where the high performers, I think really differentiate themselves is that they pause to say, what can I do, what must I do to regain certainty and control? Both of those are very actionable and interestingly, one of the best things people can do is to ask for help. Asking for help isn't weakness, it's actually taking control of the situation.

Oscar Pulido: Right, and that leader who finds themselves in the stress center and knows how to cope with it, it's almost going back to an earlier question, right? The leader who's in the comfort zone, perhaps the really good leader recognizes that now is a good time to ask questions of what could go wrong or what am I missing, and to not develop overconfidence, but to be almost like a healthy paranoia, I think is how I'm picturing somebody who knows how to properly, navigate being in that box.

Peter Atwater: Yeah, they're never complacent, they're always anticipating something that could go wrong and they're not of it. They're not being doomsday about it it's a much greater awareness of the fact that conditions change.

I think about at the other end of the spectrum, some of the most interesting conversations I've had have been with, emergency room doctors. The stress center is their day, and they spend their day going back and forth and back and forth, and their behavior in the stress center is so different from what particularly in corporate leadership. If you listen to emergency room teams, they're talking candidly about what's wrong. they're sharing information. They're not focused on what happened as much as what is, so there's never a concern about blame or shame.

It's like, look, this is where we are, and all of the energy is focused on resolving not only the problem, but the vulnerability arising from the problem. In the medical world, the difference between curing a patient and healing a patient is the restoration of confidence, the elimination of the vulnerability that patients feel. And I think sometimes leaders get themselves so focused on the problem, what's broken, what's crashed, what's burned, and they forget that what makes something a crisis isn't the problem, but the feelings that arise from the problem and that as much attention needs to be given to those feelings as to the situation itself - because the crisis won't be done until those feelings are restored.

Oscar Pulido: And an emergency room doctor, certainly emotions run high in a hospital or any sort of medical setting. Maybe bringing it back to markets because emotions can run high with markets as well, and you talked about Covid and some of the behaviors that we saw during the Covid era, or you talked about hoarding cash, especially in stressful periods for markets where investors, don't want to lose money. When you think, about some of the recent market shifts in history, how do you apply this frame, these four boxes, to how investors react?

Peter Atwater: So, if we look at what happened with the regional banks earlier this year, you could see that sense of panic people moving rapidly into the stress center. And I think one of the things Oscar, that's so unique about today is the speed and scale at which groups can mobilize and translate changes in sentiment into action. Between social media and online trading, what we're seeing is these microbursts of energy and I think that in investors today need to appreciate that the speed at which markets are moving up and down, arguably meme stocks represent the behavior at the other extreme, is that we're seeing this highly impulsive, highly emotional behavior at both ends of the spectrum. and to not fall victim to it. As I've said, panic is a sign that we're approaching the

lows in confidence. It's not a time to be afraid, but a time to be preparing for a turn that's likely to happen imminently, and the same things with manias. Don't become seduced by the siren song.

Oscar Pulido: And it makes sense and I think about Warren Buffet and be fearful when others are greedy and be greedy when others are fearful. It's kind of what, you're touching on, being sometimes a contrarian, you know, Hopefully the emergency room analogy that person is a well-trained, professional who knows how to control their emotions. But it seems like in markets people have trouble controlling those or have you witnessed something differently?

Peter Atwater: So, what I found is that individuals may have a hard time controlling their own emotions. It's very helpful for them to use the framework that I have to identify where is the crowd today, where are others? And it's remarkable to me how quickly we can spot where the crowd is on this quadrant. And just being able to objectively say the crowd is panicking allows you to take what would otherwise be a highly subjective and emotional phenomenon and look at it almost clinically. And that then allows you to make decisions in a much more really decisive and definitive way that allows you to have distance between, your own emotion and actions.

Oscar Pulido: And that then speaks to how investors can use those insights, knowing where the crowd is in those four quadrants is what allows you to make that, forward looking decision in your portfolio. That is what sets you apart from the crowd. And if you do that, that's usually where you generate better performance.

Peter Atwater: Yeah, and there are three dimensions that are easy to identify because at all locations. Our confidence, those feelings of certainty and control, our actions and our stories exist in equilibrium. So, I can look at where the crowd is in three different ways. What are the headlines that we're seeing in financial television and or, what are the actions that we're seeing people buy? As an economist, we talk a lot about elasticity. I think we overlook something called confidence elasticity, which is to say, how does confidence drive the choices we're making? And there's a high confidence elasticity for cash, for example, when confidence is low, that's when we demand it most.

And just knowing that the range of investments that we're going to buy is a function of our level of confidence allows me at all times to spot where the crowd is. Because what's hot in the minds of investors is revealing their level of confidence. Are they stampeding into cryptocurrencies or are they stampeding into cash? Those are things that I see at the two ends of the confidence spectrum.

Oscar Pulido: Peter, when I think about investors, I'm thinking about mom and pop and the individual investor, but have you worked with what I'll call professional investors, portfolio managers, people who do this for a living, who wake up every day and are thinking about what stocks or bonds to buy, and if you've worked with those folks, how do they think about this confidence map, the four quadrants, and what do you observe in these individuals?

Peter Atwater: So, most of my clients are institutional investors, and in the same way that they're looking at economic data, they're looking at, industry data. They're using sentiment as another overlay. And so, what they're interested in is that the indicators of sentiment that I identify as being representative of things that might be important to them in their portfolios.

So, for example, looking at the behavior in luxury today and the excesses that we're seeing there and how is that different maybe from what we saw a year or two years ago? Because, cultural trends,

from the music we listened to, to the TV shows that we watch have a bearing on our behavior and they reflect how we feel. The media is an enormous mirror of our mood.

Oscar Pulido: And Peter, just taking a step back, maybe I should have asked you this at the beginning, but why is this topic of confidence something that you have dedicated So, much time to? Just curious as to what is it that got you interested in either this particular topic or maybe even just behavioral economics, in the first place?

Peter Atwater: As somebody who spent the first part of his career in financial services, I had never really considered the role that emotions play in the choices that investors make. I sort of missed the forest for the trees. During the financial crisis, it became clear to me that we made a series of choices to borrow, to lend to buy homes that were in characteristics completely different in 2007 from 2009. And so, what I wanted to do was to understand why did we make those decisions? Were there characteristics that were universal? That while the means may change, what are we doing differently and consistently from crisis to crisis, from euphoria to euphoria. Twain says, history rhymes and I wanted to know why. And what I found was that the behaviors that we exhibit all act in a very consistent way based on our level of confidence, and this is something that exists not just in the markets, but outside of the markets. The trends in fashion, repeat the trends in architecture, repeat the trends in politics, repeat. There's so many different ways that confidence sets up what we're doing outside of the markets that then become useful to investors in the markets.

Oscar Pulido: So, some of that you had real world experience, working in financial services and now when you stepped out into academia, you had an opportunity to just see the role that emotion plays in markets. And I think for certain, anybody who's watched the markets this year, or even over a longer period of time, could attest to the fact that it is an emotional, exercise investing and those who can control it probably do a better job in the long term. Peter, we appreciate you joining us and sharing with us your framework. congratulations again on your second book, the Confidence Map. And thank you for joining us on The Bid.

Peter Atwater: Thank you so much, Oscar.

Oscar Pulido: Thanks for listening to this episode of the Bid. Subscribe to the bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

For more information go https://www.blackrock.com/corporate/compliance/bid-disclosures

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0823U/M-3026434

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido. Today we continue our best of summer series, which means I'm joined by our Bid producer, Stevie Manns. Stevie, this is becoming a nice little pattern, having you on the podcast.

Stevie Manns: It's fun. I'm enjoying my Bid debuts.

Oscar Pulido: So let's keep going through some of our favorite episodes, of this year and I think it's my turn.

Stevie Manns: It is your turn, and this is the final one.

Oscar Pulido: Okay. I was thinking back to earlier in the year in March when a seemingly quiet week in the markets turned into a lot of headlines around Silicon Valley Bank, a bank that I had not really paid a lot of attention to in the past, and it was a reminder that markets are stable until they're not, and all of a sudden we have a lot of volatility to talk about.

And we had to spring into action to record an episode with one of our favorite guests, Alex Brazier. Alex is the deputy head of the BlackRock Investment Institute, and Alex came on to talk to us about why these events that were occurring at the time in March were not like 2008, because I think a lot of us feared that it was a repeat of the global financial crisis.

Stevie Manns: Yes, we had to spring into action, like you said, we're speaking about it on Monday, we recorded it Tuesday and we put it out Wednesday. And to your point, there was a lot of panic about are these events the start of another 2008 crisis? What's going to happen next? Is this just limited to the us? Is this going to happen across the globe? And as you say, the market panic seemed to be everywhere.

Oscar Pulido: Exactly, and having lived through the 2008 financial crisis, I was reminded of how there are probably a lot of people who don't really understand how a bank works until it fails, and it really is, the banking model is all built on confidence and Silicon Valley Bank.

And we subsequently recorded a few more episodes in the weeks ahead, but Alex's was really the first one that reminded people that a bank is built on confidence and when, depositors deposit their money with a bank and the bank goes out and, invests it in an asset, when that asset,

underperforms, when it behaves a certain way, it can be difficult for that bank or perhaps impossible for them to pay their depositors who want their money back the next day.

And so to me it was like people, they walk by a bank, they drive by one, they go in one. Probably pretty frequently or they interact with one, but do they really know how it works? And this crisis reminds people just like the basic functioning of a bank.

Stevie Manns: And the way technology has changed, now that you're able to access your funds and your money so much quicker, and to some extent that exacerbated some of these circumstances. It was unprecedented in some ways and no one really knew how this would play out.

Oscar Pulido: And let's be honest, Alex is one of our favorite guests. You and I talk about this pretty often. I think maybe he's only made one mistake ever when he did a recording for us. He's very eloquent. Everything he describes makes a lot of sense, he can take very complex topics and make it easy for people to understand. So anytime we have Alex in the studio, it's just always a pleasure to listen to him.

Stevie Manns: Fabulous storyteller. And you're right, a one take wonder!

Oscar Pulido: Well, you get to hear his voice again. Here's Alex Brazier.

Oscar Pulido: Alex, we're both sitting here, it's Thursday, March 16th, financial markets have been spooked by events, in the banking industry on both sides of the Atlantic. so, can you just explain what's happening and what led to this crisis?

Alex Brazier: It's been, an eventful week, I suppose. The story goes back some way, but before we look in depth at the last week, I think it's useful to remind our listeners that really what's happening here is that the fastest rate hiking cycle since the 1980s was clear that was always going to cause some economic damage and expose some cracks in the financial system.

And what we've seen in the last week is those cracks actually beginning to appear and as we'll come on to discuss, that means more of the economic damage is yet to come.

So that's really the scene setter, the sharpest fastest rate hiking cycle since the 1980s. But then what actually happened over the last week, well, really useful to talk about three things that have happened.

The first is what happened with, Silicon Valley Bank and US regional banks. Then what did the authorities do? And perhaps, the third thing, bringing us up to date is how it's rippled across the Atlantic to European banks.

And starting with the first of those, US regional banks. What really happened at Silicon Valley Bank, well, it was a bit of an outlier in two important respects. The first is that it had a very large share of its deposits, greater than USD250,000. So, they're uninsured deposits, and those are typically more flighty and more likely to, be withdrawn in stress than insured deposits. And the second thing it had in which it was an outlier, was that it had a very large book of US treasuries and mortgage-backed securities. And of course, as interest rates have gone up a lot over the last year, the market value of those securities has fallen a lot.

Now, Silicon Valley Bank hoped that it wouldn't have to sell these securities. It hoped to just hold them until they matured. But to link these two outlying characteristics together, a lot of its depositors were spooked and asked to withdraw their money, and as a result, it was forced to sell some of these securities at today's market prices and realize some of the losses. That meant that more depositors withdrew their money as the bank realized some losses. and so, it entered this kind of spiral, downward and the authorities then stepped in to take control of what was at that stage, a failing bank. The issue of course, then prompted depositors, particularly uninsured depositors, to withdraw money from other regional banks like Signature Bank, and the authorities stepped in there, as well.

So, what did the authorities do when they stepped in? Well, they've seized control of these banks written down the equity, and they've protected the insured deposits as they normally would. But very importantly in these cases, they've also used what's called a systemic risk exemption, which allows them to protect the uninsured deposits as well.

So, these banks failed, over the weekend and on Monday morning, all the depositors. Whether their deposits were insured or previously uninsured had access to their money on Monday morning. So, the authorities have dealt with these banks not by giving a bailout to the shareholders. This isn't shareholder friendly, but by protecting, the depositors in those banks, so that was the US authorities.

And then the third aspect really of what's happened in the last week is that the crisis has rippled across the Atlantic. And it's not that European banks have in any way the same underlying issue as these regional US banks. And they're not directly connected either, but there is a channel of contagion, which is that following what happened in the United States. Markets are now applying greater scrutiny to banks around the world, including in Europe, and they're applying greater scrutiny to banks that have challenges or even where those challenges have been going on for years.

And as a result, we've seen market confidence and volatility in Europe, we've seen the Swiss National Bank step in with liquidity support for one of its banks, Credit Suisse, and so we see how this evolves from here.

But it's important to note that we don't have the kind of contagion channels that we had in 2008, but there is still this contagion channel across the Atlantic where markets are now looking at banks differently even where they don't have new challenges.

But I just go back to the root cause of all of this, which is the fastest rate hiking cycle since the 1980s, which was always going to cause some degree of damage and expose some financial cracks. And that's really the underlying root cause of everything that's gone on in the last week.

Oscar Pulido: Alex, you mentioned 2008, which is hard to believe it's a decade and a half ago, but the headlines of the past week, for those of us who lived through 2008 and that crisis, it's hard to not try and draw comparisons, and during that financial crisis, you were part of the team concerned with financial stability at the Bank of England, so you were in the thick of it then. How do you see what's gone on over the past week compared to what happened in 2008?

Alex Brazier: There are uncomfortable echoes of course, anytime you get any sort of problem in the financial system but there are some really important differences this time, which mean it's not quite the same.

The first really important difference going to what's happened in the US is that, back in 2008, the issue was really exposures on banks, balance sheets, subprime mortgage exposures that were really opaque, really difficult to find where they were, figure out how much they were worth... and so there was a lot of uncertainty across the banking system about who was holding the problem assets. And so, the contagion spread through the system as people lost confidence in all banks.

And the only way to solve it was effectively to dig into banks’ balance sheets with the stress tests at the time, and provide state recapitalization, taxpayers money, into banks that it was found had a hole in the value of their assets.

I think what's different this time in an important respect is that the assets at the heart of this in the US banking system, far from being opaque are actually the most transparent and easy to value of the lot. It's US treasury bonds and mortgage-backed securities. And so, it's very clear to assess where the losses are on those assets and who's holding them.

And that makes it very different in an important respect. And it's clear when you do that, that Silicon Valley Bank, for example, was a very big outlier. Relative to the whole of the banking system. So that's a big difference from 2008, we've gone from opaque losses. To very transparent, losses on some of these really transparent securities.

I think the other thing that's really different is where the system starts the banking system in particular, in terms of how much capital it's got, and that capital's there to absorb losses while protecting the deposits. So, we've started in a position where banks have lots more of their own shareholders money on the line than they did back in 2008.

And so even though pretty much all US banks hold US treasuries and mortgage-backed securities, and so they will have incurred some mark to market losses as interest rates have gone up over the last year.

The losses over the system as a whole are significant, but eminently manageable within the capital base that US banks have now got. So unlike 2008, this isn't a problem with asset values, that's going to overwhelm the kind of capital base of the whole banking system.

So those are two big differences, from 2008. And I think the third big difference is that the authorities now have more tools to deal with this.

We saw last weekend the Fed stepped in very quickly. I think because it was able to assess the problem and mark down assets and figure out who had the issues.

The Fed came in very quickly with a new lending facility, the bank term lending facility, to effectively support banks that were experiencing a withdrawal of deposits. So, where this had a knock-on effect from Silicon Valley Bank to some of the other regional banks, people with withdrawing their deposits to put them into bigger banks. The Fed was able to launch a facility to basically make that process run much more smoothly and stop regional banks needing to undertake forced sales of some of these securities like US treasuries and mortgage-backed bonds.

So, the authorities have more tools, they also now have more to deal with banks when they fail in a way, they didn't in 2008, when they faced a kind of invidious choice between bankruptcy, which of course means depositors money is locked up, and bailout.

This time they've got so-called resolution tools to deal with failing banks. So, in those three important respects, transparency of where the problem is, the ability to use the tools they've now got and a bigger capital base in the banking system. That makes this a very different proposition,

Oscar Pulido: And maybe specifically on that third point that you mentioned central banks and the toolkit that they have now, which is partly a learning from 2008. So, you've mentioned the Federal Reserve, putting that toolkit to use. You also mentioned the Swiss National Bank, which is acted as a backstop to one of their important financial institutions.

So, are we okay now or does this have ripple effects from a macroeconomic perspective going forward?

Alex Brazier: Yeah. I think despite this being different and despite all the tools at their disposal, this will have ripple effects for the economy, in the US and in Europe actually. And why is that when we're in this different situation? Firstly, in the US regional banks are still under pressure and they'll be under pressure for two reasons.

The first is that despite the way these failing banks were resolved over last weekend, Depositors are still withdrawing their money, in some cases, to place it with some of the bigger banks. So regional banks are finding it more difficult to raise deposits and fund their lending.

Now, as I said, because the Fed has launched this, bank term lending facility, that process can be much smoother than it might otherwise have been but nevertheless, what we're going to see is some of the regional banks need to adjust their businesses, shrink their balance sheets, and that means. Tightening their, credit supply conditions, the loan officers at these banks won't be extending lots of credit now, and that means for the economy as a whole, a tightening in credit supply means less credit available.

Now, that's going to have an economic effect. It's going to tighten financial conditions for businesses and households and that's going to help to slow the economy in the way the Fed's rate hikes were actually designed to do.

That's one ripple effect onto the economy and I think in Europe, a similar thing's going to happen. So even though it wasn't the same underlying problem, because of this contagion channel where markets are applying more scrutiny to banks, it is more costly for banks to raise equity, to issue debt. And that's going to be passed on to lending conditions to the broader economy.

And it's also going to tighten conditions in financial markets because those banks are going to be less willing to make markets, and act as dealers in those markets.

So financial conditions for the economy are going to tighten, not on the scale that, they did in 2008. And in a way, what we're seeing here is just the normal response to a rise in interest rates. It's happening through some sudden channels, but I go back to this point that the ripple effects here are really the effects of the sharpest rate hiking cycle since the 1980s, but it is going to affect economic activity through these channels.

Oscar Pulido: And so that fastest rate hiking campaign that we're seeing since the 1980s, what do central banks do now? Do they take a, pause, with hiking rates and remain in this, whatever it takes type of mode to backstop financial institutions?

Or do they continue with hiking rates to combat what has been a, an inflationary background, really globally?

Alex Brazier: This is a very different episode to 2008 in one other respect as well, which is that we go into this with central banks facing an inflation problem. Both the Fed and the ECB have got the problem of stubbornly high core inflation.

So, inflation's come off its highs, but it's still not on track either side of the Atlantic, to actually come down and settle close to their 2% targets. So, they were needing to raise rates, slow their economies probably generate recessions if they wanted to get inflation all the way back down to their targets, and that's a very different situation to the one we were in 2008 and the one we've been in every kind of financial wobble over the last 30 or 40 years, in fact.

So, the playbook where central banks respond both with tools to address financial problems like lending facilities like we've seen this week, and rate cuts isn't on the table this time. What we think they'll try and do, to the extent they can, is effectively separate two issues separate.

On the one hand, maintaining financial stability, where they'll be using lending facilities in the way they've done over the last week, and monetary policy, interest rates, where they'll be looking to deal with their inflation problem.

And in a way what the Bank of England did last September is a good model for this, a good guide for this, faced with problems in the UK gilt market, it launched one operation, some temporary purchases, of gilts to deal with that financial problem, whilst at the same time raising interest rates to deal with its inflation problem.

And that is the playbook we're more likely to see here at this stage, central banks using lending operations to deal with financial issues whilst using interest rates to continue to deal with their inflation issues.

Now that's very different, and we've seen actually the ECB just before we've recorded this, go through with its earlier guidance that it would raise interest rates by 50 basis points. this month it's gone through with that suggesting its use of interest rates isn't being diverted to addressing other issues in the banking system. That said, with credit conditions tightening as a result of these issues in the banking system, that's effectively going to do some of central bank's work for them. It's going to tighten credit conditions; it's going to slow the economy. Central banks won't need to raise interest rates as much as they otherwise would've done to deliver the economic outcome they're looking for- which is a recession and getting inflation down.

So, they're going to do a bit less than they would otherwise have done. So, more rate hikes, but not as many as we might have seen. But the big point here is that they won't be coming to the rescue of markets, in our view, with aggressive rate cuts because of the inflation issue, that they're facing and that's a big difference, I think to the past.

Markets have priced in now some big rate cuts over the course of the year, but as it stands, they're likely to try and maintain this clear separation of two sets of tools, two targets, lending facilities for maintaining financial stability and interest rates and monetary policy for dealing with inflation.

Oscar Pulido: The scenario you're describing sounds like central banks are going to be multitasking for the foreseeable future. Alex, I know you've had a busy week, thank you for spending part of it with us here on The Bid

Alex Brazier: Thanks Oscar for having me.

<<MUSIC>>

Stevie Manns: So Oscar, we talked earlier about how banking is all about confidence. Did you feel more confident about how things were going to progress and a few months later, what are your thoughts in terms of hindsight?

Oscar Pulido: Well, I think whenever you hear Alex you're talking to somebody who has many years of experience in the financial sector, and in this case, he has worked in the halls of monetary policy, in England someone who's speaking with credibility. So you immediately, are listening to him and thinking this is somebody with a credible opinion. But at the same time, in the midst of this market crisis and market volatility, living one day to the next.

And now that we can fast forward five months, and the banking crisis was relatively confined- it did not spread more broadly, we did not see another 2008. Actually markets have ground higher, over the course of the last few months. Stock markets are higher, inflation is starting to come down and so we're almost not even talking about this anymore, we're resurfacing this episode because we remember in the thick of the moment what it was like. But I did come out of that feeling more confident after listening to Alex and now five months later, a lot of what he said has really come true.

Stevie Manns: It must be great being Alex and you can be right about a lot of things.

Oscar Pulido: That's why we have him on as a frequent guest.

Stevie Manns: Definitely. Well, Oscar, it's been so fun reliving some of our favorite episodes for this summer series. Perhaps we can do it again sometime?

Oscar Pulido: That'd be great. Let's do this Best of summer series maybe every year. And for those of you that are listening, thank you for listening to The Bid. And don't forget to subscribe to The Bid wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

MKTGSH0823U/M-3041417

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido. Today we continue our Best of Summer series, which means I'm joined by a guest, Stevie Manns, our producer of The Bid podcast.

Hi Stevie.

Stevie Manns: Hey, Oscar.

Oscar Pulido: So you and I have both picked one of our favorite episodes that we've done this year, and hopefully our audience has enjoyed re-listening to it or maybe listened to it for the first time. It's now your turn to pick one of your favorite episodes again. Which one is it?

Stevie Manns: It's the Art of Negotiation. How to ask for more with Professor Alex Carter. Norm Shah, was the host of this episode. you weren't here because it was women's history Month and sorry, Oscar, but that's not you.

Oscar Pulido: I understand.

Stevie Manns: So during the month of March we had senior leadership from around BlackRock interview women from the world of business and beyond, inspirational leaders that they look up to. And Alex Carter came in to talk about negotiation. She is a professor at Columbia Law School. She's written a book asking for more. It's and I love this episode. I think this is something that I will listen to at least once a year.

So many people think that negotiation is something that perhaps you do at work or it's always something where someone loses out on something and it's this idea that she talks about of steering, we are always negotiating to get to where we want to go, and it doesn't have to just be in a difficult conversation or situation.

Oscar Pulido: That's right. And I, recall as well from the episode that, there was a point in her life where she realized she needed to start putting into practice some of the things that she was telling people to do. So sort of following her own advice, and there was this moment of hesitancy, but she powered through and ultimately now following her own advice.

Stevie Manns: Absolutely. And there was something that Normandy said about the steering thing, and she, she said, um, she loved that metaphor you are steering and she said that she'll use it, going forward and every day.

And I checked in with her this morning. I said, Hey, Nirmitee, do you remember talking about this and saying that you were going to use it? How is that working out for you? And she said, Oh my God. It is so ingrained in everything that I do now, I almost forgot where it came from. And I love that, and it's so fun when you listen to an episode or a podcast and there's something that you take away and you really implement that. This podcast has been something that I've taken away and implemented. I even read Alex's book, she was kind enough to give me a copy, I think it's such a fabulous episode to re-listen to. There aren't that many episodes that I would do that for.

Oscar Pulido: Great. Well let's re-listen to this one again.

<<MUSIC>>

Nirmitee: Alex, welcome.

Alex Carter: Thanks, Nirmitee I'm happy to be here.

Nirmitee: So, let's start with the first question. Who is Alex Carter?

Alex Carter: Big question. I was born in Brooklyn. I am a lifelong New Yorker who made a 17-year temporary pit stop in New Jersey for the sake of my marriage. I am somebody who loves to learn. and now I'm really fortunate to be a person who is in her dream job.

By day, I'm a professor at Columbia Law School. I teach conflict resolution. I help people work out their problems, and I help students to step into their futures. And then outside of that, I'm a published author and a keynote speaker, a mom of a 12-year-old girl and a wife.

Between your tenure at Columbia and the book and motherhood and other things, when did you realize it was your Ah-ha moment that this is what you were meant to do?

Nirmitee, I'm a lawyer, so when you ask me for one aha moment, I'm going to give you two.

Nirmitee: Okay. Buy one, get one free. Indeed. Yes.

Alex Carter: The first moment was this. You know, I think a lot of people look at my CV and they assume that I always knew where I was going in life, and that couldn't have been further from the case.

I went into law school. I had absolutely zero idea of what I could do after graduation, and it wasn't until my last year there that I took the course that would change my whole professional life. The reason I took it is a friend of mine pulled me aside and she said, Hey, I just took this class. It involves a lot of talking. I think you'd be great at it.

So, shade aside, I enrolled in the class and this was mediation. And mediation is the art or science. We'll get to it of helping people work out a dispute, helping people negotiate. And the first time I stepped into this dingy room in the New York City courthouse and helped these people work out a dispute, it was as though I heard Morgan Freeman's voice coming down saying, Alex, this is it. This is what you should do for the rest of your life.

But here was the second moment, because you see after that, I grew really comfortable helping other people negotiate. I was really good at it. Then came the moment where for the first time, I had to negotiate for myself.

Early on in my career, I was in these jobs that were all lockstep. You walked in, the comp was but then I had to finally put on my power suit and my tall heels. That was my thirties back when I was wearing heels, walk into the office, and I got a good offer, and inside I had a crisis. Why? Because I realized that I thought I had to just accept the first offer I was given.

I realized that I had absorbed this message, that negotiation was something I could do for other people. But if I did it for myself, I wasn't collaborative, I wasn't going to be liked or worse, I would leave less for other people. But I had just enough on the ball to call a senior woman in my field, and I asked her, What should I do?

And she said, I'm going to tell you what to do, Alex. You're going to get back in there and you're going to ask for more. And here's why. Because when you teach someone how to value you, you are teaching him how to value all of us, meaning all women. So, if you're not going to go in there and do it for yourself, I want you to do it for the next woman who's coming after you, do it for the sisterhood.

That was the moment I realized I don't just have to do this for other people. I am worthy of applying my own skills to myself, and in fact, it doesn't leave other people with less. It builds a bigger table for other people to sit.

Nirmitee: I just want to comment on the fact that you make the table bigger, I agree with you 100%. But let's go back to the first point you made which was around art or science. So, what is negotiation?

Alex Carter: Well, it's interesting art and science are actually much closer than we think. They're just two different ways of trying to understand humanity, who we are, and to make sense of our world.

And negotiation, therefore, is both. There are observable phenomena that have been documented in research, and that's part of the science. But then you sit down at the table and it's two human beings or maybe more human beings looking at each other and talking, and that's nothing but art. Because I may go in with all of the research, but then in the moment I'm relating to another human being.

So, it's interesting because there have been all sorts of technological advances even when we think of negotiation, programs that can simulate bargaining, but in the end, unless the negotiators themselves are replaced by machines, we have to have some creativity, some differentiation, some sense of, the art, the creativity, the imagination behind negotiation.

Nirmitee I agree with you. So ChatGPT, everyone's talking about it! So, what happened is someone from BlackRock went to ChatGPT And said okay, create a portfolio that will be the market for the next 10 years. And ChatGPT instead of creating a portfolio actually created a disclaimer saying that you cannot beat the markets with predictability. But I feel like that's the machine versus human, that humans transcend logic sometimes or fall apart in face of logic. And that's what might make a negotiation more interesting

Alex Carter: Oh, we are, predictably irrational. In fact, Nirmitee, I start a lot of my negotiation classes by setting up a simulation.

