The Bid podcast

Make sense of financial markets with The Bid, and uncover BlackRock’s perspective on timely market events and investment ideas. Every other week, strategists and portfolio managers discuss the latest on topics such as geopolitics, sustainable investing, technology and artificial intelligence.

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  • MARY-CATHERINE LADER:  What it means to retire has been evolving for some time. Before COVID, that meant stopping work entirely was no longer the goal. But in the wake of the COVID-19 crisis, it may mean that stopping work will no longer be possible. So how should retirement savers navigate what’s next?

    Welcome to The Bid, where we break down what’s happening in financial markets and explore the forces shaping investing. I’m your host, Mary-Catherine Lader. Today, BlackRock’s President, Rob Kapito, and Head of the Retirement Group, Anne Ackerley, talk about lessons learned from prior crises, share the numbers from our recent survey of retirement savers in response to the downturn, and give their advice for staying prepared through uncertainty.

    Rob, Anne, thanks so much for joining us today.

    ROB KAPITO:  Thanks for having me.

    ANNE ACKERLEY:  Thank you so much.

    MARY-CATHERINE LADER:  So, Rob, as the President and a founder of BlackRock and a veteran of this industry for several decades, how has this crisis compared to other crises in your career?

    ROB KAPITO:  Well, most of the crises that we have been through have been financial crises.  Now, many of them actually may have led to health issues, but this is really the reverse.  This is where this is a health crisis – the first pandemic that I have actually been through – and it certainly is going to lead to many financial issues simply because businesses have been closed down, people have been laid off.  People have been asked to shelter in place, and certainly this is going to affect peoples' financial future.

    MARY-CATHERINE LADER:  And speaking of financial futures, for those who are saving for retirement and particularly if they're closer to retirement, this is a really scary time.  There's been so much market volatility, job loss as you mentioned, health at risk, and you recently wrote a letter to retirement savers in response to those concerns and specifically the coronavirus.  What is the most important thing for retirement savers to know right now, Rob?

    ROB KAPITO:  Well, this has been something that's been brewing for quite a long time.  We have an aging population across the globe and one of the things that we have noticed is that people are living longer, and they haven't saved enough for the future.  And now with the pandemic, interest rates have come down to all-time lows.  The expectation is that they will stay low for longer and whatever the solution to the pandemic is, we all know that it's going to take longer.  And it's going to make it harder for people to be able to save and also invest at returns that are going to enable them to retire in dignity.  So, this is an issue that we've been very focused on and trying hard to create awareness of the issue and solutions for retirees.

    MARY-CATHERINE LADER:  But it sounds like there's no simple one piece of advice.  It's a challenging situation.

    ANNE ACKERLEY:  One of the big changes, I think from maybe prior crises particularly with respect to people who were saving in their 401(k) is there have been a lot of changes toward people getting into the right kind of investments, into those diversified, age-based asset allocated investments, widely known as target dates. A target date fund is really an all-in-one solution.  I don't want to say totally set it and forget it, but to some extent you say when you want to retire and so long as you're investing, as you age it makes the right asset allocation choices for you.  So, when you're young and you're a long way away from retirement, you're probably largely in equity in a target date.  And as you get closer to retirement, we start to take risk off the table: more bonds, less equity.  And so, we're taking risk off because particularly as you get right up close to retirement, if there is some sort of market downturn, you wouldn't want to be in all equities. I know particularly in your letter you were talking about if somebody was in that kind of vehicle, if they could at all, understanding that these were very hard times, to try to stay the course.  And if they could, chances are as the market does start to rebound and it's already showing some signs of that, they wouldn't subject themselves to even further losses by not being able to get that rebound.

    ROB KAPITO:  Well, it's hard not to be frustrated when you see and hear the volatility in the marketplace, and you want to take action either to protect your principal or to make extra returns.  And you know, we coined a saying that we think it's more important to have time in the market than timing the market.

    MARY-CATHERINE LADER:  Speaking of timing, Anne, we do these retirement surveys on a range of different retirement-related issues every year.  We did one in January of this year before this crisis, and then we did one again after in the wake of it.  How are the answers and responses that you saw different given the market environment right now?

    ANNE ACKERLEY:  As Rob said, this is a pretty scary time and we know over the last three months that one in four workers in the United States have lost their jobs.  That's about 20-plus percent of the workforce.  And we knew actually coming into this that people were already struggling.  Forty percent of Americans had no retirement savings as they were nearing retirement and we also knew that 40 percent couldn't come up with $400 for emergency savings.  So, we knew that people were already having some trouble.  I will tell you, I did think the results of the survey were a little surprising pre- and post-.  We actually found that for the people who were confident about their retirement beforehand, they were largely still confident after the April survey, which I found a little bit surprising.  What I think is happening is if people were confident beforehand, they were confident because they were in a 401(k).  They were saving already.  They were probably getting the match.  And chances are that might not have changed in April.  It was the people who were already not so confident about their retirement – they weren't saving enough, they weren't getting the match.  We saw that they felt even less confident in April.

    MARY-CATHERINE LADER:  And so, when it comes to managing and saving amid the crisis, what were retirement savers most concerned about?  If their sense of their own standing was kind of the same, surely some things had changed given how much markets changed.

    ANNE ACKERLEY:  Right, and mostly what they were worried about was the value of their nest egg.  What was happening to it?


    ANNE ACKERLEY:  And whether they were going to be able to weather this downturn.  And again, there's been a lot of change in terms of what people used to do and what they invest in now, and there's been a lot of education. So, while they were concerned, in fact we saw less than one percent of people trading in and out of their investments within a 401(k) during this crisis.  So, people are hearing and if they can they're staying the course.

    MARY-CATHERINE LADER:  That's interesting, and as you mentioned, well before the coronavirus we've talked a lot about the retirement crisis.  About the nest egg, even without the sort of context that we live in right now, not being enough for many people.  How have your views on the retirement crisis, Rob, perhaps evolved in this environment?

    ROB KAPITO:  Well, I think we still have to get the message out to enough people, and I don't think that they're saving enough.  And when you have a crisis, people get very nervous, but I was actually thinking about this this morning that if someone went to sleep in the end of February and woke up today and they looked at the markets, nothing happened.  And while the economy seems disconnected from the markets, there's a lot of liquidity; there are lot of people looking for assets and that's helped the stock market continue to grow and bond prices remain low.  So, there aren't a lot of alternatives at the time when there is a crisis, and that's why people shouldn't just – their reflex is to try to do something, and it actually works against them.  So, I think we have to make sure that people are aware that this is a long-term view that they have to take, and if you go back and look at any of the financial crises, it's really the same.  It's keeping your portfolio asset allocated properly.  Making those minor adjustments along the way as you get closer to retirement. So, we still need to do a lot of education because in this country as well as many other countries, people live paycheck to paycheck.  And in some of the surveys, people said they would save if they had an extra $200 a month.  They would start saving.  So, saving is not something that is common in the United States as much as it is in other parts of the globe, but we all know, diversification, long-term, put away some money for an emergency and for the future is the most important.  But we still have to create awareness amongst the general population.  Living longer is supposed to be a good thing.  

    ANNE ACKERLEY:  Coming out of the survey, one thing that we saw that didn't change really was this sense of one of the biggest concerns is, people have, they're afraid of running out of their money.  And pre- and post-crisis, you know, over 80 percent of the people in our survey said they want help from their employers in figuring out if they have enough money.  And they say they not only want their employers to help them get kind of to retirement, but through retirement in terms of the types of things that are available to them in their 401(k).  And I think we as an industry will have a chance to reevaluate the systems again and say, where do we need to strengthen, and I think one of the key areas will be around helping people with this notion of are they going to run out of money? How can they generate income?  And as Rob said, you know, needing to be thinking of solutions and innovations around that piece of it.

    ROB KAPITO:  The other part of education that's important is there is some notion that people can retire on social security.  And social security was not meant as a vehicle that you can retire on solely.  It was meant to supplement the income that you have.  So, you do have to save.  And how many times have you heard members of your family say you need to save for a rainy day, or save for an emergency?  All of these things that your parents and grandparents told you are true. I think you also have to use your longevity as a benefit.  So, the one point that I want to make is saving for retirement is not for the older generation; it's for the younger generation.  The earlier you start, the more that you will be able to accumulate and the better a situation you will be in by retirement.  So, even for kids coming out of college today, the first thing that you should do is get invested in a 401(k) at your company, or start one, or start a savings and retirement plan, because the earlier you do the better you are going to be when it becomes time to retire.

    MARY-CATHERINE LADER:  You mentioned, Rob, in the topic of emergency savings how thin that barrier is for some people to start saving just $200 extra a month.  Surely there, I mean, there's a lot of behavioral research around this, but are there innovations that are starting to work?  That are starting to actually change behavior.

    ANNE ACKERLEY:  I think there will be even more focus from the industry on short-term savings and long-term savings and helping people build up that short-term emergency fund, so that they can protect their long-term savings.  And one of the things we've seen in this crisis and look, this has been an incredibly difficult time for people, particularly for people who have lost their jobs, needing to take money out of the retirement account.  And in fact, surveys have said that upwards of 50 percent of people who have lost their jobs may need to tap into their retirement savings.  And in fact, the CARES Act which was passed and again provided lots of benefits to people really in need has allowed people to take money out of the 401(k), up to $100,000 with no penalties and to pay taxes over time.  And, look, we're supportive of that when people need the money, but really post this, as an industry we've got to focus on having those short-term accounts so that we can protect that long-term account.  Because once people take money out of their retirement account, they tend not to put it back in.  And it may not seem like taking out a lot but it's exactly what Rob said about the compounding.  You take money out and you lose the compounding for the rest of your life.  And so, I think we'll see continued innovation in this area, particularly maybe with technology and how can we use technology to help people save short-term and kind of once they've filled up that bucket, start filling up their long-term bucket.  And I think that'll be a really important part for employers in the industry to play.

    ROB KAPITO:  This is also not an issue for low-income or minimum wage people or middle-income or high-income.  This really affects everyone, because most people get used to a certain style of living, and they have figured out from the money that comes in and the money that goes out that they can maintain that lifestyle.  And now when you go into a period of time when there is no money coming in, what is the lifestyle that you are able to afford going forward? There's a rude awakening to people.  And so, when we're going to go into a period where 20 million people are going to be out of work, you're going to see your neighbor who didn't plan, who didn't save, and when you watch that it's going to be very difficult and very frustrating and it's going to create an environment which could go one or two ways.  It's going to increase peoples' awareness that they should have been saving more, but at the same time they're going to try to maintain the same way of living that they had in the past and therefore they may tap into their retirement.  And they know it's the wrong thing to do but they want to maintain the lifestyle that they have.  And I think our message is that you really have to think about this long and hard because it's probably better to cut back the lifestyle a bit so that you don't have to do it in the future when you know that there's not going to be income coming in.  So, this is why we do a lot of work with individuals and 401(k) plans and companies to make this education available to people so that they know what can happen before they get into that situation, so then they can take the proper measures that are going to help their future and not hurt their future. 

    MARY-CATHERINE LADER:  Listening to you both, it sometimes sounds like the system is really complicated and puts so much of the burden on the individual and so, Rob, you mentioned how employers want to, are chipping in to ease that burden, but do either of you anticipate any sort of policy solutions that might affect what this landscape looks like and what one needs to do to be prepared, especially as the shape of, and the length of, our lives is changing?

    ANNE ACKERLEY:  Yes, I think there should be continued policy enhancements.  And we can go back to 2006 with the Pension Protection Act that allowed the introduction of target dates.  Things like auto enrollment, auto escalate, default investments, all those sorts of things have happened.  Right at the end of last year we had the Secure Act which also had some improvements to the system.  We need to keep going.  You know, this is going to sound simple -- but let's just make it easier, and anything we can do to make it easier for people to save money is a good thing.  And so, I think a number one thing that we're going to have to address is access.  We know today that 50 million Americans don't have access to a 401(k) plan through their employer.  And that's often because they're working through small businesses, maybe because they're gig economy.  But we know when people have access to a plan, they're much more likely to save than if they have to do it on their own.  And so, I think one of the key areas will be, how do we make it easier for small businesses to offer these types of plans?  Can we reduce the administrative burdens?  Those sorts of things. 

    ROB KAPITO:  I think this is part of our responsibility, is to take care of the older generation.  And I think we should be aware, one way or another, we're going to have to be involved in this because if we have an aging population that cannot retire and cannot afford, then government is going to have to pay for this and we pay for that, so in some way you'll be paying for it in your taxes.  So, I think it's an advantage for all of us to create these programs so that we have a population of people that, as I mentioned, could retire in an appropriate way, give up jobs to the next generation, the younger people.  And prosper for all the hard work that they did.  So, this is not just a U.S. issue.  This is a global issue, and I think anything that we can do to make this easier on the investment side and make it easier through the use of technology is going to be beneficial to the entire population going forward.

    MARY-CATHERINE LADER:  Anne, Rob, thanks so much for joining us today.

    ROB KAPITO:  Thank you for focusing on a very, very important issue

    ANNE ACKERLEY:  Thank you so much for having us today.

  • MARY-CATHERINE LADER: In the past just few months, as everyone’s focus turned towards managing through volatility in markets in the wake of our current crisis and thinking about a public health crisis, we expected that climate might be put a little bit on the back-burner. And we've seen absolutely the contrary, that in talking with clients, we see a growing recognition that it’s important that they understand and quantify climate risk and understand how these non-traditional financial events could have a really material financial impact.

    OSCAR PULIDO: Welcome to The Bid and our mini-series, “Sustainability. Our new standard,” where we explore the ways that sustainability and climate change in particular, will transform investing. Earlier this year, BlackRock announced a series of changes regarding sustainability: launching new products that increase access to sustainable investing, being sustainable portfolios ourselves, and increasing transparency in our investment stewardship activities. As part of this announcement, we also made a commitment to use data to better understand environmental, social and governance risks.

    Today we’ll speak to Mary-Catherine Lader, Head of Aladdin Sustainability and regular moderator of The Bid, and Trevor Houser, Partner at Rhodium Group, where he leads the Energy and Climate Practice. BlackRock and Rhodium Group recently announced a partnership for data on the physical impact of climate change. We’ll talk about the advances in climate data, how this impacts investor portfolios, and what that means for company behavior in the future. I’m your host Oscar Pulido, we hope you enjoy.

    MC and Trevor, thank you so much for joining us today on The Bid.

    MARY-CATHERINE LADER: Thank you for having me, Oscar.

    TREVOR HOUSER: Thanks, Oscar. It’s great to be here.

    OSCAR PULIDO: Well, I have to start here, MC, the truth is, you’re usually moderating the podcast and today you’re a guest, so how does it feel?

    MARY-CATHERINE LADER: Well, I would much rather be the person asking the questions, but I’m still delighted to be here with you today, Oscar.

    OSCAR PULIDO: I think you have a little bit more pressure on your side today than you usually do. So, the reason you’re a guest, by the way, is that in your day job, you actually lead the Aladdin Sustainability efforts. Trevor, you head Rhodium Group, which is an independent research provider for both the public and private sectors. BlackRock and Rhodium have recently announced a partnership. So, I’d like both of you to talk a little bit about what that partnership entails.

    MARY-CATHERINE LADER: At the beginning of this year, we said that climate risk is an investment risk. And the challenge is that it’s really difficult to quantify that and make it actionable and that is because there is limited data and very few tools that can make that data useful for investors to understand what exactly is the climate risk associated with their portfolio or a certain asset, and then very difficult to make that integrated in your investment process and relevant. So what BlackRock, through our financial technology platform Aladdin, and Rhodium, who is really years ahead of anybody else in combining climate science with big data and economic research, what we hope we can do together is translate climate scenarios and climate impact into financial impact. And help investors understand how different climate scenarios would affect a given investment. That sounds reasonably simple, but frankly, nobody has done it so far. 

    TREVOR HOUSER:  The only thing I’d add to what MC said is from our perspective, at Rhodium, we’ve spent the past seven years taking advantage of new types of research, new computing tools to be able to provide actionable information on climate risk and data that we think at scale has the ability to shift capital markets in a way that makes our economy more resilient and sustainable over the long term. And what we’re looking for is a partner to help us apply that research at scale in a way that could really have that transformative effect.

    OSCAR PULIDO: So when we talk about climate risk, I think of hurricanes, wildfires, we all watch the news and we all see the manifestation of climate risk in many ways. But how exactly do we measure physical climate risk? I’m curious, what goes into the analysis?

    TREVOR HOUSER:  Yeah. It’s a great question. Hurricanes are not new; wildfires are not new; heat waves are not new. But as releases of greenhouse gas emissions in the atmosphere increase, it’s increasingly clear that the frequency and severity of those weather events is growing. And that creates significant risks to individual communities, businesses, investment portfolios and entire economies. So, when we’re talking about climate risk, that’s what we’re referring to is the increased frequency and severity of a range of extreme weather events due to warmer temperatures in the atmosphere.

    OSCAR PULIDO: And MC, you touched on investment risk being a big part of this equation and one of the things that has been talked about this year is again, climate risk representing an investment risk.  So, how do we take the measuring of that climate risk and translate it into investment portfolios?