Here it is. I set people into teams of two. and I tell them, each team, one person needs to raise their hand and volunteer for something. The person who raises their hand, I say, I've just handed you $20 and here's what you're going to do. You have one chance to turn to your partner and make an offer for how much of the $20 you'd be willing to split with them.

Here's the catch one offer. Accept or reject if your partner accepts you keep the $20 in the proportion that you propose. If they reject the $20 comes back to me. Do you know what happens, a lot of times, especially in shared groups? People offer $10. They might offer eight. They might

Nirmitee: I was thinking I would offer 10

Alex Carter: Okay. And why would you offer 10?

Nirmitee: Because it seems fair, and the chances of them wanting to split are higher. Maybe I would offer nine. But not more than that. Like I wouldn't go to eight. I would feel like maybe 11 bucks for me, nine bucks for them. Maybe a good offer and then that way we both get to keep some money.

Alex Carter: Yeah, because you took the risk, you raised your hand. So maybe you apply a little premium Yes. To the $10 to get a little extra, right? Yes. Okay. But you're thinking about risk.

Here's the thing. The economically rational thing to do, is if you're offering me to offer me one penny, and the economically rational thing for me to do would be to accept that penny

Nirmitee: Because you're better off with that one penny than you were a minute ago when you didn't have the penny.

Alex Carter: Correct.

Nirmitee: This reminds me of, Daniel Kahneman's experiments in behavioral finance.

Alex Carter: Absolutely. And I love his work, I'm always thinking about whether my brain is in system one or system two. But here's the thing, human beings don't act rationally when it comes to economics. And you see this play out all the time. You get a monetary offer. Maybe it's a deal you're striking with a client. Maybe it's for salary. And yes, you're thinking about, I want to be better off financially. But the money also means something, doesn't it? It stands for something. It stands for fairness. It stands for achievement. It stands for recognition. And so, we have to be aware that even though at the table there could be a Pareto optimal outcome, we're almost never going to be there because of the human beings at the table, who value sometimes things more than rationality.

Nirmitee: So, coming back to the art versus science have you seen a change in the last 20 years in terms of how people approach some of these negotiations, has the general level of understanding of negotiations improved?

Alex Carter: So yes and no. I will say when I look now at popular media, movies, tv. You remember that Show Entourage, right? You would see these high stakes negotiations all the time, and so I think in general public awareness has been raised about negotiation but not always accurately.

And that's part of the reason I wanted to write a book, because I felt like I was seeing depictions of negotiation everywhere that didn't mirror what I knew negotiation to be. If you look at Succession, for example, or Entourage, you're going to see a negotiation that means the following, it cuts to us. And actually, then we would be two guys in suits.

If you look up negotiation on Google and you go to the image search, I've done it. It's a lot of white men in suits. So that's part of the depiction we get about negotiation. And it's part of the reason I think that I've read a lot of negotiation literature and I didn't see myself in any of that.

 It was tough for me to pick up a book and to find something that I thought, yes, I can actually use this with my friends and colleagues and family. So, there's definitely a representation element to it, but there's also a substantive element in which I felt popular portrayals were falling short. They show the last couple rounds of a heated monetary negotiation to get to an agreement. And most people, in fact are taught negotiation is a back and forth over money to get to some kind of compromise.

Nirmitee: Yeah, when everybody loses, I'm so everybody loses right? There is no win-win in negotiation.

Alex Carter: And I reject that on a number of fronts. First of all, negotiation is not just about money. I actually learned what negotiation was on my honeymoon. And it's not just because I married another lawyer, okay? But picture this, we're in Hawaii. The two of us are in a kayak on the Waialua River, and our guide up ahead turns back and says, all right folks, let's negotiate these things to the left because we're going to hit that beach up there.

And I gotta tell you, everybody else was enjoying the scenery and my brain, love of learning was immediately somewhere else because of all places in the world a kayak in Hawaii was where I learned what negotiation really means because I thought, that's right, if I'm negotiating my kayak toward a beach, what am I doing? I'm steering.

And what if negotiation wasn't haggling over money? What if it was just the process, like a kayak of steering my relationships in the direction I wanted to go? And with that in mind, I went back to the office the following week and I saw opportunities to negotiate everywhere because it wasn't just about asking for salary once a year. It wasn't just about the twice a year I would sit down with a client and say, let's hammer out this retainer agreement.

I could be proactively calling and saying, tell me What's happening in the company? What's keeping you up at night?

And all of a sudden, we were negotiating, and our relationship grew closer. And then when I do have to deliver difficult news, when we do have to have a monetary conversation, we are in such a better place than we would be if I was in a kayak, and I just took my hands off the paddle.

Nirmitee: Steering, there is a part of me, the bossy part of me, which feels like I'm going to now use this as a metaphor for pretty much everything I do in my personal and my professional life. That was very insightful, but you started off your conversation with the space you wanted to create, so a woman not being represented, and as a woman, you wanted to make the pie bigger. So, what's the purpose? What drives you and what do you want to accomplish?

Alex Carter: Do you know the reason I'm sitting here with you today, and the reason I have a book published at all is that six years ago, a student of mine who had graduated and was now in law practice asked me to go to coffee. And we went to coffee, and I thought we were there to discuss some career advice for her.

And instead, she said to me, you've had such a profound effect on my life. I want to help you achieve your legacy. What do you see as your legacy on this earth? Her name's Kristen Ferguson. I was floored. And in that moment, I answered instinctively, and I said, my mission on this earth is to hold up a mirror so that every single person who comes to me, whether it's as a student in my course, somebody I'm training in negotiation.

And when I go into large companies, it's just a bunch of individual relationships. I see each person in that room in this way. I want them to hold up a mirror and see their highest and best and then I want to help them open up a window between them and somebody else to be able to resolve conflict, see the other person better, and see situations more clearly.

Nirmitee: And then if somebody asked you, somebody told you, where do I start? Besides reading your book, how does one start down this journey of steering and or looking at the world in a way where you create these situations for everyone around you to be better?

Alex Carter: The place you start is where every negotiation starts, and that's with yourself. If negotiation is about steering relationships, the most important, the most central relationship of your entire life, will be the one you have with yourself. And so, it starts with self-knowledge.

People ask me all the time, what's the source of my power in negotiation? I think they think it's how much you can go in and physically fill up a room and I'm five two in sneakers.

Okay? I will never be the biggest person in any room. But the expert negotiators are the people with the most knowledge, they understand themselves extremely well. They understand the situation extremely well, and then from that stable base, they're able to get to the table, listen minutely to every word the other person says, and by doing so, crawl up inside that other person's brain space and get to know them better than they know themselves.

That's how you become an expert negotiator.

Nirmitee: So, Alex, in your Wall Street Journal bestseller, Ask For More 10 questions to Negotiate Anything, what are the two or three most important questions? What's the distillation there?

Alex Carter: Back when Ask For More came out, I spoke to the Wall Street Journal and they asked me, Alex, where should everybody start in negotiation? And I said, you should start here, what's the problem I want to solve?

Most of your negotiation success, and if you're at a company, most of your company's innovation success will rise or fall on whether you are solving the right problem. That's number one.

A question I love for people to ask is, What do I need? And making a complete list in a negotiation of the tangibles and the intangibles. The tangibles spring to mind immediately, right? It could be money, a particular role, headcount, resources, but the intangibles are really important.

People might say, I need autonomy in this role. recognition. respect, and then I want you to ask, what does that look like for me? Because Recognition, respect, autonomy, can look totally different for you than for somebody else. So that's really important.

And then when you're talking to somebody else, I can't tell you how many teams I train, where people come into a business development meeting, and they start with a pitch. Hi, I'm Alex. Here's what we do. Here's what we can offer.

I tell people to walk in and ask what I call my magic question. Two words. Tell me about your business. Tell me what success would look like for you. here Tell me what's keeping you up at night? Tell me, if we were to work together and we had a phenomenal result, what would that look like in your business a year from now?

But it doesn't matter, whether you're asking that question in a business development meeting or you're asking it of your 16-year-old when they come home from school instead of “how was your day? tell me about your day. It is the broadest possible prompt. It gives you the most information, it creates the most trust, it is the number one question that you should ask in any scenario.

Nirmitee: Nice. I'm going to go and ask my 16-year-old “tell me how your day was instead of how was your day? Where I get meh and her staring into her phone, as most 16-year-olds do these days.

Alex Carter: Do you know why your 16-year-old doesn't respond when you say, how was your day?

Nirmitee: No, I wish I did

Alex Carter: It's because how was your day is not a real question. It's a social script. It's what we do when we are sitting down together. How are you today, Nirmitee? I'm great. How are you? How was your weekend? Wonderful. How was yours? It means let's get through this so that then we can discuss the real thing we're here to talk about. And nobody recognizes a fake question more than children. They smell it and they will not answer it.

And so, I started pivoting and I would ask my daughter, tell me about art class today. Tell me who got in trouble. Tell me the silliest thing somebody did today. And then I allowed for lots of silence and all of a sudden, we start rolling.

Nirmitee: Nice. So, I have homework. This is awesome. Alex, thank you for your time today.

Alex Carter: Thanks for having me.

<< MUSIC>>

Stevie Manns: So Oscar, I know you weren't part of that conversation, but listening back, How has that made you reflect on some of the conversations or negotiations that perhaps you may have in your everyday life?

Oscar Pulido: I think it goes back to something you said at the intro, which is that negotiation isn't just something that takes place in the workplace, that it's ongoing in our lives. And I actually like the part where Alex says, her job and her mission and her passion is resolving conflicts and helping people resolve their conflicts.

And, that has applicability in so many parts of your life. And frankly, if we did a little bit better job at that across the world, I think we'd be in a better place.

Stevie Manns: this was super fun. Thank you very much for going through this with me, and I look forward to your final pick next week.

Oscar Pulido: Sounds good. We'll keep you in suspense until then.

Stevie Manns: Okay.

Oscar Pulido: Thanks for listening to this episode of The Bid. We'll be back next week with our final best of Summer series episodes. Subscribe to The Bid wherever you get your podcasts.

<<THEME MUSIC>>

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

And today we continue our best of summer series, which means I'm joined by Stevie Manns, our Bid producer. Hi Stevie.

Stevie Manns: Hi Oscar.

Oscar Pulido: So, I think it's my turn to pick another one of my favorite episodes, and I'm going to pick the one on geospatial data and how it can impact investing. I thought this was a really fascinating episode that had an interesting personal story attached to it that I didn't anticipate. You might remember Josh and Mike joined us to talk about how they're processing all of these, I think they used the word petabytes of data, that was the quantity that they about.

Stevie Manns: Yes, and we had to figure out how much a petabyte actually was!

Oscar Pulido: Yeah, I don't think I had heard that term maybe before they mentioned it, but the personal story was interesting because Josh talked about a set of friends that he had living in California who were constantly having to move due to wildfires. And it was that impact that wildfires had on California families that led him down this path of wanting to understand weather patterns and one thing led to the next then all of a sudden, they're processing all these different types of data points to think about the next investment decision.

Stevie Manns: Yes, and to be someone who's able to see something out in the wild and then bring it in and have it inform something that you do in your day job that's able to help clients, that's able to help other people. I thought that was really cool and impactful and I've found the whole conversation really insightful.

Oscar Pulido: it also made me think that I'm just a walking data point. I'm constantly leaving some sort of trail, whether I'm at an airport, if I'm checking into a hotel. and it's not just me, all individuals have a data trail that they leave, and businesses leave data trails. And he talked about alpha hiding in plain sight and for those in the investment industry, alpha's really hard to generate. it is what you're going after, excess return versus the market. So, the fact that he painted this picture of, well, it's actually right in front of you, you need to know how to put it together and where to look was an interesting visual.

Stevie Manns: I completely agree.

Oscar Pulido: Well, with that, why don't we give it a listen?

Stevie Manns: Let's do it.

<<PREVIOUSLY APPROVED EPISODE RO 2856997 PLAYS>>

Stevie Manns: So, Oscar, I know you work with Josh and Mike. Was there anything from that episode that perhaps you didn't know? Was there something new that you learned? What were your thoughts coming out of that discussion?

Oscar Pulido: I think it was just a reminder of how modernized investing is becoming how much almost science there is behind it. When you think about the quantity of data, when I went to business school and was taking finance classes, we were kind of digging through a balance sheet, trying to understand the financials of a company, and that still happens, but 20 plus years later since I've graduated, there are folks processing, petabytes of data. And so, I think for me it was just a reminder of how modernized investing has become and how much you have to stay ahead of the game if you really want to truly outperform the market or try and outperform the market.

Stevie Manns: Absolutely. And I think we're going to see AI allow for much more of that data analysis and will, I'm sure take this technology forward and take investing forward so it's an exciting space to watch.

Oscar Pulido: I agree. And I also thought, I'm glad Josh and Mike are doing this, because I certainly couldn't!

Stevie Manns: Oscar, this was fun. I think next time I'm going to pick the next episode.

Oscar Pulido: Indeed. Well, thank you for listening to this episode of The Bid. If you've enjoyed The Bid so far, do subscribe wherever you get your podcasts.

Disclosure

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.​

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.​

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded.

©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.​

Oscar: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm Oscar Pulido.

Today I'm pleased to welcome a co-host, Stevie Manns, The Bid's producer. Welcome, Stevie.

Stevie: Thank you, Oscar. It's lovely to be here.

Oscar: Stevie. I'm just the voice, but it turns out you're the mastermind behind the production of the podcast, so it's great to have you on the microphone.

Stevie: Well, thank you Oscar, and if I may say, I think you're the host of the most!

Oscar: I appreciate that. So, Stevie, as we wind down our production for summer, we thought we'd take a look back at some of our favorite episodes so far this year in case our audience has missed any of them. And so, you and I are each going to pick two of our favorite episodes and talk a little bit about what made them stand out for us. So, you're going to kick us off for this summer series. What's your first pick for us?

Stevie: I'm really excited about this. So, my first pick is the Metaverse episode we did with CEO of Magic Leap, Peggy Johnson. I just loved this conversation, I loved her insights, it was such a visual episode. I loved picturing all of these future devices that we're going to be wearing, imagining what the future's going to look like. And you know what, it just brought me back to being a kid, watching the Back To The Future of Trilogy.

Oscar: That is also one of my favorite trilogies of all time. I have the music going through my head right now.

Stevie: Huey Lewis and The News?

Oscar: That is definitely one of the classics. And I love the scene where he's also judging the band early in the movie, which is like a nice irony that maybe the younger generations don't fully appreciate right now.

Stevie: I never got that until I watched it much later. I was like, that's Huey Lewis!

Oscar: Exactly.

Stevie: I'm a huge Star Trek fan as well so it really tickles me to see this come to life. Peggy mentioned these devices that we would be wearing, we only did this a few months ago and Apple has already come out with this new, very expensive device and that's what she threw forward to, that these devices are going to be so expensive when they come to end-consumer initially. What was it like for you to record this episode because you didn't know what she was going to say, so how did it feel to be interviewing Peggy?

Oscar: I didn't know what she was going to say and that's probably what made it very interesting, the visual that she painted. And I was picturing myself wearing these, augmented reality glasses walking down the street, thinking about how they would help me get to the location that I need to get to. So, it did feel futuristic, but also that it wasn't that far into the future.

Stevie: It's here. I don't know if it's here with Apple now, but it will certainly be in the next few years, I would think.

Oscar: So, let's take a listen to the episode.

Stevie: Let's do it.

Oscar: So, Stevie, what was one of the key takeaways as you listen to that episode again?

Stevie: I thought the stat about reducing training costs by 80% was astounding. And what that's going to give businesses the ability to do and the capacity and all the, all of those efficiencies. I think that's incredible. What about you? Was there anything else you took from that episode?

Yeah, I think going back to the visual nature of her discussion, just the comment around the factory worker. Learning how to use a piece of machinery in a very digital format, that really resonated with me as opposed to having to leaf through a very lengthy manual of instruction. I think we've all been in a job where we've been given a manual or a handbook or a guidebook and wish that there had been a much simpler way to do it. So, I hear you there.

Oscar: Sounds more fun. So, I think this is usually where I do the outro, but I'm going to let you do this part now.

Stevie: Ooh. Okay. I thought you would never ask! Next up on The Bid, we’re continuing to introduce a new short-form series from the BlackRock Investment Institute on Mondays, and then it's Oscar's turn to pick his favorite Bid episode as we continue our “best of” summer series. Thank you for listening to The Bid. I'm Stevie Manns.

Oscar: And I'm Oscar Pulido.

Stevie: Make sure you subscribe to The Bid wherever you get your podcasts.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

The first half of 2023 has seen its fair share of headlines and volatility across global markets, including higher interest rates, bank failures, and a dramatic US debt ceiling moment.

As we look ahead to the second half of 2023, what are the emerging trends investors should be watching and what opportunities might these factors present?

I'm pleased to welcome back Alex Brazier, Deputy Head of the BlackRock Investment Institute to help us look ahead to the rest of the year. Alex, welcome to The Bid.

Alex Brazier: Thanks Oscar for having me back.

Oscar Pulido: Well, Alex, you are back. In fact the last time we talked, we were discussing the relief that markets were feeling from the U.S. Debt ceiling agreement, and you mentioned that there was an upcoming investor Outlook forum taking place at BlackRock's headquarters in London. So perhaps, we can start with some takeaways from that forum.

Alex Brazier: Yeah thanks, it's been a busy few weeks and as you say, we did assemble, BlackRock's most senior investors, in London two weeks ago now for two days of intense discussion. And really I think the top line conclusion I took from that is a wide acceptance that we're in a new regime, a new macro and market regime, that brings new and different investment opportunities. So this new regime is something we've been talking about for a long time, it's actually playing out now. We had 30 years of stability where central banks always came to the rescue whenever anything looked to be heading south in our economies, and we had sustained bull markets. And now we've seen major developed markets flirt with recession, and yet central banks have raising rates and certainly holding tight with their policies.

So that's the new regime playing out from a macro perspective, but that's really not a council of despair. And the thing I took away from our meetings in London the other week is that, far from it, the opportunities may be different, but they are no less than they used to be. So, sure, this is an environment where, simple static portfolios at the broad asset class level won't any longer be the best you can do, and it's not an environment really for taking big macro risks when central banks aren't coming to the rescue.

The opportunities now come from zooming in being precise, finding the disconnects in the way markets are pricing some of the volatility, finding relative value, and also from harnessing some of the mega forces- the big tectonic shifts in our economies that are playing out now.

So yeah, I took away it's a new regime. It's a different regime. It's playing out but actually that means there are new and exciting opportunities that are different from the past, but no less than the past.

Oscar Pulido: I love some of these terms that you mentioned, Alex. "Zooming in, being more precise." I think you said "mega forces" and tectonic shifts. So it sounds like it was a lively debate in London to say the least. And we've talked about this new investment regime with your colleague Wei Lee a little bit earlier in the year.

So maybe just go into a little bit more detail about what we think this looks like when we say new investment regime and how this is playing out?

Alex Brazier: The big shift here as I say, is we're going from a world in which most major economies, their supply capacity was just growing steadily over time. And so the job of central banks was really just to keep stoking up growth and come to the rescue whenever growth threatened to head south. And that's the way they achieved their inflation targets.

So they had a structural easing bias. Rates were always below their neutral level. Central banks were always stoking things up, now we're moving to the opposite. And as I say, in develop developed markets, we've seen growth stall, Europe's had a recession as the energy shock has squeezed incomes. The US even on some measures, may have just about had one too, if you look at measures like gross domestic income alongside measures like gross domestic product.

And all of this is before the full effect of central bank actions come through- tightening financial conditions, tightening credit conditions- and yet central banks are not coming to the rescue with rate cuts. In fact, they're signaling further increases. Why is that? Well, it's cuz their economies are basically overheating despite having had recessions. And that's because economies aren't able to produce as much now without generating inflation because of things like labor supply problems and energy supply problems.

So central banks have gone from, having this sort of structural easing bias to having a structural tightening bias. They're constantly trying to hold back growth in order to get inflation down to their targets. So they're, they're holding tight, they're holding policy tight, and markets have been gradually adjusting to this. We've seen it in fixed income markets, for example, as bond markets have started to price in that, central banks won't be cutting rates this year, even as growth slows, they'll actually be keeping rates pretty high. The U.S. two year yields now up pretty significantly, and that's the market adjusting to the fact that central banks aren't coming to the rescue.

That does create challenges for risk assets. It means more volatility, means more growth, volatility, it means more earnings volatility means more equity volatility, and risk asset volatility, but... does also mean serious opportunities for income from particularly short dated bonds where yields have risen pretty sharply and increasingly emerging opportunities to lock in some of that income with longer duration too.

So this is a regime where there are challenges, sure, the macro regime creates more volatility, but also, central banks holding tight means higher yields means real opportunity for income in portfolios as well.

Oscar Pulido: Yeah, and it's interesting to hear the side by side. On the one hand you're saying there are big parts of the world that might be in recession, maybe you have to look closely at the data to really see it but by textbook definitionthey're experiencing a recession or certainly a slower growth environment.

You're saying there's gonna be more volatility, central banks are not coming to the rescue as they have in the past. But despite all of that you mentioned the opportunities are there. They're different, but they're no less. So where can investors look for those investment opportunities?

Alex Brazier: I think this is actually the big thing coming out of our discussions in London the other week. So the first is obviously that income is back with yields, higher central banks holding tight, there are opportunities now in portfolios to lock in some of that income.

Now, it's not a great environment for overweighting risk assets as a broad category in a portfolio, but nor is it an environment to bunker down and wait.

Partly because in this new regime, macro volatility is just something that's here to stay. It's a fact of the regime, so it's something to adjust to rather than wait to pass. The big thing is that we're not taking big macro risks in portfolios. We're just taking different risks in portfolios. and let me, give an example of a few here.

The first is that zooming in, within equities, there's an increasing population of stocks where investors are now compensated for some of the risks in the macro environment. And US equities, for example, remain the lion's share of our baseline portfolio. But there's also opportunity in zooming in further within developed market equities to tilt portfolios because we see opportunities, for example, in tilting equity exposures to towards Japan, where the macro pictures quite different to other developed markets.

The Bank of Japan is still in the business of ensuring inflation that actually gets up to its target rather than trying to squeeze it down like other developed market central banks. That means growth prospects are somewhat stronger there. We also see opportunities outside developed markets, tilting portfolios towards emerging market equities where many of the macro risks are actually better reflected in market prices.

And there's opportunities from zooming in within fixed income exposures as well. For example, towards US inflation linked bonds and away from European inflation linked bonds, given the ECBs even greater determination, we think, than the Fed to get inflation down to its 2% target. Now. All of that is just examples of how broad asset class exposures might not be the way to generate additional return in this environment, but by being precise, by zooming in to find these relative value opportunities within asset classes, actually there's real opportunities In the old regime where central banks were coming to the rescue, you didn't need to be particularly precise- broad macro exposures did the job as well as anything else in terms of generating investment return.

But now you can do a lot better by being precise and finding some of these relative value opportunities within the asset classes.

Oscar Pulido: And it's interesting you said don't wait for macro volatility to pass. it's here to stay, so adjust to it. And that gets me thinking that maybe investors tend to wanna wait for the coast to be

clear and everything is calm and then they start looking for those investment opportunities but maybe by then it might be too late and markets have moved and you've highlighted some of the areas that they should be identifying. You also mentioned mega forces. How many are there and why are these important?

Alex Brazier: we're highlighting five,in our outlook. what do we mean by megaforce? we mean these sort of big tectonic shifts in the way the world economy works and the way economies work that are gonna have a big effect, not just at the macro level but also on which companies win out relative to others, so they're gonna be a big driver of returns. And again, this is part of the general theme of focusing less on the macro picture and more on what are the underlying forces and what winners are they gonna create? So a good example of that's in the first half of this year. Where one of these big forces, these mega forces, turned out to be as important as the Federal Reserve in driving the SNP 500. And that is, the growth of artificial intelligence.

Over the first half of the year, much of the US equity performance has been driven by a handful of stocks reflecting the realization, I think, of the potential of some forms of AI and in particular the need for semiconductors and other chips to enable that to happen. So it's a real example of how even in a difficult macro situation, some of these mega forces, these themes, can be much more important as a driver of return. And actually, as we say in the Outlook document, we think that artificial intelligence theme could actually have further to run too, because looking carefully at it, there's not just opportunities in some of the chip needs but also in the needs for data to actually really exploit the power of AI.

So people who are involved in putting data sets together, cleaning data, making it able to be accessed for large language models, for example, stand to gain from this trend. And it's not the only mega force in town either. As I say, we've got five of them in the report, it's not just the growth of artificial intelligence, it's also aging populations.

It's also a rewiring of globalization, of course, the transition to a lower carbon economy, and also a reshaping of the financial system as well. So these are big mega forces, big drivers of relative returns, and as we say in our outlook, things to be harnessed, opportunities to be gained to increase returns in this new regime.

Oscar Pulido: And these mega forces feel like they have a long-term nature to them. but you mentioned that they've also impacted year to date returns with artificial intelligence being just as important as what Jay Powell was saying at the Fed. And you see that in the performance of markets, but AI gets a lot of attention so maybe talk about a few of these other, mega forces in more detail. You mentioned aging population, the rewiring of the global economy, I think is how you phrased it. Why are these important?

Alex Brazier: Well, it's not just that they'll shape the macro picture looking ahead. The forces we're looking at here, unlike AI actually are all things that will limit the capacity of economies to supply goods and services, at least for a period. Take aging populations, for example, as we age,as a collectively age at least, dependency ratios go up, there are more older people relative to people in the working age population. That means economies produce less, but they don't, in and of themselves demand less. The mix of spending in economies shifts towards things like healthcare, and that means they're generally inflationary. Central banks face a challenge. They have to, as we were saying in this new regime, hold tight to try and keep inflation down towards their targets, but

they don't just affect the macro picture. Because they change the mix of spending towards things like healthcare, they actually changed the mix of, earnings in the economy as well.

And so looking for opportunities where the aging of populations isn't really fully reflected in company growth expectations in things like healthcare or elderly care. It potentially creates interesting investment opportunities.

The other around, the rewiring of globalization is really the ongoing fragmentation of the global economy. We've been through a very long period where the only thing guiding supply chain construction was economic efficiency. We're now entering a period where it's not all about efficiency, it's about geopolitics as well. That's gonna reduce the efficiency of supply chains. It's gonna, again, hold back the supply capacity of economies, it's gonna shape the macro picture, but potentially creates really interesting investment opportunities as those supply chains rewire.

So where will new industrial capacity be built as supply chains are rewired? Is that reflected in pricing of securities in those geographies? Those are interesting questions to us for harnessing this particular megatrend, which sounds like it's a negative. And maybe is at the macro level, but actually creates interesting opportunities at the sector or company level.

And then of course, there's the transition to a lower carbon economy, which to us is being driven by policy, by technology, by changes in consumer preferences. And we're trying to assess how are those things changing? How is it gonna shape company earnings over time? And is that reflected again in, in market prices?

So to us we treat all of these mega forces in the same way as we treat Jay Powell. We ask, what does it mean for where the economy is heading? Is that reflected in prices and where it's not? That creates interesting investment opportunities.

Oscar Pulido: So, Alex, if I were to summarize a lot of what you mentioned, there's a lot happening. The new investment regime that you and colleagues from the BlackRock Investment Institute have mentioned. It's playing out, it's here to stay. And the investment opportunities are there. They might be different than what they've been in prior regimes, but they exist.

Alex Brazier: Absolutely right.Not the same opportunities, but lots of new opportunities.

Oscar Pulido: And Alex, maybe just a final question, which is when you describe this investor forum in London, is it a pretty cordial discussion or is it some good debate between the investors.

Alex Brazier: Yeah, it's, it's always pretty cordial, but, pretty healthy debate, I would say, especially in something like a new regime where we're collectively getting to grips with what the new dynamics are and where the new opportunities are. But I think everyone feels this is an exciting time. It's a new regime with a new playbook and new things to figure out, and that's a real opportunity for us to help our clients.

Oscar Pulido: All right, we'll look forward to hearing more c color commentary the next time one of these investor forms takes place. And Alex, as always, thank you for joining us on The.

Alex Brazier: Thank you.

Oscar Pulido: Thanks for listening to this episode, or The, Bid. Next up on The Bid. we're introducing our new weekly short form series from the BlackRock Investment Institute called Market Take.

Market. Take is a quick digest of what's driving markets and will be available as its own podcast where you can subscribe. You'll be able to hear the first three episodes right here on The Bid for the next few weeks on Mondays. So look out for our new market take series starting in July.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Mark Wiedman: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Mark Wiedman. Today we're talking about food: from the farm to your fork, to your recycling or compost bin. I'm pleased to welcome Mark Schneider, the CEO of Nestle. Nestle is the world's largest food and beverage company1 with more than 2000 brands and products in 188 countries. What does Nestle have to do with the transition? Well, the processing, the packaging, the distribution and the consumption of food actually produces about a third of human greenhouse gas emissions2. In this episode, we're going to talk about why and how Nestle is transforming their value chain in the transition to a low carbon economy. Mark, welcome to The Bid.

Mark Schneider: Thanks for having me.

Mark Wiedman: Why don't we start by talking about Nestle and your business?

Mark Schneider: To a US audience, Nestle is mainly known as a chocolate maker, but of course we do cover wide range of food and beverage products. In fact, we're the world's largest food and beverage company with about 94 billion Swiss francs of revenue in 2022. And we cover all the main categories in food and beverage from coffee to pet care, to medical nutrition, infant nutrition, and of course, the chocolate that we're so well known for. And, that also means, we are exposed to a wide number of agricultural commodities that are needed to make these products.

Mark Wiedman: Let's talk about Nestle and carbon emissions and start by why does it matter to Nestle what your carbon emissions are?

Mark Schneider: It matters to Nestle because when people think about greenhouse gas emissions, what comes to mind first is: air travel, automotive, energy generation, a heavy industry. But in fact, food production around the world is very much linked to greenhouse gas emissions. So depending on what study you look at, between a quarter and a third of the world's greenhouse gas emissions are caused by agriculture, so food and beverage production, and unlike many other activities, eating and drinking is not something that we can go without. As the leading company in this space, we feel an obligation to do something, and I believe this is part of future proofing the business. Just like you futureproof the business through convincing research and development and new products. So one additional feature that you want to work for is a better greenhouse gas footprint.

Mark Wiedman: What is your roadmap layout in a few simple bullets, and how are you tracking?

Mark Schneider: So minus 20% by 2025. This is judging from 2018 levels and it's regardless of the growth we achieve in between and it's the totality of all greenhouse gases, so not just co2. So that means we also need to tackle methane, which in some cases is trickier than co2. It's minus 50% by 2030. then it's that famous net zero by 2050.

Mark Wiedman: What are you most concerned about in terms of achieving your 2030 objective? What's the biggest obstacle?

Mark Schneider: There's a set of pretty steep mountains to climb. There's not just one individual obstacle here, but, clearly, we all had to run these projects. Some of them have tremendous lead time, so something you're doing now may give your results two or three years down the road only. And so learning how to try that to be sure that there is consistent improvement over time. I think that's also something that we had to train the organization on because, we had not done it before.

Mark Wiedman: Could you explain how food and the production of food and its disposal emits carbon? How does that work?

Mark Schneider: There's of course the carbon footprint of our operations. Some of the operations in our factories, the logistics both inbound in factories and outbound. All the things you would associate with the company's operations, including travel. That is the easiest part. And that's the part where we are already picking a lot of low-hanging fruit. And then there is about more than two-thirds that really sit in our agricultural supply chain. So this is the greenhouse gas emissions that come about as the key commodity ingredients that we use for our products are produced. And that's the hardest part, and that's the steepest hill to climb.

Mark Wiedman: So what produces those carbon emissions in the chain from planting food to getting it into your factories?

Mark Schneider: Well, It depends on the ingredient. But the key greenhouse gas emissions are related to everything associated with livestock. Think about dairy production. Think about meat. So there you have to first of all generate the food. And then, cattle in particular, you have methane emissions that come from the digestion and so it all adds up to a very powerful mix of CO2 emissions, methane emissions, that are very significant and a lot higher than with plant-based products.

Mark Wiedman: So animals, especially cows, lead to lots of carbon emissions, but there's also carbon emissions even with producing plants and vegetables, and other ingredients that feed into your food. Where does that carbon get emitted?

Mark Schneider: So a lot there has to do with the way we do our farming. In some cases, unfortunately there's deforestation to begin with, to create farmable land. Then the way we look after our soil, we tend to deplete the soil and that of course leads to a lot of, CO2 release from that soil into the atmosphere. It also leads to degradation of the quality of soil over time. So clearly changing our methods of farming and switching to either conservation agriculture or regenerative agriculture is a key unlock when it comes to improving the greenhouse gas footprint.

Mark Wiedman: What is regenerative agriculture?

Mark Schneider: Some of the common themes as part of regenerative agriculture are taking good care of the soil, keeping it covered at all times, having cover crops, having intermittent cropping minimum or low tillage. And just trying to keep the water management of the soil at its optimum. This way over time, not only do you avoid the depletion of the soil, but you can also in fact add to it and capture some additional carbon. There's also conservation agriculture. All of them are a material improvement over some of the traditional agricultural methods that are being used widespread today.

Mark Wiedman: So how are you working with your supply chain? How do you work with farmers?

Mark Schneider: So this is the key challenge. In addition to intermediate suppliers, commodity exchanges, we're dealing with six to 700,000 farmers directly around the world, or in some cases cooperatives. And, you can't just throw your weight around and tell them how to do it in a different manner the next day. You have to give them help. They're the most exposed part of the supply chain. They're immediately exposed to the maladies of the climate and weather, their capital cushion is a lot lower than many of the other businesses in the supply chain. And so this is where we need to give a helping hand. We call that concept a just transition. So it's about giving technological help. It's about also giving some of the micro lending and, financial support or paying a premium for products that are made according to these practices.

Mark Wiedman: Mark, give us some concrete examples.

Mark Schneider: So a good example is in cocoa farming where independent of the size of the farm, we are paying for a number of practices that we consider to be important for the long-term success of the farm, and also for preserving human rights and avoiding child labor , for example. So independent of the size of the farm, if you send your kids to school, we pay premium for that. If you're pruning your trees we pay premium for that. And if you fulfill all of the requirements, we pay some additional premium on top of that. And so this way, we're helping the farmers switch to more regenerative practices at the same time avoid issues such as, child labor and lead to higher farmer incomes.

Mark Wiedman: What's the biggest resistance that you hear from farmers?

Mark Schneider: The initial conversion from that traditional industrial agriculture to regenerative agriculture, day one requires some additional investment, and usually comes with a period of 2, 3, 4, 5 years of reduced outputs. So literally it's investing more and earning less, which of course, to anyone around the world, would not be an attractive proposition. And so people are reluctant to do this. You also then have to provide that safety net that people can make it through that period, and without too much of a financial disadvantage.

Mark Wiedman: How much of a production loss might that experience during those first few years?

Mark Schneider: Very much depends on the location of the crop, and this is another thing we have to do, it's not about basically writing one set of guidelines and then, one size fits all, rolling it out. You really have to work on that location specific solution. But it depends a lot on the specific circumstance.

Mark Wiedman: At Nestle, you touch farming, packaging, the production of actual food, logistics, recycling. Across that whole chain, where do you see the most promise for decarbonization?

Mark Schneider: Clearly in the supply chain, and unfortunately, that is the hardest part. And of course, you're literally removing greenhouse gas emissions, one kilogram, one ton at a time in so many places around the world. So there's not one factory that you switch around and turn around and then all of a sudden problem solved. It's an incredibly decentralized job that is why it takes some time to be effective.

Mark Wiedman: What about the product itself? Is there low carbon product?

Mark Schneider: I think there are products that by design have a lower greenhouse gas footprint, and so any plant-based alternative compared to a meat based one, for example, has that and consumers like that feature, in addition to any potential health benefits.

Mark Wiedman: What are you hearing from customers about their willingness to shift to plant-based alternatives from traditional cow-based production?

Mark Schneider: I think there is significant interest out there and for a number of different reasons. So clearly, environmental concerns are one. Animal cruelty, especially among the youngest of consumers, that's another key reason to switch to those products. And then for quite a few middle-aged consumers, there is an interest in switching to plant-based, simply due to health considerations, because quite often, we're offering a similar amount of protein with lower amounts of saturated fat and lower total calories.

Mark Wiedman: Many of your products are sold to supermarkets. How do the prices compare for low carbon versus high carbon food?

Mark Schneider: So in the case of plant-based initially they were more expensive and they still are more expensive. Some of that is simply the fact that they were positioned as more premium products. Some of it is the fact that, some key ingredients such as, soy isolates, pea isolates were initially in short demand. I think over time this will even out. And there is no reason why, in the long term, these products should be more expensive, because, when you look at the way they're being made, it's so much simpler to just basically have the crop and turn it into a product, as opposed to, having a crop, feeding an animal, and then making the product from that.

Mark Wiedman: I think a lot of our listeners understand decarbonization in the automotive sector. What's the biggest opportunity for making consumers more aware of the carbon impact of what they eat?

Mark Schneider: I think, some sort of standardized consumer facing labeling would certainly be helpful. Because right now everyone is using their own terminology. So I could easily envision a world where, in addition to some basic nutritional information, there would also be another label that gives basic environmental information, but gives it in a way that is standardized and harmonized across the industry. And then when it comes to the companies, I think, a pretty harmonized carbon disclosure is also very helpful so that investors and other stakeholders can basically form their own opinion.

Mark Wiedman: Where do you look to for having standardized disclosures for customers and shareholders?

Mark Schneider: Well, I think for the customers, it tends to be pretty much a country by country approach. It's the same for nutritional values so this is where you have to respect, you know, sovereignty and people taking care of their consumers within their jurisdiction. When it comes to, the corporate disclosures, I think there you have a better angle when it comes to international standards. You know, it could be under some of the disclosure rules, it could be under international agreements. There has been, for example, a very promising project led by

the World Economic Forum, trying to harmonize some of those. And obviously the audit firms also have an interest in agreeing on harmonized standards here.

Mark Wiedman: From a policy perspective, it may not be a straight line, but from consumer demand, is it a straight line? Are we seeing continuous demand increasing for decarbonized product?

Mark Schneider: So generally it was, then came COVID and then came the inflation wave. And so currently we're also dealing with affordability issues. Understandably when these products are more expensive, that diminishes some of the growth expectations short term. But I would be very surprised if, longer term you wouldn't see a resurgence of interest because the interest in the environment, interest in animal rights, I think all of those are on the rise.

Mark Wiedman: As a CEO, you have to disclose your carbon footprint. What are the biggest barriers for Nestle? What are the biggest obstacles to an efficient, clean, clear disclosures?

Mark Schneider: I mean, the key problem is, I don't have to disclose it as a CEO, and so people don't. And we do, we're quite committed to this, and every year you can see our progress. And in fact, we're one of the few companies where, in spite of our growth, the greenhouse gas emissions are already below our 2018 baseline and year after year, you'll be able to track our progress and you'll be able to judge whether we are in line with that net zero roadmap that we issued. But many companies don't bother to disclose. You have no idea where they are. And of course, you have to assume that it's not a priority, and that to me creates an uneven playing field and something that needs fixing.

Mark Wiedman: Mark, you joined Nestle six and a half years ago. How has your vision of decarbonization and your Nestle strategy changed during that period?

Mark Schneider: I think it gathered intensity, and to me, the key starting shot was that we were taking that pledge, according to the science based targets in 2019, that we were basically managing our greenhouse gas emissions consistent with the goals of the Paris Agreement, and that means limiting the rise of temperatures to one and a half degrees over pre-industrialized levels. And under those rules, then once you take that pledge, which of course is a highly public thing, within two years, you're required to issue a set of, time-bound intermediate targets and also specific steps on how to get there. That's our net zero roadmap, which we issued within one year of taking the pledge. Cause frankly, one of the reasons we had here was we, didn't wanna wait two years, this is an urgent matter and clearly plans rarely get better in the second years of their making. And so, when that came out, it was seen as the gold standard in how to do it in food and beverage, and that really gave incredible clarity to the organization and what they had to do and what the levers were, and it really galvanized the entire firm and added a lot of intensity.

Mark Wiedman: When you look at what Nestle needs to learn from other sectors, other industries, and what other industries can learn from Nestle, what would you highlight?

Mark Schneider: I think on the inside of the firm, our operations, this is where we do a lot of benchmarking with other industries, to see what the best practice is and, uh, what we can do, where we have no role model to look to is when we look upstream in our supply chain. This is where everyone is learning with us. And so this is literally learning by doing. And sometimes you make mistakes. You find a dead end that's not giving you the results you want. You have to give up on that, and then double down on something else that gives you better results. So this is a lot of trial and error. But of course at the same time, you have to work fast because, if you want to meet the first intermediate goal, which is a minus 20 percent by 2025, there's not a lot of time left.

Mark Wiedman: What's the number one criticism you receive either at Nestle or in your industry that you think is fair?

Mark Schneider: I do think in addition to the greenhouse gas footprint, the one other key concern that is highly visible is plastic spillage into the environment as a result of packaging being discarded. And so plastic has a lot of advantages when it comes to product safety and shelf life and avoiding food loss. But obviously, we have to work on better recycling systems. We have to work the spillage of plastic into the environment, and that one is highly visible. Unlike carbon, which is not visible, the plastic bottle on the beach somewhere that is highly visible and so consumers are quite concerned rightfully so.

Mark Wiedman: What's the most important thing to get the world to net zero?

Mark Schneider: I think consistent effort. That to me is key. And not just in our industry, but also elsewhere. If regulators and the public sort of fade in and out of this, nothing will get done because whether it's our industry over industries, I think all of this is long-term effort and, step by step we can get there.

Mark Wiedman: Mark, thank you for being so generous with your time and your thoughts.

Mark Schneider: Thanks for having me.

Mark Wiedman: Thanks for listening to this episode of The Bid. Make sure you subscribe to The Bid wherever you get your podcasts.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Oscar: Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

As we approach the midway point of 2023, the economy has had a turbulent ride thus far. This year, we've seen bank failures across the globe, a debt ceiling showdown in the US, high inflation and central banks raising interest rates to their highest rates in over a decade.

The typical 60:40 portfolio. needed an overhaul after a rocky 2022, and investors are looking for a new balance. But during that reassessment, one asset class seems to be having a standout moment among investors That asset class is gold. In this episode, we will take a look into the history of this commodity and what investors should consider when allocating to gold in their portfolios.

I'm pleased to welcome back Gargi Pal Chaudhuri, Head of iShare's Investment Strategy, to help us take another look at why gold is having its moment to shine.

Gargi: Gargi, welcome to The Bid. Oscar, it's wonderful to be here.

Oscar: You have a special seat, on The Bid podcast Gargi, you're a frequent guest. And today we're talking about gold, which is having a bit of a moment, and I think when a lot of people think about gold, they think about the gold rush of the 1800s or maybe a piece of jewelry, or maybe the color of the sky in New York in recent periods. But we're actually talking about gold as an investment. So, tell us a little bit about the history of gold as an investment in a portfolio.

Gargi: So, you ask an important question around the history of gold and thinking back, 2-3 thousand years ago, gold was still very much a medium of exchange.

It was a store of value and artifact of beauty. I think more recently, if you look back to about 700 BC, that's when we were really thinking about gold as a medium of exchange, a medium of payment. If you think about what happened in the 1790s with the Mint And Coinage Act US Congress passed that act putting a fixed price on gold with parity to the dollar.

And more recently, in 1971 when we broke the gold connection with the dollar, I think all of this was the period where, Gold came to the forefront as an investment as that second thing that we were talking about, which is around the medium of exchange and a store of value.

And I think it's important to think about why we as investors gravitate towards gold, and I'm sure we're going to talk more about it, but why is it gold? Why isn't it something else? When we are talking about precious commodities, and I'm Indian, as you can hear from the voice.

And obviously historically my family, has invested in gold. But why? And if you think about the periodic table and you look at all the elements and you take out the ones that are reactive to air or react with water or rust

too easily, you're left with very few that can actually stand the test of time, that can be stored without getting rusted, that are ductile and malleable.

That is why it has, held its value held its status as something that can be a source of investment and also be all of those other things like a medium of exchange and of course, artifact of beauty.

Oscar: So, you took us back to 700 BC, so you went way back in the history books to start to tell us a little bit about gold as an investment, but why is it having a moment right now if it's been around for so long? What is it about this particular period that is bringing it back into the spotlight?

Gargi: A few things. So, number one, there is a lot of concern around economic growth and historically we have found when there are periods of concern around the future of global growth, investors have turned to assets like gold, which are likely to be a good diversifier to traditional investments such as equities, such as bonds. So, number one, there is some concern right now around the growth dynamic globally of the US. So that's one reason. Number two, I think geopolitical fragmentation, geopolitical risks. Especially when you think back to just last year with the war in Europe, with Russia, Ukraine, that led to a lot of angst. Again, if we thought about what were some of the concerns you had for 2021, none of us put war in the forefront in 2021, for 22. So, I do think this geopolitical risk that arose and actually frankly concerns around more geopolitical political risks that might be abound is another reason that investors are thinking about gold as an alternative.

Another reason, and I think this is a very interesting and important one, is the path of interest rates and the part of the US dollar. And we talk about the path of interest rates, and particularly it's the path of real interest rates, so inflation adjusted interest rates. Remembering that while gold bangles are beautiful, and while gold can be stored in a vault for centuries, it still doesn't have a yield. So, when you buy a bond, you have an income associated with it, you have a coupon associated with it. When you buy a stock, you might earn some dividends associated with it. Gold does not have that. It's a non-yielding asset. So, in a world if interest rates are moving higher, you can gravitate towards the bond markets to earn that higher interest rates. You might not be as attracted to gold.

But in a world where you expect interest rates to move lower or remain stable, if you expect real interest rates, so that inflation adjusted interest rates to move lower, I think investors could find gold, more attractive in those moments. And I certainly think that's happening right now.

And then another one, we talked about the dollar, but I do think, historically the dollar and the gold has had a negative correlation. So again, if your expectation is for the dollar to decline or even just not to increase anymore, that could be another powerful dynamic for adding gold to a portfolio.

But for all of the things that I mentioned, I think two that are probably in the forefront of investors' minds right now, are number one this diversification away from the dollar, and we've seen many central banks, especially in the emerging markets, we've seen central banks such as China, India, Russia, that have been adding to their gold reserves to diversify away from the dollar. So that is something that's happening. It's been happening for a few years now, but certainly has been pretty profound in the last couple of months. And then the second one is this fear of a geopolitical event or a global growth slowdown that is driving this current moment and this current price action.

Oscar: So, you mentioned a number of things that impact the price of gold. But maybe just to go back to interest rates for a quick second- because it feels like that's always something that we're talking about, especially when we have you on The Bid- which is on interest rates if they're high, that all else equal doesn't make gold that appealing. But you're saying that it's not just the level of interest rates, but what they look like adjusted for inflation, and if those are headed lower, then that might provide a little bit of demand for gold in the market.

Gargi: So, it's a very good clarification, Oscar. We have to remember that markets are forward looking, so it is what investors expect interest rates to do. So, if I own a real rate, so if I own an inflation linked bond, for example, and I expect that real interest rate that I'm earning by owning that bond to go lower in the next six months or next year. Those are the two options, you own the bond that real interest rates that you're earning right now, it could go lower, or you could own that, and you expect that real interest rate on that inflation like bond could go higher.

So, in each of those scenarios, you are still earning a coupon on your inflation-linked bond. When your expectation is that real interest rates can either remain here or actually real interest rates are so low and remember in the US that real interest rates were zero or negative for a long period of time, then you might think that you could own a non-yielding asset, which might give you a better outcome.

But if real interest rates are you hold them, you expect them to remain pretty steady and you don't expect them to go lower in the near term, that's when you might want to gravitate towards gold. So, it's that relationship between real interest rates falling in a falling real rate environment you might want to gravitate towards gold as opposed to in a rising real rate environment where you might want to think about waiting to buy the real rates. Does that make sense?

Oscar: It does make sense? And I think another reason that investors look at gold is the belief that it's a hedge against inflation. is that a correct assumption for investors to make?

Gargi: Yeah, a lot of times, I have clients that talk to me about inflation and they're looking for that ultimate inflation hedge and investors turn to gold.

Historically, if you look at price performance, there was one period of time in the seventies, very, specifically in the early seventies where inflation, as we know, was in the double digits, and when gold was a hedge. Outside of that though no other period of high or very high inflation has actually resulted in gold being a good hedge.

So, outside of that very early 1971-1974 period we haven't found gold to be a good inflation hedge. What it has been is a good geopolitical hedge. What it has been is not so much an inflation hedge, but a hedge where more of a stagflation hedge actually, where again, if you expect real interest rates to go lower, which you would in a stagflationary environment, that's when it has actually worked as a better hedge.

So, I think it's a little bit of a misconception. And when you look at the performance of gold, it's been more mixed in inflationary or very high inflationary periods outside of that one time that I mentioned, but when we expect real rates to move lower- and by the way right now, I do expect real rates will stay at current levels for some time and then eventually by the end of this year or next year, start moving lower- I think that could be one catalyst for gold to remain in the forefront of investors' minds.

Oscar: You also mentioned the periodic table, I must admit I pulled it up, a couple days ago, but partly in anticipation that you and I would be speaking and actually, do you remember the symbol for gold on the periodic table.

Gargi: Come on! Au!

Oscar: Okay. Okay I remembered it too, but I needed to look at the periodic table and you touched on that there are other metals That have similar characteristics, there's not many, but there's things like silver, platinum, palladium,

Gargi: Rhodium, palladium,

Oscar: Very good, so now, why are those, not benefiting from this moment that gold is having? Or are they?

Gargi: Historically gold has been this really respected, metal, right? I would classify gold and silver in the same bucket. Obviously silver, not as much as gold. Rhodium and palladium were discovered much later, centuries later, we weren't reading about them in the time of the Egyptians and Bhagavad Gita and the Iliad and Odyssey, which all mentioned gold actually. So, they weren't around because they just weren't discovered. Platinum has a very high melting point, which again, you couldn't use that, especially in the olden days, you couldn't use that to build gold blocks or gold nuggets, et cetera. You couldn't use that melted down to create jewelry, now you can because modern technology- high temperature furnace- but you couldn't back in the day.

So today silver certainly can have its moment, but this risk of hedge characteristic, so all the things that I talked about earlier when it pertains to, geopolitical risk, that certainly resides more with gold. And that's because gold has, historically, we went back and talked about the 700 BC, the form of payment the 1792 Coinage Act, if you look forward 1934 Act, historically there has been a lot of correlation of gold as currency, gold as method of payment. Until 1971 you had to have your currency backed by gold, and then of course, in 1971 that was, dismissed. But silver and platinum never had that. So now, even though we don't live in a world when any currency globally is backed by gold anymore, those other elements just don't have that same cash to them, if you will.

I'll also add that when we think about silver or when we think about, any other precious metals, we always think about what are the users of it. So, silver does have many other users, obviously, in addition to being used for jewelry, you can use it for, other purposes, which gold can't be. So, I, I think depending on what you are looking for as an investor, Silver can be a very good addition to your portfolio, but it might not have the same risk of geopolitical risk, hedge diversifier for your US dollar reserve that gold does.

Oscar: Essentially gold just has a longer history and sort of unique aspects to its story of why it serves as an investment in a portfolio. And I think for much of that history, only until maybe recently, buying gold was a clunky exercise, literally buying gold bars, which are heavy, and you've stored them somewhere, in a personal safe. But that's changed dramatically over the last 15 or 20 years, right? So maybe talk a little bit about how investing in gold has modernized.

Gargi: So, to your point, you could invest in gold as a form of jewelry, but if you invested in gold bar form then there was the cost of storage, not only is it finding a place to store but the cost of that storage, not everybody has the capability of renting out space in a huge vault to store their gold bars. Or even if they do, I think that that's an expensive proposition. I think what we have seen in modern days today if you're an investor looking to invest in gold, there are a few ways to do it.

Obviously, you can participate in the futures market that's the right or the option to buy gold in the futures market - that's not actually gold. What many investors, especially those that are truly worried about a geopolitical risk event or a massive global growth shock, you actually want to see that asset that you own, and I think the rise of gold ETFs where when you buy that ETF you know that your ETF is backed by gold, which is in a vault in New York or London.

That has risen in the past few decades and that has given everyone, you don't have to be a rich billionaire with a home in Switzerland and a vault to have access to storing gold. You can, buy an ETF that gives you access to gold and do it in a very liquid and very efficient manner.

Oscar: I'm laughing a bit because I think about some of the recent episodes we've done, which hopefully you've listened to as well, and we talk about things like artificial intelligence, we've talked about digitization, and here we are talking about gold, which, feels like a bit of a relic in investment market. So how is it that gold has endured during this digital age?

Gargi: Sure. the risk of sounding like a relic, which I don't want to, I will say that gold has survived because it can be a diversifier in your portfolio. It gives you that ballast, and it can be tactically an opportunity for investors looking to invest in the face of slowing a growth shock or geopolitical tensions. And that has held through many business cycles. I'll also say another big reason that we're talking about gold now is that historically for institutions looking to trade gold, it has been a pretty expensive venture. We talked about that, the storage costs and things like that.

ETFs now more recently have helped and accomplish the digitization, for gold for every type of investor. For more sophisticated clients using technology such as blockchain ledger, having a digital gold currency could help institutions trade even more efficiently.

So, we have alleviated some of the issues that may have existed a few decades ago with digitization. And the main reason that we are still talking about gold is some of the drivers of gold that existed a hundred years ago. And what we talked about when we started the show in terms of holding its value, being a medium of exchange and being an artifact of beauty. Many of those things still hold, and that's why we are here talking about it. But the good news is it has entered the digitized age with ETFs, allowing every type of investor to have gold backed, ETFs in their portfolio.

Oscar: Gargi, you've given us a great history lesson. You also wore a piece of gold jewelry today that I noticed, and I think there's a little bit of a story behind it.

Gargi: I did. So, I got married 15 years ago, and as I mentioned, I'm Indian, so for many of you who don't know this, Indians are actually the largest buyers of gold for wedding jewelry purposes. And I wore my wedding jewelry for this podcast to bring home that point. And there is such a thing as wedding season demand. So, every year in September, August or September, October, you'll hear people in the western world talk about demand for gold coming from Indian wedding season. And it's so exciting whenever I hear someone random talking about it! And based on what I'm wearing, in my hands right now, it is factually correct. Lot of Indian wedding gold demand.

Oscar: Well, thank you for bringing that special token to today's podcast. And thank you again for joining us on The Bid.

Gargi: Thank you for having me.

Oscar: Thanks for listening to this episode of The Bid. Don't miss the next episode featuring our midyear outlook. And subscribe to The Bid wherever you get your podcasts.

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Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Historically, cash has often been seen as a temporary parking place for funds or as a means to bridge the gap between investment opportunities. However, with higher interest rates in effect and global economic uncertainties looming, cash has emerged as an asset class that demands another look. So how might investors consider cash as an asset class right now?

I'm pleased to welcome Beccy Milchem, Head of International Cash Management at BlackRock. Becky will join us to talk about the role of central banks and their recent rate announcements, how technology might impact the future of the asset class, and the top three things investors should consider when it comes to cash in uncertain market conditions.

Becky, thank you so much for joining us on The Bid.

Beccy Milchem: Thank you for having me, Oscar.

Oscar Pulido: So, Becky, today we're talking about cash, which I have to imagine is a topic that is of interest to a lot of people. but when I think about cash, I think about currency and bills in my hand. But when you think about it from the context of an investor's portfolio, I think it means more than that. So maybe you can help elaborate on that a bit.

Beccy Milchem: Yeah, and I think it's a really good point. The term cash can mean different things to different investors. From readily available overnight cash, which could be held in a bank deposit or an overnight money market fund to cash and cash equivalents, which could encompass things that term out a little bit more, typically out to three months. Or even anything out as far as 12 months to two years and physical, money market securities that are held within a portfolio.

Oscar Pulido: And I think of the. phrase "cash is king" that seems to be something that gets said once in a while, but actually for many years, over the last 10 or so, with interest rates so low, it was quite punitive, I think, to have cash- you weren't earning much of a rate of interest. Now we're going through a cycle where central banks have been hiking interest rates quite aggressively, so how does that impact now the way in which investors are thinking about their cash allocation and their portfolios?

Beccy Milchem: Yeah, and I've always preferred the term Cash Is Queen! I think we went through a long period of time where people really didn't focus on it. As the world went into lockdowns, central banks were responding quickly to help economies, and many reacted by taking interest rates down to near zero or maintaining negative rates. These lower base rates were intended to feed through to lower borrowing costs for businesses and households so that lending didn't grind to halt and that people were able to keep spending.

As an investor of cash through our money market funds, we really had to be focused on client needs through those initial lockdown periods, and the reactions to problems that we all faced and what that meant for clients’ liquidity needs. In times of market volatility, we know that liquidity is a priority for all types of clients, and we will typically hold much higher levels of overnight and weekly liquidity in the money market funds that, that we manage. The aftereffects of the pandemic though and how central banks are reacting now is also having a very direct effect on cash investors. Global shutdowns meant that we have experienced a huge global supply shock with certain parts and goods very limited in availability, which has had a knock-on effect on prices increasing as demand has outweighed supply, and the war in the Ukraine has further compounded this issue but also not helped investor confidence levels. While some of those higher cash balances that people had through the peak of the pandemic are being spent down as a necessity.