    MARY-CATHERINE LADER: What Rhodium really does is take climate models and macro-economic research and combine those to create to damage functions and model out the financial impact of given scenarios. But the impact is really different depending on different asset classes. So you can imagine that for those assets that are oriented around a physical location, like a mortgage-backed security or a municipal bond or a utility stock for example, where the value is vulnerable to the physical environment surrounding that asset; that you can model the potential changes in the temperature and you have data that indicates what happens in that particular location when temperatures rise or fall, and you can come up with a proxy for how the value of a home or the credit worthiness of a municipality might change based on those events. What we’re also working on is quantifying that for corporate securities. So how do you think about the impact on revenue, how do you think about the impact on operating expenses for a company with a global footprint? For a company that may not have totally physical assets? And so, part of what we’re trying to do together is think about the right methodology to approximate the impact of climate change on corporate operations around the world. But in short, it’s not easy.

    TREVOR HOUSER: So maybe, Oscar, let me take a specific example and we can walk through the entire process of how we do this research and then how BlackRock is applying that. So, let’s take two places: an agricultural community in southern Illinois and a suburban neighborhood in southern Florida. So to understand how climate change could impact the local economies and individual assets in those two places, we start by collecting model output from these large climate model researchers around the world that develop these sophisticated, what are called, general circulation models to project how increased concentrations of greenhouse gases in the atmosphere change temperatures, precipitation, hurricane activity, sea-level rise, etc. We take that model output and we downscale it to a local level to understand how these changes globally are manifesting in southern Illinois or in suburban Miami. And out of that, we get information about how the days above 90 degrees are increasing or how the frequency of extreme precipitation events, or the frequency of CAT5 hurricanes are increasing. So that’s hazard information. Then what we need to do is quantify the impact that those changes in climate have on a local economy. We, six years ago, realized that to give people actionable information about the impacts of climate change, where they live, work, invest, you needed to combine two disciplines: you needed to combine climate science with econo-metrics. If you tell an investor your building is going to have ten more days a year above 95 degrees, that’s not actionable information. What does it actually mean in terms of the operational cost of the building or value of my building? Fortunately, there’s enough variation just in normal weather that we have this rich empirical dataset about what a day above 95 degrees or what a category 5 hurricane does to economies and individual assets. So our team combs through terabytes of historical weather data and historical economic data to identify these statistical relationships. And those are the damage functions that MC mentioned. Since we've had 105 degree days in the past in southern Illinois, we know what a 105 degree day does to corn fields in southern Illinois; since we’ve had category 5 hurricanes in the past in suburban Miami, we know what a category 5 hurricane does to property values or to local economies in southern Florida. And so, we take all that rich historical information and create these econometric models, and then we apply those to projections for how days above 95 degrees or frequency of CAT5 hurricanes is going to change in the future under different emissions scenarios.

    MARY-CATHERINE LADER: And so Oscar, when we say that climate risk is investment risk, you now have enough extreme weather events to have some indication as to what the financial impacts of these non-financial activities, events, may be.  So, if you think about what we’re living through right now, with COVID-19 and the pandemic. If you could have said, well here’s the economic and then financial impact when these parts of the city are shut down or when these things happen, I think that illustrates what we think of today as maybe not immediately material in typical financial analysis actually is extremely important in understanding the risks inherent in portfolios and investments. And so that is what we’re trying to do with climate risk.

    OSCAR PULIDO:  Yeah. It’s really fascinating, Trevor, to hear you talk about data that relates to climate and weather and the environment, and then following the thread of how it impacts the economy and then, MC, you had mentioned earlier, that this then has very practical implications for an investor. So inherent in that response is that you think data is a game-changer when it comes to helping investors think about how to invest in a sustainable manner?

    MARY-CATHERINE LADER: You could argue that sustainable investing is data-driven investing, that sustainability as an approach is defined by data. It’s not like equity or fixed income where you have contractual terms that determine a set of cashflows or what happens in certain events. Instead, what sustainable investing is, is observing and measuring the behavior of corporations or the potential behavior of certain assets and to try and quantify them to catalog that over time; and to then draw conclusions about which companies or which assets you think might perform better under certain risk scenarios, whether that’s climate or who has better governance practices, or stakeholder management, labor practices, that have been demonstrated over time to deliver better returns or reduce risk. So, in short, data is critical to being able to understand the sustainability of a portfolio and I think it actually defines the entire investing strategy. That’s part of why we’re seeing this rise in sustainable investing now is because in 2013, for example, we had less than 20 percent of S&P 500 reporting their actual sustainability-related data; and now you have over 80 percent. And not only do you have more big companies doing that, but you have them more than doubling the number of data points that they are sharing, and then we also have some convergence around a few increasingly dominate disclosure frameworks that are indicating how a company should gather that data, how they should measure it, and the like, that’s creating some degree of standardization. It’s still not enough. There’s still real divergence between different sustainability metrics, but that at least proliferation of data is allowing more and more investors to have confidence that they can understand with some credibility whether a company’s behaviors are more sustainable or not.

    TREVOR HOUSER:  So, there are a few developments over the past few years that have made this kind of research possible at scale. The first is that the global climate models have – through the work of hundreds of thousands of person hours around the world, research institutions that range from the Hadley Centre in the UK, to NASA and NOAH here in the U.S. – global climate science has just improved a lot. And so, the ability of the scientific community to estimate how changes in emissions impact climate at a local level has really improved. The second and equally important is this explosion in big data econo-metric research that allows us to, for the first time, understand how those changes in the climate impact economic activity, impact markets at a local level. And then the third innovation is the rapid decline in the cost of scalable cloud computing. We are analyzing daily temperature, precipitation, storm activity, at a hyper-local level all around the world for decades into the future; and it’s an incredibly computationally intensive exercise. And just three or four years ago, the scale of the computing required would have put this kind of research out of reach for even a mid-sized research institution like Rhodium. But innovation in cloud computing and in econo-metrics have really made that possible now, at scale.

    OSCAR PULIDO:, When you think about it in your space and climate data, where are we and what inning are we in? Do you feel like there is more of an explosion of data to come going forward?

    TREVOR HOUSER: I would say the climate science data, so models that project changes in temperature and precipitation and sea-level rise, they’re probably in the seventh inning. And the IPCC, the Intergovernmental Panel on Climate Change, the scientific coordinating body, published their first assessment report in the mid-1990s and have updated that science every five to six years since. Translating that climate data into economic outcomes, we’re only in the second inning; that’s really the new frontier of research. And what’s required to make changes in the climate relevant to individual people, investors, and economies as a whole.

    OSCAR PULIDO: So that’s actually a good segue, because that makes me wonder, what has the demand been like for the data in this space? It seems like you mentioned that just more recently people are starting to understand how the data that you collect around the climate has investment implications. Is that now causing an increase in demand for this data as opposed to a few years ago?

    TREVOR HOUSER:  Yeah. We've definitely seen a step function change in interest, in demand for climate risk data over the past couple of years, and I think that is due to a couple of things. The first is, up until the 2017 hurricane and wildfire season, we had been in a period of relatively low hurricane activity in the U.S. And then in 2017, obviously there was Hurricane Maria, Irma and Harvey; 2018 was also a large hurricane season, those occurred alongside record wildfire seasons in California and occurred alongside a big report from the Intergovernmental Panel on Climate Change in the fall of 2018. And the combination of those extreme weather events, advances in the science – and I think what had already been a growing level of interest and awareness among investors – really led to a tipping point in demand for climate risk information. That the investment community – and MC has a probably even better perspective on this than I do – I think that that was really the point for the investment community when climate risk started to move from just being one more element of your ESG strategy to really a core element of your risk management approach. MC, do you think that’s right?

    MARY-CATHERINE LADER: Definitely. And I mentioned this before, but I think it’s really true in the past just few months, as everyone’s focused turned toward managing through volatility in markets in the wake of our current crisis and thinking about a public heath crisis, we expected that climate might be put a little bit on the back-burner. And we've seen absolutely the contrary, that in talking with clients, we see a growing recognition that it’s important that they understand and quantify climate risk, and understand as how these non-traditional financial events could have a really material financial impact.

    OSCAR PULIDO: MC, just to continue down that path, obviously the partnership announced between BlackRock and Rhodium is a strong vote of confidence that BlackRock really views the data and analytics that Rhodium produces as very valuable to the investment decision making process. So, how does BlackRock plan to use that data in terms of managing portfolios?

    MARY-CATHERINE LADER: So, two things. One, we’re using it ourselves in our investment process as an asset manager, so our portfolio managers can run their own analysis as they build portfolios. But two, we’re building a product called Aladdin Climate that is a software application that will allow any clients of Aladdin Climate to better understand those risks; the risks of the physical impact of climate change that Trevor talked about, as well as risks associated with transitioning to a lower carbon economy. So it’s not like calculating duration, or it’s not like calculating something that everyone knows what the formula is, and you know how to interpret and digest that information as you make decisions. We think at this stage, it’s important to allow investors to interact with the data a little bit more and to understand what the assumptions are to make their own assumptions and so that is why we’re building this product.

    OSCAR PULIDO: And so, how do you think the dataset or what is available for investors to make decisions around sustainable investing, how will that change in the next five to ten years? And what aren't we measuring today that you think we will be able to measure in the future?

    MARY-CATHERINE LADER: So, I think it’s going to accelerate rapidly from here. And that increased attention and focus is going to increase scrutiny on the data that drives determination of sustainable investments. And I think that will put that much more pressure on asset managers to make sure that they can deliver credible products and then asset managers to put pressure on companies. That’s one dimension of it, growing demand is going to increase the data that is released and produced. The other is that there are more and more ways to gather information about companies. What do we not measure today? There are some things we measure but just not well today, for example, so how a company manages their employee satisfaction, for example; what elements of that are important? Is it elements of compensation? Is it retention? Is it certain practices that deliver productivity that can drive outperformance? We don’t really have the best way of measuring and capturing that today. That is one example.

    OSCAR PULIDO: So Trevor, it’s clear that investors benefit from being more informed around climate risk as they think about building more resilient portfolios, but speak about the broader societal benefits of having more information about climate risk and how you think companies will adapt going forward as a result of this?

    TREVOR HOUSER:  So first, the more proactive companies and capital markets are in thinking about and understanding the ways in which the climate is changing and what it means for their own business or for their local economy, the more successful they’re going to be in mitigating the damage done by future changes in climate, whether that’s by optimizing supply chains, investing in more resilient infrastructure, reducing their emissions footprint. And at a broader level, the more effective that companies and investors are in preparing for and mitigating future climate risk, the less risk it presents to the economy overall.

    MARY-CATHERINE LADER: Look, we talk about portfolio resilience, Oscar, all the time. I know you do. And that’s part of what has motivated our entire shift to sustainability as a standard and also our dialogue with companies through investment stewardship that we think it’s critical that management teams are clear and transparent about what they’re doing to manage for these potential scenarios. And so for those reasons, we absolutely anticipate the significant shift in capital allocation that Trevor alluded to.

    OSCAR PULIDO: MC and Trevor, we’re ending each episode of our sustainability mini-series with one question to each of our guests, and that is, what was the defining moment that changed the way you thought about sustainability?

    TREVOR HOUSER: That’s a good question. So, I think for me, early in my career, I worked at the U.S. Embassy in Beijing and as an entry-level hire, one of my jobs was to track air quality and write a reporting cable back to DC on the quality of air in Beijing. And what I thought was going to be this fairly obscure task turns out that was one of the most closely watched cables leaving the Embassy because it determined the level of hardship pay that foreign service officers working in Beijing received. And as I looked at that air quality data coming across my screen every day and talking with the embassy doctor about what that meant for the health of the Embassy staff, let alone the health of 1.3 billion Chinese citizens breathing that air on a daily basis, it became clear how central environmental protection and sustainability is to economic development prospects; that you really have to address both together, and that if you don’t, you’re ultimately going to run up against serious constraints to growth. And I think that’s even more true in the case of climate change, that unless we address head on the risks of climate change and figure out how to move our capital markets and our economy in a more sustainable direction, then we’re going to hit some real hard limits to growth and prosperity going forward.

    MARY-CATHERINE LADER:  So my first job out of college was doing renewable energy investing. But one of the things I had to work on was we were experimenting with emissions reductions at coal pants, which are controversial and many people would argue that they don’t really work. But we were investing in a few different projects to try. And one of the things I had to do was go down to these coal plants, mostly in Missouri, and monitor the application of chemicals that were intended to reduce emissions and make sure that the tests all went properly. And as I was educating myself on basic facts about this coal plant, it hit me that this one plant had the energy output that was a multiple of the entire renewable energy portfolio that had been constructed over several years. And I think that’s when it hit me that this would be a very long road. While it is nearly 15 years later, and so it has been kind of a long road, where we are today in terms of the mainstream demand for sustainable behaviors from corporations and for understanding the impact of climate on the economy is a world away from where we would have been.

    OSCAR PULIDO: Well, I think it’s clear from this conversation – and MC, you touched on this – that this is no longer a niche topic, it very much is mainstream the topic of sustainable investing, and listening to both of you talk, it’s clear that you're both passionate about this. So thank you so much for joining us on The Bid.

    TREVOR HOUSER:  Thanks, Oscar.

    MARY-CATHERINE LADER: It’s been a total pleasure.

  • OSCAR PULIDO:  In case you haven’t noticed, the stock market has had quite a volatile year already. And while for most investors, that’s the focus of the day to day, there’s an area of the market that often gets overlooked: credit. So what is credit? Simply put, it’s the vast market of bonds that companies issue to fund their growth ambitions. And there is a lot that credit can tell us about the overall health of the global economy.

    Welcome to The Bid, where we break down what’s happening in the markets and explore the forces changing investing. I’m your host, Oscar Pulido. Today, we’ll talk to Jimmy Keenan, Chief Investment Officer and Global Co-Head of Credit at BlackRock. He’ll talk to us about how companies are adapting to the COVID-19 pandemic, what it really means for a company to default, and how investors can navigate a low interest rate world.

    Jimmy, thanks so much for joining us on The Bid.

    JIMMY KEENAN:  Thanks, Oscar. Thanks for having me.

    OSCAR PULIDO:  Well, Jimmy, I don’t know about you, but my work from home situation, I’m in a room that has a television and somewhat reluctantly, I have the financial news on in the background just to keep tabs on what’s going on. One of the things I’ve noticed is that the majority of the news flow talks about the stock market. And I think that’s what people are generally familiar with. But you invest in the credit markets and I wanted to ask you just help us understand, what does that mean when we talk about the credit markets?

    JIMMY KEENAN:  Yeah, obviously, the public equity markets are probably the most visible measure of how people think about the markets. And in general, when you’re talking about equities, those are ultimately the ownership of the companies. When you talk about the credit markets, it’s just simplistically the debt of the company. If you thought about owning a home, the equity owner owns the home, but the mortgage is the debt that is lent to that home. It’s the same from a corporate side. Those equity owners are looking to borrow money to either finance their company for growth or acquisitions. It might be expanding business or just optimizing their capital structure. And so, simplistically, we lend to the health of the cash flows of a business. And at the same time that the equity owns that long-term growth potential, as the debt, you’re ultimately giving that up, but you have a contractual obligation with regards of that company to be able to pay you an interest expense and they ultimately pay you a maturity, meaning pay back your debt in full. And so, from a company’s perspective, most companies will issue some form of debt and they can vary between the risk. You have what we call investment-grade companies which are going to be your less risky companies and those might be the bigger capitalized companies that you would see in the Dow or the S&P 500. But then, there are lot of smaller companies that have that in the leveraged finance or called the sub-investment grade market, which can include the bank loans, or the high-yield market. And generally, they’re usually a little bit small over company. They have a little bit more risk on them or they might have more financial risk on them. And that is a lot of what we look at from the credit markets and the more you go down or increase risk in credit, the more sensitive you’ll be towards the value of that equity and that cash flow.

    OSCAR PULIDO: So from everything you’re explaining, this sounds like a very big market. How do investors think about the credit markets relative to other investments they’ve made in other asset classes?

    JIMMY KEENAN:  Investors tend to invest in it because it is a diversifier, right?  At first, the income is very much a focus and so for our investors, they come in and would reduce either their government bonds or cash in order to invest in the credit market in order to get some income and reduce what we would call duration risk or the interest rate sensitivity. But you also see equity investors move into the credit markets as a way to derisk or diversify the risk. Because the credit is up in the capital structure, meaning it’s more senior than the equity, it has less volatility and less downside risk than the equity markets. And so, it behaves well or better than the equity markets in kind of a downturn like we are seeing today.

    OSCAR PULIDO:  And you talked about the visibility that the stock market often has and I’m just reflecting back on the last couple of months as we’ve been living through the coronavirus crisis. The stock market started to sell off in February as it was starting to get a little bit uncertain about what was going on. The credit markets as you’ve described, and you talked about corporate bonds and bank loans, in early March, we really hit an inflection point. What had been a more quiet area of the market really took a leg down. And so, I’m just curious you must have been right in the center of that. What happened? What was the catalyst that caused the credit markets to sell off as well?

    JIMMY KEENAN:  As the reality of the pandemic expanded globally, it created a bunch of uncertainty about what the growth profile would look like and what the earnings profiles look good in companies. You started to see some volatility in February. And you started to see just that equity risk with that uncertainty about earnings start to come down. Obviously, that accelerated as the realities of the pandemic increased and there were a couple things that really happened to your point and what happened in the broader credit markets. I think there was a recognition that the speed at which the virus and itself was going to increase or spread through society and the lack of I would say, the insufficiency with regards to the healthcare infrastructure to combat that, that was a real humanitarian crisis. And then the response to that from a policy perspective was to shelter at home or in simplistic terms, reduce the economic activity and reduce activity broadly speaking. And so, what the credit market then started to see was the reality that, in order prevent the humanitarian crisis was going to shut down the economy and then, beyond I would call equity risk, it then started to create a real risk of potential impairments and defaults through the credit market. Meaning that if the economy was going to go down at such a level of rate that companies wouldn’t be able to pay that down, you might see a big spike in defaults. So, the credit markets then started to reprice and at that time, there was no visibility in that March of what the government aid and support might be alongside the policy of shutting down or shelter in place. What you then started to see is, the cost of capital started to go up and then that becomes a spiral that is what we will call, deleveraging and derisking.