What we're finding is investors are still really cautious about dipping a toe back in and taking more risks, so actually there are a lot of people still holding higher levels of cash.

From late 2021, we saw the Bank of England make the step to increase interest rates, and they have been followed by the Fed in March 2022 and the ECB, which moved its deposit rate back to zero in July last year, having maintained a negative deposit rate since 2014. Each central bank is attempting to combat rising prices by slowing demand, and we have seen a steady pace of increases up to this point.

From a cash perspective, we've gone from an environment where the opportunity costs of returns, to your point around different cash investment options was really low, and thus cash probably became a bit of an afterthought within portfolios. And what we've seen in the last few months is that with interest rates constantly moving higher, a more proactive approach to managing cash is definitely warranted.

One of the reasons that many investors have turned to money market funds is to help them proactively manage duration, risk, and effectively outsource this to a team of portfolio managers whose job is dedicated to the cash investment options available through money markets. Typically, money market funds will position themselves extremely short in duration ahead of expected central bank hikes that the fund has dry powder to deploy post the rate increase and will quickly reflect a prevailing market rate.

Oscar Pulido: I think we're used to seeing sort of volatility in the stock markets, and for that matter, we've seen a lot of volatility in the bond markets, but you've also highlighted that there's just a lot going on in the cash markets with changes in interest rates across the world. Now this also reminds me, I've heard you say that not all liquidity is created equal. So, what do you mean exactly by that?

Beccy Milchem: So, one thing that I think tends to be common amongst cash investors is that when you have a need for cash, you want to make sure you have access to it and a reasonable amount of certainty as to what you have to hand.

Now, for us and for many investors, the ultimate liquidity is that overnight cash bucket, because you know you've got it there when you need it. And as I touched on earlier, one observation I would make about the last year is that coming out of near zero or negative interest rates into an extremely dynamic interest rate environment has meant that it has been very challenging to make the right call if you are terming out your cash investments beyond overnight.

When you've been at zero and suddenly there is something on the table, it's quite easy to have that bit of a magpie moment of something bright and shiny that's not zero and jump straight in. And what we've seen is a lot of investors locking up money for a few months or even a year, which might have looked really attractive at first, but when you consider how far central banks have moved, The Bank of England, has moved, 12 times in between that December 2021 and May this year. So many of the term exposures that clients may have invested in might not have paid off through the duration of that investment. We often hear of term deposits with banks being self-liquidating, which is true if you don't need the cash until maturity, but it's definitely not the case if you need it before. Term bank deposits are typically unbreakable, meaning that you have to pay a penalty if cash is accessed early. And similarly, if you need to

raise cash by selling direct investments in money market securities, there will be a price to pay if that instrument is not offering the prevailing rate.

Now, the case in point here has really been the short-term US T-Mobile market. In the run up to the debt ceiling debate, so highly rated short-term government bills typically offer significant liquidity in that they are easy to sell if you need to raise cash. But spreads on these exposures have been more volatile as investors have been avoiding holding positions with maturities close to the X-date, which is the date that would potentially mark the treasury running out of funds.

And to give you a live example, the yield on a US T-bill maturing on the 1st of June has at times been trading 200 basis points higher than a bill maturing at the end of May. That's a huge difference if you are a forced seller in this market, which is why we think that money market funds or liquidity funds make so much sense for investors.

They give you access to a sizeable pool of readily available cash, as well as portfolios of very high-quality holdings that evolve as the circumstances change. Now, we love T-bills for the liquidity that they would typically offer but what we typically do in this kind of scenario is rotate portfolios proactively in a way that as an investor, if you're not focused on the cash markets, you might not be able to do readily yourself.

Oscar Pulido: And you highlighted an example about investors who, as interest rates were going up, started to allocate to instruments that offered them a higher interest rate, but also locked them in at that interest rate and therefore they missed out as central banks continued to hike interest rates. And so therefore, as much as that is cash, it wasn't as liquid as they wanted it to be.

Beccy Milchem: Exactly, it's still cash and if you know you can hold that investment for the duration, it's fine. You're going to get your cash when you need it,

but sometimes those unforeseen expenditures can come and hit us at a personal level or even at the institutional level, and so that's where liquidity and it not all being equal comes into it.

Oscar Pulido: You've touched on central banks, you've mentioned the Bank of England, the Fed, the ECB, all have embarked on one of the fastest rate hiking cycles that we've seen in a few decades. As we're appearing to reach the cycle where maybe those rate hikes are going to slow or potentially even pause, what does that mean for some of those cash markets that you've been talking about?

Beccy Milchem: Yeah, central banks have a really difficult battle on their hands. They're continuing to grapple with bringing inflation down when economic growth is also perceived to be in a very delicate balance.

The recent May meeting saw a further 25 basis points increase from the three majors you mentioned, but it's definitely slowing the paces as we look forward, and we're probably close to the peak, but with a huge amount of uncertainty around inflation, numbers still running so high, and the added overlay of politics in each domestic market and at the global level, I think there's still a bit of an uncertain path ahead. Central banks themselves are now much more data dependent than they were a few months back with a growing awareness that the lag of transmission of previous hikes still has to catch up with within consumers. Now markets themselves are predicting that many central banks will go too far increasing rates and thus need to bring them back down a bit within the next sort of six to 12 months depending on which currency you are looking at.

This means investors are facing a yield curve that includes market pricing of those rate cuts, and in some cases has become inverted in that timeframe. So as a cash investor, you may plan your strategy based around when you have a known cash need and have different buckets for everyday use. A big expenditure for you and I might hopefully be something like a holiday, a car, or a house purchase, for institutional investors, that might be like a known acquisition or a transaction from a portfolio positioning taking

place, in a few months. But from a practical perspective, an inverted yield curve in short term markets means you're probably not going to get compensated appropriately for the risk of locking up your cash for say, six months or a year. There is also still a lot of risk in turning out your cash if markets have got it wrong and rates stay where they are or perhaps even move higher still.

So, the way our portfolio managers are thinking about this is that throughout most of this hiking cycle, the market has underpriced the level at which rates will be moved to by central banks. So, unless you're looking at the markets all day, every day, that's a really difficult thing to keep on top of.

And at the end of the day, an investment strategy comes down to tolerance and appetite for risk. But if you are a cash investor with daily or short-term need for cash, there are not too many downsides to staying short at the moment. So, options that give you daily or next day access to your cash will allow you to be nimble, but you do still need to make sure those options are reflective of where interest rates are, as with inflation running where it is right now every basis point earned on cash is also critical.

Oscar Pulido: So, Becky, one of the underlying themes that you've touched on is, being nimble, and being active and flexible with your cash portfolio, which is again, I think an area of the market that many people don't realize you need to be as nimble in. You've also touched on a number of things that have clients concerned, and perhaps one of the reasons why they continue to maintain a higher cash allocation. It's things like inflation, you touched on the war in Ukraine, you touched on the debt ceiling. What are some of the other concerns that clients are raising?

Beccy Milchem: The cash investors, are typically concerned about whether they're going to be able to get access to their cash when they need it. And the mantra that most cash investors live by including ourselves, comes under a three-pillar approach.

So, the first being safety or capital preservation, knowing what you're going to get back, the second being liquidity and knowing you've got access to it when you need it. And the third being yield. And when it comes to concerns or things being raised by clients at the moment, they've typically fallen under one of those pillars.

Firstly, the vulnerabilities in the banking sector this year have highlighted concerns of having all of your eggs in one basket, both from a capital preservation perspective, but also about always having that timely access to cash. As we talked about earlier, investors might be more defensively positioned than usual, given broader market sentiments. The level of cash they have may be much more than they are used to holding. Now in the past this may not have warranted too much thought, but now they may be thinking they need to practically diversify their exposures. Individual investors may have some level of government protection on bank deposit products, but investors with much larger cash balance, particularly on the institutional side, will need to think about how they prudently diversify their risk to individual counterparties and monitor their exposures.

Again, outsourcing the diversification and credit monitoring to dedicated products such as money market funds with their dedicated resources looking at this on a daily basis might be the most efficient way to manage those risks. Secondly, and as I've already mentioned, most investors are concerned about having access to their cash when they need it, and their liquidity and the debate around the US debt ceiling has prompted investors to be cautious around exposures in US T bills that may have some risk of delayed payments.

Now, I would hope by the time this recording goes out that we may have a resolution on the debt ceiling. But having been here before, this feels like a world trodden path for dedicated money market portfolio managers who will typically naturally rotate out of maturities in that X date window. And where investment guidelines allow, they'll rotate into overnight repurchase agreements.

They're collateralized by US government debt to give that portfolio the resiliency it needs. Now. Finally, my third pillar was yield, and the return on cash investments has also been much more in focus, in part spurred on by media coverage, prompting investors to review what their cash is earning. But cash has really gone from being the afterthought thought to being the asset class that many conversations are focused on as investors survey the options available.

Oscar Pulido: Beccy if we can switch gears a little bit and talk about technology. We hear a lot about artificial intelligence and how it's affecting virtually every industry, including asset management. How do you see the role of technology impacting the cash industry?

Beccy Milchem: So, in response to the US Regional Bank challenges, it's been widely reported that cash moved much more quickly in 2023 than it did during the global financial crisis.

Now, I think that is partly down to how quickly digital media spread the news of troubles in regional banks, but it is also down to the fact that physically moving cash can be a lot easier via technology today. We see a lot more of our investors accessing our money market funds through some kind of platform which can offer trading efficiencies and straight through processing, all enabled through the technology that exists today that didn't in 2008.

Similarly, a lot of the technology that helps companies look at things like cash flow forecasting means that a lot of institutional investors simply have a better line of sight on what cash they have available to invest today. Now we are seeing a lot of asset managers and banks investing in cash investment technology, and we're starting to see some of the functionality that we are used to in our personal lives through banking and investment applications on our smartphones be rolled out on institutional cash trading platforms.

I'm not quite sure it's in the realms of AI, but a big thing for investors is the level of automation that can be driven and across certain institutional investors, we see a lot of demand for sweep technology whereby the investment platform can simply take the level of excess cash determined by an underlying client and efficiently sweep this into their chosen investment products such as a money market fund.

And I think the other area that's really moved along is that technology can really help with all of the important reporting elements. And so, we look at the ways that clients interact with the technology, and they're looking at things like simplifying and automating things such as positions reporting, or what aggregate exposure is across a number of credits across their overall portfolio, even down to the cash.

Oscar Pulido: So maybe just looking ahead, you've touched on a lot of different aspects around the market environment right now, but what are two or three things investors should be thinking about with respect to their cash allocation as they look forward?

Beccy Milchem: So hopefully it's come through today, but I think cash is most definitely an asset class you need to think proactively about, and I think it comes back to that mantra that we live by capital preservation, liquidity, and yield, but maybe put slightly differently, know where your cash is, know how quickly you can access it and what it is earning.

Most of us don't have time or dedicated people in our teams to look at this all day, every day, so think about the tools you can use to more efficiently help you manage your cash and whether it's right to outsource it. And similarly in these uncertain times, which I don't think are going away, navigating terming out cash investments will continue to be challenging, but there are dedicated products that will continue to help proactively manage these risks. And my advice would be really to talk to an asset manager who has a specialty in this space.

Oscar Pulido: Well, Beccy, thank you so much for shining a spotlight on an area of the market that, maybe doesn't always get the attention that it needs. And thank you for joining us on The Bid.

Beccy Milchem: Thank you so much for having me.

Oscar Pulido: Thanks for listening to this episode of the Bid. Next week on The Bid, Mark Wiedman talks to Mark Schneider, CEO of Nestle, on the role of food in the transition to a low carbon economy. Subscribe to the bid wherever you get your podcasts.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido. Today is Thursday, June 1st.

The debt ceiling has been capturing headlines for weeks now. And the recent vote in US Congress has drawn a line under the drama on Capitol Hill for the next two years. But what does this mean for markets and are investors feeling reassured?

In this special episode of The Bid, I'll be speaking to Alex Brazier, Deputy Head of the BlackRock Investment Institute to look at what happened, how markets are reacting, and what investors can expect going forward now that the debt ceiling crisis is behind us.

Alex, thank you so much for joining us on The Bid.

Alex Brazier: Oscar, thanks very much for having me again.

Oscar Pulido: So, Alex, we're talking about the debt ceiling, which has been in the headlines for some time now, and I wonder if you can just take a step back and fill us in around, what has happened and where are we now?

Alex Brazier: Well, yeah, it's been front and center for the last few weeks really what happened is that the US government reached its debt ceiling, which is a level of debt set by Congress that it can't go beyond, and that limit was $31.4 trillion. And given the US government's spending and tax plans, it needed that to be lifted. But of course, its opponents wanted it to change its plans in return for lifting the ceiling. Now, importantly, without an agreement, US government would've basically run out of money to pay its bills. The US Treasury estimated that it would've run out of money on the 5th of June, so that would obviously have been hugely disruptive, both for the economy directly, but also for the financial system with the US government unable to pay interest on or make scheduled repayments on existing debt.

It would've been in default. And that's absolutely critical because the financial system relies on the US government and its securities as ultra-safe, reliable assets, hence the real focus on all these negotiations in Congress. But now, an agreement has been reached at the 11th hour, and it's been passed by the US Congress.

Now the debt ceiling limit has been suspended until 2025. And in return for that, the US government has moderated some of its spending plans. That means markets are breathing a sigh of relief now. But that just means really attention is shifting back to the underlying economic situation in the

United States, which hasn't really changed very much while everyone's been focusing on the debt ceiling.

Very sticky inflation, very tight labor markets, US economy is, effectively overheating. And the question that markets and policy makers are grappling with is, what will it take to bring inflation down? And that took a backseat for a while, that really important question, while everyone's focus was on the debt ceiling, but now that's coming back front and center.

Oscar Pulido: Alex, you said $31.4 trillion, which is a big number even for an economy as big as the us. Can you help clarify some terminology though? We talked about the debt ceiling, you mentioned default, and then we also were hearing about a government shutdown. How do those three things interrelate to each other?

Alex Brazier: So, the debt ceiling, as I say, is set by Congress and it limits the amount of debt that the US government can have issued at any one time. So, as I say, that's 31.4 trillion, even as you say, relative to the size of the economy, that's 120% of US GDP. So, it's a big number. Now default is a situation where the borrower, in this case, the US government, can't service the debt, that it has in issue, so it can't make scheduled interest payments, it can't make scheduled repayments of that debt. And the risk here was that because it was going to hit the ceiling and not be able to issue more debt, the US government would've had a cash flow problem. and been unable to make some of those payments, and therefore it would've been in default on its existing debt.

Now, a shutdown is also what happens if the government doesn't have the cash to run its operations and to pay its employees. And we've seen that in previous debt ceiling, episodes. And all these things are linked because if the government hits the debt ceiling and has a cash shortage, it effectively needs to shut down its functions.

It needs to stop paying its employees, furlough its employees, and it risks not being able to make payments on its debt and therefore it would be in default. So, the debt ceiling, the risk of default and the risk of a shutdown of its operations are all inextricably linked.

Oscar Pulido: It makes sense. And curious then, how has this impacted markets now that the risk of a default seems to have passed, I think that risk is now firmly off the table, if I'm not mistaken?

Alex Brazier: That's right. I think that the immediate risk is off the table. The debt ceiling itself has been suspended for two years now until 2025. But I think what's really critical, is that this doesn't mean we can just move on and forget this ever happened. We can't forget US fiscal policy, the tax and spend policy.

And this episode, this, negotiation will actually have a bit of a hangover on US economy and markets in two respects, really. Both of which will add to volatility in bond markets, in fixed income markets.

The first is that the position of US fiscal policy, by which I mean the government's tax and spending plans, is still pretty challenging. The agreement doesn't change those plans very much. the congressional budget office yesterday estimated that spending's going to be about 65 billion lower next year as a result of this agreement. But that's just 0.3% of the US economy. And you set that against a deficit, which is how much higher spending is than tax revenues, of around seven and a half percent of GDP at the moment, and you can see that actually the impact of this on the overall tax

and spend position is actually pretty small. Now. That deficit, that seven and a half percent of GDP deficit is higher than any time outside the second World War post the global financial crisis and the Covid crisis.

And it's happening at a time when the US economy is actually overheating. So, the US fiscal position is actually in a pretty challenging place and stabilizing government debt in the United States, in a situation where we've got higher interest rates, a big deficit actually means that tax and spending plans need to adjust quite a lot over time.

And in our view, market attention will increasingly focus on that over time, rather than on the kind of immediate debt ceiling risks. And that will add to, volatility in bond markets.

The second hangover, I think, is that we're going to see now a burst of issuance by the US government in coming months to effectively replenish its bank account. So, we're going to see issuance, particularly of short-dated treasury bills, all of this at a time when the Federal Reserve isn't buying US government debt through quantitative easing, but actually running down its holdings of government debt through so-called quantitative tightening. So that second hangover too, is going to contribute probably to some volatility, in fixed income markets. So, the immediate risk is off the table, but some of these important hangover effects are going to increasingly come into focus particularly in bond markets.

Oscar Pulido: And Alex, what about. Equity markets. You mentioned that there's going to be volatility in bond markets and sometimes that then unnerves the stock market investor, but perhaps the stock market investor is now saying, we have this headline behind us and time to take risk, or how do you think about that situation?

Alex Brazier: I think the equity market, a bit like the rest of us, will be breathing a sigh of relief that this agreement has been reached, but also focusing back on the underlying economic picture, which as I say is one of really sticky core inflation evidence of a tight labor market and rising wages and an overheating economy really, that presents real challenges for the Federal Reserve. And that's where the equity market, we think will turn its attention back to, and it's where it was before the debt ceiling episode, but that too was going to contribute to volatility, I think.

Oscar Pulido: And Alex, as we approach the mid-year point, what are you focusing on for the second half of the year?

Alex Brazier: Well, now that we've moved on from the debt ceiling issue, we are focused on this underlying economic situation of sticky inflation, tight labor market. And there are really two important macroeconomic questions in the United States now.

The first is how material and economic slowdown is needed to deal with that inflation? The Fed itself thinks a recession might be needed to do that. And the second is, how high will interest rates need to go to do what the Fed wants to do? Recent developments in the labor market and inflation actually suggests there's a real possibility now of more rate hikes over coming months.

And we're also focused on some of the longer-term trends, like how AI, demographic shifts, geopolitics and the energy transition will actually affect the economy and markets. It's difficult to lose sight of those, even amid some of this volatility around the debt ceiling.

So next week, BlackRock's assembling a hundred senior portfolio managers in London to debate many of these issues. I expect it to be pretty lively with some fierce exchanges. I mean, we’re pretty passionate about these issues because this is a new macro environment, it's really difficult. This inflationary environment's very different to anything we've had for the last 30 years.

And we are totally focused now on how we can unlock the investment opportunities in this new regime for our clients. And that's what we'll be debating fiercely, next week. And I hope you have us back to discuss some of our conclusions,

Oscar Pulido: We will absolutely have you back, Alex, thank you for providing us this update and we look forward to having you back to hear more about that convening that is taking place in London. Thanks for joining us on The Bid.

Alex Brazier: Thanks, Oscar.

Oscar Pulido: Thanks for listening to The Bid. Don't miss the upcoming episode on our mid-year outlook later this month. Subscribe to The Bid wherever you get your podcasts.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Oscar Pulido: Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

What's the difference between developed, emerging and frontier markets? How do differences in per capita wealth, technological advancement, and liquidity affect the investment opportunities across these various economies?

Here to shed some light on this topic is Emily Fletcher, portfolio manager from BlackRock's Fundamental Equities business. Emily will highlight some of the risks and opportunities that emerging markets present and provide her observations as an investor who is meeting with companies and handpicking stocks across the world's developing economies.

Emily, welcome to the bid.

Emily Fletcher: Thanks so much for having me, Oscar. It's great to be here.

Oscar Pulido: So, Emily, maybe we could start with a simple definition, emerging markets and developed markets, we hear these terms a lot in investing, what's the difference between the two and then why is it so different to be investing in emerging markets?

Emily Fletcher: I think there's a bit of a misperception around emerging markets that they're countries that are less economically developed and poorer than developed markets. And whilst that is true for some countries such as your India or your Indonesia, which do have a much lower GDP per capita, it's not at all true of countries such as Qatar and the UAE, which are some of the richest in the world. It's also not really about level of technological development. Korea, for example, is extremely developed from a technological perspective.

Actually, definition of emerging markets is all about the level of development of the stock market, its settlement custodian, currency trading systems. Countries are analyzed and they're split into two buckets. Those that have the most developed systems in place, classified as developed markets, and those with less comprehensive trading systems classified as emerging markets.

Also, I think in the majority of cases, there tends to be a difference in the level of institutional development between emerging and developed markets with the institutional frameworks stronger within developed countries. In terms of what really sets apart emerging markets from developed markets, I think it’s the complexity, the volatility, and the dispersion that we see across the universe.

In terms of complexity, we're talking about 25 countries, each of their own political and economic cycles. They all have their own currency and bond markets. In aggregate the markets trade for 20 plus hours a day over six days a week, whereas developed markets tend to have harmonized economic cycles. In terms of volatility, emerging market index has had a peak to trough move of more than 20% in 19 in the last 20 years. And on top of these index level moves, we see huge dispersion between stock performance. Typically, two thirds of the stocks with emerging markets move more than 40% in each year. So, this makes it a really fantastic place to be an active investor because you'll get an opportunity to buy most companies at some point during each year.

I think there's a perception that high volatility is a negative feature for emerging markets. The historic emerging market narrative was that countries would grow faster than in developed markets and given how deeply cyclical all of the emerging markets are individually I think this illusion of smooth growth was never an accurate portrayal. Instead, what we really have is a wild, exciting, volatile hunting ground for active investors who can benefit from the complexity of 25 nonsynchronous markets, offering 4,000 highly diverse stock opportunities.

Oscar Pulido: So, you mentioned a few things there, and maybe just to recap, while the term emerging markets is one terminology to describe all these different countries, they can be very different. Some on a per capita basis are poorer, some are actually quite rich. The stock markets could behave very different from the economies. There's a lot of volatility, which I think for you as an investor represents good opportunity. We've heard from Wei Lee, our Chief Investment Strategist at the BlackRock Investment Institute, she's talked about how emerging markets are an interesting, investment opportunity, part of the reason being that coming out of the pandemic, the central banks in these countries were quick to raise interest rates and perhaps they're towards the end of that rate hiking cycle. So, talk a little bit more about what other reasons are there that excite you about emerging markets?

Emily Fletcher: Yeah. First to just follow up on Wei Lee, was saying, I agree. Inflation did start to rise in emerging markets and developed markets about the same time, so beginning of 2021. But interestingly at this point, the emerging markets generally started to hike interest rates, but in developed markets, we didn't see them start to hike until about a year later, so early 2022. And emerging markets have generally continued to hike interest rates since then. So as a result, for most of the countries in emerging markets, interest rates are now higher than inflation. Most of them have a positive real interest rate. And this early increase in those rates has meant that in some countries, particularly those in South America, we have seen an economic impact already feeding into the economies. And we've seen that slowdown in economic activity already happen in these countries, as we are perhaps worried about in more of the developed markets now.

When we went through Covid, developed markets such as the US the governments were able to give their population some handouts. And that was something that we didn't see in emerging markets to the same extent. They just didn't have the same capability to replicate that and in a way that has some benefits for emerging market now, because we are seeing lower second round impacts going into inflation to the point where we think inflation has fairly clearly peaked across the majority of emerging markets.

So emerging markets, they started raising interest rates first, and they're likely to be the first to cut interest rates. And as those interest rates come down, then we should see consumers and

companies that will end up with more money in their pockets as the cost of debt becomes cheaper and we should then see growth accelerate across emerging markets. And that turning point is normally a time when emerging market, equity markets, start to do quite well. And it's a good time to think about investing into these countries on the back of that cyclical activity pickup. I think another area to comment on would just be the huge credit expansion we've seen in China year to date. So, in the first quarter, China added total social financing of about $2.1 trillion, and that's something like adding the entire Indonesian banking system every month in terms of size. We did see significant slowdown in Chinese economy last year as they battled covid but with this credit extension, and we think we, that should really drive significant benefits with reopening, particularly with this liquidity we're expecting transaction volumes and values in the property market to pick up, and then as consumers feel wealthier for that wealth effect to then trickle down into growth in a lot of Chinese consumer areas.

I think another area is just around margins, so emerging markets have really progressed from copying to innovating to in some areas now actually being global leaders such as electric vehicles or leading-edge chip manufacturing. And these are areas where we now see higher margins in emerging market corporates versus their developed market peers.

So far, this isn't the predominance of emerging market investing and the aggregate margin difference across emerging and developed markets still remains high, but it would be really interesting if we could see any closure of this gap in the future, which would then mean that emerging markets, which are currently trading on trough from very low earnings, could arguably look really interesting from a valuation perspective.

Finally, I think it's just important to think about liquidity. For the majority of my career, emerging markets have been fairly out of favor, and as a result of that, I think we have seen liquidity come down in terms of the volumes that are traded on emerging markets, stock markets. There's a lot of commentary at the moment that, investors are looking for the Fed to stop hiking, looking for a pivot, and post that, they'll start looking at emerging markets, but I think we do need to remember that liquidity is low in these markets and sometimes it's actually hard to buy post-event when everyone is trying to move in the same direction.

Oscar Pulido: So, Emily, you've painted a really interesting background of the opportunities in emerging markets. I heard you mention profit margins are lower than in some of the developed markets, like the US, you’ve talked about companies that are, becoming innovators and leaders in their space. You also mentioned China. I think the amount of stimulus that China has enacted being the equivalent of the banking system of Indonesia, it feels like you could spend all your time just looking at investment opportunities in China as the largest emerging market but talk about maybe what other countries are of interest to you.

Emily Fletcher: Yeah, I wanted to pull out a couple of opportunities here actually. And the first one of them would just be Indonesia, which is a country that we think has seen a fairly substantial improvement in its economic outlook over the last few years. Indonesia's the world's largest exporter of nickel. Historically, nickel was predominantly used to make stainless steel, but by 2030, we think nickel will predominantly be used to make batteries for EV cars. So, Indonesia in 2020 exported nickel to the of about 12 billion. by 2025, that'll be $45 billion, already a pretty substantial growth. Now it's a country that historically has borrowed from abroad, it's run a current account deficit to finance its domestic growth. But the size of the increase

we're seeing in those nickel exports is such that that structural current account deficit was about 3% of GDP pre-covid. It's already shrunk by about one to one and a half percent of GDP. And we think it will do the same again over the next couple of years. So that should have the benefit of making Indonesia much less reliant on borrowing from abroad and needing to attract foreign capital. And that should result in improved domestic liquidity in higher domestic economic growth. The cost of borrowing in Indonesia should come down slightly, and the volatility and currency movements in Indonesia should reduce a bit, and that should make Indonesia a much more attractive investment destination.

And another country I'll pull out is very much a cyclical opportunity. But I think Brazil stands out at the moment. It's a country in the world, with the highest real interest rates. So, interest rates are very high, despite the fact inflation peaked in March, the economy at the moment has slowed. Brazilian companies and consumers have struggled with that really high cost of debt. And part of the reason that rates have been so high is that investors have been concerned, post the election of Lula as President in Q3 last year, that his administration would pursue very expansionary fiscal policies, but this really hasn't been the case to date. And as we go into the second half of this year, Brazil's likely to be in a position where the central bank could cut interest rates. As they do the pressure on companies and consumers will ease and we should see an acceleration of growth and that is a market that's currently trading around historic trough valuations, so I think potentially a cyclical opportunity there.

Oscar Pulido: When you talk about some of these individual countries you've mentioned the exports of nickel will be very helpful to Indonesia, so does that help every single company that's trading in Indonesia or does the economic backdrop in Brazil help every single company? Or do you then have to dig in and really sort of identify the winners and losers from that economic backdrop?

Emily Fletcher: Mm, so emerging markets is really about pulling together all the sources of information. So, what is happening in a country, those trends I talked about in Indonesia and Brazil are really important in kind of setting the backdrop for where you should be looking for stock opportunities. Then it's about digging in, as I said, it's about 4,000 different stocks within emerging markets that will all have their own specific company drivers. and all trade again with additional dispersion on top of that. So, you can see that that is just a huge amount of information to pull together, and you really want all of it to be pulling favorably, to be finding the best opportunities, so to be a great company, a great stock in a great market, and to pick it just before the turning point and then you can do really well. And that need to have all of those boxes ticked, I think is again, what makes emerging markets so interesting from an active perspective that you can, really find some interesting opportunities in and amongst.

Oscar Pulido: And Emily, it turns out you have a special expertise in frontier markets, so help us understand what is the difference between an emerging market and a frontier market?

Emily Fletcher: So, I really see Frontier markets as a sub-category within emerging markets. If we go back to thinking about the difference between emerging markets and developed markets, being around the level of development of the equity markets, frontier markets is really just a step down from that. It's the set of markets that are even less technologically developed than emerging markets, or it can be the set of markets, that trade with lower liquidity than emerging markets, so where you see a much smaller volume of trades executed over any given year. And actually, what's been interesting over the last 10 years since I started looking at frontier markets is that we have seen quite substantial technological advancements in a number of stock markets, that would've

historically been considered frontier markets such as Saudi Arabia or Qatar, and very much now promoted to become emerging markets.

Oscar Pulido: I think there's a reputation amongst these emerging and frontier markets of high volatility and in fact, you touched on it in some earlier comments about these big swings in stock markets that you see. How do investors manage these dramatic ups and downs?

Emily Fletcher: I think that's a very fair point to pull out and especially in some of these smaller markets in and of themselves they can be inherently and deeply risky and volatile.

But one of the really interesting things about these smaller markets particularly is that if you create aa basket of them put together a portfolio of them, you actually generally end up with something that in aggregate is much less volatile than if you were to look at emerging market indices at that level.

And it's a really interesting one, but they actually are still places in the world where you can find diversification. In these smaller markets and tends to be the smaller you, get with markets, the more there's a dominance of local political and economic events, and those events tend to impact performance more.

There are generally minimal trade flows between smaller, emerging and frontier countries, so problems in the real estate market in Vietnam will tend to have no impact on the level of oil production in Argentina. Recent election in Thailand had no impact on the subsequent Greek election. Constitutional change in Chile won't impact interest rate movements in Saudi Arabia. So, it's very interesting that you still have huge benefits of diversification from looking at some of these smaller markets.

Oscar Pulido: So, you, mentioned that you're an active investor, which means you're picking individual companies in each of these emerging and frontier markets and part of being an active investor, I imagine, is you're visiting these countries to be on the ground to understand what's going on in, the local economy. So, what are some of these countries you've visited and any good stories about some of your recent visits?

Emily Fletcher: So, I've been to about 35 emerging market countries now. Actually, I always find it rather unnerving traveling with security. I think it's having grown up in the UK I'm not used to seeing guns around at all. Luckily all the guns I've seen on my travels have been those held by my security detail. But there was one time in Nigeria where I was followed by Security on a track with, probably the largest sort of sub-machine guns I've ever seen that I did find a little bit unnerving.

I did get the opportunity once to visit the Zimbabwean Stock exchange while it was still using an open outcry system, which was absolutely fascinating to see but is now transitioned to a fully electronic system. Otherwise, I reckon I probably could have a successful second career as a travel agent. I would highly recommend visiting the mountains in Oman, the Polo Club in Lahore, Pakistan, the dead cow oil fields in Argentina, and there's some fantastic palm trees inside the Central Bank of Kuwait. My favorite food comes from Vietnam, but the best meal I've ever eaten was in Mexico.

Oscar Pulido: I thought I had some interesting stamps in my passport, but I'm realizing that it probably pales in comparison to yours. Emily, thank you for giving us this tour of, emerging and frontier markets and thank you for joining us on The Bid.

Emily Fletcher: Thank you. It's great to be here.

Oscar Pulido: Thanks for listening to this episode of The Bid. On the next episode, we will consider the world of cash investing and the opportunity for investors in an environment of higher interest rates. Make sure you subscribe to the bid wherever you get your podcasts.

Disclosures

This material is intended for information purposes only, and does not constitute investment advice, a recommendation or an offer or solicitation to purchase or sell any securities, funds or strategies to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of the date of publication and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risks. BlackRock does and may seek to do business with companies covered in this podcast. As a result, readers should be aware that the firm may have a conflict of interest that could affect the objectivity of this podcast.

In the UK and Non-European Economic Area (EEA) countries: this is Issued by BlackRock Investment Management (UK) Limited, authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel:+ 44 (0)20 7743 3000. Registered in England and Wales No. 02020394. For your protection telephone calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock.

In the European Economic Area (EEA): this is Issued by BlackRock (Netherlands) B.V. is authorised and regulated by the Netherlands Authority for the Financial Markets. Registered office Amstelplein 1, 1096 HA, Amsterdam, Tel: 020 – 549 5200, Tel: 31-20- 549-5200. Trade Register No. 17068311 For your protection telephone calls are usually recorded. 

For Investors in Switzerland: This document is marketing material.

In South Africa: Please be advised that BlackRock Investment Management (UK) Limited is an authorised Financial Services provider with the South African Financial Services Board, FSP No. 43288.

 ©2023 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners.

Oscar Pulido: Another month, another Fed meeting, and yet another increase in interest rates. For the first time since 2007, the federal funds rate in the US is above 5%. Where does the Fed go from here? Have we reached a peak in inflation? Here to help answer these questions. Here to help answer these questions, I'm pleased to welcome Gargi Chaudhuri, Head of iShare's Investment strategy. Gargi will help us make sense of today's market environment and the investment opportunities that lie ahead.

Gargi, thank you so much for joining us on The, Bid.

Gargi Chaudhuri: It's great to be here. Thank you for having me.

Oscar Pulido: Gargi, it's May, the Fed has just raised rates for the 10th straight meeting. We're above 5% on Fed funds rate for the first time since 2007. Inflation is still a problem. The markets are volatile, and we've had the collapse of another bank this time, First Republic, getting taken over by JP Morgan. So with all of those concerns that, you're hearing, what are clients saying right now and how are you responding to them?

Gargi Chaudhuri: So to your point, we've had the fastest rate rising cycle with 500 basis points of rate hikes in a course of 14 months. It's hard to believe now that in the beginning of last year, rates were still at zero. the big thing that clients are reiterating over and over again to us is the need. To be flexible in this time, the need to be nimble in moving around portfolios because the story keeps shifting, right?

So, if we look back to the first quarter of 2023, when you came into January was actually a pretty good month. Remember, that was when the reopening of China story came about. Then you had February, not such a great month, then March, nobody saw the bank turmoil coming about, but that happened.

April comparatively was a lower volatile month, but of course you had some idiosyncratic risks and now we're sitting at May with what we think is the final rate hike for this cycle. So I think there's a huge amount of discussion around nimbleness in portfolios. That's one thing. And the second thing that we're talking a lot to clients about is really the return of income.

Clients are so excited that you can actually earn some income, especially in fixed income and where they should do that, how they should do that, and how they can reallocate back to the fixed income market. So that's been very topical for us. And this is across clients in the us LatAm and Canada, and globally,

Oscar Pulido: As you mentioned, every month has been different in 2023, so there's been no consistent pattern. Tell us a little bit about, the three P’s framework that, I know you've been talking to clients about. What are the three Ps?

Gargi Chaudhuri: One of the things that we discuss when we talk about markets is, what are the important things that clients should remember as they're thinking about asset allocation? What will drive markets right now for the next quarter, for the next few months, and at this juncture.

Those are number one. The Pause, that's the first P. Number two, profitability, and the number three, portfolios. So if we look at each of these individually and why they matter now. The first one is really about the pause, which is that the Fed has raised rates by 500 basis points, over 10 rate rising cycles over 14 months, and now, they pause.

The Pause is not the same as the other P word, which is pivot, which many investors expect. Actually, the market expects the Fed to cut rates. We don't think that's going to happen. And why not another P for you? Prices! Inflation remains pretty high, much above the Fed's target, which is 2%. As of right now, we're sitting in May, when we last looked at inflation numbers, they were closer to 5% than to 2%. So, all of this allows for the Fed to pause, but not pivot, not to cut. So that's the first P.

Also we're talking a lot about profitability, which is actually related to one of the, Ps, which is prices in a world where prices are going up, where inflation has been a consistent problem over the last 18 months.

Looking at companies that have the ability to pass on prices, that have the ability to have margin resiliency, to be able to be profitable, even in a period of slowing growth is really important. Finding those companies, finding those sectors that have pricing power, that have profitability, which have earnings growth, which have a strong balance sheet.

Those are really important. And then we'll move to the third P that we spend a lot of time talking about. As I mentioned earlier, which is around portfolios and specifically the role of fixed income in portfolios. How at this juncture with the Fed Funds rate being a little bit over 5% allows for investors to earn a lot of income in very high-quality parts of the market. So, you can sit in treasuries, which are backed by the faith and credit of the US government and earn 5% in certain parts of the treasury market. You can earn close to 6% in certain parts of the very high-quality corporate credit market. So again, thinking about the portfolio construction in this environment is really exciting.

Oscar Pulido: You mentioned Pause, and that's your view that the Fed is going to, take a chance to kind of just assess what they've done over the last 10 meetings for the camp that's out there that thinks that they will pivot, that they will cut rates. What's their argument as to why they think that will happen?

Gargi Chaudhuri: So, I'll talk a little bit about why we're in the pause camp, and then talk a little bit about the Pivot camp.

So, the Pause camp is entirely because of inflation, Congress has given the Fed two mandates. The first mandate is to have prices be stable which is defined by the Fed as 2% on PCE. The second mandate is having the job market remain pretty resilient.

Now they are doing very well on the job market front, unemployment rates as of right now, are sitting at close to 50-year lows. We haven't seen a labor market this strong in a very long time. But on the inflation side of the mandate, they are actually not getting to that 2% level that is their target. So, they don't necessarily need to raise rates higher at this juncture, 5% is a pretty high and a pretty restrictive level of interest rates, at the same time, they don't really need to cut rates either because they're so far away from their inflation target and the labor market remains strong.

The question is why then is there so much discussion and debate around whether the Fed should cut rates? There have been some financial cracks that have emerged more recently, as you pointed out earlier, was in the banking sectors where, especially for the small and medium sized banks, they have begun to come under a meaningful amount of pressure and the fear that pressure continuing would mean that credit will continue to tighten.

Small and medium sized banks are a big resort for small businesses for loans. If you're a small business in this country, you are responsible for a majority of the jobs of this country. So, if small and medium sized businesses are unable to get the credit that they need from the small banks, that becomes a problem for the entire economy in the US. So, investors and the market actually, that is now pricing in that 'pivot narrative' that is pricing in rate cuts by the end of 2023 is actually foreseeing this credit tightening becoming a larger issue as time goes on and the Fed needing to cut rates to stimulate growth as a result.

I'll also say that certain interest rate sensitive parts of the economy have already begun to show some slowing. You've seen that in the housing data, you've seen that in the auto sector. So there have been certain manufacturing components that have begun to slow down. there is the senior loan officer survey we were talking about earlier, Oscar, the Slews that's become a very common or very hip data point to look at these days because the Fed has popularized it and talked about it quite a bit.

All of that is showing a little bit of credit tightening in the economy as well. So those investors that are thinking about rate cuts for the remainder of this year are thinking about that because of the slowdown that is already emanating and expectations of more slowdown because of the impact on small and medium sized banks and the ramification that would have on the small businesses.

Oscar Pulido: So, can we go back then to profitability? Now you talked about quality companies and what does that mean? Are there particular sectors or industries that when we talk about quality, that tend to come to mind more than others?

Gargi Chaudhuri: So, when we say quality companies, what we really mean is a group of companies or certain sectors, that have really strong fundamentals. And what do we mean by those strong fundamentals? We talked a little bit about the ability to be profitable. It's really important for them to have low debt, especially in a world where interest rates are higher, where debt servicing costs can be going up, having that low leverage ratio can be important, and having free cash flow. That

ability to weather slowing economic periods and having the cash flow that allows them to do so. And all of that can be manifested in companies that are higher quality companies, so they have stronger balance sheets. Now, in a world, if interest rates were back to being zero, let's say we were back in 2020 and it rates were at zero.

I think in those environments that resiliency of balance sheet isn't as important because rates are at zero and companies, are not paying as much for the financing of their debt. Real rates were actually negative instead of, the very positive, amounts they're at now.

A lot more could be done in a zero real rate environment if you were a company that wasn't as profitable because you didn't have that debt burden or that debt financing burden. Right now though, we are in the camp of higher for longer. We've reached that higher part. We've gotten to above 5%, we haven't reached that longer part. So, the longer is going to happen for the remainder of the year, and in that environment of staying higher for longer, we think that quality characteristic really comes to head in both the equity as well as the bond markets. So, looking at sectors like energy, technology a lot of free cash flow, strong balance sheets. And frankly, those are the parts of the market, that have done very well. people have gravitated towards those very strong companies with strong balance sheets that have cash flow and are profitable and have earnings growth power.

Oscar Pulido: And then maybe to go to portfolios, you touched on there's income in the market now with interest rates having gone up, the investments in one's portfolio are generating more cash flow. You look a lot at flows. Where are people, what are they buying? What are they selling? what are you seeing are investors allocating away from stocks into bonds because of that income that they can generate? Or are they moving out of cash or is a little bit of all the above?

Gargi Chaudhuri: So first of all, last year, as we all know, and experienced, 2022 was just a rough one for investors, whether or not you were in the safest parts of the, market, which is, which tends to be bonds or if you were in the equity market, which tends to have a little bit higher volatility, you had a pretty rough, investment period for at least 20, 22.

Many investors had they chosen to be in cash, would have actually had a safer outcome. This year though, what has happened is quite the reverse. Both equity markets and bond markets have done well, but many investors because they had this negative experience last year have chosen to remain in cash. So, one of the things,

we are seeing investors do is actually step out of cash for the first quarter of this year, we saw them step out of cash to the very front end of the fixed income market, so to treasuries and investment grade credit in the front end, so you could earn a lot of income, but not take a lot of interest rate.

And more recently, in April and May, we're actually seeing investors taking a little bit more interest rate risk in the fixed income markets, but still remaining high quality. Still looking at companies or sectors that are most highly rated within the fixed income market, so whether that be treasury bonds, or whether it's very strong companies like investment grade credit rated companies. So, we are seeing those flows gravitate towards the fixed income markets.

The other thing that I would say that has been more of a recent phenomenon is actually investors moving away more from the value like stories. And when you think about the different types of, investments there are there's value and growth. Value of course tends to do well and the part of the business cycle where the growth is beginning to take off and now when there's some fear or

expectation of a slowdown, growth is where people are allocating capital to. Our research shows that growth does make sense, but allocating to those areas of the growth companies that are still fairly priced, so growth at a reasonable price.

And again, energy sector and certain areas of tech sectors could be things that investors could consider. The last thing that we are looking at or that we have found interesting in flows is gravitation towards gold, which is interesting. you have the trifecta of real rates that are moving lower remaining constant, you have a little bit of a fear, a flight to quality, if you will. And you also have, investors are, that are worried about a growth slowdown. And all of that has pointed to investors moving towards gold. So that's something, it's a pretty recent phenomenon, not something we often talk about, but certainly gold has, begun to shine again, to use, a very overused expression, but certainly seeing, some flows there.

Oscar Pulido: As you point out, last year was such a difficult year that investors are saying, if I had been in cash, I would've been fine. And so maybe I should do that again in, in 2023. But you've highlighted a number of different investment opportunities that have presented themselves this year and that you think are still very worthwhile going forward.

Gargi Chaudhuri: Yeah, look, if you need the cash for liquidity reasons, of course holding cash, especially, depending on how you're holding it, you can be something that is absolutely needed in your portfolio for liquidity reasons, and that makes sense.

But if you're holding it for fear reasons, if you're holding it because you expect an exact repeat of 2022, what I would say is the valuations have changed meaningfully, especially in the fixed income market. And this is where earning some yield in the fixed income markets and having that ability to make some total return in the fixed income markets, that opportunity has now risen because the Fed had not raised by 500 basis points this time last year.

Oscar Pulido: I'm just curious, you speak to a lot of clients and investors around the world, whether it's in the US and Latin America, Europe, you name it. And so, is there a common question or concern that you hear from them?

Gargi Chaudhuri: There’s a couple. One that comes up a lot is around the fears of a global recession. Interestingly, that was something that was coming up a lot towards the end of last year. There was a huge fear of a stagflation, so an environment where growth is slowing down, but inflation's remaining high. That slowed down pretty meaningfully in January, and perhaps some of that was because in Europe the winter wasn't as bad. China had the reopening. There was some sense of optimism, so that slowed down.

But more recently, I would say over the last three or four weeks, the questions around a recession have come back. They're not around a stagflation this time around, they're much more around a recession. If that's going to happen in the US if we expect that in Europe, so that's something that's definitely top of mind. And what should investors do in a recessionary environment? Where should they turn to in a recessionary environment? Especially because last year fixed income wasn't that appropriate allocation. So having that conversation around where in fixed income and why this time is different because of course we talked about, the US but globally, many other central banks like the Bank of Canada, for example, done with their hiking cycle. If you look at, Bank of England, they're closer to being done than not. And ECB probably still has some more rate hikes to go, but again, many of them have moved a lot further on that hiking process.

And then the second thing for the first time in a long time, US investors are asking about emerging markets as an option. So, I think that's interesting because I hear from for example, investors in the LatAm or investors in Europe who have historically been allocated to the emerging markets, especially in the equity space, but in the US this is the first time that we are seeing US investors ask about emerging market debt, local currency, emerging market debt, and single countries within emerging markets.

So not viewing emerging markets as a monolith, but a view around should we be allocating to India because they've heard about India now being larger in population than China, or thinking about China because of the reopening or thinking about Mexico because of friend- shoring.

So, the view of US investors thinking about, different emerging market countries has been really exciting and something that's new and hopefully will continue for some time.

Oscar Pulido: I'm listening to the comments that you're making and the statement that, or the phrase that comes into my mind is, it's a marathon, not a sprint. When you think about the discipline that you need to exhibit with long-term investing, and speaking of marathons, one thing I learned about you recently is that you've run 25 of them, in your life. So talk to us a little bit about the parallel between the marathons that you've run and what it is that your day-to-day looks like working in iShares investment strategy.

Gargi Chaudhuri: Thank you. Love this question. I want to write a book about this one day. So a couple of things immediately come to mind, when you train for a marathon, you have to put in the work, You have to go for your long training runs, and I think the work that we're doing with our clients and helping them understand the markets, and invest accordingly.

The other one I would say is, and I often don't do this, but I should, and after 25 marathons, I've learned the lesson is start slow and then get comfortable because it is a long run. And similarly, to running, I would say the same for investing.

Start slow. If all you can do is take a small amount and put that away in a diversified fashion. And that's all you can do. And you don't have to get too crazy. Don't have to listen to every earnings call of every company. You don't have to do that. Later, once you've gotten used to the investing lifestyle, once you've gotten used to looking at data or earnings or any kind of economic indicators, you can become a more sophisticated investor.

But start slow. The last thing, I guess I would say, and I use this for markets, but also for people's careers, run your own race. When you're running a race, you might be on mile 20 dying and someone might pass you by running seven minute miles. They are having another race. You are not running their race.

Similarly in investments, if you have a friend that's invested in something very cool and something very esoteric, that might be amazing for them. But you think about your own portfolio and what it needs. So run your own race in the markets in your career, but certainly in the investing landscape.

Oscar Pulido: It's great insight and we wish you luck on your 26th marathon whenever that takes place. Gargi, thank you so much for joining us on The Bid.

Gargi Chaudhuri: Thank you.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out our recent episode with Way Lee on the new investment playbook in action.

Thanks for listening to this episode of The Bid. On next week's episode, I'll be talking to Emily Fletcher for a Stock Picker's Guide to Emerging Markets.

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Mark Wiedman: Welcome to The Bid where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Mark Wiedman. Today we are going to India. You know that India has the biggest population in the world, but what you probably don't know is that it is leading the world in digital payments.

The man inspiring this leap forward is Nandan Nilekani. He is the co-founder of Infosys, the digital services firm and for 14 years he's dedicated himself to the digital transformation of India. I met with Nandan in Mumbai this year and invited him to share his story at our new Hudson Yards office in New York. In this episode, you'll hear about how Nandan landed the job to create this digital ID system. Why India has been able to leapfrog technologies and how building a digital public infrastructure has brought a new model of economic growth to India. Welcome Nandan. Nice to see you.

Nandan Nilekani: Thanks Mark. Thank you for having me here.

Mark Wiedman: The building out of Infosys. What was the founding vision and what is it today?

Nandan Nilekani: Well, the idea of Infosys was to create a globally respected technology company and it took us a long time because we began in 1981. And, uh, that was an India that was very different. There was no economic reforms. It was difficult to do business. But I think come the nineties when India had the first wave of liberalization we were able to grow very rapidly. And we set many, many records. We were the first Indian company to list in the U.S. We listed in NASDAQ in 99. We are among the first to deal with foreign investors so we introduced a lot of sort of cutting-edge reforms in the way capital markets work in India and set the bar for corporate governance and so on. And we have 1700 clients around the world. And, it's been a very successful 40-year journey.

Mark Wiedman: What was your contribution as a leader for the many years you were with Infosys full-time?

Nandan Nilekani: Well, I was primarily on the business side. I was looking at global sales, global marketing. And I was also the CEO for five years from 2002 to 2007.

Mark Wiedman: So we get into the mid-2000s, you're CEO. Take us on your personal journey from there to when you started embarking on the transformation of your country.

Nandan Nilekani: So I stepped down as CEO, I was the co-chairman. I also wrote a book in 2008, called Imagining India. It's a broad sweeping book about many ideas - why urbanization didn't happen, why education didn't happen, why something else happened, and so on. And one of the ideas was, let's also look at having a Digital ID and use technology to make a difference. So that was embedded in that book somewhere.

And then I got a call from Prime Minister Manmohan Singh, to implement this idea. And he said, we have this project for giving everybody an ID. At that time it was not a digital ID, it was just an ID. It had to be unique and unique meant that Mark gets only one number in this system. And why did we need this ID? The two reasons.

First was India was building its welfare state and was going to be sending money to people and wanted to make sure it reached the right person. Because without an ID, you can't do that. The second reason was that India didn't really have a very robust birth registration system in those days, and many births were not registered because the birth happened in the village far away from the district, you couldn't get a birth certificate. So, in some states, more than half the babies born did not have birth certificates. Again, that did not matter when they lived their entire life in the village, but the moment they started migrating without ID, they couldn't get anything done. They couldn't board a train. They couldn't get a job, they couldn't open a bank account. They couldn't explain to the cop who stopped them. So ID became an essential you know, asset for people. So both the inclusion of getting everybody into an ID system and the efficiency of giving money directly to them, drove the government to think of the ID project. It had actually begun conceptually in 2006 by the time I came on the scene in 2009, it was ready to roll and I stepped into that job.

Mark Wiedman: So that was the genesis, the birth moment. What was the founding set of actions you took in 2009?

Nandan Nilekani: So I brought a bunch of very good bureaucrats from the permanent bureaucracy, but I also needed deep technologists. I assembled a bunch of technologists from all over the world who all volunteered to make this happen. And then I brought this group together and they were from two different cultures. So I didn't want internecine warfare. So I set such an audacious goal that they forgot about the differences and focused on the job.

Mark Wiedman: And your big audacious goal was what?

Nandan Nilekani: I'll just take one intervening point. I served in the government from 2009 to 2014 and when I began my term, I had made a public statement that I, I would deliver 600 million IDs and then step down, which I did.

Mark Wiedman: So zero in 2009. 600 million by 2014. When was your first ID issued?

Nandan Nilekani: September 30th, 2010. Peak was one and a half million a day.

Mark Wiedman: I think something the, particularly the U.S. audience might not fully appreciate is that when you started, you had a huge portions of the population that had no formal other than the voting booth had no real actual status in the eyes of the government.

Nandan Nilekani: Yeah, exactly. Because the lack of birth certificates. In the U.S., maybe 98% of births are registered. So a birth certificate becomes your root document based on which you vote or whatever, decide your age. But if you don't have a root document, then how do you take a few hundred million people and give them an ID and they have no id. That was the challenge we had, and the only way we could do that was a very complicated technological thing called biometric de-duplication, where we took each person who enrolled and compared them to all the people we had in the database to see whether the person was duplicate or not. So if we had 500 million people in the database and a million people enrolled, we do 500 trillion matches every day to eliminate duplicates, very sophisticated technology wise, but the politics was more difficult than the technology.

Mark Wiedman: India is famously decentralized so getting all those individual states to sign up, how did you get it done?

Nandan Nilekani: First of all, I made it non-threatening because what happens in any organization and in the government is if we come with a new idea, they would've said, what do they do to me? So I had to prove to people that this was not in any way affecting anybody. All I was saying, John is John, Ashok is Ashok, Mohammad is Mohammad. Whether John deserves a passport, the passport guys will decide. Whether John deserves a driver's license. So I said, I'm not taking away your power or agency, I'm just helping you do your job better. So the moment you position this as something enabling them to do the job better, and you don't take away any of their power, they're fine with it. So I had to do that with all these players.

Mark Wiedman: So you get to 600 million, where are we today?

Nandan Nilekani: Now we are at 1.3 billion people have the ID.

Mark Wiedman: So right now, 1.3 billion. . Indians have the id. How do they use the id? What are the applications?

Nandan Nilekani: They use it in two ways. They use it to authenticate themselves so wherever they have to prove who they are, they can do an online identification verification, and that does about 80 million transactions a day. And you can also use that to do what's called as a ‘know your customer.’ It's called electronic KYC, and it's used to get a new mobile connection or to open a new bank account and so on. and that is about five to 7 million a day. One of the big use cases is what we call as micro-ATMs, is how, how do you get people to be able to withdraw money easily from the bank account? In the old model, you have to go all the way to the city to the branch. You have to go to an expensive atm. A micro-ATM is nothing but a small mobile phone, smartphone, with maybe a base app on it. So that is there with people around the country, in grocery stores and so on. And if I want to withdraw money from my bank account, I just go to the neighborhood grocery store, authenticate that I am X and I want to withdraw five hundred rupees from a bank account and he gives you five hundred from his drawer and on the system your account gets debited and his account gets credited, so it's all settled. So he becomes an atm, a manned ATM, and now we have a few hundred thousand of these micro-ATMs around. Suddenly you are made cash in, cash out, accessible to a billion people. So that's an example.

Mark Wiedman: Okay, so 2014 rolls along and shockingly you've hit 600 million. you step down. What'd you decide to do then?

Nandan Nilekani: Well then I also had a small detour and I stood for election and I lost the election. Okay, why was this crazy guy standing for election? So I felt I want to get more things done, and I thought if I'm inside the system as a politician, I can get more things done. That was my plot logic. Anyway, so that didn't work.

Mark Wiedman: So that was almost nine years ago, when you stepped down, went for the by-election for the world. May not have been great for you, but the election results were great for the universe because you just took on your next chapter. What was the next chapter and how did you continue?

Nandan Nilekani: See around that time, in the ID days, I built the direct benefit transfer platform with the NPCI, which is a National Payment Corporation of India, which is a nonprofit that does all payments in India. So I knew them very well and we started thinking about how to do a real-time mobile payment system. And that's what led to a new product we designed in 2013 called UPI. Unified payment interface.

Mark Wiedman: And this is where the world actually starts to pay attention.

Nandan Nilekani: We designed a payment system, real time payments, small value, small transaction fee between any bank account to any bank account from any consumer app to any consumer app. So this is what you call it, a four-party system. For example, I'm using Google and my bank account is State Bank of India, you're using phone pay your bank on HDFC Bank. You can seamlessly transact. So this was ahead of the curve in terms of thinking through how payment should be done, and we launched that in May of 2016 with the idea to create this kind of payment system.

Mark Wiedman: Before we go to the astounding results, what was the core kind of intellectual architecture connecting the unique ID to payments that you were able to unlock and create that system launching in ‘16?

Nandan Nilekani: So unique ID not only gave ID, it gave electronic KYC, and electronic KYC reduced customer acquisition costs for newcomers in markets like banking and mobile phones. So essentially, KYC reduced costs of customer acquisition and therefore allowed new newcomers to come and compete in markets. Then we felt that unless we make payments ubiquitous and cheap, you can't really create a transaction economy, and it had to be.

Mark Wiedman: When you say that, what's a non-transaction economy? What do you mean?

Nandan Nilekani: I mean, the way the West evolved the internet was, it was a advertising-led economy. Because in the, in the U.S. you spend $700 per person on advertising. And then that money was earlier spent on television and print. So what happened was that money migrated to the internet with digital advertising, with all the big, big tech companies. In India, there's no money in advertising, but people don't have that money to spend. So we had, we said, if you really want to create a flourishing internet economy, it has to be based off transactions. But then to make a transaction economy, you need to make them very efficient, low cost, and very small value. So that led us to the conclusion that you need a very fast real-time payment system.

Mark Wiedman: So the founding vision was, if we're going to make the internet a reality in Indian lives, we're going to actually need to create a real-time digital payment system because without it, we'll just never get there and, the internet will pass us by. So you launch in May 2016, what did it allow somebody to do?