    OSCAR PULIDO: When you say deleveraging and derisking, can you go into a little bit more detail about what that practically meant for businesses?

    JIMMY KEENAN:  You had businesses or funds in the market that were essentially getting margin calls, which means that, the bank was charging a higher cost of capital to that because the risk and uncertainty of those businesses is much higher and you just saw this vicious spiral of deleveraging in mid-March. And that was going pretty aggressively. And the governments and the central banks and the Fed started to recognize that very quickly and had a very coordinated response with a significant amount of speed and magnitude. And what you’ve seen since then is just the better-quality businesses have all rebounded. They’ve been able to access the markets. Early in that March period of time, as companies started to get uncertain about it, you saw a lot of news around this with regards to businesses drawing down on the revolver. Meaning, they had bank availability that would be similar to like, borrowing all the money you can on your credit card. Almost every company was doing that and that was continuing to put more and more pressure on the banking system as well, which forced more tightening of capital. So, as you get through this, the Fed programs were significant of scale, they reduced that financial risk and you started to see a stabilization of the market.

    OSCAR PULIDO:  So, let’s talk about policy. Although I have to admit I’m thinking about the number of long nights you must have had throughout March as all of this was happening. But one of the things that probably allowed you to start to get some sleep was when the Federal Reserve stepped in and maybe you can speak about the significance of what they did in March because we’ve been accustomed to seeing them buy government bonds for much of the post-2008 period, but they actually took the step to also start buying corporate bonds. Why was that an important decision?

    JIMMY KEENAN:  Yeah. The first thing I would say, the pandemic and itself and the policies around it; there are unique things that are different than any of the downturns that we’ve had. In order to protect humanitarian crisis, there was a decision to shut down the economy, right? And I would say that the response, as you outlined, of the Fed was very aggressive about deploying a variety of programs that existed in 2008 and reenacting them. But also, this was slightly different because of the domino effect as you start to shut down the economy has a significant impact across the supply and demand chain and every single business is ultimately getting affected by this. There are some businesses that are positive, but in general most businesses you’re seeing top-line declines down from 50-100% and that businesses are not necessarily set up to do that. But what they’re really trying to do and again, how do you bridge this economy in a period of time we were asking the policy makers are asking people to stay at home? Right? And so, the reality of all of the programs that they put in place is stabilizing the financial system. So, high quality companies are able to access the liquidity, but also injecting more liquidity directly to make sure that other businesses have means and ways they can access the market or just access liquidity to be able to essentially self-ensure or survive this period of time. And then when you get down to small businesses, that’s where some of the other more government programs and the Federal programs that are trying to inject liquidity right into that to help employment and to help small businesses survive. Because this is obviously, a very difficult period of time for a lot of business owners and a lot of employees.

    OSCAR PULIDO:  It certainly is difficult and it’s hard to imagine it getting any worse. I’d like to talk a little bit more about the economy now and when I think about data points like, the jobless claims or the unemployment rate, again, it just seems like, these are numbers that are outliers already. So, just curious, where do you think we are in terms of the stage of the recovery? Is the worst behind us? Do you see a recovery?

    JIMMY KEENAN:  Yeah, that’s a good question. I mean from a starting point, the virus in itself is going to probably define where we are. I think, the financial market instability of March with regards to dealing with the unknown of the impact of the virus on who it will impact and how fast it’ll spread. But also, we didn’t know what the policy response was going to be at that point to. So, all the actions with regards to the markets were dealing with unknowns. I think that a lot of that based off of the Fed policy and the ECB and other central banks around the world, that worst is behind us. I don’t think you will see the level of financial instability that you saw in March. Now, dealing with the fact of the unknown and realizing the weakness of economic data in Q2 and potentially Q3, Q4 and beyond, we are now dealing with the fact that companies are trying to fight for survival as are individuals and people. And so, that’s where businesses, yes in some cases they’re able to seek liquidity and aid, but at the same time many are reducing expenses in order to try to survive when they have no revenues coming in. And unfortunately, in many cases, that means that, that’s what’s driving the unemployment rate because they are reducing expenses for that point of survival. I think, you will continue to see that maybe not at the same pace, but I think you’ll continue to see some of those levels go up in the short term. Hopefully, that will be balanced as again, we have more data. You will start to see the reopening of the economy and you’ll start to see some level of economic activity start to come back up and I think that’s a positive. So, from a data perspective, I think Q2 will probably be the worst from a realized point of the macro data from the economic activity because I don’t think we’ll come back to the same level of economic shutdown. But what that does mean is that, as you get into Q3 and Q4, the unknowns are different industries, different regions, the slope of recovery is going to vary based off of behavioral changes, but also just some of the damage done based off of the last several months and the weakness in certain economies. We will deal with more defaults and more bankruptcies.

    OSCAR PULIDO:  So, what does that mean when a when a company defaults? You also used the term bankruptcy, which just sounds like a scary term. But you’ve also talked about companies needing to survive during this period. So, do you have concerns about the ability for some of these companies to pay back their debt? You talked earlier about this contractual obligation that they have when they issue a bond to an investor to pay on that bond, but is that contractual obligation at risk and how do companies deal with that?

    JIMMY KEENAN:  Yeah, it’s a great question. I’d say, in any recession or in any normal environment, there are companies that default. Default ultimately means they fail to pay on an obligation and that might be the debt on that, but it also might mean they fail to pay one of their suppliers or their landlord depending on what kind of real estate the company incorporates. All of those are going to be contractual obligations of the company. And if they’re not making enough revenues in order to pay those then, yes, they may have to restructure that. So, that happens in normal times, but in normal times, it’s a minimal amount. In a recession, many companies may not necessarily be positioned for different levels of recession or how it may affect those companies. And yes, so you do see restructurings increase in that environment. To the question of what does that mean? Nobody wants to default. It’s not a great thing. It’s not necessarily planned. However, it doesn’t necessarily mean the company goes out of business. Sometimes you restructure because you need to because your business has changed or the environment has changed and in order to operate more efficiently, you need to restructure your balance sheet to today’s environment. And when businesses have taken too much debt or have too high of a debt burden on there and ultimately, don’t have necessarily the earnings, what a restructuring means is that you’re taking that debt profile and all the contracts that the company has and you’re ultimately restructuring them, so that the business can run and operate in today’s environment without the burden of debt. I would say, for lack of better words, choking the company. The goal of all that is to be able to keep a company operating, keep people employed and allow this business to function with a better capital structure. So, defaults aren’t the end of the world. They ultimately allow a company to rebalance itself that it can operate and then hopefully, should be good for employment and healthy. But as you do that and you stabilize those companies, you allow for the economy to kind of start to run again.

    OSCAR PULIDO:  It sounds like when you talk about restructuring if I were to use a simple example, if I, Jimmy, had owed you $10 over the next year and you realize that now I’m financially burdened and I’m going to have trouble paying you back that $10. Perhaps you come to me and say, look you can pay me those $10 over the next 18 months instead or maybe over the next two years, or maybe I have to pay you $11 back over the next two years. I’m trying to simplify, but is that is that sort of what happens at these individual company levels?

    JIMMY KEENAN:  Yeah, and every situation is going to be a little bit different on what’s best. I mean, in the short term what you see right now is, most creditors and equity owners and operators meaning, the management teams themselves, recognize the current environment and the crisis and everybody’s working together to try to allow for companies to get through this in an optimal manner. But there are other businesses that are going to face real challenge with regards to that debt and so, yes. What you’re referring to is, the conversations that are going on which can be complex just because of the legal obligation and how many people own it and trying to get everybody on the same page. So sometimes, it requires going through a bankruptcy process and a court in order to get all of your debt and all of your equity holders all on the same page. It’s kind of like, if you owned a home and you had a high level of debt on that home, and necessarily couldn’t pay the mortgage, your first conversation is going to be with the mortgage provider, can you have some level of forgiveness there or change or change terms? But ultimately, if you can’t pay, then you may restructure that and the bank still has value, but that house still exists. And in most cases, when you’re talking about a company, those companies will still exist. There are cases where you will see liquidations or companies close down because they can’t operate. But in general, most businesses are going to restructure and if it’s a good business and viable, it will try to operate and yes, come to some agreement with its both its debt holders and its equity holders.

    OSCAR PULIDO:  Jimmy, that’s really helpful. You’ve painted a really good picture about what the credit markets are, how they function, and you’ve also talked about your view on the economy. But let’s talk about investing in credit markets. With the Fed having cut rates to zero and government bonds yielding very little, how does that impact what you’re seeing in this space?

    JIMMY KEENAN:  Yeah. I think there’s a short-term and a long-term view on that. I mean, from a long-term perspective, I think we have some challenges. When we came into 2020, we had a lot of aggregate debt in the global economy and since the financial crisis over the last 10 years, we’ve done a lot with regards to shifting that debt from households and banks on to government balance sheets and central bank balance sheets, but we still had this lower growth, lower interest rate environment globally speaking coming into 2020 because of the debt burden. Obviously, the response to the pandemic is something that and rightfully so, the governments have stepped in here to ensure the health and welfare of the people and the economy. But the expense of that is ultimately incurring a lot more debt on to the government level. So, I think the reality of this and there are different policy responses to deliver, but in all likelihood, you’ll have volatility, but it is going to continue to put downward pressure on growth and downward pressure on, ultimately, rates which are determined by that growth and inflation. And so, from a long-term perspective, I do think that will keep global interest rates at very low levels. And so, when you think about that, if we can stabilize growth and get through this, which we will, science will win, society will get through this, we’ll start to stabilize at a growth level but we will still have to deal with that debt burden. And when you think about how do you put your portfolio together? Because at the end of the day, if we’re going to be dealing with global interest rates at very low levels, it is hard for people to supplement their income that they get from their jobs with income that they get from their savings for a long-term retirement.

    OSCAR PULIDO: And what about in the short term?

    JIMMY KEENAN: I think in the short term, it’s all about where we are from recovery here. What’s the shape of the virus in itself? What’s the policy from here out and what that means from the level of economic activity? And then how that flows down into how do you price risk assets, whether you’re talking about government debt, in general, fixed income or corporate debt or equities. And that’s going to be the more short-term issue. And I think there are a lot of opportunities out there. The worst may not be behind us in all things, but I would say, March through May has been a pretty severe period of time. And so, from a long-term perspective, it’s a pretty good time to invest in a broad range of assets. Although, I think you need to be careful. From a short-term perspective, if you need liquidity, then I think, you balance your portfolio differently.

    OSCAR PULIDO:  There’s a narrative or I guess, an observation by a lot of folks who are watching the market that the stock market has recovered, but it’s really a handful of companies that are driving that recovery and that there’s a few winners and most of the stock market actually still underwater for the year. And the winners are companies in technology and some in the healthcare space. Is that also the case in the credit markets, Jimmy? Is it really about a handful of companies or a handful of sectors or industries, or is it more broad-based in terms of what you’re seeing as an investment opportunity?

    JIMMY KEENAN:  One, it is a bit more broad based. When you think about the high yield market and the loan market in general, you’re dealing with smaller businesses. So, some of them have very strong secular tailwinds with them and are doing well in this environment, but in general it’s not as consolidated as you see the big cap equity companies. But at the same time, you’re talking about as you think about the diversity of different industries and different spaces, there’s a broader range of winners and losers associated to that and businesses struggle. And so, we see it right now in areas like oil and gas. The virus itself and the downturn of the economy has slowed demand, but they’re also supply issues associated to that. So, that has put real pressure on oil prices and therefore, has put all pressure on all things related to the energy markets. And you’ll see other things around lodging, leisure, entertainment that are, I would say, struggling in today’s environment, but at the same time across the credit markets, there’s still a lot of software companies, a lot of tech, cable, a lot of hospitals and healthcare businesses and pharma companies and you have a broader range of bifurcation where companies are doing well in this environment, but at the same time, other businesses that have really been hurt because of the current shift in how the economy is operating like, people are still eating, but they’re not eating at restaurants or eating at home. So, take out has become better than restaurants and things like that. And that will evolve over time, but certainly as we get through this, I do think there will be behavioral changes and businesses will need to adjust to those trends.

    OSCAR PULIDO:  And Jimmy, at the beginning the year before we hit this period of talking about coronavirus, one of the things that we were talking about and we’re still talking about today is sustainability. BlackRock has taken a very strong stance on sustainability and the view that climate risk is investment risk. And I’m just curious in the corporate bond arena or the credit arena that you invest in, how important is sustainability in the investment decision making process?

    JIMMY KEENAN:  Yes. Sustainability has obviously got a big trend. I would say over the course of the last several years as sustainable investing and ESG or environmental and social and governance-related risk, we’ve defined it differently and we’ve now broken down our process across our teams to define and understand those risks. At the end of the day, we do believe that those trends, those companies who are going to score higher in those measures around those sustainability measures will ultimately be better performers. And at the same time, those who are going to score worse, they will have ultimately worst credit fundamentals and are going to be tougher investments. And so, we do see that when from our standpoint is pricing in those risks, when we look and try to assess a credit and we think that trend is only going to increase, and we see that more and more now as investors have demanded it. We have started to look and broadly speaking, look and value companies in that method. We see it at the boardrooms of companies, right, where companies are trying to understand their business and making investment decisions or capital expenditure decisions or decisions on how to run their teams and employees and in a manner that is more sustainable. So, I do think it is almost a necessity to think through when you’re thinking about investing right now.

    OSCAR PULIDO:  It definitely sounds like it’s a core part of your decision-making process. Jimmy, you’ve shared a lot of great insights, I wrote down a number of things, but the one that I underlined was when you said, “Science will win.” I think people are in need of some optimism from here on out. So, thanks so much for your insights and thanks for joining us on The Bid today.

    JIMMY KEENAN:  Thanks for having me.

  • Tom Donilon: This is the third great crisis of the very young 21st century. Following 9/11 and the 2008-2009 Financial Crisis, we now have the 2020 coronavirus pandemic.

    But to paraphrase the famous book by Reinhart and Rogoff—this time really is different. I believe that policymakers now face the most difficult crisis since WWII, and perhaps the worst peacetime crisis in modern history.

    Catherine Kress: When we kicked off the year, geopolitics was front and center in the market narrative. Just a few months later, the COVID-19 pandemic has exacerbated and accelerated many of the key geopolitical trends already underway. In response to the crisis, we’re seeing fragmentation between countries and a striking lack of great power leadership. We’re also seeing heightened tensions between the U.S. and China as we count down to what will undoubtedly be an unprecedented presidential election in the U.S.

    Welcome to The Bid, where we break down what’s happening in markets and explore the forces changing investing. I’m your host, Catherine Kress.

    Today, we’ll hear from Tom Donilon, Chairman of the BlackRock Investment Institute and former U.S. National Security Advisor on how the COVID-19 pandemic has shaped the geopolitical environment. Tom recently shared his perspective at a global town hall for BlackRock’s employees. In this episode, we’ll give you an inside look at what he told us about what makes this crisis different—and the key geopolitical themes that he sees emerging.

    To begin, Tom made the humbling point that we’re in a unique and extraordinarily difficult time. But what makes this crisis different? Let’s hear what Tom had to say.

    Tom Donilon: First, this is a crisis of a very unusual sort—essentially, the economy has been forced into a coma by policymakers seeking to halt the spread of the virus and prevent overwhelming healthcare systems. The financial response has been extraordinary in its scale and timeliness, and the extent of cooperation between monetary and fiscal authorities.

    But second, this is also a health crisis; and these are the most difficult challenges. At least in the United States and Europe, the financial authorities can act in a timely and effective manner. They are well exercised. Not so on the health side. We face great uncertainties as to the duration and the severity of the pandemic—and the ability of nations around the world to deal with it.

    Third, unlike 9/11 and the Great Financial Crisis, there has been a striking lack of international cooperation this time around. This time around, the G-7, G-20, and the UN have played decidedly lesser roles in addressing the crisis. And there’s been a real absence of great power leadership, and it’s particularly striking.

    Fourth, there are significant uncertainties as we try to envision the post-crisis environment—and few historical parallels to guide the way. I think behavioral analysis is going to be critical as we try and determine how individuals, and businesses, and nations will conduct themselves in a post-crisis environment. To quote the historian Adam Tooze, who wrote a significant book on the 2008 crisis, “This is a period of radical uncertainty, an order of magnitude greater than anything we’re used to.”

    And last, in addition to bringing new things forward, I think this crisis is going to accelerate and exacerbate the geopolitical trends that preceded it.

    Catherine Kress: Tom offered his perspective on why this crisis is different. The global economy has been forced into a standstill; as a health crisis, this one is much more difficult to handle; nations have acted apart instead of together; and there’s a lot of uncertainty as we try to move forward.

    But Tom also mentioned that the crisis will accelerate geopolitical trends that were already in place. He sees four trends taking shape: a coming storm for emerging markets, a worsening outlook for U.S.-China relations, massive state intervention into the private economy, and continued de-globalization.