Nandan Nilekani: It allowed somebody to make payments from any app to any app, from any bank account, but it was very small scale. We wanted to tackle person to person payments and person to merchant payments. By October of 2016, we were doing a hundred thousand transactions a month.

Mark Wiedman: Okay, so the vision is basically exploding these level of transactions directly, a hundred thousand in October ‘16. Then what happens?

Nandan Nilekani: Then in the month of November, on November 8th, 2016, India demonetized its currency. Essentially,we drew currency notes from the economy and said, we'll put in new currency notes, but then people could, didn't have money to pay.

Mark Wiedman: There was uproar everywhere. They're taking away the currency. Some people thought it was a bungled rollout, but it actually created a catalyst moment for you.

Nandan Nilekani: Yes, because, suddenly people said, can we do digital payments? And fortunately we had something to do digital payments and, and that's how the BHIM application was launched by the Prime Minister and then after all these other applications came. And so basically the payment boom was driven by two things. One was the demonetization stuff and the second was Covid. Because Covid again gave a big boost to contactless payments. So both these things gave the sort of tailwinds for the growth of digital payments.

Mark Wiedman: Where are we today in digital payments in India?

Nandan Nilekani: Today we have, last month was 8.7 billion digital payments. 300 million people use it and 50 million merchants have QR codes at which you can make these payments.

Mark Wiedman: So you walk into a small shop, a Kirana, there will be a little QR thing.

Nandan Nilekani: I mean, a guy on the street selling coconuts will have a QR code on his cycle. He'll give you a coconut, drop it out there and you make the payment.

Mark Wiedman: So, in New York, sometimes on the street, the vendors, they don't have a way of taking digital payments. You're saying basically anywhere except for maybe deep, deep, deep farmland, that person will be prepared to take the digital payments. How is that changing people's lives?

Nandan Nilekani: Well, it's increasing their efficiency. They're doing more transactions. It's improving the safety. Because if you are a woman selling vegetables on the street, if you take only cash by the end of the day, you have lots of cash and then you're eligible to extortion or theft. Now it's all going into the bank account. She doesn't have to go and deposit the money, it's all in the bank account. And they're also going new innovations, for one, is the payment speaks, it's a sound box. It's important because if I'm running you know, we have India, these restaurants where they make everything, dosas and whatnot, and he has no time to give the dosa and take the money and give a change. Now he has a small audio box there with a QR code, so he gives the dosa and tells the guy to go there. He go there, pays, and the sound box says, received 75 rupees. So he is using his audio hearing so he can deliver more dosa, his hands are free, no payments required. Millions of shops where they have these devices. Lots of innovation.

Mark Wiedman: So India today where is it going to be in five years regarding this ecosystem you're creating?

Nandan Nilekani: Well, first of all, you are going to have financial inclusion with everybody having a bank account. With mobile prices dropping, mobiles are going to be ubiquitous. Everybody already has the ID. UPI is expected to go to 1 billion transactions a day, from about 300 million now. We, we think we are halfway on this digital transformation journey. So there are three, four big ideas that are in the works. The first is democratizing credit because we think that if data can be, people can be empowered with their own. Then they can use it to improve their lives. So if a small business can use his bank details or his tax payment details or whatever and securely give to a lender and get credit, then he is using his information collateral to get credit. So we think that'll democratize credit to millions and millions of businesses who didn't get access to credit. So that's going to lead to broad-based economic growth. The small businesses can now get access to credit. So that's the one big idea.

Mark Wiedman: When you look around the world, where else do you see innovation around ID and payments?

Nandan Nilekani: Like this? Nowhere. I think that for example Brazil has a very good payment system called Pix, which has done extremely well. But it's only within the banks. I met the governor recently and I think it's doing a great job. It's a bank-to-bank real-time payment system that does high volume transactions.

Mark Wiedman: What was interesting is in Brazil, they started off the payment system because you have people in the Favellas who are very poor, much more dangerous than Indian equivalents who were being mugged and have all their cash taken. And so you had the urgency of getting cash out of the hands of a single woman or man walking home from his job and actually into the computer systems. Even though it's, you can obviously still there are ways of getting money from people, it's much harder.

Nandan Nilekani: That's right.

Mark Wiedman: So that same innovation, why have we not seen this level of innovation in the West?

Nandan Nilekani: So, it's actually a broader point, which is interestingly, countries that come later to technology can leapfrog.

Mark Wiedman: This is real leapfrogging. As somebody who's leapfrogged in a couple of ways already in your career, you've leapfrogged technologies more than once.

Nandan Nilekani: So we did well with ID, we did that with payments. We are doing that with democratizing credit and putting data in the hands of people. We are building a new infrastructure for open digital commerce, which allows everyone to join a grid of payments and grid of commerce. So, any small shop can become a supplier on this. So, it's gonna lead to a lot of hyper-local commerce. Unlike in the West where you have only large-organized trade, or you have e-commerce. India has millions and millions of small businesses, which is common by the way, many countries. So how do these small, millions of small guys, how do they participate in e-commerce? So, we are creating the pipes for that. And then we are also doing a lot of work on logistical improvements because India was a single market for service, because of the fact that our telecom banking regulations are national. So, it's a single market for services, but it was a fractured market for goods. So now with the government of India reforms in GST, putting in a single tax system, making all tax payments, digital, road tolling all that stuff, but much better versions. Making markets more efficient, creating a single market for products and services, enabling millions of small businesses to participate in commerce. And the basic thesis, Mark, is if the, if the world is going to be a digitally intensive economy, the architecture of that is very important.

Mark Wiedman: What would be your message to us, all of the listeners here around the world, about how to bring the kind of thinking and innovation you've brought to India, to the rest of the world?

Nandan Nilekani: Well, I think you know, now we call all these things, we call them as digital public infrastructure. And we think that this is an idea whose time has come. And we are happy to see that many countries are saying we want to adopt some of this around the world. We think there'll be about 50 countries who are looking at some, not the whole thing we did, because that's quite big, but, you know, pieces of this, like ID. Philippines is implementing ID similar to this, Morocco is implementing an ID. Some people are looking at payments, so I think you will see countries saying, oh, look, there seems to be a way of doing things which will actually benefit us. I mean, to go back to my point, the pandemic showed us that our lives were digitally intense. We are entwined, you know, we ordered our goods online, we ordered our food online, we did our learning online, we had our meetings online, we had relationships online. So if an economy and society is going be so heavily entwined with digital stuff, you have to think of the architecture of that in a way that's, that you have more economic growth. So our whole thesis is that actually a new model of economic growth, which is more democratic, more inclusive, and which is better for society. I think this is a great time to be doing these things. I think we have seen that you can bring massive change if you want to, and anybody can do it. It's not like, it's not the privilege of a few. So I think every one of these people here can change the world.

Mark Wiedman: You know, Nandan, it is a time in which ideas have a potential to reach scale like never before in human history.

Nandan Nilekani: That's right.

Mark Wiedman: Nandan Nilekani, thank you for joining us.

Nandan Nilekani: Thank you, Mark.

Alex Craddock: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Alex Craddock, Global Chief Marketing Officer at BlackRock.

The rise of the internet and social media has heralded in a new age of information, but also of misinformation in today's highly competitive market. Building and maintaining brand trust is essential for the long term and can make or break a company's reputation and bottom line. So how can businesses and brands protect their reputations, and how much does it matter to investors here to help us look to the future of brand trust?

I am really pleased to welcome Lex Suvanto, CEO of Edelman Smithfield, a specialized financial communications boutique within the global PR firm Edelman. Lex brings two decades of experience in PR with a focus on formulating compelling messaging to win support from investors and key stakeholders.

Lex, welcome to The. Bid.

Lex Suvanto: Thank you, Alex.

Alex Craddock: Great to have you here, Lex. So, look, to start, it would be really great to understand how do you define and measure trust?

Lex Suvanto: Why don't I provide a little background on the trust barometer? So, we've studied trust for, 20 years at this point. The latest survey, 28 countries surveying 30, 32,000 people. It's safe to say it's the defining research on a topic of trust and reputation.

If you think about it, trust is a forward-looking metric, a projection into the future, a willingness to accept uncertainty. People only, ex people only invest. If they believe in the future. So, after two decades of researching trust, we break it down into four dimensions: ability, dependability, integrity, and purpose.

Trust defines an organization's license to operate. Every year we conduct the research, and we find important and provocative insights about people about the world. For example, in recent years, it's become clear that trust has gone from being top down. To being conveyed locally, peer to peer.

Interestingly, people around the world view a coworker, someone like you, people like us as more credible than a CEO, more trustworthy than a politician.

Alex Craddock: Wow, thanks Lex. It sounds like you are measuring the ultimate currency in a relationship.

You just wrapped up your latest trust barometer in what has been a turbulent start to an economic year. What are some of the key trends that you are seeing, and are there any emerging trends that are important for us all to be aware of?

Lex Suvanto: A really important takeaway that's useful and important for the audience to understand. In recent years, a major insight is that business is now the only trusted institution. The business sector has a lead of more than 10 points versus government and media. On the other hand, governments are seen as a source of false and misleading information by almost half of respondents around the world.

Compare that, though, to my employer's newsletter, the newsletter that we get inside of our companies, that's considered by people around the world as the most trusted source of information. More broadly, more than half of people around the world say their countries are more divided. Today, economic optimism has decreased.

In 24 of 28 countries, we're seeing all-time lows in economic optimism. Personal anxieties are increasing, fear of job loss, inflation, climate change, nuclear war, and there's also a mass class divide. People in the top quartile of income brackets are more trusting than people in lower incomes. So, it's no surprise that respondents report that social fabric has weakened Amid this division, we also found that a person's ideology has become their identity.

Here's an interesting view of that. Only 30% of people say they would help a person in need if they strongly disagree with their point of view. Only 20% of people say they would work with somebody who has a strong different point of view. In this environment, survey respondents say they want the business sector to do more, regardless of political affiliation.

More than half want to see business doing more, collaborating more, to address societal issues such as climate change, economic equality, healthcare. But, at the same time, business can appear politicized when addressing these societal issues.

Alex Craddock: So, it sounds like there's been a lot of change over the last few years. So, let's go a little deeper. What are you seeing in the latest trust barometer findings that are specific to the financial services industry?

Lex Suvanto: So, low levels of trust clearly played a role in the recent banking crisis. Just this week in banking earnings, we saw one of the biggest regional banks lose a hundred billion in deposits.

We saw UBS gaining billions in deposits. Clearly, there's a difference of trust playing out right before our eyes. In the research over several years, financial services is among the least trusted sectors, second only to social media. That was an outcome of the great recession. It has gotten better over the last few years, but only 38% say financial firms serve the interests of everyone equally and fairly.

Central banks at the center of the recent crisis are not trusted. In four of the five global financial markets. But here's an interesting fact, again, back to my employer. Employees working inside of financial services companies trust their own employer more than in any other industrial sector that we survey.

This means that we've got brand ambassadors, anyone working inside of a financial services firm, we've got brand ambassadors that are ready to speak out on our behalf.

Alex Craddock: You just referred to the difficult and challenging start we've had to the year, um, global economy has been under stress.

The financial industry in particular with the collapse of several regional banks in the US and the acquisition of Credit Suisse by UBS, has really had a tough start to the year. In all cases, these fractures across the financial services industry happened fast, and the shocks have rippled around the world causing a huge amount of market volatility and stress. What are the implications of these recent events on trust in the financial services industry?

Lex Suvanto: So, a lot's happened in the last couple of months. We actually went back into the field in April. The earlier research I was citing was from a few months ago. But given the significance of the recent cycle, we went back into the field in April to measure any differences.

No surprise that in April, the research showed an increase in economic anxiety for people, which then translated into concerns about the health of their own bank. A majority of people are concerned that the recent disruptions will impact their own bank, 22%. Small but meaningful say that they would look for an alternative bank to place their deposits that's meaningful.

There have been notable declines in two areas that are worth mentioning. There was a drop in people saying that financial services has a vision for the future that they can believe in. There was also a drop in people saying that financial services serves the interest of everyone equally and fairly, a drop in number of people that say that.

But I refer back to Larry Fink's annual letter. And I quote, Long-term investing requires trust in the financial system, and a fundamental belief that tomorrow will be better than today. We need leaders today who will give people reason to be hopeful, who can articulate a vision for a brighter future.

Unfortunately, given after the recent cycle, the numbers are going in the opposite direction. So that's an opportunity for all of us to think about.

Also, the regional banking crisis highlighted the role of social media. Through the crisis in Silicon Valley Bank. There were thousands of tweets saying run on the bank with pictures of people lining up at the bank doors.

Clearly this added to the chaos and panic. Um, the crisis was then compounded by people having access to their deposits, being able to move their money at the push of a button. So that creates a new risk that anyone in this, uh, sector needs to think about a new risk for banking institutions. And one could easily argue that maintaining trust with consumers is getting even more important, the relationship, the communications, the marketing, given the fact that people can change their financial provider and partner with the push of a button.

Alex Craddock: So, talking about new risks and having seen how social media has disrupted trust, especially in the last few months, I can't help but think about the potential disruption from artificial intelligence we're all talking about it. Would love to hear your thoughts around AI and its implications for trust.

Lex Suvanto: Many may have read CEOs of large technology companies are referring to AI as terrifying. One CEO referred to AI as potentially leading to civilization destruction. So, the question of trust is a prominent part of the AI discourse happening right now.

The issue is that none of us really understand AI, and there's a rising concern about accuracy and bias. Even the CEO of Google recently pointed to hallucinations observed in the output of AI systems. Lack of transparency is a big part of that. Recent research found that 72% of people say that knowing a company's AI policies is important before making a buying decision.

So, here's the question. Do you understand your firm's AI policies? More than half of millennials and Gen Z say they will consider switching brands. If data policies, including AI, are not clear. So, brands and companies need to demonstrate responsible use of AI. Companies will need to be prepared to explain decisions made by those systems.

We've all read that AI increases the potential for bias, depending on who created the algorithm. One hurdle is that there's no agreed upon definition of fairness. So, the problem is there's no universally accepted fairness definition that can be programmed into ai. It begs the question. Whose values do we use in AI?

Then there's the question of accountability. If an AI system is wrong, who's accountable? When you call a customer service hotline, you can ask to speak to the manager, but if an AI system gives you an answer you don't like, who do you ask? What manager do you speak to? Ultimately, AI systems will need to be able to explain.

The system itself will need to be able to explain why it's giving you the answer that it's giving. Businesses will need to produce AI responsibility reports just like ESG reports. In the recent research we conducted in April, we asked consumers how they feel about AI and financial services products. We were encouraged to learn that two and five Americans believe AI will improve financial services.

Some say it already is, it already has started to improve these systems, so that's a good start. Our job as professionals and leaders in this sector is to maintain and build on that trust that will require building principles, fostering transparency, and helping people know how to use AI and the technology ourselves.

Alex Craddock: That's really interesting and it's great to hear that the ongoing theme for us all is this need for greater transparency and really helping our customers understand how AI is helping them and how we're using the data to help them.

Lex Suvanto: That's right.

Alex Craddock: So, it sounds like there's a potential opportunity there, which is great.

I think one of, one of the more exciting trends around the world, that we're seeing in investment management is the rapid emergence of a new generation of younger investor, think young millennials, older Gen Z, under the age of 35, could you tell me about the key characteristics of this generation in terms of building trust and how should they be treated differently than other generations?

Lex Suvanto: So, the gen Z generation is already one of the largest segments in the US- between millennials and Gen Z, it may very well be the largest already. Definitely poised to reshape consumer economic and political trends. But a major finding, and this cuts through all aspects of marketing to this generation, a major finding, is the emergence of what we call belief driven buying.

Nearly two out of three consumers today buy or advocate for brands based on their values. Gen Z is leading that trend. Here's some characteristics about Gen Z.

Gen Z consumers feel the need to take action and fight for their future given the issues that they see in the decades ahead.

They unite around causes such as sustainability, educational access, equality, mental health. This influences where they shop, where they buy, who they will vote for. They live and build relationships through technology; they control information flow through social media. As a result of all of this, gen Z is turning corporate marketing upside down.

Nine and 10. Gen Z-ers want the brands and services they buy to get involved in causes that they care about. They have a strong belief in the influence of experts and believe in influencers. They buy on their beliefs and want to work with brands that stand with them on the issues that they care about.

I was recently teaching a class to a group of Gen Z-ers from all around the country. One student from the Southwest said, when I see a brand that's getting involved in global and societal issues, it gives me hope. It gives me hope.

I share that anecdote because that statement isn't about politics. That statement is more about their view of the viability, their view of the health of the future. So, to build trust with Gen Z, corporate leaders need to ask themselves a few simple questions.

Are your products and services tailored to Gen Z? What do your products stand for? Are your technologies and social media meeting the expectations of Gen Z and how they use it.

Alex Craddock: So, there's a few things that we're going to have to think about as we want to engage this younger audience of investors and how we build trust with them, but I think it's such an exciting opportunity for our industry.

You've shared a lot of great insight about trust from the latest trust barometer study. Bringing all of these things together, what are the two or three key insights that investors should take away and what should they do differently to build trust with our customers based on your insights?

Lex Suvanto: Absolutely. I can offer a few high-level takeaways and then a few tactical takeaways. So, the first one is, business needs to business as the most trusted institution needs to work on helping to break the current cycle of anxiety. And division and polarization in our world as the most trusted institution, the business sector must help restore economic optimism.

Businesses must help temper polarization by investing in fair compensation training, focusing on local communities to address the mass class divide, businesses and government must work together to build consensus and collaboration on policies and standards and businesses must help advocate for the truth.

To be a reliable source of information to promote fair discourse. A few tactical considerations in this fast-paced environment. Just on the heels of the regional banking crisis, it's clear that it's important to over-communicate, make information easy for stakeholders to understand and access. Establish what we would call push channels.

Be prepared with communications tools that reach your audiences where they are quickly and easily. And action pack your narrative. What we mean by that is emphasize the actions you are taking to stabilize your company, to strengthen your position, even to stabilize the environment and the industry. And lastly, don't underestimate the importance, the growing role of the Gen Z generation.

If you can build trust and advocacy among Gen Z, they will become fierce advocates for your products and your brands.

Alex Craddock: Sounds like a great set of takeaways for us all and I think within that a lot of opportunity for us. So, look, Lex, thank you so much as always, I mean I love the trust barometer. It's just a great insight for us. We are in a time of change, there's a lot of market stress, but I always sort of look back over history and go, look, you know, in these times of change and these times of stress, actually there's a lot of opportunity. And I think, what you've given me, and hopefully everybody here is a lot of hope that there's a lot that we can actually do to build trust, especially with this new generation of younger investor that's embracing a highly digitized way of engaging with us.

We need to think differently and approach the experience differently. But I think ultimately, we're going to get the best reward of all, which is the trust of our customers and our clients.

So, Lex, thank you very much for joining me today on The Bid. I appreciate it and um, speak to you very soon.

Lex Suvanto: Thanks, Alex.

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Alex Craddock: Thanks for listening to this episode of The Bid. If you’ve enjoyed this episode, rate and leave us a review.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Have you ever wondered if the weather can impact your investment decisions? What if we could map the impact natural disasters have on economies, or immediately understand the impact of a geopolitical conflict on your portfolio?

Geospatial data provides information on the physical location and characteristics of assets, infrastructure, and resources. This data has the potential to revolutionize investment decision making by providing investors with insights into the spatial dynamics of different markets and assets.

To help us gain a better understanding of this new and cutting-edge investment trend and how this information is gathered and used, I'm pleased to welcome Joshua Kazdin and Mike Pensky, who are both part of BlackRock's active investment business. And we have spent the last several years developing a geospatial investment capability and bringing these insights into active investment portfolios.

Josh, Mike, welcome to The Bid.

Mike Pensky: Thanks for having us.

Josh Kazdin: Glad to be here!

Oscar Pulido: Mike and Josh, you both work in the active investment business, which I think of as you're trying to outperform the market, and in order to do that, you have to have really unique information and insights that allow you to do that.

I think historically, you're meeting with company managements, you're analyzing the financial statements of companies in order to develop those insights, and I think some of this still happens, but another way that you can do it - and that you guys have pioneered - is this thing called “geospatial data”. So, what is geospatial data and how did you start on this project?

Mike Pensky: So, Oscar, the way to think about geospatial data, is it's just data that's all around us. It can be objects or events or really anything that has a location associated with it near the surface of

the earth. Right now, you're sitting in the world somewhere, right now you're sitting here with us. Outside it might be really hot. People might be walking around the commercial district, the airport at the local city might have a lot of activity, there are a lot of hotels that might be booked in the area. All of these are concepts that are geospatial in nature, they're associated with location. And so, what are the data that are associated with it that we can measure?

We can measure the extremity of temperatures; we can understand the foot traffic around various stores and retail locations. We can understand what hotel bookings look like. We can measure the GPS traces on trucks as they're moving around the city.

All of these happen in certain locations, and they have investment implications associated with them that we can actually leverage in our portfolios. Ultimately, to us, geospatial data is about getting information that's more timely, that's different than what you can get from other data, and it really is associated with actual real human economic activity happening in real time.

Oscar Pulido: Maybe Josh, touch on why did the two of you partner up on this initiative?

Josh Kazdin: Part of the reason why, honestly, was I had a couple of friends in San Francisco who wanted to start a family, and usually when you start a family, you move out of the city and you go out into the suburb somewhere, maybe someplace that has a little bit more room to move. You have a yard for your kid to run in, there are schools. And every year after they moved out of San Francisco, they had to pack up their home and get into a car and drive away because there were wildfires. In California, you fear wildfire season every year. That cost on a family, on a community is really hard to quantify. We wanted to better understand how extreme weather events were ultimately impacting households, businesses, and the markets.

A couple of years ago, Mike and I decided to explore what were the effects of FEMA disaster declarations on economic activity at the county level in the United States. By the time we got comfortable trying to understand that relationship, the pandemic hit. And that became an entire geospatial problem in and of itself. Social distancing data started to get released both in the United States, in Europe, and across the world. And our group started to pull in that data and use it to forecast which areas were going to have a government shutdown, which businesses were going to be impacted, and how that was going to ultimately impact our portfolios.

The minute that we got comfortable with that, Russia invaded Ukraine. And in the horror of that atrocity, we immediately sprung into action to try to understand how the war was ultimately going to impact our client's portfolios. Where were the investments themselves and ultimately, which companies were likely going to be impacted?

Certainly, stranded assets during that time were much more about a McDonald's in Moscow than it was anything buried under the ground. Across each one of these areas, geospatial became a really critical piece to understanding either a risk or an opportunity that would impact our client's capital.

Oscar Pulido: You've both painted this really interesting picture, this sort of lens on the world that you are uniquely seeing with all these data points. You talked about airport activity and talked about social distancing activity and the insights that provided. But I can't help but think about the sheer quantity of all the data points that you're looking at. How should people think about what you're doing in the geospatial realm with this term big data that gets talked about a lot?

Josh Kazdin: So, our team's motto is that we turn data into alpha. Usually that data can come in three different ways. People think either it's traditional, it's big, or it's alternative. Let's just give a quick overview of each one of those.

Traditional data is the usual suspects of financial information that people have been using over the last century to try to understand markets.

This can be everything from, financial statements to the SEC, macroeconomic releases, industry reports, analyst ratings even returns themselves. Those are just the traditional data sets that we use to think about markets. Usually, you can put it into a nice spreadsheet, load it up on your computer and make a decision about what you want to invest in.

The bigness of data, however, covers both the size as well as the computing resources that you need to explore that information effectively. We're not talking about the megabytes of a PDF that you might download, or the gigabytes of an update to your iPhone, we're talking about terabytes or petabytes of data that require a huge amount of computing power to be able to understand.

Alternative data can be big or small, but usually it's strange, unstructured, not mapped to an investment that you're trying to analyze. So, if you are thinking about what people are searching for online in terms of a product that they might want to buy, or as Mike mentioned before, the GPS trace in trucks as they're moving through a supply chain or news that is coming out halfway across the world in a different language. What topics are they talking about? What is the sentiment? What companies are implicated by that? All that might be classified as alternative data because it's going to be hard to map to an investment. It's going to be difficult to wrangle, but it could ultimately lead to an informational advantage, that you can use to better make investments. But in order to use it effectively, you need to extract, translate, map, and transform it systematically and at scale to generate alpha.

So, in short, traditional data can be big, alternative data can be small, but by bringing all types of data together with some strong economic sensibility, we'll find value that's often overlooked by others in the market.

Oscar Pulido: Maybe going to the geospatial, you mentioned terabytes and petabytes. I'm not even sure I knew that second word to be honest. But how are you gathering all this information? I understand that it's insightful when you have it, but just gathering it and organizing it must be a lot of what you've spent your time on in these last couple of years?

Mike Pensky: The way I think about our geospatial effort is that it's been trying to marry three disciplines that are actually a little bit different from each other. The first one is technology and computing. The second one is data science, and the third one is economics or finance research. Let me take you through each one of those in turn, just to give you a bit of a flavor of what that means.

From a technology perspective, Josh just talked about big data, geospatial data can be really big. Just to give you some numbers, our geospatial platform up to this point has processed about 20 terabytes of data and we're really just getting started from my perspective. To put that into context, the entire printed collection of the US Library of Congress is about 10 terabytes of data. We've already exceeded that and we have a lot more to go. So, you really need a lot of expertise in computation and technology to be able to run operations on that type of data.

The second one is data science. Some of the data we use is publicly available, some we purchase, but in any case, we need to find ways to actually glean insights out of it.

One very simple example that's been a very important part of our project is trying to tie companies to physical locations. What we've done is we've purchased a database of about 200 million points of interest, so where companies are located around the world. What this database has is detail on what each location is. Maybe something relating to a website address or a description, but it really doesn't map very cleanly to tradable companies. What we've had to do is create data science models that give us a lot of accuracy in being able to map those 200 million locations to 60,000 tradable stocks. That is actually a really hard data science problem, it requires some really complex models, but that again is something that we really need to leverage in this effort.

And then finally, more traditional finance economics research. This is the most nuanced, but maybe also the most interesting. So, we have the data, for instance, NASA, the National Aeronautics and Space Administration, gives us data about the temperatures on the surface of the earth. We get it effectively as multicolored images. we have the data, it's free. So, what do you do with that? How do you actually glean insights?

This is what we do every day. You take some hypothesis, so this might impact economic activity somewhere. We run that through our research process, testing what activity it might impact, test how we might be able to implement that in portfolios. And really the goal is to get a lot of comfort that over an intermediate horizon we can reposition our portfolios in response to that data as we're getting it and benefit our clients.

Oscar Pulido: Do you have a maybe more specific example of how that happens. Because you've talked about the sheer quantity, the two times the library of Congress is what I heard in terms of the processing and you're still going, so you have a lot of data points but being able to make an investment decision from them, and what would be an example of how you use maybe some of the weather related information that you gather?

Josh Kazdin: Let's stick with the example of extreme temperatures just for a moment. In one of our first experiments looking at this topic, we observed that GDP growth in outdoor related industries tended to drop during periods of abnormal amounts of extreme temperatures, either extreme cold or extreme heat. Last summer, we observed hotter than average temperatures in Europe.

This had an immediate impact on economic activity. You can't put a new roof on a house when it's above a hundred degrees outside. You might not want to go to an outdoor event, but both can be moved into the future once temperatures start to moderate.

So, the data that we've looked into suggested that a drop in economic activity can oftentimes be temporary. This rebound effect is something that is often underappreciated in the market, and it creates an investment opportunity. For a macro investor, you might invest differently in European equities versus other opportunities during periods of extreme weather or extreme temperature, and then explore getting back into those positions after temperatures normal.

Mike Pensky: Another example I would give you is measuring the availability of renewable energy. To give you an example about 20% of the EU power generation comes from solar and wind right now and so as a result, the winter of 2021 to 2022 was a little bit of a tough one for Europe because it coincided with both very cold temperatures, so more demand for heating, but also at the same time

as following a period of calmer winds. One of the things we were able to find is that if you intersect the location of wind farms with the amount of wind that blows across them, you can measure how much wind power will actually be generated as a result.

Now intersect that with the extremity of temperatures at that time, and you can get an understanding of the marginal demand that you might see for non-renewable energy sources to plug that gap. And we were able to effectively demonstrate that by using these geospatial elements, these geospatial tools, you can predict what the change in prices of non-renewable energy, such as natural gas might.

Oscar Pulido: So what you're saying, Mike, is that you had information about the weather that gave you insights on the demand for energy, whether that be renewable or non-renewable, and at the end of the day, that just allowed you to make a forward looking decision in portfolios that in the absence of that weather data, you wouldn't have been able to make?

Mike Pensky: That's exactly right, Oscar. And the important thing to also emphasize is that it's not just having the data, but also relating that to the economics implications of what this means. you want to demonstrate that there is increased demand for energy at this point in time, but you also want to demonstrate that there is potentially a decline in marginal supply of renewable energy, which will then require an increased demand for that non-renewable energy source. And that's really what we can trade in portfolios.

Oscar Pulido: You know most people get up in the morning and they look at the weather and influence is what they're going to wear. Is it too hot? Is it too cold? And maybe you guys do that too, but you've also taken this a step further to think about what you're going to do from an investment perspective. Weather's an important component of this, but Josh what else does geospatial data do? Because I get a sense that there's more that it can do than just weather-related insights?

Josh Kazdin: Absolutely Oscar. Once you start looking for geospatial data, you'll see it everywhere. The question, as Mike was alluding to before, is not just what data you want to look at, but ultimately, what economically sensible questions do you want to answer? Most recently, there's been a lot of turbulence in the US banking sector centered around Silicon Valley Bank. One of the ways that we took geospatial approaches to this data was that we looked to see which banks were also exposed to the Bay Area, both in terms of where their physical locations were, but also importantly, the location of where all their deposits were, which we get, data from the FDIC on. This helped us better understand the spillover impacts of the most recent banking turmoil in other parts of our portfolio.

Mike Pensky: Another exciting project that we've just completed looks at trying to understand the evolution of portfolios from the lens of US cities. We often talk about trading country exposures in portfolios but one thing that we found quite exciting is that there's actually a lot of dispersion in economic activity even within, let's say the United States. An example would be, post COVID, there's been a lot of migration within the US particularly as, remote work has become more popular that actually has a lot of important spillover effects.

For example, as more people, let’s say, move into a region, economic activity might accelerate real estate in that market might accelerate relative to another region where maybe that is not happening. And what ends up happening is companies that are in those locations will actually benefit from that increased demand and as a result, you can actually position the portfolio in

response to shifts and economic activity, not just at the global level, but even in very small regions. And this all takes very specific and precise measurements of geospatial economic activity that we can trade within the United States.

Oscar Pulido: I'm remembering an example from a while back. You're probably going to tell me that we've moved on from this a long time ago and it's so much more robust, the satellite images of parking lots of a Walmart and the images would tell you whether there's high economic activity or not. And I think that's an example of geospatial. But you might tell me that we've moved on past that already.

Mike Pensky: I think you're right. When most people think about geospatial, they think of those images of cars in parking lots next to retail locations. But we have moved much beyond that. Hopefully the examples that we've given kind of demonstrate the breadth of the amount of data that we can process and the broad applicability of this. It's not just about retail, it's actually very broad. Where we can trade equities, country exposures, rates, currencies, it has very important meaningful implications that we can map to asset classes.

Josh Kazdin: In all honesty, the possibilities of this type of data are boundless. Some of the biggest questions that we have today in the market are geospatial in nature. What does the world look like after globalization as supply chains trade, start to move more into different regions? what do we think about how artificial intelligence will ultimately be changing production. And are we supposed to be looking at consumption physically as people are going to a mall or online? All these different questions have ultimately a geospatial component to them and to us, geospatial data is the alpha that's ultimately hiding in plain sight.

The ability to take anything from the physical world and map it into your portfolio, discover some economically sensible relationships and then position your portfolio to take advantage of them is a huge opportunity for our clients. It's like the number one rule in real estate, sometimes it's ultimately just about location, location, location.

Oscar Pulido: The statement you made around alpha hiding in plain sight resonates because what you're saying is the information's out there, there are insights to be derived about trends in the economy, trends in markets, but you need, it sounds like, computing power. And there's the two of you, but presumably there's a big team behind this that is helping you process, analyze the insights, but that alpha hiding in plain sight seems to best encapsulate the fact that the information's out there, it's just a matter of having the right resources to be able to derive it.

Josh Kazdin: A hundred percent. And in all honesty, this entire effort wouldn't exist but for a huge team of dedicated, talented, intelligent collaborators. These are engineers, researchers, portfolio managers, all unified by a passion to try to understand what's happening in the physical world so that we can better do financial research using geospatial technology, and help our clients maneuver their portfolios to take advantage of what's going on.

Mike Pensky: And then I'll say I think we are still in the early stages here, one way I sometimes think about this is natural language processing wasn't really a big part of the investment landscape now it's absolutely everywhere. we think it'll take time, but we think that this geospatial idea, these concepts, the data, it'll become much more important in portfolios over time, particularly as the tools are built out, and we're very excited to be a part of it.

Oscar Pulido: Mike, you talked about natural language processing has made a lot of advancements and how we use it. Think ahead the next 10, 20 years for geospatial. What do you imagine it's going to look like and how you're going to utilize it?

Mike Pensky: As I mentioned, Oscar, we're still at the early stages and I think we're going to take incremental steps towards a final vision, to be able to evolve portfolios really as the world turns. In the interim, what are things that we're trying to tackle? Interacting different data sets with each other, trying to use many things happening to predict what will happen then after that point. But ultimately the thing that we would love to happen is the world turns, a bunch of stuff happens on the surface of the earth, and we immediately know how to reposition our portfolios in response to that it'll become much more automatic where we'll be able to interpret these events and actually be able to reposition portfolios.

Josh Kazdin: If you think about today, any news article that you read is going to have a mention of a city or where the reporter is talking from. If you look on social media, you'll oftentimes find a geospatial tagged piece of information about what somebody is talking about, where they're talking about it from, or if they're live streaming from a concert or from an experience that they are having.

If you look at where ships are positioning across the globe and where tradable goods are moving, each one of these have geospatial data within them. And so, we want to be able to use all of that information in near real time to uncover actionable insights that we can use to better invest for our clients.

Oscar Pulido: Outperforming the market is hard work. But just listening to the two of you, it sounds like you're doing some pioneering work that hopefully increases the odds of that going forward. So, Josh and Mike, thanks so much for joining us today on The Bid.

Mike Pensky: Really appreciate it.

Josh Kazdin: Thank you very much.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you've enjoyed this episode, check out our recent episode on the top three tech mega trends for some other interesting developments in the world of investing.

And make sure you subscribe to The Bid wherever you get your podcasts.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido. The digital transformation has been accelerating since the pandemic began in 2020, from fully remote to hybrid, working to the digitization of products and services.

Efforts are underway to integrate digital technology into all areas of business, fundamentally changing how businesses operate and deliver value to customers. It's also a cultural change that requires organizations to continually challenge the status quo, experiment and get comfortable with. Here to guide us through this change and help us look to the future.

I'm pleased to welcome Cristiano Amon, President and CEO of Qualcomm, a firm that has helped develop technologies that make the smartphone in your pocket, the computer that it is today, and that is now taking those same technologies and putting them into everything else from the auto industry to the Metaverse.

Cristiano, welcome to The Bid.

Cristiano Amon: Happy to be here, Oscar.

Oscar Pulido: Well, Cristiano, it's been three years since the pandemic began, and I think many of us were aware that there was a digital transformation going on in the world, although feels like the pandemic made that, more front and center for us as, many of us had to work from home. We found ourselves on video calls and zoom calls.

I'm just curious, was that when the digital transformation began, in your opinion, or when did it begin? When can we point to that being the start?

Cristiano Amon: That's a great question. I don't think it was the beginning but was the acceleration for sure. And there's so many different ways to describe it. I'm going to maybe describe it in a couple different ways. One is immediately when the pandemic hit companies needed to connect to the other people and, no matter where they were, but then they realized they also need to connect to their assets. And that's what we saw, and we continue to see that everything into a company needs to be intelligent; it needs to be connected, it needs to have a digital twin of it in the cloud.

I think the other way to think about it is it has been an ongoing process that the economy is becoming more digital. So, I think those two things are reality and I think what we saw, a significant acceleration of that into the pandemic.

Oscar Pulido: So, what are some examples that tell you that digital transformation is underway?

Cristiano Amon: I think one is cloud connectivity is now paramount. Everything is in the cloud. Your data is in the cloud. Information in general is in the cloud. The second thing is what I mentioned before, a digital twin of everything. It's a digital twin of you, a digital twin of your car, a digital twin of everything else.

And then the second point of this is, all of the processes are being digitized, and I think that creates a significant improvement in efficiency and productivity. Now, here's the interesting thing, we look at the current situation right now in the current macroeconomic environment, and we have not seen that it had slowed down some of the enterprise digital transformation because companies will digitally transform for growth, but they also digitally transform for cost reduction and become more efficient. I think that's really what you're seeing broadly and that has continued into 2023.

Oscar Pulido: Right, so even though the economy may be slowing down or feeling the effects of rising interest rates, the digital transformation is ongoing.

You mentioned at an enterprise level, it's ongoing and the pandemic accelerated it, what's the investment opportunity then? Because when we talk about digitization, it's certainly much more than just digitizing what's on paper. And so, when you think about the investment opportunity, how do you quantify that?

Cristiano Amon: It's very significant. If I'm not mistaken by 2030, we're going to see multiple trillions of dollars in investment in digital and it's really across the board. It's investment in cloud, it's investment in intelligent devices outside the data center.

It's investment in connectivity, and it is very significant. I almost want to focus on how industries are going to be competitive or not. I think there's now this broad understanding that if your industry is not being digitally transformed, you may not be able to compete.

And I think because of that, we see there is an accelerator chase for many enterprises how they're going to digitally transform. And the industries that are not traditionally digital, you start to see the creation of the Chief Digital Officer or those type of positions because it becomes paramount to what their future is going to be.

Oscar Pulido: And so, on that point of maybe focusing in on industries, I know that one of the industries that you speak a lot about, as CEO of Qualcomm, is the auto industry, which maybe some people find surprising when they think of the history of your firm. But how is the digital transformation, impacting the auto industry or how will it impact the auto industry?

Cristiano Amon: That's a great question and actually it has been one of my favorite topics of conversation. Everything that we just talked about it before I can look at what's happened in the auto industry, we can find many examples of that.

So, Oscar, first if you step back and you look what's happening in the industry, investors ask car companies two questions.

The first question is, are you electrical? But the second question is actually the most important one. Are you digital? You know, the car is really becoming a connected computer on wheels, and I think it's changing pretty much everything into the car. Let me walk you to some examples.

First, you have all of the digital cockpit experience, all of those different screens in the car right now, allow for the first time, the car company to communicate directly with their customers. Before that was done by the dealership. Now the car company is in direct contact with these customers.

So, you started to see things in the car, for example CRM systems going into the car. That's our partnership with Salesforce, how Salesforce get integrated into our platform and Snapdragon Digital Chassis. You started to see a lot of services coming to the court, digital services, especially with electrification.

It is being determined that if you have an electrical vehicle, when you're charging, you're spending more time in your car and if you're spending more time in your car, you're going to be entertained, you're going to work from the car the same way that you work from home. And I think all those things are happening as you have those screens in the car connected to the cloud.

The other thing that is happening is now the car is connected with its maker 100% of the time into its digital twin. You get new features, you get softer upgrades, you get new capabilities, you'll buy a car and it gets better over time. And the list goes on and on all the way to what's happening with leading towards a zero-crash environment with assisted driving and what we call ADAS, as well as autonomy getting a scale at really at all tiers. So, it's an incredible transformation with digital technology happening in this industry.

Oscar Pulido: Cristiano, when you talk about that vehicle that you just described, I was picturing myself sitting in this machine that has all these kinds of cool tools. How much of that is actually available now and how much of that is several years in the future. Where are we in that being a reality for most people?

Cristiano Amon: No, it's actually started to happen right now. If you look at some of the new cars they're launching right now in 2023 with some of our digital cockpit platforms, you start to see those beautiful screens, you'll see screens coming from the ceiling of the car and you started to see all of those new services enabled by 5G. It is happening now, but as you think about what's happening 24 and 25, we're now talking about new models in 25 and 26, it gets better and better.

Oscar Pulido: So you're saying it's starting to happen now. We recently spoke to Peggy Johnson, who's the CEO of Magic Leap, and she talked about the metaverse, this blending of our digital and physical worlds. And she talked about how for it to impact the end consumer, the hardware has to get better, the connectivity has to get better, and so we still weren't quite there yet, but you're describing it as like it's actually here already. How do you think about Peggy's comments in terms of what you're seeing in that digital cockpit?

Cristiano Amon: I think actually there's some similarities to what's happening in the car also with what's happening in virtual reality, augmented reality, mixed reality. For example, one of the things that we see a lot of interest in some of the car makers, and I'll come back to this virtual reality thing. But in the car, in addition of all the dashboard and all those screens, you also have a heads up display. You have the windshield and you also have an opportunity to super impose information that comes from the digital side into that display, so it's another area of transformation.

But let's go back to what's happening in the virtual reality / augmented reality space. We've been investing on this for more than 10 years. Virtually now every one of the commercial devices that you see out there for virtual reality, augmented reality, mixed reality is using Qualcomm platforms, a great example of that is the Quest devices from Meta.

We recently launched Pico, with ByteDance in China, and there's a number of other devices out there being built or launching. That concept that you just brought up, this is what's happening. You are going to have the connection between a physical and the digital world.

And for us, we can see that information in some of those experiences with glasses as a natural thing. So, the technology is going to cycles and if you look at some of the new devices that are being launched right now, they're significantly smaller. We know that humans are going to reject if you have to walk around

the street of a big helmet, but if you have something that is significantly smaller, then people are going to use it and then the potential is really incredible.

Let me give you an example of something simple. We used to make phone calls but then in the 4G era as the phones became computers and your smartphone, we started to text people and we communicate [via] text. But now we had the pandemic and now we hold the phone in front of us right now to do a video call. It's a very well understood technology challenge that we can do today, if you have a glass and I'm going to call you and I'm just going to render a hologram of you right in front of me and we're going to have a conversation, as simple as have a phone call like you right in front of me.

And so, I think the potential for this technology is very big and it could be as big as phones. We see a lot of interesting developments with this across all of the different ecosystems, and I don't think that reality is that far. If you look up what Meta has done, they already have critical mass, it was significant to have a lot of developers. There are some interesting enterprise applications. For training, for education, you have the ability to have collaboration tools and I think we're in the very beginning of something very big which is going to be the metaverse.

Oscar Pulido: I'm just old enough to remember the phone that you were describing that was clunky and big to hold. And certainly, when you think about how that piece of hardware has gotten smaller, lighter, and the transformation it has on people's lifestyles, and that's consistent with what Peggy said around as the hardware gets lighter, it becomes easier to use and therefore has a bigger impact on consumers.

So you touched on the auto industry and you painted a really interesting picture of how car manufacturers now can get better data about their consumers. Can we talk about maybe another example, the industrial sector? How is this impacting manufacturing or retail, this digital transformation?

Cristiano Amon: When we look at the diversification of Qualcomm and if you look at what we're doing right now in addition to mobile, the automotive industry, we have this very broad IOT category and one of those elements in the IOT is the industrial.

And we're starting to see a lot of demand because of the impact that it has on all those different verticals, one of those verticals is manufacturing. As a matter of fact we used to count our customers on two hands in mobile, and then at some point we're counting them on one hand. In industrial, we have over 16,000 customers today, and it shows how much, the potential is for our technology to be part of the digital transformation.

Let's go to your question, which is manufacturing, and is a very profound change enabled by technology. So you look into a factory floor facility and all you can do, you can connect every one of the equipment. Even the software that you are going to run on a robot, you can run that from the cloud, connected with technology such as 5G.

A couple things that changed, the name of the game in the nineties, you build the biggest factory you can build in Asia, and you're going to have the lowest conversion cost, and you have the higher productivity for your fixed capital. Now, if all of your equipment is connected to the cloud, you can have distributed manufacturing, you can have smaller factories all controlled by the cloud, and you have the economies of scale having a bigger factory.

It's changing how people think about manufacturing is actually bringing factories back to regions that would not have the ability to, because competitive. But that doesn't stop there. You have the ability in the factory floor to use those technology, you have handheld devices, you have the ability to use the same robots to do more than one product, you reduce the cost of re-tooling the factory if you have short product cycles because everything is wireless. You don't have to rewire the entire factory. And then you have also big data and how you use data and analytics to continue improving your process. So, it's a very big transformation and one that is also underway.

Oscar Pulido: And so, as companies and industries participate in this digital transformation, what are the cybersecurity risks that, they should be thinking about or that they're asking you about as they undergo this shift.

Cristiano Amon: Great question, Oscar. Especially if we think about everything becoming digital, everything's cloud connected, the surface area is now much bigger. One thing is somebody hacks into your phone and another thing is you have this technology now on the grid for the utility companies, you have the technology now on healthcare, you have the technology on manufacturing. I think that's both a challenge as well as an opportunity. One of the largest investment areas we have in our chips is security. Where do we store important things such as credential and biometrics? How we do it with encryption, how we do it with multi-factor authentication, how [do] we do softer attestation?

One of the things we just announced was a solution for industrials called Aware, which is a cloud layer that connects to the chips. We announced the Aware Signature, when you actually can validate that the software running on the chips has not been modified, and you can attest to the safety of the software. So, it's going to be an opportunity for innovation, it's going to be an opportunity for investment, it's going to be an opportunity for differentiation, but that's part of becoming digital. Security needs to be front and center.

Oscar Pulido: Maybe I can also ask you about AI, artificial intelligence, which is a buzzword now, and how does it fit in the context of this digital transformation?

Cristiano Amon: This is one of the biggest opportunities we have in front of Qualcomm right now, and I may not give it justice to the size of the opportunity the way I describe it - it could be transforming our company dramatically. So, things that are happening with AI, as AI is evolving and evolving fast, and you look at those Large Language Models, for example, like ChatGPT and you look of how those new models work. You have a very Large Language Model, you have to run them multiple times when you do those queries and you have the opportunity to do not only text, but it's going to be images and video and the reality is you're going to have to run those things locally into the devices.

You won't be able to scale into the data center. A simple way to describe this. If you do something as simple as a search and now, you're going to do a search by chatting with the search results and asking queries, you significantly increase the cost of the search because the computational power, so you have to move some of that to each individual device. This is now one of the fastest growing silicon areas for our chips, we're building very large capacity, very efficient processors because of our phone DNA, you have to run the very high-performance computation, but you cannot compromise on the battery life, and I think that's an opportunity to bring AI to everything.

I actually believe that in the same way that we have upgrade cycles, driven by the transition of a feature phone to a smartphone, the transition of a 3G to a 4G, to a 5G. People are going to want to build a new device, a new smartphone, a new computer, a new car just based on AI capability.

Oscar Pulido: So, Cristiano, you paint this picture of the digital transformation impacting so many industries now, and then what's coming in the future. And I, I said before I was old enough to remember that big phone, I'm also old enough to remember like an old school record player and it makes me think that maybe there are some things we don't want to digitize and some things we like to have in the analog version. So, as you think about this transformation going on, what are some of the things that you think we should keep in kind of analog form?

Cristiano Amon: That's a great question. Well, first, let's just hope that restaurants and, food places continue to be analog, it's going to be horrible if it's digital, but you know, it's an interesting question. I like to answer this question, when you think about something as simple as wrist to watches, right?

You can saw what happened from mechanical watches, going to digital watches, but you still have some charm and something special about mechanical watches. And I think some of that's going to happen, it's like vinyl coming back. So personally, I do a lot of work with the automakers to transform the car into a digital connected computer, but I have a passion for muscle cars from the seventies I'm restoring too. And those are all analogs and they are fun!

Oscar Pulido: Sounds like there will be room for both in the foreseeable future based on customer preference. Well, Cristiano thank you so much for joining us on The Bid today.

Cristiano Amon: Happy to talk to you.

Oscar Pulido: Thanks for listening to this episode of The Bid. If you enjoyed this episode, check out our episodes on the Metaverse with Peggy Johnson and the top three technology megatrends.

And don't forget to subscribe to The Bid wherever you get your podcasts.

Oscar Pulido: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance. I'm your host, Oscar Pulido.

Recent events in the banking sector around SVB and Credit Suisse have made clear the importance of staying nimble as investors. The old investment playbook is out and a new regime that considers high inflation and interest rates is in. Here to explain what investors can expect in Q2, I’m pleased to welcome Wei Li, Global Chief Investment Strategist for BlackRock.

Wei, welcome to The Bid.

Wei Li: Thank you so much, Oscar, for having me. I'm very excited to be here.

Oscar Pulido: Wei, the markets have given us quite a ride already in 2023. And just taking a step back, it feels similar to 2022, not so much in terms of the returns across asset classes but what is driving those returns. Last year we talked a lot about macro drivers in the market, so things like the Fed, interest rates, inflation, that seemed to have a big impact. Would you agree that this year is more of the same?

Wei Li: Absolutely. So, if you think about the whole of 2023, so far it has been a very macro market, right? So, if you think about the US market, for example, more than 90% of the year-to-date return, were driven by seven names. Mostly tech names. So, we're talking about, the market being a very macro driven and duration driven type of market so far this year which is, I think intuitive in that what we have seen is significant rate moves translating into parts of the equity market that are duration sensitive, reacting and overreacting.

But our expectation is that the focus of market would shift from the broad brush, the prevalent market narrative being rates and duration and top down, back to fundamentals, back to basics, and back to earnings.

And on that basis, if you think about, the trends that we expected coming into this year, so specifically I'm talking about earnings would come under pressure and margins would compress, they're actually playing out. If you look at the last earnings season, for Q4 last year, it was the first quarter of earnings contraction since late 2020 for the US Equity market. And we have seen negative operating leverage, we have seen decreasing margins.

So, all of those trends they are playing out. It's just that actually markets were not taking note of that because the prevalent narrative of the market is very macro driven rather than micro driven. But it is my expectation that focus will shift to earnings and micro and fundamentals and basics over time as we look at the rest of 2023 because over a longer period, indeed it is the earnings that very much determine how equities would perform.

So just to put the year-to-date markets into context and frame that in a very macro perspective, but I do think that earnings will matter more and more as we navigate the rest of the year.

Oscar Pulido: So, as we enter the second quarter of the year, I can't help but think back to some of the themes that you and other members of the BlackRock Investment Institute have mentioned over the past year. You've talked about the end of the great moderation and the beginning of a new market regime that we'll see higher volatility across things like interest rates and inflation. You've also talked about how the investment playbook of the past may not apply going forward, specifically as it relates to central bank policy. So, take us through how your thinking has changed on some of these fronts.

Wei Li: That's a great question, Oscar. It’s a great question because it's important to take stock right now in the second quarter of the year.

As we entered 2023, the overall framing that we had is that this year is likely going to be on aggregate a better year for risk assets in comparison with 2022 where we had bear markets in equity than bonds. And the reason why we had that view and why we continue to have that view, is because we think that the inflation is falling, but parts of it will stay persistent. That's number one.

Number two growth is falling, but we're talking about a shallow recession, so not a deep and protracted one.

And then number three is central banks instead of hiking rates aggressively at some point this year they're going to pause and that is a different type of environment versus surprising on the hawkish side throughout the course of last year. So that's number three.

And number four for why we think that this year on aggregate will be a better year for risk assets is that China is restarting and reopening versus being in lockdown for 2022.

So, sitting at the beginning of Q2 and revisit all this framing that we had at the beginning of the year, what has changed? Did any of this change, let's go through them one by one.

Inflation is falling, yes, indeed. But also, our expectation that parts of inflation are persistent. And that's getting more and more appreciated. At the beginning of the year, there were hopes, not our hope, but there were hopes in markets that inflation would just fall down to target without pain to the economy. And I think that's now looking less and less likely and being appreciated as well. So, inflation is falling, but part of is persistent. So, we haven't changed our view on that front. And I think that's more embraced now, as we see evidence of a tight labor market and sticky core inflation.

On the second point about growth slowing down, I think the time horizon over which recession would kick in, I think that has been pushed out a little bit versus expectation at the beginning of the year, given resilient consumers- you look at retail sales, for example. So, we still think that recession is coming but instead of Q2/Q3, maybe second half of the year is looking, more likely given the resiliency in the consumer side of the economy. I would say, though, the banking turmoil may represent a downside risk that would take time for us to fully understand the magnitude of this banking shock and related credit crunch.

But I would say recession core is still in place, but maybe pushed out a little bit more versus expectation at the beginning of the year.

Central banks, we're getting close to peak in Central Bank rate hike cycle, that we have not changed. But markets are hoping that central banks would come to the rescue of the economy with markets currently pricing two rate cuts into the end of the year and two, three rate cuts heading into next year -that we don't think would happen.

So, we're still leaning against market hopes for rate cuts this year. And that's, why we have been modestly underweight parts of the equity market because markets are hoping for the old recession playbook, and

central bank's cutting rates. I just don't think that would happen for this year precisely because of the inflation dynamics. So that's point number three.

China restarts - we had a view that China growth for this year would have a six handle, and that was our view at the beginning of the year. I think consensus is moving closer to that now, and the momentum for China restarting is being more appreciated. So, we haven't changed the view, but I think it's becoming more and more of the consensus.

But what would say didn't quite appreciate is how strongly sentiment wanted to embrace the rebound. So you think about the strong momentum coming into 2023 our assessment is that it was really a fear of missing out rally, right? I hear from, clients and investors, across the world, that last year was really hard for portfolios because Equities were down and bonds were down.

So, it would be very costly, after experiencing last year, to miss out on a rebound, which is why some are positioning for the rebound, whilst recognizing that things could get worse before it gets better, and we could be heading into every session before we come out of it.

And yet some are already positioning for that rebound, and I think that fear of missing out is that sentiment boost to market. And it's always hard to quantify things like that, but I think that's the missing piece so far this year as I revisit what transpired in the first quarter.

Oscar Pulido: Way. You touched on 2022 and how tough a year it was for both stock and bond investors, but also you shared the view that 2023 would be better. Can you talk a bit about bonds in particular? I think this was an area that most surprised investors last year, and specifically the losses they experienced in their bonds. So what opportunities are you seeing now in this particular asset?

Wei Li: I think bonds are more interesting now because income is finally back. So, if there is one silver lining out of a very traumatic year, that was 2022, is that, yeah, you get paid now. For sitting in reasonably, no risky fixed income assets.

For the most part of last year, and for most part of this year we were close to maximum overweight investment grade credit, so quality credit. We trimmed that maximum overweight to modest to overweight to take some profit because spread has tightened quite a bit. But that idea of being paid for taking very little credit or duration risk, for that matter, is very appealing.

So I, like bonds on aggregate, but specifically front end of the curve- very front end, I'm talking about T-view in the US treasury market, as well as still a relative preference for quality credit over high yield, credit given our view that we are still heading to a recession and default currently tracking at a low single digit could go up a little bit, and that could impact high yield bit more than investment grade.

I would say last thing about investing in bonds, we currently also have a relative preference for emerging markets that over on aggregate developed market bonds because, emerging market central banks, they were ahead of the curve in hiking rates coming out of the pandemic to the extent that they now have a bit of a buffer, the number of emerging market central banks that are hiking rates is decreasing. And some of them are even talking about cutting rates. So, there is something there that makes emerging market that bit more attractive. And also, if you look at traditionally the excess return for emerging market debt versus their developed market equivalent, that tends to be proportional to the economic momentum of the emerging market economies versus developed market counterparts.

And currently given the restart, that is happening in emerging markets, and also specifically in China, that is boosting the relative growth momentum in emerging market, which is another reason that we favor emerging market debt.

But more broadly, just to say, income is attractive in bonds for once. After waiting for decades of very low yield, that makes bonds more attractive compared to before in developed world preference for very front of the US treasury market. And also, still a preference for, IG quality, credit over high yield and emerging market debt looks quite okay

Oscar Pulido: Okay. Got it. So it sounds like there are definitely opportunities in the bond market. You mentioned the shorter end of the government bond market. You talked about investment grade. You mentioned emerging markets. You've also talked about inflation, and I just want to come back to that. You said earlier that it is falling, but it will remain persistent.

And I want to come back to this theme of living with inflation and this concept that central banks won't be coming to anyone's rescue. So, what is it going to look and feel like for investors right now in terms of living with that kind of inflation?

Wei Li: Yeah, we're going to be living with higher inflation, higher than pre pandemic levels of inflation for longer than many expected.

And I think if you look at market pricing markets are under appreciating the degree to which we're going to have to do that. If you look at 10-year break even at some point it was just about 2- 2.1%. in our view in the US 3 is the new 2 in terms of where inflation would settle.

So, part of the new investment playbook is being more dynamic, it's being more frequently assessing your investment views. So, when market dislocation like that present itself, we leaned into it and we added to our inflation-linked, bond, preference even more. So now actually looking at the market pricing 10-year break-even is now comfortably above 2.3.

So, we have what we view as a target level as we think about where things should settle and if market dislocation present opportunities, we take advantage of that. That's point number one.

Point number two, you are absolutely right, Oscar, where in an environment where there are structural forces, that means inflation.

It's going to settle at a higher level than what we got used to previously. And that is considering some of the cyclical forces driving inflation down, right? So, we're talking about goods, deflation, like goods, service rotation coming out of the pandemic is bringing part of the inflation mix down.