    First, let’s dive into emerging markets. The pandemic has certainly put lot of pressure on some advanced economies – like the US, Italy, Spain and the UK. But a big worry has been among developing countries — countries like those in Asia, Latin America and Africa — whose economies are already fragile, with limited room for policy and weak healthcare infrastructure.

    Tom Donilon: The pandemic is going bring a storm to the emerging markets. These countries face really a tough set of pressures.

    One: weak healthcare infrastructures alongside more limited institutional capacities make emerging markets particularly vulnerable. India, for example, has less than 1 hospital bed for every 1,000 people. By contrast, South Korea has more than 12. Social distancing policies are often impossible to implement, and restrictions on the export of medical supplies and equipment from Europe and the United States I think will exacerbate their challenges.

    Two: emerging markets are facing a severe loss of income and significant capital flight. The IMF now expects the per capita income will shrink in 170 of 189 member countries as revenues from commodity exports, tourism, remittances, and global demand from the developed markets crash. Capital outflows from the emerging markets have been roughly 4x the size of that during the Great Financial Crisis.

    Third: the coronavirus comes at a time when the emerging markets are economically constrained in their ability to provide relief. We could very well see a series of sovereign and corporate debt crises—creating spillover risks for the global economy. Now, the IMF is seeking to offset the crisis and appears prepared to leverage its firepower to confront it. The debt moratorium announced by the G20 was welcome, and we could slowly see developed market stimulus make its way to the emerging markets via increased demand.

    Over the weeks and months ahead, pressure on governments in the emerging markets to relax lockdown policies and provide economic relief will grow. Emerging market policymakers face really difficult choices. Extended lockdown brings unsustainable poverty levels. By contrast, a premature return to activity could cause mass outbreaks of the disease.

    Finally, and more generally, emerging markets have been key beneficiaries of globalization—with drastic reductions in poverty and the building of middle-class households. Decades of progress are now at risk of being erased, leading to greater inequality between countries. This is a key concern of our global analysis, and I think should be a real focus of the developed world and the international financial institutions.

    Catherine Kress: The bottom line is that emerging markets face significant challenges on the road ahead—challenges that may threaten critical progress against poverty and social stability in these nations.

    The second trend that Tom discussed is China, and U.S.-China relations more broadly. We started the year with the view that U.S.-China tensions were structural in nature and broadening to include multiple dimensions, like technology, trade, finance and others. Let’s hear how Tom’s view has evolved since then.

    Tom Donilon: The coronavirus has exacerbated already fraught relations between the United States and China. Whatever goodwill came from the Phase 1 trade agreement has been lost amid mutual recriminations, a push by China to advance its global position, and bipartisan backlash in the United States.

    On the U.S. side: There has been an aggressive effort to place accountability on China for the virus’ origin and efforts to conceal the outbreak. On the China side: China has launched a multifaceted effort to gain a geopolitical advantage coming out of the crisis.

    Bottom line: I fear that U.S.-China relations will continue to deteriorate post-crisis, no matter the outcome of the November elections. The two countries will emerge from the crisis with reduced trust, and decoupling will accelerate in areas beyond technology. This is a very big challenge for policymakers.

    Catherine Kress: Tom’s view is that U.S.-China relations will worsen across the board—especially given that it’s an election year in the U.S.

    The next trend he highlighted was the scale of state intervention. In response to the crisis, both monetary and fiscal policymakers have taken extensive steps to keep the global economy afloat. In Tom’s eyes, those measures are just the beginning.

    Tom Donilon: The pandemic has led to a massive policy intervention by governments around the world into the private economy. The extent of that intervention in my judgment is only going to grow given the requirements. Developed market governments are deploying a monetary and fiscal response at a scale never seen before in peacetime. One thing we know from European history, and in the United States as well, is that crises and major events like wars often produce states that are larger, more powerful, and more intrusive.

    One particular area of increased, coronavirus-driven intervention is the use of surveillance technology—using cell phones—to identify those who’ve come in contact with infected persons, to track the direction of the disease, and to enforce quarantine orders. The techniques have been used successfully in Asia—particularly in South Korea.

    This begs the question: Will these intrusions that you wouldn’t normally see outside a crisis environment, particularly in countries with strong privacy traditions, will they be sunset after the crisis – as, by the way, is the case in Singapore, where the laws have indicated that they’re going to be sunset. I would bet generally not.

    Catherine Kress: Tom mentioned that times of crisis often produce states that are larger, more powerful and more intrusive. This expanding state authority is taking place against a backdrop of heightened geopolitical fragmentation and de-globalization.

    The current crisis is shining a light on the vulnerabilities that companies have in their supply chains. Between reshoring activities, border shutdowns and some of the stockpiling activity that we’ve seen, Tom shares his views on the risk to globalization as we know it.

    Tom Donilon: The coronavirus has brought nationalist, protectionist trends into sharp relief. And de-globalization I think is set to accelerate.

    The pandemic has triggered a wave of export restrictions. At least 69 countries have banned or restricted the export of protective equipment, medical devices and medicines. In the U.S., officials have explicitly called for the reshoring of medical supplies through tax breaks and “Buy America” provisions. Global trade, already under pressure from the U.S.-led trade wars of the past two years, is now set to contract more than 10% in 2020.

    Second, governments around the world have implemented extensive travel restrictions. We haven’t seen these kinds of restrictions on the borders since WWII. As countries seek to protect themselves from importing the virus and to preserve employment, it’s likely these travel and migration restrictions may be some of the last to be lifted.

    Third, and more generally, the coronavirus — and the nationalist impulses it’s ignited — will increase pressures on globalization and supply chains and force a re-evaluation of the interconnected global economy.

    Building on pressures from the financial crisis, rising populism, U.S.-China competition, business leaders and policymakers are now recognizing the need for greater supply chain resilience and diversity, even if at the expense of efficiency.

    We have national security and reliability concerns — most visible in the U.S.-China tech war — that will now extend to concerns, I think, over pharmaceuticals and medical equipment. And the drive towards greater localization will add further strain, just as larger government presence in the economy will bring increased focus to protections for domestic industries. That’s a lot of pressure. It’s a lot of pressure on supply chains; it’s a lot of pressure on globalization. I think we will look back on this moment as really an important point in the history of globalization.

    Catherine Kress: While the COVID-19 pandemic has become the only story in the news cycle, the November presidential election in the U.S. is likely to be one of the most consequential in modern history. As someone who has been close to several U.S. elections, Tom shared his perspective on how the pandemic will impact the November presidential contest.

    Tom Donilon: First, the coronavirus has injected a massive amount of uncertainty into the November elections. None of the assumptions that we held before the crisis remain useful for analysis, in my judgment, at this point. The only bit of clarity we have came when Senator Sanders dropped out of the race, thereby confirming Vice President Biden as the Democratic nominee. And the Democratic party is now in the process of uniting behind Vice President Biden.

    Second, the pandemic has dramatically upended the nature of campaigning and the presidential nomination process. Vice President Biden is campaigning virtually from his home in Delaware, and the President is present every day, and in some parts campaigning from the White House briefing room. Already, 16 states and Puerto Rico have delayed their primaries, and the Democrats have postponed their convention.

    Moving forward, we will see the parties battle over efforts to deal with voting in the time of coronavirus. Fights over extending voting times, early voting, vote by mail, other access issues. Now some have asked — it’s been one of the questions I’ve gotten the most over the last couple of weeks — is could the President could delay or postpone the November election. The answer is no. The date of the election on the first Tuesday in November is set by an 1845 statute passed by Congress. That date can only be changed by Congress. U.S. elections, by the way, took place during the Civil War in 1864, during the 1918 pandemic, and during the Second World War. And in 1864, President Lincoln famously stated, “If the rebellion could force us to forego or postpone a national election, it might fairly claim to have already conquered and ruined us.” I think the same thing would be said about the virus this time around.

    Approaching November, state polls are the measure to watch. Though national polls show Vice President Biden ahead, just a few battleground states will decide the outcome of the election. Indeed, in two out of the five last presidential elections, the winner of the popular vote lost the overall election in the electoral college. These factors point I think to a close election.

    Catherine Kress: In summary: the most complex crisis of the 21st century, a coming storm for emerging markets, continued deterioration of U.S.-China relations, massive state intervention, accelerating de-globalization and a tightly contested U.S. election.

    Tom painted a pretty grim picture. But it’s not all bad.

    Tom Donilon: While the coronavirus presents enormous challenges, it also presents significant opportunities. The crisis has stress-tested our social contracts and now forces us to address those areas where we’ve historically underinvested. With good leadership, we have an opportunity to re-evaluate the effectiveness of our international institutions and cooperate on building new ones— specifically, I think, around healthcare.

    Catherine Kress: Another opportunity we see: sustainability. We believe the current crisis is putting a bigger focus on creating a more sustainable world. There’s been a concern that when we hit a downturn, investors would run away from sustainability. But in this crisis, we’ve seen the opposite: investors are looking to sustainable investing more than ever, and sustainable investments have shown resilience despite uncertainty.

    This shift toward sustainability, along with the trends that Tom discussed, have been on our radar for several years; but the coronavirus crisis will amplify each of them. This crisis may forge a new path for years to come.

    Thanks for listening. We’ll see you next time on The Bid.

  • MARY-CATHERINE LADER: The coronavirus has spread to more than 180 countries. As the virus has progressed worldwide, how has that impacted different countries at different points, and what lessons can we learn from how regions have navigated the pandemic?

    Welcome to The Bid, where we break down what’s happening in the markets and explore the forces changing investing. I’m your host, Mary-Catherine Lader. Today, we talk to four of BlackRock’s leaders around the world whose regions have been most affected by the coronavirus. We’ll travel from Asia to Europe to the U.S. and touch on how the virus has affected global markets, where we’re seeing signs of recovery, and what we’re hearing from our clients.

    So let’s turn to Asia, where China and a few other countries are beginning to curb the impact of the virus. We asked Geraldine Buckingham, Chair of BlackRock in the Asia Pacific Region, to talk from her standpoint in Hong Kong what the shift back to normalcy feels like.

    GERALDINE BUCKINGHAM: As the virus became very public around Chinese New Year, China went into quite extreme lockdown, particularly in parts of China like Hubei Province.  And it was a very, very challenging time for our Chinese colleagues.  I think over the last few weeks, there's been more of a sense that things are normalizing.  Certainly, colleagues report that on the ground in major cities like Shanghai.  But there's obviously concern about imported cases.  And we are seeing travel restrictions.  I think it's interesting, though, that when I speak to clients who have much larger operations than us on the ground in China, many report that they're effectively back to normal in terms of people in the office, et cetera. I think that the fundamental issues that existed in China around the lack of retirement infrastructure and lack of retirement savings, the need for international capital, these issues are unchanged.  I've been quite impressed how through this crisis Chinese clients and regulators have remained incredibly keen to engage.  They certainly haven't taken their foot off the gas.  We've been able to continue to move forward, albeit, a bit more slowly.

    MARY-CATHERINE LADER: Geraldine talked about how business in China is beginning to come back online. What are the signs she’s looking out for to gain confidence of a fuller recovery?

    GERALDINE BUCKINGHAM: Look, I think it's going to be incredibly important for people to have some sense of the health outcomes.  What is the virus peak in major economies?  How is that being handled?  I do think the physical and monetary response we've seen from central banks and governments around the world has been extraordinary.  The scale of investment, you know, in some cases 20% or even more of GDP from governments recognizes, as many of them have said, that nothing's off the table to support economies through this period.  And I think that also gives the market some confidence.  But I do think ultimately this is a health crisis that has then flowed into the financial system. We, obviously, for our own operations, are tracking a range of indicators.  It's everything from government restrictions to the number of cases to the growth in number of cases, you know, restrictions like school closures, about 15 or so risk indicators across each of our markets to ensure we have a handle on what is the situation both in terms of what is the situation today, but is it trending positive or negative?  And we'll use that as very important input to making decisions about what level of operations we should have in place for our offices. 

    MARY-CATHERINE LADER: Geraldine mentioned a host of indicators that we’re looking for in markets and for our own business. And while we’re still in the early stages here in the U.S., China and other countries in Asia look to be the first to come out of the crisis. So, what can the rest of the world learn and hopefully follow suit?

    GERALDINE BUCKINGHAM: The COVID-19 crisis obviously started in Asia earlier than many other parts of the world, and that presents something of an opportunity to learn from the Asian experience.  We’ve seen markets like China, South Korea, Taiwan and Hong Kong appear to be leading with steps back to normality. It’s interesting to note, though, that even over the last few days, countries like South Korea and China, to some extent, have reported a few new clusters and spike in cases, demonstrating how hard the return to normal life actually is. We’ve got markets like Australia and Singapore that saw a sudden uptick, but are now returning more to normal, and then other markets like India where they’re trying to return to normal, but pretty significant lockdowns remain in place.

    In terms of markets more broadly, it is clear that this crisis will change the world. And sadly, de-globalization at least for a period looks like it will be under real pressure. This pandemic and the following economic crisis has really exposed fragilities that I think were there before, but are seen more clearly now: weakness in the healthcare system or the political system, populism, income inequality, all of these things I think are getting more focus as we see how this crisis will actually play out. The response from government around the world has varied, but health experts do seem to agree on the same overarching measures for containing the outbreak. It’s not rocket science; test widely, make tests extensive and affordable. Secondly, isolate those who are infected and those who have come into close contact, so contact tracing is incredibly important. For an unknown period of time, social distancing looks like it’ll just be necessary, so whether it’s school closures or whether it’s large events, certainly travel, it’s unclear how all of these things come back to the normal we’re accustomed to. And finally, good personal hygiene, like washing hands, is I think a change that’s here to stay.

    MARY-CATHERINE LADER: While Geraldine provided perspective from the ground in Asia, next, we’ll shift to Europe, one of the epicenters of the coronavirus: Italy. But like China, Italy has also had time to recover. Have those signs of optimism started to trickle through?

    GIOVANNI SANDRI:  The situation is improving materially.  And the national health care system is now less stressed with available beds in the ICUs and less people hospitalized. 

    MARY-CATHERINE LADER: That’s Giovanni Sandri, Head of BlackRock in Italy.

    The impact of the virus is different region by region, though.  The center and the south of Italy seem to be now quite under control while the rich regions in the north, mainly Lombardy where everything started, are still reporting new cases.  And authorities are looking very carefully at how things evolve.  That said, the general feeling is that the worst should be behind.  And now the focus is on two areas. First, the fiscal response with the support of the European Union to help the economy to restart. Second, how to structure phase two with reactivation of at least part of the functioning of the country.  Regarding the latter, the business community is pushing the central government to allow as many sectors as possible to restart as soon as possible.  On the other hand, medical advisors continue to be more cautious and monitor the new infections trend very carefully, looking for a longer track record.  The next weeks will be key to understand what can be done without taking too much risk of a second wave as strong as the first.

    MARY-CATHERINE LADER: At last, the worst is likely behind us in Italy. And Giovanni says that he’s starting to phase into a “new normal.” So what will normal look like there?

    GIOVANNI SANDRI:  Thanks to the application of a rather hard lockdown, the experience in Italy is actually consistent with the epidemiological curve we saw in China where the crisis started at the end of January and things are starting to normalize after three, four months.  The Italian authorities are currently discussing to relax some of the restrictive measures. And by the end of May, beginning of June, we should start to see some normalization with specific restrictions in place for a longer period.  So, for instance, schools are not going to open until September.  Same as China, it will be key the way phase two is designed and executed with the objective to limit the risk of a potential second wave.  A vaccine will take months and probably initially will be available only to selected categories.  The focus now is to have better equipped hospitals with more personnel, more beds, more ICUs, more efficient ways to test individuals, and offer more effective symptomatic treatments.  The general consensus is for the so-called "new normality" i.e. a more normal life with some limitations, for instance, the travelling, large gatherings, starting before summer with restrictions relaxed gradually going towards the end of 2020 and entering 2021.  Unfortunately, it is too early to say exactly how the new normal will be at the end of this process.  Another important element for phase two is coordinated European approach.  This is key to avoid the closure of borders within the European Union.

    MARY-CATHERINE LADER: Giovanni talked about normal life in Italy, but with increased restrictions. So what lessons can we learn from that about how to navigate the virus?

    GIOVANNI SANDRI:  What happened was unexpected.  We have not faced anything similar in our modern history.  And mistakes were made, but that was almost inevitable.  What we can say now is that a key element is speed.  Unfortunately, this was underestimated at the beginning.  And although everyone saw what was happening in China first and after in Italy, governments were slow in taking drastic measures needed to contain the virus.  The experience in Italy tells clearly that the sooner you act, the quicker you can have the situation under control.  It is not by accident that the most impacted area in Italy is still Lombardy, where everything started, and the virus spread for at least a couple of weeks without controls.  While the situation in other parts of the country, particularly in the south, which, by the way, has a much weaker health care system, is significantly better.  Very important is also the transparency towards people explaining what's going on.  It is not easy when you're still learning and you do not know everything.  But it is important to be transparent anyhow and communicate clearly and openly.  A critical element that has emerged from the crisis is also the additional complexity given by the split of powers between central authorities and regional ones.  This has created some confusion in handling the crisis.

    MARY-CATHERINE LADER: As Giovanni mentioned, we haven’t faced anything like this crisis in modern history. Across the board, the consensus from all of our leaders around the world is that coronavirus presented an unprecedented challenge to markets. So, over the course of their careers, through many crises, what’s made this one so unique?   