But structural forces like aging demographics, labor shortage, geopolitical fragmentation, and the net zero transition, which ultimately is a series of supply shocks, means that inflation will settle at a higher level, which is why as we think about portfolio construction over both the medium and the long term, we need to think about inflation protecting our portfolios, which is why we think we’ve got to dig one layer below the debate of 60:40, 40:60, 50:50, or whatever it is, we actually need to go into another layer of granularity and think about, yes, 60:40, 50:50, but what is your 60, what is your 40 bonds? But it's, going to be more granular than that. We have a preference for inflation links, bonds over long duration nominal bonds for the reason that I just talked about in that market pricing, is under appreciating that we're going to live with higher inflation than before, but also thinking about the role of real assets in portfolio construction from the perspective of inflation protecting your portfolio.

So, as we evolve portfolio construction, think about real assets, private markets, but of course also recognizing the higher rate environment, what does that mean? But also thinking about, going one layer below and thinking about what your bond allocation should be and currently we have a preference for inflation linked bonds over normal bonds.

Oscar Pulido: Well, it sounds very consistent with everything that you've been saying about the new investment playbook that is required going forward.

So, Wei, thank you so much, for all these insights and thank you for joining us on The Bid today.

Wei Li: Thank you so much for having me, Oscar.

Oscar Pulido: Thanks for listening to this episode of The Bid.

Next time on The Bid, Cristiano Amon, the CEO of Qualcomm, joins me to talk about the digital transformation that is underway and how it will transform industries across the board.

If you’ve enjoyed this episode, why not share it with a friend and subscribe to The Bid wherever you get your podcast.

Anne: Welcome to The Bid, where we break down what's happening in the markets and explore the forces changing the economy and finance.

I'm your host, Anne Ackerley, Head of BlackRock's Retirement Group. As we continue this mini-series, during Women's History Month, The Bid welcomes four senior female leaders of BlackRock and their guests for four special crossover episodes in partnership with my colleague Samara Cohen's LinkedIn video series, In Progress. I'm excited to continue this mini-series as I speak to another incredible leader about progress and purpose.

I'm pleased to welcome Dr. Lucy Marcil. Lucy is an assistant professor of pediatrics and associate Director for Economic Mobility at Boston Medical Center. She is the co-founder and executive director of Boston Medical Center's Street Cred Program, a non-profit providing anti-poverty financial services in pediatric waiting rooms. Dr. Marshall is also a TED Fellow and the recipient of the American Academy of Pediatrics Anne E. Dyson Child Advocacy Award.

Wow, Dr. Marcil, welcome and thank you for joining me today,

Dr Marcil: Thank you for having me, Anne. I'm very happy to be here.

Anne: Why don't you tell us about street cred and the work you're doing there?

Dr Marcil: Street Cred is a program designed to help improve financial wellbeing as a part of pediatric well childcare. We focus mostly on infants in the first year of life because that's when we have the most access, they come in and see us seven times. And at each of those visits, we deliver a bundle of economic services focused on building economic stability and asset building so that children and their families can be healthier and thrive.

We currently have about 225 babies enrolled in this program. And we've been operating since 2016. one of the services we provide is tax preparation. We've done about 6,000 tax returns and returned 14 million to families.

Anne: I mean, wow. Talk about meeting people where they are. What prompted you to start this program?

Dr Marcil: Really it was a patient driven innovation. As a pediatrician, I see every day that health problems kids come to me with are often driven more by their environment, their life circumstances, than the biology within their bodies.

So, for example, a child with asthma might keep coming back with asthma flares because the housing in which they live has a lot of mold in it, or there's air pollution in the environment around them. I give them an asthma inhaler, but it only temporarily helps. It doesn't really fix the problem. And sometimes parents can't even afford that inhaler.

I was frustrated by this and felt like we really need to address one of the root causes, which is poverty or financial instability. I knew that there was a tax credit called the Earned Income Tax Credit that is the largest cash transfer program available in this country but that 20% of families don't get it at all, and 60% of families who do, miss out on hundreds of dollars because they go to for-profit tax preparers.

In 2015 A colleague and I started talking to patients about this, trying to find out, do they get this credit? Do they know about it? How do they get it? Found a lot of mothers were not getting it, they didn't know about it, they maybe weren't even filing their taxes. We started trying to refer families to community-based free tax sites, thinking that would be a great solution.

We had a mom who took her infant and toddler on two buses and a train across town to this tax site. It was closed. She went back the next week because she was determined and found out that she was missing a key piece of documentation so they couldn't do her taxes.

Dr Marcil: But when she came back for her baby's next visit, she said, I have to come here all the time. Why couldn't you have just done this here for me? Why did you have to send me across town? So, she inspired this work. We thought that's really smart of you to want to do something that. makes better use of your time in a place you have to go anyway,

So, we started doing taxes. And then over time wanted to build on that and incorporate other underutilized financial services that could get families cash, things like food supports, food stamps, paid family leave, college savings accounts for children, asset building tools through housing. And that's where we're at!

Anne: It's such an incredible story and in some ways. so obvious and in other ways, so not obvious, that you could do this. But as I think about it, packaging financial services with pediatric care really requires trust. how did you, begin to build trust with your patients, in, what you were doing and in this program?

Dr Marcil: Luckily patients generally trust their doctors, which is what we wanted to take advantage of - people are used to talking to their doctors about very sensitive topics.

But money isn't usually one of them. So, we weren't totally sure if that trust would translate and kind of took a leap of faith and started asking patients, 'would you want to talk to us about this?' And interestingly, there have been a couple surveys now done. About 70% of families say, I do want to talk to my doctor about my financial status.

And they recognize that impacts both their physical and their mental health. So, we took advantage of that preexisting trust, and then we made sure in our model to build in longitudinal in-person relationships. We know that that really matters for trust- having that in-person connection, meeting someone every time they come into a visit, we found that that really helps build trust.

And the other thing that's very important and probably obvious is that we focus on trying to have a team that reflects the patient population we serve. So, making sure that we have shared language capacity, shared cultural background as much as possible so that patients feel like they can relate to the people who are serving them. You talked a little bit about the connection of health and wealth, that people are willing to talk about money with doctors.

Anne: So interesting. Where are you starting to see success in this connection bridging health and wealth, and as you think about the work that you're doing how do you think it's going to impact your patients' families and their futures?

Dr Marcil: There are a couple examples. The first is taxes. That's what we've done the longest, and we certainly have found that on average, get families back 2,500 to $3,000, but we can do up to three years of past tax returns. For some families, we get them $10,000 back at once, and that clearly has a huge economic impact, but it's not just the immediate money that they get back, it's also the accumulation of the effect.

We educate people about the fact that the earned income tax credit is actually designed to encourage work. The more you work up to a certain amount, the more money you get back. The maximum credit is about $6,600, and then it plateaus. This is very different than most public benefits, like say food stamps, which every dollar you earn decreases the amount of food stamps you get.

And one example, I had a mom, we did her taxes. She was working part-time for the government she said to me afterwards, 'wow, I didn't realize that if I work more, I get more of this credit back. I'm going to ask my boss tomorrow if I can work more hours' and so that is empowering to her and it also is going to have an accumulative effect so that over time as she works more hours, she makes more money, there's more economic stability in her family over years.

Another example would be the 529 college savings accounts we've been helping patients open. Our state Massachusetts as well as I would say about half of the states in this country now offer, an incentive to open an account.

So here in Massachusetts, if you open an account in the first year of life, the state will put $50 in, which isn't a ton of money, but certainly it's an incentive. Most of our patients have not actually, ever invested money. So, there are a lot of barriers to families taking advantage of this. Nationally, families who have 529 accounts tend to be white college educated and higher income earners.

The families I serve 90% of them are in Medicaid, about 40% of them are immigrants or English is not their first language, very low-income populations, majority of them identifies either black Hispanic or Latina, definitely do not fit the demographic profile of the typical 5 29 account holder.

We have found in our work opening 5 29 accounts that we're able to get about 20% of families opening accounts compared to about 3% nationally who hold these accounts.

And we know that having a college savings account, even if there isn't, money in the account or there's only a dollar in the account, is associated with three times increased likelihood of going to college and a similar increase in likelihood of graduating from college.

There's a study in Oklahoma that showed when the state put money into these accounts, it was associated with a decrease in maternal depression and an improvement in child, socio-emotional wellbeing at age four.

And that clearly is before they have access to the money. So, you might wonder why? Our thought is that it gives families hope and it creates a growth mindset. The sense that someone is investing in their family and that their child does have a chance for a better future. So, our hope in helping families open the accounts as that there will be a similar effect down the road. Parents are very enthusiastic about helping their children build a better life.

Anne: Wow, there was so much in there about the impact that you're having, and it makes me think a lot about getting people, the information they need when they need it to empower them, is just, so important and removing some of the frictions that keep people from taking these actions.

Maybe switching subjects a little bit, you work with women every single day, it's Women's history Month, but can you talk a little bit about some of the discrepancies that you've seen both medically and financially, with respect to women and, how do you think we can overcome them?

Dr Marcil: Yeah, that's such an important topic and there's a lot of work to be done in this area. The vast majority of parents that I see are women and women identifying. We certainly see some parents who, identify as non-binary or who are men, but, probably 90% of the parents I interact with identify as women.

They face a disproportionate burden of childcare in terms of the impact on their bodies, they have been pregnant, they have given birth, and also in terms of after having the children. Many of the parents, I know all of them that I see are raising children by themselves. So, there may be a partner who is involved but doesn't live with them, or there may not be a partner involved at.

Often there's multi-generational family members helping parents take care of their children, but the mother has the primary responsibility, which I think is probably on average true around the world. That is a lot of responsibility, on their bodies, but also on their physical lives. And understandably, that takes a toll on their health.

Pregnancy is inherently risky. It is associated with worse health than not being pregnant. There's a risk of death, and as you've probably seen in the headlines nationally, black women in particular, even when they're wealthy and well educated, are at increased risk of death from pregnancy and post -partum.

But having a child also impacts ability to work. Unfortunately, in this country, we do not have access to good, affordable childcare for many families. And on a daily basis, I see moms who really want to be working, they want to have a career. They understand not only that it's important for their family's economic stability, but for their own development and growth. But they can't afford childcare or they have a job that has erratic hours and that's a huge barrier.

Unfortunately, many women I see quit their jobs when they're pregnant because of the health problems they're having and because they know they're not going to be able to have childcare with the intent to start working again later. We know for women across the economic spectrum that quitting jobs then leads to backsliding in terms of wage potential and career trajectory.

So, it's kind of a depressing picture I just painted, but I do think there's a lot we can do.

One example is in Massachusetts, we do now have paid family medical leave. It's a state policy depending on the specific situation, women can get up to six months of leave, both for medical problems and for taking care of a new child. Non birthing parents can also get paid family leave. So, this is a super important policy that unfortunately we are seeing inequities in how it's being accessed. A lot of the parents I work with don't know about it and they're not taking advantage of it.

And then the last thing I'll say about this is that educating and empowering women around these topics is really critical. So, we actually right now are running a financial coaching group for parents all the parents who are participating identify as women, and they have told us how empowering it is to have this financial knowledge, but also to have an hour a week where they are not primarily taking care of their children.

We're providing childcare during these sessions and are just able to connect with other adults and think about adult topics like their finances. Financial literacy is something that could be embedded into many aspects of our society, and unfortunately, it's not. And so, it is something that we could be doing more of.

Anne: Going through my mind so much is the impact of, childbearing and childcaring on women that isn't just in the moment when they're having their kids or their kids are young, but it actually follows them all the way through their life.

And I'm the Head of Retirement and think a lot about women in retirement and this notion that women have to take off and not always have paid work to care for children, winds up showing when they get to retirement the money that they've been able to save is often, at least in America, 30, 35% lower than men. So, this is something that continues throughout their lives and I'm so with you on we need more paid childcare, and we need to make it easier for women to work and to have children.

Just so much in there and I love that you're empowering women, with knowledge that they're able to use to make their lives better.

So, moving on, one of the themes of Women's History Month, the series that we're doing, is really about purpose. And so how do you think about, the purpose in the work that you are doing?

Dr Marcil: That's a great question. My foundational belief is that everyone deserves the opportunity to have a good life. Right now, our society is structured such that that is not the case. At birth some children are inherently unlikely to thrive because of their race, their economic status, their family composition.

And so, the purpose of my work is to change that fact. Not just because it's the right thing to do ethically, I mean, it definitely is and that is my primary driver, but also because it's the right thing for our country. We cannot continue to thrive as a society when a substantial minority of our population is struggling economically and in respect to their health.

There is a huge financial case for this that you probably understand better than I do. There are great economic losses when we have this chunk of our population that isn't thriving economically, that isn't healthy, and children that are then not going to grow up and be able to contribute to the workforce and have health problems.

There is a financial case for that and as well as the kind of human rights argument, but that's the purpose of my work.

Anne: Stay tuned because BlackRock is soon to publish a report about, if we could fix some of these things, the impact of women in the workforce and what it could contribute to the overall economy. So, you're right, this is the right thing to do, but it's also important for our country in terms of continuing to be able to grow and make sure everybody can have the lives that they want to live.

I would imagine that it might actually take time to see the impact of what you're doing. How do you think about progress and measuring success?

Dr Marcil: Right. what. You just said is so true about pediatrics in general, that we struggle to quantify the impact of our work because often you don't see it for another 18 years. Children in general are relatively healthy compared to adults, so they're not that expensive to take care of. Health insurance and healthcare systems don't invest as much in them as a result because there isn't that upfront cost and they don't want to pay for something, they're not going to see a return on for 18 years.

So, part of it is just faith in the process. I know that investing and making sure an infant is at a healthy weight is getting good nutrition, is being emotionally nurtured appropriately is going to lead to a healthier, thriving adult.

Dr Marcil: But I also rely in the short term on the numbers of people we're serving and the metrics -how many tax returns we've done, how many accounts we've opened, how many connections we've made, as well as direct feedback from families. I am a practicing clinician, I see patients on a daily basis, and they often spontaneously give me feedback on the work that we're doing. And so that in itself, regardless of what happens in 18 years in the moment, it's been empowering to that family and that matters. I put all those things together and feel assured that the work we're doing is important and has an impact.

Anne: I'm so inspired by what you're doing. As we come to an end what piece of advice would you give your younger self, starting off in your career?

Dr Marcil: I think I would tell myself to stick with my gut and to follow my convictions. I say that because when I was young as a child and a young adult, I actually had the least self-doubt. I was very confident and sure of my vision and what I was going to do.

Medical training is a system that's really designed to mold physicians into a very specific career path and build specific characteristics. I don't exactly fit that mold, I'm a bit of an entrepreneur and innovator and throughout that process I did get feedback that maybe I should try to be a little bit more traditional. And it took me on a journey of doubting my convictions and trying to conform, but then coming back more recently to that conviction to follow my gut and my vision.

So, I would just say that believing in that internal clarity that you have is really important and not to get dissuaded by others.

Anne: That is great advice and thank goodness you are following your gut because you're doing really terrific work. I just want to thank you for the work that you're doing and really thank you for all the time you've given us today.

Dr Marcil: Thank you so much for having me, it's a delight to be here and I've learned a lot from you too, and I'm excited to read that report that you mentioned that's coming out soon.

Anne: Thanks for listening to this episode of The Bid. If you haven't already, check out the previous episodes in this four-part mini-series featuring some other inspiring female leaders as we celebrate Women's History Month.

And make sure you subscribe to The Bid wherever you get your podcasts.

Mark Wiedman: Welcome to The Bid miniseries, The Real Leaders of Net Zero, where we talk with CEOs about what they and their companies are doing to move the world to net zero. I'm your host, Mark Wiedman. On this episode, I'm joined by Josu Jon Imaz, CEO of Repsol, a global multi-energy company based in Madrid, Spain. In 2019, Repsol was the first oil and gas company in the world to announce its commitment to be net zero by 2050.

Why did they make that decision? What's their plan to get there? We'll talk upstream and downstream, electrification versus decarbonization, and why technology is the biggest ally in this ambitious effort. Josu Jon, welcome.

Josu Jon Imaz: Thank you, Mark.

Mark Wiedman: Could you give us a quick overview of Repsol and explain upstream versus downstream in your operations?

Josu Jon Imaz: Repsol is an energy company, based in Spain. We were an oil and gas company that six years ago started a journey moving towards a multi-energy view, providing to our clients all the energies they need: either hydrocarbons, gas and also renewable power either for electric mobility or to be used at home. We were from the very beginning a company with more downstreamers, let me say, than upstreamers. Downstream in our sector means all the industrial activity, in our case it is: refining, chemical plants, LPG plants (and so on) and all the distribution and commercialization businesses we have to be very close to our clients. That means our service stations and also the retail power business. We have our main downstream activity in Iberia, (Spain and Portugal), also in Peru. When we talk in our business about upstream, we are talking about the exploration and production activity of hydrocarbons, so that means oil and gas. Because Spain is not an oil producer country, we have, of course, an international footprint that is mainly based in North America, United States and Canada, and Latin America, where, because of our historical language, linkages, etc., we have a strong presence. We have an exploration and production activity in the North Sea (UK) and Norway, and also in Northern Africa, Algeria and Libya. On top of that, we are also in South Asia, producing gas in Indonesia. Let me say that we are mainly gas producers, that means that two thirds of our total production in what we call the upstream, the production of hydrocarbons, is gas. Natural gas is a really important fuel at home in terms of security of supply as we are seeing today, but also in terms of transitioning and reducing the carbon footprint in the world. We were the first oil and gas company in the world committing with a 2050 net zero target. We launched that commitment in 2019. We have a clear pathway to get these targets.

Mark Wiedman: So today you're about 2/3 in oil and gas. You expect that number to drop as you've made that commitment to get to net zero by 2050. Why is decarbonization part of your business and part of your strategy?

Josu Jon Imaz: First of all, because we know that we are part of the problem, because hydrocarbons (they) are CO2 emitters. We want to be part of the solution, that means that the world has an important concern related to the emissions of greenhouse gases and this kind of emissions have to be reduced, so we have a clear commitment to do that. It's important to measure this effort, so to know what we have to do, we have defined an indicator. (We are in some way, engineers, chemists, and so on). That is called the carbon intensity index. That is some way of measuring the total CO2 emissions we produce, not only in our operations, also taking into account the CO2 emissions of our products that is produced by our clients, divided by the total energy we produced, including here, oil, gas, renewables and so on. Talking about 2050 is easy, because it's far, but it's also important to have clear milestones and targets to evolve year after year. That means that by 2025, we are going to reduce by 15%, this carbon footprint and 28% by 2030. By doing that, we are going to be aligned with the effort that the world needs to fulfill the Paris Agreement targets.

Mark Wiedman: From a public policy perspective, I completely understand why we need to shift under the Paris Agreement, but as a CEO, as a steward to your shareholders, why do you care about reducing your carbon emissions?

Josu Jon Imaz: Because I don't want to have a profitable Repsol in 2021- 2022. I want to guarantee that we are building a company that could be profitable in 2030, 2040. Being profitable in the short term, having profits in a quarter, is quite easy. In some way, the dilemma of a CEO is to try to combine both targets. I mean, being profitable today, delivering today, but at the same time, paving the way to be profitable in the long term. To do that, you need, in some way, first of all, to have a clear vision about what to do. Second, to build, let me use the term, some kind of coalition, where you have to include your employees, the high management of the company, your board that has to support this view, because sometimes you are going to suffer in some metrics in the short term to get these targets. And, of course, your shareholders, they have to be part of this narrative, saying that today at 40% of the current institutional investors of Repsol are investors sharing these ESG targets. That means that they want to invest in companies that are not only focused in having profits in the short term, but also building the foundations for being profitable in the long term. So, let me say that we are doing that also to make money today, but mainly to be able to make money in the future.

Mark Wiedman: Why is decarbonization the key for oil and gas companies for making money in the future? 

Josu Jon Imaz: We have to gain the license to operate. The world is changing. We have to think that the world is going to develop a great effort to reduce the CO2 emissions in the future. I mean, otherwise we are not going to have a solution in terms of temperature increasing, climate warming and so on. That means that we have to think that the oil demand, not now, not perhaps in five years, but in 20-30 years, is going to be lower than what it is today. New forms of energy are appearing and these forms of energy are going to be part of the energy basket that our clients are going to use, so I think that it makes sense, first of all, to leverage in the current client base we have to build this new business. I'm going to put you an example, I don't like to be very theoretical sometimes. If we have 24 million clients in Spain and Portugal and we are selling them today gasoline, diesel, LPG at home and so on, it makes sense to start offering not only the diesel they need for a car, but perhaps the electric recharging service that they need for an electric car that is starting to be part of the current car fleet in Spain or in Portugal. We launched, for instance, 13 years ago this electric vehicle recharging service in Spain. We were the first company starting with this service. We are today the company that is growing the most in the number of clients we have in the retail power business, because we are starting to offer bundle offers to our clients to refill or to fuel your car, but at the same time, offering the possibility to have a full, renewable power consumption at home, so that is part of our business. We have this competitive advantage and at the same time, we are paving the way to be competitive in the future.

It doesn't mean that oil is going to disappear from our world, because even in a world with no emissions, (zero emissions), we are going to see that a part of this whole production is going to be used to produce fibers, asphalts, fertilizers, plastics, and so on. All that is going to be needed, but probably a part of these energy demands is going to be fulfilled. You’ll see some other forms of energy that could be renewable that are going to be part of the basket, but then let me say that sometimes we try to make a confusion between electrification and decarbonization and it's not exactly the same. I mean, electrifying is important. It's an important part of this effort, but we are going to need decarbonizing liquids to decarbonize a main part of the economy. For instance, planes, the maritime sector, trucks, chemical companies, cement plants and so on are not going to be electrified knowing the current technologies in the short term, so we are going to bet also in favor of decarbonizing liquids.

Mark Wiedman: You're making an important point when most people think about decarbonizing, in their minds, what they really mean is electrification. Because they're talking about basically driving an electric car and using a heat pump to heat and cool their homes. That's what they're thinking. But what you're also saying is that, actually, huge parts of the carbon intensity of our economy come today from industry, from agriculture and from things that cannot be electrified easily, like heavy trucking and long-distance airplanes. So what are the technologies and businesses that you are driving at Repsol to actually capitalize on the transition?

Josu Jon Imaz: We have a quite a unique refining business in Europe in terms of competitiveness. We have five refineries in Spain. If you analyze the in net cash margin terms of all the European refineries, you will see that our five refineries are in the first quartiles in terms of competitiveness, so we are investing hard in this refineries and we are transforming, in some way, this concept of refinery and trying to shift them towards what we call multi-energy hubs. What does it mean, is that oil is going to be a part of the feedstock of these refineries, but on top of oil, we are starting to use a feedstock of vegetable oils, recycle oils, animal fats, products coming from urban waste, products coming from plastic pyrolyzing, etc. to produce fuels or hydrogen, we are going to use CO2 industrial streams plus renewable power. All that is starting to be part of the feedstocks of our refinery. So, what is the output of all that? That the products we are producing, sometimes diesel, sometimes jets, sometimes gasoline, are more and more decarbonized and their total carbon footprint, it’s scope three, is going to be reduced because a part of the CO2 they are emitting has been previously fixed, because they come from wastes, vegetables and so on, so that is part of this industrial transformation. From our point of view, that is going to be fully needed, because otherwise we are not going to be able to decarbonize all these sectors you mentioned before.

Mark Wiedman: I want to capture this point. You've got lots of work to do to replace, gas and petroleum for electricity generation for mobility, but what you're saying is that for a long time, we will be using fuels that come in liquid form. What you're talking about is decarbonizing the production and the carbon content of those fuels, so that airplanes will continue to fly without magical electric batteries, that ships will continue to go the oceans, but the fuel that we'll use will have a lower carbon content. What’s the biggest challenge in making that happen?

Josu Jon Imaz: Let me first of all say the advantages, because the first advantage is that that is going to allow us to decarbonize these sectors, because otherwise we are not going to have solutions in decades to decarbonize then. Second, that we, as a society, are saving a lot of money, because the infrastructure is there. The plane is there, the engine is there, and the challenges, of course. There are a lot of challenges in this journey. The first one we have is to develop some technologies. We have to invest more in these refineries. We have invested in Repsol, 400, 500 million euros per year in this business to decarbonize these plants. Today, for instance, we have a project that is going to be in operation next year, in 2023, that is going to produce 250,000 tons per year of sustainable biofuel, coming from waste that is going to be used either for biodiesel, biojet as a sustainable addition fuel and so on. We are launching another investment in Tarragona, in the Northeast part of Spain, that is going to use urban waste (400,000 tons per year, more or less) to produce methanol that could be used either to feed the chemical cracker to produce plastics or to be combined with gasoline to decarbonize these gasolines. We have technological challenges. We have to invest higher in that, as perhaps the unknown part of all is that technology has to be developed for some of these applications, but, I think that on top of that, we need a more open mind from regulators, because sometimes when regulators are, in some ways restricting the view about the technologies that could be used to decarbonize the world, they are reducing the incentive we could have to invest in these new technologies that are going to be fully needed to decarbonize the world.

Mark Wiedman: When you think about the technologies that exist today and the business models associated with those technologies, what's most attractive for you in investing today, towards a decarbonized world? 

Josu Jon Imaz: Short term, what is profitable today? Clearly speaking, biofuels, advanced biofuels, but in products where we could guarantee today, the feedstock supply, power generation produced with wind and solar energy and of course, all the areas related to the materiality supply to our clients in commercial terms. The first one is hydrogen, but from my point of view, we are fully committed with this pathway, because we think that we have a unique position in the Iberian peninsula to boost this business and when we enter in new advanced biofuels, (in some cases coming from biomass, coming from urban waste) and when talking about what is called e-fuels or synthetic fuels that are going to be produced (I'm talking about hydrocarbons that are in molecular terms, diesel and gasoline molecules or jet molecules, but that are produced using as feedstock, CO2 streams from an industrial stream that is going to be reduce a carbon monoxide, CO, and hydrogen produced with renewable energy that in combination with carbon monoxide is going to produce these hydrocarbons). I mean, that is not science fiction. It's something that we are starting to launch, so I think that we have to invest in what is the short term, what is going to give us profits today, but at the same time, we have to pave the way to some technologies that could be in some years, part of our business. And, uh, let me say that as an oil and gas company, it is part of our business also to combine risks and having a basket of investment work, we are taking different degrees of risks in our portfolio.

Mark Wiedman: Let's imagine that you and I start a venture capital firm together. Where would you make your biggest long-term bets on technology and business models changing?

Josu Jon Imaz: Let me say, and that is perhaps, I have a biased view of it, because not only because of my history as a chemist, but also because of my background as a refiner and in the chemical business of Repsol, but I think that it would be in the decarbonization of liquids, which is perhaps one of the most hidden parts of what we are going to need in coming years. We could have a unique opportunity to boost this business and we are in the right place to do that, because Spain, I mean, is wonderful from the point of view of many things, like the style of life and so on, but on top of that, Spain is also a core country in terms of developing renewable businesses, because we have not only the resources: sun, wind, and so on, we have the talent, because we started as a country in this business of renewable energies 25 years ago, so we have the infrastructure to do that. To produce these new e-fuels, this new hydrogen, this new synthetic fuel work, we are going to use waste based in the circular economy and at the same time we are going to use renewable power as feedstock to produce these kind of products and having the right industrial assets to do all that.

Mark Wiedman: You've worked in the public sector. Now you're leading a private firm. How do you think that government, companies, other social actors need to work together to drive decarbonization?

Josu Jon Imaz: I think that the dimension of effort requires a company effort, not only from companies and from the public sector. (I think) from the rest of the society, also citizens. They have to be engaged in this effort, because we need a clear view from the public sector, defining regulatory terms, the targets and the pathways to achieve this figure. We need commitments from private companies. Private in the sense of private owners, managed companies like Repsol, and we need all (of them), because we have to invest in this new, low carbon platforms in this business. We are also going to need the commitment of the whole society, because we also have to act on the demand. I think that being able to reduce the demand from consumers and not only now, because we are in the midst of an energy emergency in Europe, but also in terms of being able to cope with the CO2 emission effort. So I think that we need this coalition, this combined action among these three actors.

Mark Wiedman: Last question. What do you think is the single most important thing that needs to happen to get the world to net zero?

Josu Jon Imaz: Perhaps, if I have to give you three answers, I would say technology, technology and technology. I think that technologies are allowing us to achieve what we are doing, I mean, we couldn't imagine 15 years ago what we have achieved as a society in terms of producing the current, cheap renewable power using solar panels, so I think that we have to invest in technology and we have, from the public sector, to allow companies in an open-minded view to incentivize this effort to invest in technology. I think that technology is going to be one of the biggest allies we are going to have to get this ambitious effort.

Mark Wiedman: Josu Jon, thank you again for joining this episode.

Josu Jon Imaz: Thank you, Mark. It has been a pleasure.