    SARAH MELVIN:  The coronavirus is first and foremost a health crisis.  In my career, there's never been an equal situation of this scale or magnitude. 

    MARY-CATHERINE LADER: That’s Sarah Melvin, Head of BlackRock in the United Kingdom.

    SARAH MELVIN:  It's also the first time that the economy has been shut down purposefully in order to stem the spread of a virus.  We've honestly never seen this speed of recession before, but we've also never seen this scale of coordinated policy response.  And some of this policy response will have significant ramifications for portfolio construction for our clients. 

    GERALDINE BUCKINGHAM: It's really difficult to say the virus has been similar to any other crisis that I've seen in my career. 

    MARY-CATHERINE LADER: That’s Geraldine Buckingham again.

    GERALDINE BUCKINGHAM: I don’t think the world has seen something of this scale in many, many decades.  I think it's a crisis for humanity that has then flowed into the financial markets.  And first and foremost, this is a tragic human event and will obviously have very broad social implications, not just for those who lose loved ones through this experience but also through the financial implications that it bears.  In terms of market volatility, the closest thing I've seen is the global financial crisis of, you know, 12 years ago.  I was still in consulting at that time.  But I think that was quite different because that really was a credit crisis that sort of originated in our financial institutions and then spread into the economy.  I think banks in many parts of the world are in stronger shape. I think it's very encouraging that governments and central banks have recognized this as quickly and as fully as they have and that within a matter of weeks we've had literally trillions and trillions of dollars pumped into the global economy to try and limit the negative implications of the economic shutdown that's been required to deal with the human tragedy that's unfolding.

    GIOVANNI SANDRI:  Larry Fink in his recent letter reminded all of us that in 44-years career, he has never experienced something similar.  I cannot say anything different in my 23 years. 

    MARY-CATHERINE LADER: That’s Giovanni Sandri.

    GIOVANNI SANDRI:  I went through the global financial crisis.  It was a deep crisis.  But this time is actually different; it is the first time that the life of billions of people across the world has been impacted so much. Awfully and as we expect, this is a huge, short or midterm shock which will have less negative long-term accumulated impact on the economy compared to the global financial crisis.  Not everything is bad.  Some things will be for good, for instance, a smarter use of technology and more investments in the health care sector.  The crisis is also an interesting example to everyone of what a global shock triggered by the real world can cause.  Today, it is a pandemic.  Tomorrow, maybe the implication is coming from climate change.  We believe attention to sustainability will come out stronger from this crisis with increased focus on the environment and also much more focus on the social elements and the role of companies in society.

    MARK MCCOMBE: Unlike the great crisis of 2008 and 2009, I think clients have been quite sanguine about what's happened in markets. 

    MARY-CATHERINE LADER: That’s Mark McCombe, BlackRock’s Chief Client Officer who’s based in the U.S.

    MARK MCCOMBE: This pandemic is not one particular group's fault.  And no finger pointing has taken place.  I also think the experience of the great crisis in 2008 and 2009 has actually given a little bit of a playbook as to how to react when markets become very dislocated.  We've seen this, for example, in something like money market funds where very quickly the government stepped in and backed much of the paper that's in the prime money market fund space.  Now, I do believe that there will be regulatory reform again coming down in the future.  But I think it's clear to see that for the time being, people took this much more in their stride then they might have ten years ago.  So I feel very optimistic that actually as a community, as an economy, we're going to get through this.

    MARY-CATHERINE LADER: Sarah and Mark both mentioned their clients. There’s no doubt that the coronavirus crisis has changed the way investors will navigate building portfolios, particularly for resilience. So what’s been the client reaction? 

    SARAH MELVIN:   Each person's response to the virus is very individual and we know that many clients are dealing with personal adjustments and concern for family and friends as well as their professional responsibilities.  At the start of the crisis, many clients were focused on concerns for the health and well-being of their employees, as well as determining how to move their own people and operations to a virtual working environment.  Those concerns were soon supplemented with having to navigate shocks in the market.  How clients are reacting in terms of portfolio adjustments varies widely depending on client needs.  Some need more liquidity right now; others are looking to re-risk their portfolios.  All are reviewing their asset allocations, and that's where a lot of our conversations are right now, at the whole portfolio level.

    MARK MCCOMBE: As you think about something like our defined contribution business, we were very worried about how people would see all of the red ink as their retirement savings had perhaps shrunk as a result of this.  And we were able to take steps to reassure many of our clients that actually the old adage of investing for the long-term will pay off if you stay in the market and not to sell just because we've seen a correction.  Now, I do still think that there's more pain to be had, because clients are beginning to think about how the long-term economic impact of the coronavirus is going to affect their business.  In the first few weeks, there was a great focus on liquidity.  But, now, I think people are thinking more about structural impacts on their portfolios.  What does that mean?  Perhaps it could be something like the amount of real estate people have in their funds or the amount of private equity and whether they see markdowns in those areas that might well have an impact on the overall value of the portfolio.  And that can have a dramatic impact on asset allocation decisions as they go forward.  Also, I think equity markets have definitely been bouncing around as a result of sentiment, as well as people's concerns about the future long-term impact on the U.S. and global economy.  But I do see people returning more cautiously into the markets to look for opportunities, not in an ambulance-chasing way, but rather thinking about asset allocation and areas and assets that they might've wanted to get into previously but maybe didn't have the opportunity. 

    GERALDINE BUCKINGHAM: This crisis has really emphasized how important it is for us to be nimble to our client needs. At first, clients really needed guidance as they grappled with incredible volatility. Now, clients are responding to the changing environment with quite local issues, so for example, superfunds in Australia facing funding challenges as people are allowed to access retirement savings earlier than was anticipated. Some clients are actually looking for opportunities to put significant money to work and looking for dislocations in the market. So, it’s important that we’re able to service all of those clients in quite a different way.

    MARY-CATHERINE LADER: Market shocks represent an opportunity for investors to think about the long term. But beyond investors, the crisis will change the way that all financial services operates. So let’s turn back to Sarah: What does she expect this means for finance, and what is BlackRock focused on now?

    SARAH MELVIN:  There's no doubt there will be a new normal that appears as a result of this crisis.  Crises, though, also often bring innovation, and we've seen that in ways in which we're engaging with clients and with each other, particularly through technology.  I don’t think this will fully reverse.  I also think the lockdown is making us all much more thoughtful about the world we live in and I think that will translate to even greater focus on sustainability as we think about how we do business and how we invest. Right now, our mission is simply to help more and more people get the support they need, and we're doing that by partnering with several UK charity organizations who are on the frontline providing food supply and distribution and medical help.  We've done this through donations to the National Emergencies Trust, Team Rubicon UK, and St. John’s Ambulance who are all focused on helping people through this crisis.  Our own employees have taken fundraising activities to heart as well, some going as far as shaving their heads for charity. 

    MARY-CATHERINE LADER: Sarah provided insight into how the industry and BlackRock as a company is navigating these changes. On a more personal note, the crisis has transformed all of our day-to-day lives. I now wear a mask and gloves, and I have antibacterial solution in every corner of my home. So, our last question to our regional leaders: How has the coronavirus changed their personal lives?

    GERALDINE BUCKINGHAM: Coronavirus has had all sorts of impact on daily life.  I think perhaps the most obvious is just the difference in working.  But a number of things have really helped.  I mean, technology has been an absolute save in this scenario.  It's also been very important personally with family members spread around the world, the ability to Facetime, particularly for my young son, has meant that people still feel close together. I think it's important to remember that this is a marathon, not a sprint and that pacing yourself is incredibly important.  So, I've tried to keep something of a routine during a workday at home.  I make sure that I get out of the house for a short walk or something like that every day just to get some fresh air.  But I think it is important to be gentle with one's self and gentle with others because I think the level of stress is high.  And it's important to remember that everyone's feeling that.

    GIOVANNI SANDRI:  A lot of the things that were part of my normality have disappeared almost overnight: travelling, spending a weekend out of the city where I live, Milan, meeting my friends, even going to the barbershop or having a walk in the park nearby.  What I suffer the most is to be forced at home without the possibility to meet my old and sick parents.  They are by themselves, and we can meet only via video.  On the other end, I have the chance to focus more on my teenage daughters now, and for instance, help them with their studies from home.  And this has been quite a nice experience.  So, I continue my day-to-day job with calls replacing meetings, not travelling anymore, and now investing more time on my other job as a father.  As always in our life, also during a pandemic, there are some positives. 

    SARAH MELVIN:  What's surprised me most about this experience is the resilience of human beings, of the spirit that I've seen amongst people, the incredible unity, people helping one another. And it's so gratifying to see colleagues and friends reach out into their communities to see how they can help.  That really has been heartwarming. 

    MARY-CATHERINE LADER: As all of us around the world seek to get through this crisis, we know we’re entering a new normal, but we don’t even know what it looks like. But despite the challenges we’ve all faced, as businesses and as individuals, it’s been an extraordinary time of resilience and of coming together. Thank you for listening to this episode of The Bid. We’ll see you next time.

  • OSCAR PULIDO:  The coronavirus crisis has prompted a massive response from central banks and governments around the world to help prop up the global economy. In March, the U.S. Federal Reserve cut interest rates to zero and it isn’t the only central bank that has lowered interest rates in recent weeks. But low interest rates have been a theme for longer than the past six weeks: the truth is, they’ve been declining since the early 1980’s. So how did we get here, and what do low interest rates mean for investors who rely on generating income from their investment portfolios?

    On this episode of The Bid, we’ll speak with Michael Fredericks, Head of Income Investing for BlackRock’s Multi-Asset Strategies group. We’ll get his perspective on why interest rates became so low in the first place, what stage of the recovery we are in now, and where he’s finding investment opportunities in today’s markets. I’m your host, Oscar Pulido. We hope you enjoy.

    Michael, thanks so much for joining us on The Bid.

    MICHAEL FREDERICKS:  Thanks for having me, Oscar.

    OSCAR PULIDO:  Under normal market conditions, we would both be commuting into New York City into the same building and in fact on the same floor, it turns out you and I sit pretty close to each other. But we haven’t seen each other for many weeks, so I’m glad that we have this opportunity to talk. I wanted to ask you about interest rates first, because last month, the Fed cut rates back to zero and I’m curious to hear from your perspective why the Fed acted so quickly. But perhaps taking a step back, how did we go from double-digit interest rates in the 1980s to zero?

    MICHAEL FREDERICKS:  Yeah, it’s been an amazing shift in the interest rate environment going back to your point to the double-digit years of the 80s to here where you have short-term interest rates essentially pegged at zero and even longer-term rates, like 10-year Treasuries below 1%. And when you look back in 1990, the 10-year Treasury had a yield of about 8% and then 10 years later in 2000, it was down to 6%, and then in 2010, it was down to 4%, and then here we are, sub 1% today. And given all the uncertainty in the world today, it feels like we’re going to be in a really low rate environment for the foreseeable future but to your point, your question, how did we get here? I think a few key things contributed to this tumble in interest rates. One was look, I think we have to accept that the rate of economic growth has been decelerating over roughly that same time period, so if you went back and looked at GDP growth rates back in the 90s and even into the parts of the early 2000s, growth was running at reliably at 3-4%. And really since the end of the financial crisis, that number’s been more like 2%. Also, if you went back to 1990 and even 2000, inflation was running higher than it was today. And also, since the financial crisis, just inflation has been stubbornly low. And then finally, there’s some demographic issues here where people are coming out of the workforce as more and more people retire and that has been collectively a bit of a drag on productivity growth and it’s a bit circular, but it’s contributed to a world where just global growth is slower than it was and that’s all been exacerbating these problems with falling interest rates.

    OSCAR PULIDO:  Well, it’s interesting because I’m remembering the anecdote that my dad told me once that back in the early 1980s, just to give you a sense of how high interest rates were back then, that he slept outside a bank in order to be able to qualify for a lower rate on a mortgage that he was applying for, for a house that my mom and dad eventually bought. So, it’s before a time that I can really remember, but it gives me a sense of what the environment must have been like back then. And one thing that I can remember, however, is that over the last many years, the market experts have been predicting that interest rates would go up eventually and we had sort of started to go back in that direction. But as we just said, we’re back at zero. So, why have the experts consistently gotten this wrong and what does the market think now in terms of the future path of interest rates?

    MICHAEL FREDERICKS:  I think many of us including, I put myself in this camp, thought that rates would be higher over the last 10 years. This recovery after the financial crisis has been stubbornly low and it’s also worth remembering that the market is a global market. The market and the demand for safe-haven assets like U.S. Treasuries is not just coming from U.S. investors, but also from investors in Europe and other parts of the world where rates are even lower than they are here. So the extremely slow growth that you see in Europe contributes to the demand from European investors buying U.S. Treasury bonds and driving up the price and the way the bond math works, the price is up, the yields are lower. But I think more to your point, this idea of what did the market get wrong along the way and what were expectations. I think this is really fascinating because there is a betting market, if you will, for where interest rates will be in the future, and it’s called the forward rate market. And this is where the market sets a price, an expectation for where interest rates will be in the future. Well, one of the things you can look at in this betting market is where the market thinks that 10-year Treasury yields will be, say, 5 years into the future. And what we’ve seen is that over time – this expectation that interest rates in the future will be higher than they are today – those hopes continue to just get squashed. And when you look at this concept, how is that being priced today, the 10-year Treasury yield, which is less than 1% today? What is the expectation? It’s actually just above 1%. A lot of that hope has been squeezed out of the market at this point. I think the market and market participants have come around to this idea that we are mired in a very low interest rate environment for the foreseeable future.

    OSCAR PULIDO:  So, let’s assume that the market is right, and that rates in the future will continue to stay low. Although as you just mentioned, the market hasn’t proven to be quite good at predicting the future, but let’s just say for argument’s sake they are. Shouldn’t this be something that we’re celebrating, low interest rates? I mean, if I can refinance a mortgage at a lower rate, or I can take out a personal loan at a lower rate, why is that not a good thing?

    MICHAEL FREDERICKS:  Well, I think it is a good thing for anyone that wants to borrow money. Your mortgage rates are incredibly low-levels, auto loans are at very low levels, and you’ve also seen the corporate world, a lot of companies have been taking advantage of this low interest rate environment to do a couple of things. One, as they borrow, they’ve been reissuing debt at lower and lower interest rates. And because there is so much demand for yield, they’ve been extending the maturity of the bonds that they hold. So, it has been a positive for a portion of the population, but on the other hand, it has been a pretty negative thing for investors. You just aren’t generating a lot of yield or a lot of coupon today given where the response from central banks driving down interest rates lower. A lot of these structural demand issues where there’s a huge amount of need for income, particularly from investors around the world that are, I’d say, more conservative, don’t want to take a lot of risk. The yield on the Barclays Aggregate Bond Index, which is one of the bellwethers that a lot of institutional and retail investors look at as a barometer or a broad benchmark for a good quality pool of bonds, is about 1.4%, which is a record-low number.

    OSCAR PULIDO:  In response to the coronavirus, the crisis that we’re living through, the Fed cut rates back to zero. That’s just one of many actions that policy makers around the world have taken to combat market volatility. So, just curious from your perspective as a global investor, where are we right now? What stage are we in if you’re looking at the markets globally?

    MICHAEL FREDERICKS:  Yeah, stage is the right word. So, we’ve thought of it as a general pattern when you get in times like these, which are really volatile. You see in stage 1, there’s a big risk off – a big aggressive selling behavior within the markets. And in that phase, you generally see there is a rush for liquidity. That was certainly true in the month of March, and prices of everything fall. Stage 2 is when market settle down a bit and that rush for the exits abates and investors start to pick through and look for opportunities. And then stage 3 is generally the recovery stage and this is where it’s risk on again and volatility really dies down and markets accelerate. I think we’re quite a ways away from stage 3, but I think we’re well into stage 2, this part of the historical series and historical precedent where investors like us are dissecting different asset classes, taking advantage of whatever cash they might have to look around and find opportunities that look attractive.

    OSCAR PULIDO:  That’s really interesting how you’ve characterized the market in terms of these three stages. I’m just curious, what signposts are you looking for to suggest that we’re moving into stage 3? Do we need to see a vaccine, are you looking at the hospital data in New York, are you looking at like how the Chinese economy is doing as it’s going back to work, is it all the above? What are some of the things that you’re most curious about?

    MICHAEL FREDERICKS:  It would be fantastic if there was evidence that a vaccine was coming around the corner, but we think that’s pretty unlikely, and most estimates that I’ve heard from people that we believe are well-established to make judgments around these sorts of things has a vaccine probably 12 to 18 months out. More realistically, we’re hopeful that we will see some breakthrough from a treatment perspective more quickly and then we’ll see the vaccine come to market. And so, I think that is probably the most important thing that would give us more visibility around how quickly the economy will recover. So, the analogy that I think makes a lot of sense is that we’re all kind of staring over a valley right now and we know that the valley is deep, we’re not quite sure how deep it is or quite how far it is to the other side. But the second quarter GDP is going to be absolutely horrendous. Everybody knows that. That’s part of the reason we had such a big sell off. I think part of the reason we’ve seen a strong recovery, particularly in the equity market but also in some of the fixed income markets, has been a combination of a slowing rate of new cases – so there’s been progress on the virus front itself – but there’s also been a tremendous and very aggressive reaction by central banks, in particular, the Federal Reserve to put programs in place at a scale we’ve never seen before to put a floor under the economy as we go through this really uncertain period of time. So, I think the market has support but that’s not to say we’re in this recovery phase and I think really the important thing here is not to get ahead of ourselves as investors but to try to be patient. We’re going through an unprecedented period of time; we like having dry powder, we like having cash; it gives us a lot of flexibility to put that cash to work as we see opportunities, but I think we should expect to see continued higher levels of volatility. Not like we saw it back in March; I don’t think we’ll see that again. But there is a lot of good news priced into the stock market at the moment, and I’m not so sure that it’s going to be such smooth sailing especially when we get to the hard part about the specific plans and programs and the cadence of how we’re going to get back to normal after these lockdowns.

    OSCAR PULIDO:  And so, just to be clear, it sounds like the actions of central banks and governments, which you mentioned has been a global response, has been helpful. I think you used the term, “provided a floor,” but it’s not sufficient in and of itself to take us to that next stage of recovery.

    MICHAEL FREDERICKS:  I don’t think so. They’ve done what they could, but until there’s more clarity around the shape of the recovery, where there’s a lot of debate around will this be a v-shaped recovery, a severe contraction in the second quarter followed by a similarly-shaped recovery in the third and fourth quarter? Or will the slope of the recovery be a lot flatter than the sell-off? And I think the market is coming around with the idea that a v-shaped recovery is pretty unlikely as we start to think through the complexities of normalizing behavior again without triggering a second wave of virus patients. They were certainly bold – they being the Fed and central bankers – they were definitely bold with these plans and I think they will be there if needed to do more.

    OSCAR PULIDO:  And you mentioned that because of the stage that we’re in, we saw a lot of the indiscriminate selling and that now, there are some investment opportunities that are starting to present themselves. So, let’s talk a little bit about that. You look at the world through the lens of income and thinking about how much cash flow and coupon can you generate from investments. So, what looks interesting to you when you look at the world through that lens?

    MICHAEL FREDERICKS:  If you went back, call it to the middle or end of February, a lot of what we would call good quality assets, so that would be things like investment-grade bonds; it would even be really good quality stocks. Those quality types of assets around the world for the most part were really, really expensive. And then, in that phase one stage that we went through, many of them sold off dramatically. And it honestly hasn’t taken very long for a lot of other investors to come to the same conclusion and buy up a lot of those down-beaten, good quality parts of the market. There were, in our view, really oversold back in the mid- to late stages of March. That said, they haven’t fully come back to where they were, and I still think that there’s some strong value in thinking of it as thematically as these up and quality parts of the market. And what you’re seeing is kind of an interesting bifurcation. So, if you were to look at a market like the high yield bond market; so, these are non-investment grades, sub-investment grade rated bonds. Even within that part of the market, the best quality, the highest rated high yield bonds which are rated double B did suffer a pretty sharp sell-off in the vicinity of 15% to 20% over the course of March. And they’ve retraced a lot of that. And in some instances, what are perceived to be the best quality double B bonds that are not in industries that are being disrupted by the virus, some of those types of bonds are essentially back to where they were. I’m really surprised at how quickly those retraced the sell-off. At the other end of the spectrum are the lowest quality high yield bonds, the triple C rated high yield bonds, which by definition, those companies have a lot of leverage. And if you’re a highly levered company in an industry that is being disrupted by coronavirus, well, there are very legitimate questions about whether or not some of those companies are going to make it through. And those bonds sold off very sharply in March and really have not come back in part because there is so much uncertainty around the outlook of those types of companies.

    OSCAR PULIDO:  So, Michael, it sounds like you’re trying to be opportunistic, but you also mentioned having some cash on hand. So, that tells me that you think there might be more volatility at some point in the future and give you another interesting opportunity to buy maybe some of these high-quality assets that you’re talking about.

    MICHAEL FREDERICKS:  Yeah. That’s the right way to look at it. We are concerned that as we go through the earnings season, where companies report their earnings and generally tell the investment community what they’re expecting in the future with respect to their revenues and their profit outlook, they don’t have a lot of visibility right now. Companies are not providing forward guidance; they don’t know themselves what their business is going to look like over the coming quarters. We’re a little concerned that over the next few months, that weak visibility around what revenues will look like in the future and the uncertainty around the duration of how long that might persist could weigh on some of these assets classes, particularly on the fixed income side where we think that generally speaking, bond investors are more concerned about these cash flow issues than stock investors who will, I think, be more likely to look to the other side of the valley and think about, “Is this a good buying opportunity today if I’m a long-term holder of stocks?” Bond investors generally aren’t quite wired that way. They are more focused on these short-term cash flow issues. So, we like the idea of holding some cash and being patient and we’re going to watch how this plays out.

    OSCAR PULIDO:  You touched on this concept of coupon and generating income from your investments. Why is this so important for investors?

    MICHAEL FREDERICKS:  You know, your yield is your paycheck. Maybe ignore the yield on a bond for a second and think about the return profile of a stock. So, when you buy a stock, you’re buying an ownership stake within a company. And with that, usually comes with some sort of dividends. It’s usually pretty modest, but you’ll get a dividend and then you’re obviously hoping that the earnings of that company are going to grow and that the price will rise. And so, your total return over the long run for stocks has been a healthy contribution from the dividend, but a lot of that total return has been coming from the prices of those stocks moving higher as earnings propels the total value of the stock up. A little bit of a different story on the bond side, where you’re just hoping to get paid back. You’re lending the company money and if it’s a 10-year bond, 10 years from now, you get your money back and along the way, you’re getting your coupon, you’re getting your yield. And so, you’re taking a lot less risk than on stocks, but that yield number is really important. So, 20, 30 years ago, the yields that you were getting paid as that bond holder were a lot higher than you’re getting paid today. We talked about the yield today on that Barclays Aggregate Bond Index, if you can imagine, you’re tying up your savings into an asset class that is only paying you 1.4%. That’s hard to live off of for most people.

    OSCAR PULIDO:  You mentioned the demographics and investors that are now retiring. In fact, in the U.S., there’s 10,000 people a day that are retiring and I did a little bit of math, so that’s about 300,000 people a month. That’s about the population of the cities of Orlando and Pittsburgh. And so, these are folks now that are starting to think about how to spend some of the money that they’ve accumulated over their working years. How do they go about doing that? Is that easy or is there a risk that they run out of money?

    MICHAEL FREDERICKS:  It is so complicated and it sounds relatively straightforward, but when you start to think through the different permutations, it is really, really a complex problem if you’re a retiree trying to one, live off of your nest egg in an environment with such low bond yields. So for a lot of people, if they saved X and they’re only earning 1.5% or 2% on a coupon on their investments, it’s just not enough money to live off of, which then means that they need to carefully spend down some of that nest egg over time. And one of the hardest things to know, is probably impossible to know on an individual level, is life expectancy. But if you happen to retire in the early stages of a bull market, you’re in the perfect position. You can spend more money than you could probably imagine in retirement because in the early stage of your retirement, the markets are going higher and the value of your portfolio is increasing even as you are taking money out. Conversely, if you happen to retire at the front end of a bear market, you really need to change your spending behavior really quickly, spend less, and really hunker down. If you don’t, you’re selling down a substantial portion of your nest egg and there is less there to recover when the markets eventually bounce back. So, a better answer is a more dynamic approach to adjusting your retirement spending depending on market conditions at least a little bit.

    OSCAR PULIDO:  Hey Michael, earlier you talked about the market’s expectation for interest rates in the future. And it got me to thinking that one of the things I’ve been doing since I’ve been working from home is watching a lot of movies with my kids, and we recently watched the Back to the Future trilogy, which are some of my favorite movies. So, if you were to travel into the future and encounter your older self, what would that older self be telling you about how you navigated this period of market volatility?

    MICHAEL FREDERICKS:  You know, you get paid as an investor to stay in the market and it is very difficult to time the market, when to sell and when to buy, and I had a conversation with my father over the last week. He wanted to sell his U.S. equity exposure and I was trying to convince him to stay the course. So, I think in the long run, staying invested is the smart move. We’re going to get through this. We’re going to get to the other side of the valley and markets are going to recover and we’re going to move on. I am not trying to minimize how much uncertainty there is and will be over the next couple of quarters. It’s going to be uncomfortable from time to time, but policymakers are not going to sit on their hands; they’re going to do what they can to try to mitigate the turbulence.

    OSCAR PULIDO:  Michael, we usually end this podcast with a rapid-fire round where we ask a few personal questions and given that we’ve all been working from home now for the past several weeks, we thought we would ask you about your own routine if that works for you.

    MICHAEL FREDERICKS:  Sure. Let’s do it.

    OSCAR PULIDO:  So, what piece of technology have you found the most helpful?

    MICHAEL FREDERICKS:  So, I stocked up when it became pretty clear that I was going to be working from home for a while. I bought a professional gaming headset, which it looks ridiculous and people are giving me a hard time saying I look like a helicopter pilot with this thing on, but the audio is phenomenal, and the microphone is really clear. So that was my best call so far.

    OSCAR PULIDO:  Besides running into me by the water cooler, what do you miss about going to your office in New York City?

    MICHAEL FREDERICKS:  You know, I don’t miss my roughly 90-minute one-way commute. I don’t miss riding the Metro North, but it is really odd having all of our team meetings over the phone and not just bumping into people and sitting in the same room with everyone. We’ve been doing weekly team happy hours via Zoom and things like that.

    OSCAR PULIDO:  You mentioned you’re saving 90 minutes on your commute. So, what new hobbies, if any, have you taken on now that you have more time at home?

    MICHAEL FREDERICKS:  I am a bit of a car enthusiast. And so, I’ve gotten into a lot of these professional car detailing YouTube videos and bought a lot of equipment with spray foam and spending a lot of time seriously detailing cars and waxing them, and I’ve had a lot of Amazon deliveries, let’s put it that way, with specialty chemicals. We’ve also started growing vegetables. So, it’s still pretty cold in Connecticut where I live and we can’t plant them outside, but we’ve got a bunch of early stage vegetable seeds that are sprouting and I think in the next week or two, be ready to go. I’ve actually never gardened before.

    OSCAR PULIDO:  And do you think when we go back to normal, whenever that is, do you think you’ll be working from home more than you did in the past?

    MICHAEL FREDERICKS:  I think so. We’ve been talking a lot about that. I think in part because it has worked really well, and I do think that there is something to be said for the team dynamic of actually physically being present at least part of the time. So, I bet it will be more of a blend of maybe we spend two or three days a week in the office and two or three days a week at home.

    OSCAR PULIDO:  Well, Michael, I hope you’re right, and I look forward to seeing you back in the office. Thank you so much for joining us on The Bid.

    MICHAEL FREDERICKS:  It’s great to be here. Thanks for having me, Oscar.

  • MARY-CATHERINE LADER: Coronavirus has set a new normal in literally everything. It’s been a time of record numbers of people working from home, of volatility in markets, of economic shutdown and unemployment. These times have tested the systems that we all rely on to work, to live, and that empower the financial markets and the economy. But there have been a few bright spots. Though there is no question that we’re in a downturn, at least for now, there has been a record growth in sustainable investing.

    So what’s been behind that? Why has it been the case that while most numbers have been flashing red, so-called green investing is just getting bigger? Today I talk to Salim Ramji, the Global Head of iShares and Index Investments, a $2 trillion-dollar business, about why that’s the case. We’ll talk about what he’s learned in this historic time and how ETFs have fared during the tests of these market swings. I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Salim, thanks so much for joining us today.

    SALIM RAMJI:  Yeah, of course. Delighted to be here, MC.

    MARY-CATHERINE LADER: Right, here, in our respective virtual offices.

    SALIM RAMJI: Exactly.

    MARY-CATHERINE LADER: As that indicates, it’s been a totally unprecedented start to the year. In just the past few months, the entire structure of our professional and personal lives has changed, and that has been the case for all of our colleagues all over the world. So just to start with the obvious, what has this meant for you and for the iShares business?

    SALIM RAMJI: Well look, for me, for you, for everybody, it’s been a pretty surreal past couple of months. Personally, the good thing is I’m at home, I’m safe, I'm with my family, and relative to what many communities including here in New York, all around the world are going through, weird though it is, we’re in a good position. Even while there’s been this humanitarian crisis essentially going on all around the world, it’s been some of the most intense periods for iShares as a whole over the past three or four weeks, or the past kind of month and a half or so. 

    MARY-CATHERINE LADER:  It seems like it’s been a time that’s really tested ETFs and certainly has created a lot of conditions that many had speculated about how ETFs would hold up during the times like the ones we just lived through, so what were some of the major lessons from your perspective?

    SALIM RAMJI: Well first, just to give context, it really has been. I’d say the past month and a half or so have been the most intense stresses for the ETF category and the index category. In part because of the market volatility, in part because of things that have happened in terms of market structures. These circuit breakers on the New York Stock Exchange came into effect four times. They haven’t come into effect before. And in part, because there were just so many markets that were dislocated and people were looking to the ETF to really provide liquidity, provide price discovery, provide access, and really be able to get their money back when they wanted their money back. And that was all in a period of time where all of us, all of our partners, were all working from home. And so, the encouraging thing coming out of all of this is that in this most extreme test that we've ever gone through, iShares did exactly what they were supposed to do. They tracked the market, they provided price discovery, they provided access to markets for investors all over the world, and the thing that is a real positive is that we continued to keep our promises to our clients.

    MARY-CATHERINE LADER: There were moments or days when there was a lot of concern about illiquidity in the market and that markets might not, frankly, work in some ways, as was particularly important in times of volatility. Were there liquidity concerns with ETFs and how did that end up playing out?

    SALIM RAMJI:  Yeah. Some of the liquidity issues were most acute in the bond market. And the bond market relative to the equity market is pretty antiquated in how it operates. It’s pretty opaque, it’s not generally done on exchange, it’s done over the counter, so it’s just negotiated. And the ability to really find liquidity is its own mix of art and science. And I think that the thing that ETFs did, because of the characteristics they have – they’re on exchange, they’re fully transparent, and they’re very liquid – meant that investors were able to get a real sense of what the true pricing was in the bond market, during periods in which that wasn’t totally clear.  And I think in doing so, they added a service not just for investors, but they added a service to the market themselves, where these became instruments of modernization within the bond market itself.

    MARY-CATHERINE LADER: Given that that was a unique test — ETFs hadn’t been at this volume in previous crises – do you think there are any policy or market structure implications coming out of this period that would make sense to be broadly adopted or considered?

    SALIM RAMJI: You know, probably. Look, this isn’t over.


    SALIM RAMJI: We’ve come through the past six weeks and in the past six weeks, things have worked, but both in the world economy and in the markets themselves, this was a test but this was a first test of 2020; I doubt it’s going to be the only one. I think there will be some look at policies. But I think the thing that again was really encouraging is when you look at the policies that were put in place post-2015, around market structure, which led to a lot of the market-wide circuit breakers being activated four times in the month of March, which they’d never been activated under these new rules. So if markets were opening up outside of certain boundaries, so down more than five percent, down more than seven percent, that what would happen is there would be a temporary halt to trading for a period of 15 minutes so that the market didn’t get overly volatile or overly out of whack as a result of trading happening that was well outside the bands of normal, or even in some cases, erroneous trading. The last time they were activated was in 1997 under an old set of rules. And it worked. And so I think that was effective policy coming into action. Doesn’t mean there won’t be more, doesn’t mean there won’t be different stresses that we discover, but at least this was a good example of a series of policy changes and enacted four or five years ago that really worked and benefited markets and benefited investors as a result.

    MARY-CATHERINE LADER:  So as we’ve been talking about, this is an extremely usual time but are there some longer-term trends that you see playing out? Trends that you think will last beyond this period?

    SALIM RAMJI: Look, we’ve seen different periods of volatility over the past 10, 12 years, including the financial crisis itself a dozen years ago, and in each period of volatility, it’s been a positive motivator towards ETFs. If I can give you a couple of examples just from the first part of this year, that what we’re seeing is first of all, we’re seeing greater movements towards investors moving towards model portfolios. They’re more diversified, they’re often simpler, they’re often cheaper, and over the long term, they tend to perform better than the collection of individual securities and mutual funds and things that investors have collected over the years.  And we really saw in the first quarter, especially during the periods of market volatility that kicked in around February and March, more investors towards a model-based portfolio or total portfolio approach; I think that is certainly a trend that’s been around for a while, but I expect that is going to accelerate. And I think the second piece has been around the growth and access of sustainable investing. Sustainable investing for us within iShares this past quarter, it was a record quarter; we raised $10 billion dollars in sustainable ETFs. And just a year ago, we were managing only $20 billion, and now we’re managing $40 billion across our ETF and indexed mutual fund range. This quarter was a record quarter for us, even through the month of April, we’ve now raised more in sustainable ETFs and index funds then we raised in all of last year, and last year was a record year for us. So I think that there’s also some unlocking that’s happening that as a result of this volatility, people now have lower capital gains, unfortunately, because they have lower returns, but it’s enabling them to move to different asset classes that they’ve wanted to move to. And I think there is real pent-up demand for sustainable investing, which is why you’re starting to see greater movements towards flows. And I think the other piece around it is that sustainable investments tend to have more of a bias towards profitable companies, more of a bias towards companies with less leverage, more of a bias towards companies that by their nature are much more long term focused. And I think there is also increased appetite, especially in this environment that we’re in, towards more investments that exhibit those attributes.

    MARY-CATHERINE LADER: And we started the year of course at BlackRock saying that sustainability was going to become our new standard, so in some sense, some of those trends and drivers were anticipated or were evident, but the fact that they persisted during that period of volatility may be surprising, although the reasons you gave of unlocking opportunity and the potential to take advantage of lower capital gains certainly makes sense. But do you think there’s anything about the events of the past six weeks that influenced how investors perceive sustainable investing, or really this is a matter of timing for a trend whose time had come?

    SALIM RAMJI:  I think it’s the second point, I think it’s a trend that had a lot of pent-up demand. I wouldn’t over-interpret the past six weeks, because I think these things take months and years to really play out in terms of investor sentiment. But I do think two really important things have shifted. And it’s not just over the past three months, but it’s really looking back over the past year or two. The first is that there is real demand amongst investors all over the world, and from individual investors to institutional investors to everybody in between for sustainable investments. And I think you’re seeing it in our flows from last year, you’re seeing it in our flows from the first quarter, I expect you’ll continue to see it in the years ahead, but I think that that’s been a change in investor sentiment that’s been building for some time. Some of it is based on values and peoples’ views of the world, but a lot more of it is starting to be just based on value and peoples’ understanding that many of the risks within ESG, particularly climate risk, is a risk just like any other investment risk. And just as you can’t ignore certain categories of investment risk, you can’t ignore ESG risks. You need to build them into your process and how you think about investing. 

    MARY-CATHERINE LADER: And what incentives is that creating for companies in that there is now significant capital flows flowing into those companies that are classified by certain sustainable behaviors? Is that at a volume that it’s really creating any incentive for firms, and what does it mean for those that fall behind?

    SALIM RAMJI: There is a virtuous circle happening, MC. One piece of it is more investors want access to sustainable investing, it’s not just a niche. Sustainable investing has been around for a long time, but historically, it had been a very small niche of investors; and now it’s becoming a more, hopefully a much more mainstream way in which investors look to deploy their money. I think the second point which you raised just now is that that’s providing greater incentive for companies to disclose. And it’s remarkable, just even in the past several years; back in 2011, less than 20% of S&P 500 companies disclosed aspects about their sustainability and their ESG risks. Today, that number is more like 80%. And with that, there is now a greater lens for investors to really be able to understand what types of ESG risks companies are taking, and that creates its own circle, because then companies that are good at thinking about governance, good at thinking about the social impact of their business, good at thinking about the environmental impact of their business are able to make these disclosures, and investors who seek that are then able to identify them in a way that they weren’t otherwise able to identify it. So, I think that creates a virtual circle which really matches investor appetite with companies that exhibit those characteristics.

    MARY-CATHERINE LADER: That makes a lot of sense, as the data is getting better, the access can increase and so it creates that virtuous cycle. One thing that you also mentioned is that it’s not as though sustainable investing is new, it’s been around for a long time but just as more of a niche strategy, largely active managers and not as much index products. So, part of what’s happened now is that index products have been taking off more dramatically than other products in sustainable investing. Why has that been the case? What are the characteristics that have led to that growth?

    SALIM RAMJI:  It’s really fascinating and I think really exciting, because I think the biggest part within sustainable investing from a growth point of view, in my opinion, is that it’s ripe for indexation. And if you think about what indexation is at the core, whether you're taking about sustainable investing or any other kind of investing, it’s just automating the investment process; it’s doing it in a way which is transparent, which is rules based, and which is investable. And ETFs are really the most convenient application of this automation, but sustainable investing was kind of the area that – I don’t think it’s the area that indexing forgot, it’s just like it was its own niche and the level of index penetration in sustainable investments was like less than 7% even five years ago, where in other, more mature markets, it was like 40 or 50%. And so, it’s just a huge gap in terms of the level of index penetration in sustainable investing. And I think one of the things that’s really exciting for investors, back to this point about pent-up demand, is that the other thing that index investing, and particularly ETFs do, is it makes investing far more accessible. And so, what’s now happening is that investors of all types want access to sustainable investing. Data and disclosure is getting better, so now you have an ESG index that you can invest in which is far better because of disclosures and because of the analytics being applied to it. You can offer these at a far cheaper price, and you can offer a huge amount of choice because it’s relatively efficient to wrap something in an ETF. And I think if anything is going to be growing the market for sustainable investing, I think indexation is going to be really powerful force. Even on our own projections, the total market of index funds and ETFs that oriented towards sustainable investing are just over $200 billion dollars today; we expect before the decade’s out, that is going to grow by more than a trillion dollars. What it’s really doing back to the reference of making sustainability a standard, is it’s really making it mainstream, and it’s really providing access to millions and millions of investors who want to invest in this way, the ability to do so.

    MARY-CATHERINE LADER: And this is an obvious question, but why is choice so important? Can’t you provide access because of price, access because of awareness, and a certain range of choice, but why dozens and dozens of different options? Is it because there are different definitions of what sustainable means? Is it because some come at it with a risk approach versus a more values-oriented approach?

    SALIM RAMJI:  Yeah. I think choice is really important. Because every investor has a different starting point and a different need for sustainable investing. Some investors are very purist about what they want in ESG index. And those will only invest in companies that exhibit the best ESG characteristics defined by a set of transparent rules. But other investors, they want to improve their ESG scores, but they still 

    either buy obligation, maybe a contractual obligation that may be in their investment policy statement, they still need to track a market cap weighted index, things invested in companies that exhibit better ESG scores, but still seek to track pretty closely to a market cap weighted index. And there are other investors still that are perhaps much more values based and just want to screen out certain sectors or certain types of companies that are inconsistent with their values. Our own goal is to have about 150 ETF and index funds over the next couple of years. I don’t think we intend to have thousands, but 150 seems to us to be able to get the right level of choice recognizing that there are different segments of investors.

    MARY-CATHERINE LADER: There may be a popular misconception that sustainable investing is a matter of personal choice of individual values. And you of course referenced that is the key for some investors. But I’m also curious to what extent you think there is a generational dynamic here? Is that one of the longer-term drivers of demand for sustainable investing as we see transfer of wealth from Baby Boomer to Generation X and Millennials, or is that a popular misconception and not a critical driver in reality?

    SALIM RAMJI: I’d say it’s a critical driver, but I don’t think it’s the only one. I think that even beyond the generational shifts, which are clear, and they’re as much societal shifts as anything – I think they're just shifts in how people think about this as a risk. I think some of it is peoples’ attitudes and values, and there certainly are segments of demand, but I think that the thing that is going to mainstream sustainable investing are two powerful forces working together: one is the recognition that climate risk is an investment risk, and from a fiduciary point of view, thinking about climate risk as an investment risk has very profound implications for how we think about investing in ESG and ESG risks. But I would say an equally important force is the force of indexing being brought to sustainable investing, and I’d say it’s equally important because what it’s really doing is increasing access to different segments of the population that might not have had it. Because they might have lacked the choice, or because they might not have wanted to pay so much for active investing, or because they wanted a way, and a convenient way, like an ETF, in which to get access to this investing category.

    MARY-CATHERINE LADER: And so what does all this growth of indexing and sustainable investing mean for active? In other categories, we’ve seen that it’s put pressure on fees in active management, sometimes challenges the value proposition, it’s maybe particularly interesting here because sustainable investing was so long this niche category of choosing companies with limited data as to whether they had sustainable behaviors or not. So what do you think will be happening going forward, whether we'll see as much demand for active sustainable investing strategies?

    SALIM RAMJI:  Yeah. I’d say that there are two things, one of them is that you’ll start to see – and I think we already are seeing – many more sustainable investing activities in the realm of private markets. If you think about things like infrastructure or if you think about things like renewable power, those are both examples of things that are looking at long term investment opportunities and the ability to invest through private markets and long-term investment opportunities, that actually work quite well together. I think if you think of traditional liquid active management, I think the firms that are looking at this as another risk factor will yield positive long-term outcomes. And I think the other piece is that there is going to be a significant reallocation of capital from non-sustainable to sustainable investments. And I think one other place in which active investors can outperform is by getting ahead and seeing ahead to where those reallocations of capital will take place. But I think the final piece is just across other places where indexation has been brought, it’s also required existing incumbents to up their game. Because they think that indexation provides transparency and lower fees and convenience and for managers that are able to move towards private markets, for managers that are able to integrate ESG into their investment process, for managers that are able to stay ahead of the reallocation of capital, they will be able to grow alongside the growth in sustainable investing. But for those who are doing things that can be easily replicated for a fifth of the cost by an iShares, yeah it’s a problem. But I’d say that is good for investors and it’s good for the efficiency of the market. So that’s just an example of automation and convenience being brought to this particular part of the market.

    MARY-CATHERINE LADER: And so, in three, five years, where do you think sustainable investing – how does it look different than it looks today? Is it just investing, or what do you think?

    SALIM RAMJI: Well, I think one way in which it’s going to be very different is that indexation is going to be a much more powerful force within sustainable investing, it’s this trillion dollars of new assets that we see coming into sustainable indexing. It’s one important way of mainstreaming, but I think it’s also going to have profound effects to how sustainable investing across the board is done, just as this has had profound effects in other markets where indexation has grown. I think the big difference here, by our own projections, we expect it is going to take seven or eight years to do what’s taken 20 or 30 years in other markets, because the demand for sustainable investing is so great and the opportunities for indexation within sustainable are so great, so you are going to see an acceleration of those forces happening. And I think that that’s going to have some pretty profound shifts and changes in how sustainable investing across the board, whether it’s through active or through indexation, is going to be done.

    MARY-CATHERINE LADER: One last question and we’ve been asking the same question throughout this series of everyone who has joined. So much we talked about today, industry trends, dynamics you’re seeing as a leader of the iShares business, all solidly in the category of professional observations of sustainable investing. But I’m curious for you personally, was there a moment that changed how you thought about sustainable investing and sustainability?

    SALIM RAMJI: I think the moment for me was probably towards the end of last year. When we launched a greater number of these iShares ETFs back towards the end of 2018, I had imagined that this was a really good long-term growth project that would pay back many, many years from now. And the thing that really surprised me was the scale of the latent demand, and just the excitement and enthusiasm among all types of our clients, not just sustainable enthusiasts, but all types of our clients around the world, I would say just really surprised me, whether it was giving a speech in Tokyo, whether it was talking to a wealth advisor in the United States, whether it was speaking with an institutional investor in Germany, the degree of interest and enthusiasm around this just really surprised me to the upside. And so, I think we’re just at the very early stages of this, that it isn’t five or ten years out, it’s like last week.

    MARY-CATHERINE LADER: Well, it will be fascinating to see how that unfolds over the course of the rest of this already extremely unusual year.

    SALIM RAMJI: Absolutely.

    MARY-CATHERINE LADER:  Thank you so much for joining us today, Salim, it’s been a real pleasure talking to you.

    SALIM RAMJI:  Yeah, of course. It’s great to talk to you, MC.


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  • Oscar Pulido: The world is already starting to shift because of the coronavirus and there’s no doubt this will continue in the months and years to come. Healthcare companies and researchers around the world are mobilizing to create a vaccine; technology has shifted to emphasize solutions for working at home; and clean energy has become even more in focus as companies and individuals think about their impact on the environment.

    Today on The Bid, we’re talking about megatrends. The long-term societal shifts that we believe will persist through the pandemic. We’ll talk to Jeff Spiegel, U.S. Head of Megatrends and International ETFs about the long-term investment themes that emerged from the 2008 financial crisis, which megatrends are resonating most in today’s pandemic and how to think about investing for the long-term. I’m your host, Oscar Pulido. We hope you enjoy.

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

    Jeff Spiegel: Oscar, thanks so much for having me. It wasn’t a long commute as we’re coming in live from my apartment in New York City.

    Oscar Pulido: Oh, for sure. I’m in my home studio as well and been getting used to it over the last couple of weeks. So, I can definitely relate to that. Let’s talk about the megatrends. It’s actually been a topic that has come up a couple of times on The Bid, certainly a topic of interest for our listeners. Now, these are, as I understand, long-term structural forces that are shaping the way we live and work. But perhaps you can give us a quick refresh on what are the exact megatrends that we’re watching.

    Jeff Spiegel: So, as you said, megatrends are long-term transformational forces that are really changing the way we live and work. And these are structural opportunities with long-term catalysts that really make them feel almost inevitable, and that’s in contrast to more purely cyclical opportunities as captured through traditional sector strategies and the like. Today, a number of them are actually having really once-in-a-lifetime moments where those long-term forces are aligning with short-term cyclical drivers. Simply put, the world will be different after COVID-19, one example of that is going to be the acceleration of key megatrend themes that were already coming and are now going to arrive even faster. So, really to your question, as part of a firm-wide effort across active investors, index investors, the BlackRock Investment Institute, key external innovators and thought leaders, we’ve identified five. The first is technology: areas like AI, cybersecurity, networking, data. They’re not mutually exclusive though, so tech does play a role in all five. The second is demographics. Here, we’re talking about aging populations. For the first time in less than 10 years, there will be more grandparents than grandchildren in the U.S., more over 65’s than under 18’s, and that will be true worldwide shortly thereafter. Third is urbanization, which is about the move to cities. Over 75% of people live in the cities and developed markets in Latin America. In the EM markets in Asia and Africa, that number is less than half. We’re seeing that drive a massive catch-up effect as these places urbanize, and at the same time, the U.S., Japan, Europe, other developed areas seek to revitalize their own infrastructure. Fourth is climate change. Here, we’re talking about firms on the cutting edge of driving a clean green tomorrow through clean energy, electric vehicles and the like. And lastly emerging global wealth. One to two billion people will enter the middle class in the coming decade or so and 90% of those people live in emerging market countries in Southeast Asia.

    Oscar Pulido: So, Jeff, as you mention these five megatrends, it sounds like investing in any one of these is really about investing in multiple sectors of the economy. In other words, it doesn’t sound like just technology companies capture one of these trends or just healthcare. It feels like you would have sort of cross-sector type investments if you were trying to pursue these megatrends. Is that the right way to think about it?

    Jeff Spiegel: Exactly. So, we think that megatrend strategies should be designed in a way that they’re unconstrained, and what I mean by that is you’ve got to go global, you’ve got to get across sectors. So much technological innovation is getting adopted in non-technology areas. Think about the use of robotics in industrials, the use of artificial intelligence in communication services, the use of big data techniques in medicine. Traditional sector strategies tend not to really capture megatrends, which again, gets back to that point that they tend to be cyclical.

    Oscar Pulido: So, if megatrends are long-term and structural and meant to persist over many decades, you mentioned your commute is quite short these days. We’re all living in a very new and different reality these last few weeks and it’s difficult to think about the long-term when it feels like we’re just thinking about day-to-day and what the news flow is going to look like. So, do we have examples from the past where we’ve had these crises or these downturns where we’ve actually seen a long-term structural trend emerge?

    Jeff Spiegel: Yeah, so it’s absolutely hard to think long-term right now and investors around the world are looking at their portfolios and seeing declines at the same time as they have real fears from job security to health and safety, and that make this moment especially tough. But we know that market downturns are also opportunities, rebalancing the equities during these declines allows investors to recoup their losses and often then some when the market does eventually come back and it always has. So, cyclical downturns are often pivotal moments for megatrends. They may suffer with the broad market in a sell-off when selling can appear kind of indiscriminate across asset classes and market segments. Sometimes they can sell-off even harder than the overall market, but they tend to outperform in the aftermath. So, ecommerce is a really neat example of that. Before the financial crisis of 2008, 2009, we all knew ecommerce was coming, more shopping was happening online, firms were starting to dominate retail sales. Nonetheless, at the lows of that downturn, ecommerce was down nearly 70%, even more than the S&P 500 at its lows during that same period, but not only did ecommerce recover harder and faster than the S&P, it out performed over the next 10 years through to today by well over 20 times the returns of U.S. equities broadly1. That means the financial crisis was a huge opportunity to buy the ecommerce megatrend at significantly reduced valuations. We think it’s not unlikely that a new set of megatrends, today’s equivalent to ecommerce, have the same potential coming out of this downturn.

    Oscar Pulido: Well, you’re certainly right, ecommerce was a trend that persisted throughout 2008 and judging by the lobby of my building, it seems to be doing pretty well during the corona crisis as well.

    Jeff Spiegel: Yeah, so I would say that the farthest I am traveling on most days is to go down and get those packages and that is one of the highlights of my day at the moment to be sure.

    Oscar Pulido: You mentioned that we’ll likely see some new megatrends that will persist through today’s market volatility. So, give us a sense of what are some of the things that you’re seeing that you think we’ll be talking about in the months and years ahead.

    Jeff Spiegel: The megatrends we’re focusing on right now are actually being accelerated by the crisis itself, and therefore the long-term structural shifts we've been anticipating seem likely to come to pass even faster. And this is true in a few areas in particular, and I’ll break it down by megatrend. Within our technological breakthrough megatrend, we’re seeing a huge move to virtual work, that’s driving networks and computing systems, big data, cybersecurity, and at the same time, AI is being deployed to understand the pandemic’s course, track infections and accelerate the testing of treatments. In demographics and social change, we’re seeing the two most game-changing areas of medical breakthrough, genomics and immunology, stand unsurprisingly on the forefront of understanding and treating the disease. And then as far as urbanization and climate change, these are places where we expect that subsequent rounds of government stimulus have the potential to drive outperformance as people are put back to work in these areas. So, we know the long-term structural theses behind these megatrends. In addition, we’ve got these catalysts coming out of this crisis where some of these key areas of innovation are really playing a role and offering some hope and helping.

    Oscar Pulido: You mentioned a number of interesting themes. So, let’s deep dive. Let’s start with the genomics and immunology. There’s obviously a race around the world to produce a vaccine in pretty short order. So, how are we seeing this play out and what implications does this have for after a vaccine is ultimately developed?

    Jeff Spiegel: So, the vaccine is a key question for society and our safety. In a lot of ways, I think there’s actually a lot more to unpack there for investors. We saw genomics and immunology as key areas of medical innovation before all this started. Now genomics is helping researchers understand the coronavirus’ RNA. Breakthroughs in mRNA sequencing are allowing scientists to decode the disease at an incredibly rapid pace. That’s not actually the vaccine development itself, but it’s enabling quick drug development and experimental trials for vaccines. So, the major drug companies at the forefront of vaccine development are relying on a range of firms in the field of genomics to enable them. For investors, that’s a reason to think about the theme versus betting on the individual company that makes it to the vaccine, it’s also a lot less risky than trying to pick that single stock winner. Likewise, immunology is helping to incubate treatments that work directly with our immune systems. One of the most promising potential areas here is stimulating the body’s immune system by replicating and transferring antibodies from those who have already successfully beaten the virus. Not to mention, repurposing drugs in immunology that are used in places like rheumatoid arthritis, an autoimmune disease; not to create vaccines, but to treat those who are already infected. Again, a range of firms across the theme are set to benefit rather than the one firm with the end product that’s ultimately adopted. The latter, that one firm is really hard to identify. It’s no coincidence that these exciting areas of medicine are providing the solution to this challenge. The crisis is really only hastening the realization that will see more innovation and investment in these spaces that were the most promising in delivering personalized medicine via genomics and areas like cancer treatments through immunology and immunotherapy long before today’s crisis and that will continue to play a role long after.

    Oscar Pulido: Let me also ask you about the technology side of this. When you were mentioning some of the megatrends that we think will persist throughout this volatility, we’re working from home, we’re doing more video conference, audio conference these days just to stay connected at our respective jobs or with our families. Do you think that even after people begin returning to working in offices, will there be more remote work than there was prior to the crisis?

    Jeff Spiegel: So, I think the short answer is yes, right? If we think about this, in a matter of weeks, virtually all corporate employees around the globe started working from home, non-essential medical visits became virtual, so did learning for hundreds of millions of students, maybe more than that. So, companies leading in remote software have therefore seen their products leveraged at record rates. 5G and networking connectivity are also therefore in focus. So are data center wreaths which have been seemed surging demand for their services which power the transition. Is it the short term, is it long term? The answer is both. The fact that the internet of things is expected to double from 30 billion devices now to over 75 billion in coming years, that was true before this pandemic, but it’s not any less true today. In fact, we see the cyclical tailwind pushing connectivity forward, meaning that the future is actually coming faster. So, companies have invested in work from home tech. They are learning what many tech companies have known and been adopting for years that virtual work is actually effective and therefore likely to proliferate after this massive unplanned beta test that was effectively sprung on the world.

    Oscar Pulido: And I imagine this has implications for cybersecurity, right? If companies have more of their employees working from home, they have to be thinking about the security risk. So, obviously more people on the networks and more people on the internet. How are companies thinking about the risks to this?

    Jeff Spiegel: So, before we moved into a work from home world or WFH as the kids are calling it. Though I’m not entirely sure why since that’s actually more syllables rather than fewer. Before that, only 15% of U.S. risk executives felt their firms were well-prepared for cyber threats. So even as the number of cyber criminals on the FBI’s most wanted list went from a handful to over 40 in just the last few years, there is still that feeling of unpreparedness. That’s pretty scary at a time when we’re that much more exposed through virtual work. It means firms are massively investing in the space. And so, if we’re right that virtual working actually grows and is accelerated once we’re able to return to our offices then that investment in cybersecurity only continues.

    Oscar Pulido: Jeff, you’ve also alluded to AI a couple of times or what we call artificial intelligence. It was a topic of interest even before we got into this corona crisis, but it seems to also be playing a role in a variety of ways in which we’re responding to this crisis.

    Jeff Spiegel: Yeah. This is a great example of where the structural and cyclical are colliding and really pushing megatrends forward. Year after year, we’ve been applying artificial intelligence to solving new problems from chess to logistics, to voice-activated assistance, that’s a long-term trend. And today, AI is being applied to a range of crisis areas: understanding and mapping the pandemic, keeping track of those under quarantine. Not to mention, many leading AI firms are actually lending their AI super computing power to drug companies enabling testing of treatments in days versus the months it would take using natural or more traditional computing power.

    Oscar Pulido: And lastly, you mentioned clean energy, and you also touched on climate change being one of the five megatrends. We’ve definitely seen a growing interest in sustainability and BlackRock has certainly been very vocal about the belief that climate change represents investment risk in portfolios. But can you talk a little bit about the growing interest in sustainability and maybe more specifically renewable power. How do you see this continuing through the pandemic?

    Jeff Spiegel: So, over the last few years, we’ve seen a surge around clean energy adoption and usage. In fact, governments have pledged two trillion dollars of renewable investments in the near term. In a push driven by governments themselves, businesses, consumers, all around the world looking to go more green. Another stat I really like, 80% of U.S. consumers age 18 to 34 are actually willing to pay more for a low or zero emission vehicle. That’s the long-term trend. Short term, the stimulus the government is focused on so far is getting cash into the pockets of those who need it and ensuring the financial system keeps functioning. In the midterm, in subsequent rounds of stimulus, governments around the world are likely to put people back to work through infrastructure projects and a lot of those, we think, will be focused on clean energy. So, despite the precipitous decline of oil, clean energy has been doing well and we expect that to continue or even accelerate even further when we see those later rounds of stimulus putting people back to work in helping us build out a green economy.

    Oscar Pulido: So, a recurring point that you’ve made is that these investment themes, these megatrends, are much more structural than they are cyclical. Meaning, that they’re meant to last over many years as opposed to just a short time period. So, I guess with that, what’s the most important thing for investors to know?

    Jeff Spiegel: The most important thing for investors to know unquestionably is that staying invested and rebalancing the equities is critical in a downturn. As we discussed, it’s also hardest in a downturn. Long-term structural shifts do present an opportunity to do that. So, I would encourage investors to look at areas with a wide range of names poised for that long-term outperformance and names that were poised for it even before this crisis. Just take as a bonus, if they’re being accelerated forward, by helping us manage the pandemic at the same time. Think long term, that’s always the key.

    Oscar Pulido: Well, and it’s sound advice, Jeff. Particularly these days when we’re sort of thinking about the day-to-day and the pandemic. But when it comes to investing, thinking long-term has proven to be a recipe for success. So, thank you so much for joining us today. It was a pleasure having you on The Bid.

    Jeff Spiegel: Pleasure to be here. Thanks, Oscar.

    1Source: Bloomberg, indices used: MSCI ACWI Internet and Catalog Retail Index and S&P 500 as of March 30, 2020. Index performance is for illustrative purposes only.

  • Oscar Pulido: Over the past few weeks, the coronavirus has driven markets into turmoil. We’ve seen stock markets plunge into bear market territory for the first time in over a decade, 10-year Treasury yields drop below 1% for the first time in history, and going forward, we expect a deep shock to economic growth.

    This market uncertainty has driven a lot of questions. What are the parallels between today and the financial crisis of 2008? Is this crisis worse? What signs are we looking for which suggest we are on the path to recovery?

    On this episode of The Bid, we asked five senior investment professionals from across BlackRock to answer the most pressing questions we’ve received from our clients on the coronavirus. I’m your host, Oscar Pulido. Let’s get to it.

    First, the most pressing question that I think we’re all wondering about: Is this 2008 all over again?

    Kate Moore: In terms of the economic environment going into the 2008 crisis versus today, they could not be more different.

    Oscar Pulido: That’s Kate Moore, Head of Thematics for Global Allocation.

    Kate Moore: In 2008, we had some serious and deep fractures in the economy. We had huge amounts of debt both at the household and the corporate level. There was a white-hot housing market that was a bubble primed for bursting. And we had significant imbalances across not just the U.S., but the global economy. This crisis and this economic decline that we’re experiencing we know is caused by a health crisis. It is temporary, it is transitory, and while it is tragic and scary, it is just not the same. I must say that we’ve entered this crisis on much stronger ground. Unemployment levels were at record lows before we started. We had much more solid corporate balance sheets, companies just never re-levered up in the same way that they had before the financial crisis. Many companies, actually, are sitting on huge amounts of cash, which is a real positive. And there were no shady operations in the housing market. I think perhaps most important, though, is the health of the consumer going into this crisis. Consumers were facing positive income growth, their balance sheets looked good, optimism was incredibly high over the last couple of months until we started being faced with this health crisis.

    But I think there’s a couple really big differences between 2008 and 2020 that should give people comfort. The first and most important is the speed of the policy response. We are just not destined to repeat the mistakes that we’ve had in the past. And by this I mean, policymakers know that markets stop panicking when they start panicking. And so, we’ve seen a huge number of measures on both the monetary side as well as the fiscal side, not just in the U.S., but globally, to address some of the stress in the market and the economy. The second is markets are pricing in worst-case scenarios at a much faster speed than they had even in 2008. We were still digesting information, the news flow wasn’t quite the same, and there were large swaths of the economy which we could not really predict the outcomes. As a result, asset prices were not dislocated as quickly as they are today. And a third thing I would say is, especially for institutional investors, professional investors, there has been a rapid and I think very successful de-risking across these segments that is frankly a reaction to the experience of 2008 and I think will leave portfolios in much better shape as we endure the duration of this crisis and as we look to the next steps.

    Oscar Pulido: As Kate mentioned, the global economy was in much better shape going into this crisis than it was in 2008. And one more difference she notes:

    Kate Moore: I think the music has gotten better over the last 12 years. Some of you might remember that Flo Rida’s “Low” was topping the charts 12 years ago during the financial crisis. It wasn’t just a catchy dance tune, but eerily appropriate given the market collapse: low, low, low. Today, at least we have a little Billie Eilish and I think a lot of good alt rock. That should really help to calm people’s nerves.

    Oscar Pulido: Better music aside, taking a look at history can be helpful in understanding today’s market volatility. Which brings us to our second question: What episodes in history can we look back on to better understand this crisis? We asked Jonathan Pingle, Head of Economics for Global Fixed Income, and Jeff Shen, Co-Chief Investment Officer of Active Equities, for their thoughts.

    Jonathan Pingle: I think episodes that I look back on for very sharp down, but then relatively sharp climb out, you know, 1957, 1958 recession in the U.S. was actually partly due to a flu pandemic, actually, one of the major pandemics we had in the 20th century.

    Oscar Pulido: That’s Jonathan Pingle.

    Jonathan Pingle: Another dynamic that you could look to to think about the timing is China when it went through SARS in 2003. The Chinese economy decelerated by nine percentage points in one quarter. Another example a little bit, people forget about the 1980 recession in the U.S., it was driven by consumers really shutting down during a credit crunch as the Federal Reserve and the administration at the time tried to get Americans – there was a famous plea to cut up your credit cards, and in fact, consumer credit contracted more sharply in 1980 than it did during the great financial crisis. Now, I think the downturn we’re going through is probably going to be more severe in its trough than those three episodes. But they have a template of getting through the acute severity and then rebounding on the other end and returning to relatively solid growth. The risk is, I think, in this episode, even though I think that we’ll have a very severe economic contraction that we will bounce out of, I think policymakers want to short circuit the negative feedback loops that can lead to dynamics like the great financial crisis where there was an acute contraction and an extremely slow recovery where the economy just kept contracting and contracting and contracting. Now, with the banks in good shape, hopefully that is one positive, and certainly policymakers appear to be moving quickly to prevent some of these worst-case outcomes.

    Jeff Shen: I think from a macroeconomy perspective, what we’ve been experiencing over the last couple years is a bit reminiscent of the late 1990s where we have seen growth stocks outperforming value stocks by pretty large margins.

    Oscar Pulido: That’s Jeff Shen.

    Jeff Shen: We’ve also seen the U.S. equity market outperforming the rest of the world by a pretty large margin. And in the late 1990s we’ve also seen that the Asian financial crisis caused quite a bit of a trouble in southeast Asia. There’s also the Russia default that subsequently caused long-term capital to blow up. From a macroeconomy perspective, there’s certainly a bit more of a late 1990s that resembles a macro environment. The second episode that I think in history is relevant is when we think about 9/11, which certainly was an exogenous shock to the system that caused the New York Stock Exchange to close by about a week. And the market also dropped quite a bit and subsequently the market started to rally, given that the terrorist attack certainly was isolated, even though it’s pretty devastating. So, from these two relevant episodes I think, alongside with the 2008 financial crisis, I think none of these events are a perfect match to what we are going through, at the same time they are also useful guideposts as we think about what the future can involve.

    Oscar Pulido: One consistent view is that while there are similarities to the global financial crisis and other episodes of market volatility in the past, we’re in a different environment today. The economy and the banking sector in particular were in good shape heading into the coronavirus shock, and as Kate mentioned, we’ve seen monetary and fiscal policymakers take action quickly.

    But there’s no question that we’re seeing the impact of the coronavirus on our daily lives. Bustling city streets are now empty, restaurants and storefronts are closed, and working from home has become the new normal. Which brings us to the third question we’re hearing from clients: Is the economic impact of the coronavirus going to be more severe than that of the financial crisis?


    Mike Pyle: I think it is clearly the case now that we see that the immediate shock itself, this kind of sudden stop in activity across the economy, unprecedented historically, is going to lead to a deeper and more precipitous shock to the economy than even what we saw in 2008.

    Oscar Pulido: That’s Mike Pyle, Global Chief Investment Strategist.

    Mike Pyle: To take just one example, initial claims for unemployment insurance. Two weeks ago, there were around 210,000 people near cyclical lows. Last week, we saw over 3.2 million people claim unemployment insurance benefits. That speed and scale of shock is literally unprecedented as long as these records have been kept. Even at the peak of the financial crisis, we only saw 650, 700,000 initial claims in any given week. So that’s different.

    I think the ways in which we think the damage can and hopefully will be less severe is looking at the longer horizon. The global financial crisis 12 years ago didn’t just include a kind of acute phase, but because of the hit in particular to banks and the financial sector, the deleveraging that that necessitated over a period of many years, slowing the flow of new credit to businesses, households, slowing growth on a very long term multiyear basis. The GFC was really a series of accumulating damage to the economy over many years. And our base case and expectation here, should the world and the virus itself cooperate a bit, is we’re going to see an unprecedented shock in the short term, but if policymakers are able build this bridge across the chasm to the other side of the outbreak and a period that allows for some normalization in the next 2-3 quarters, that’s a world where it doesn’t need to be the case that the economy has sustained very significant, very substantial long term damage, and hopefully allows businesses small and large, households to really begin normalizing on a much more accelerated time line versus what we saw 12 years ago. And so I think that gets to the core of the answer, which is over the next 1-2 quarters, yes, this is going to look significantly more severe than what we saw during the financial crisis, but with an effective policy response, hopefully in a couple quarters’ time the opportunity to get back to normal, that accumulated damage that sort of builds up over many years that we saw during the global financial crisis and that gap between potential and what was actually being produced by the economy, we think that can dissipate a lot quicker, and as a result make this a less long lasting and less permanent hit to the economy.

    Oscar Pulido: So in the short term, this could provide a deep shock to the global economy. But as Mike said, in the longer term, we believe that with an effective response from central banks and governments, this could result in less damage than the financial crisis. Our fourth question: What does the timeline look like for recovery?

    Mike Pyle: You know, I think one of the places that we’re looking, as are a lot of people, is to the Asian economies — China, Korea, Singapore, Hong Kong, what have you — that really are at a different phase of this crisis and are now looking to renormalize their activity. You know there’s some encouraging signs, there have been some setbacks, so I think really keeping an eye on how far along they’re able to get in the next month or two is going to allow us to get a window into what late Q3, Q4 looks like in Europe and the United States and some of these other economies that are being hit sort of relatively later in the cycle. And that’s going to tell us whether or not this base case of a kind of one to two quarter shock is the right one or whether or not we’re in a place where this is going to be something that’s more long lasting and as a result more significant in terms of the permanent damage that the economy takes on.

    Oscar Pulido: As Mike mentioned, economies in Asia can tell us a lot about how quickly the global economy may be able to get back on track. The first known cases of the coronavirus started in China, but we’re starting to see China’s economy come back online. Our next question: To what extent has China recovered, and what lessons can the rest of the world learn from this? We turn back to Jeff Shen.

    Jeff Shen: We do track quite a bit of traditional and also non-traditional data sets in China and from what we see, capacity is certainly coming back online. Roughly speaking 80-90% of the capacity is coming back online and clearly, the parts that are least infected by the disease certainly have seen capacity coming back a bit quicker versus Wuhan and the Hubei province, which are slower to recover. The overall GDP hit to the Chinese economy is still very much up to debate, but we think that a negative ten percent GDP hit in the first quarter of 2020 is certainly quite likely. Now that can certainly change as the other economies come back online and we’re seeing a bit of a ramp up of production, especially in the manufacturing sector in the southern part of China.

    And I think the lessons learned here is probably that clearly, if you take a pretty aggressive public health response, there’s certainly a possibility to flatten the curve, from the overall spread of the disease. And it’s certainly not easy to do. There’s quite a bit of shock to the overall economic system. And I think that there is also going to be some long-term consequences related to this kind of sudden stop in the economy because some of the demand may not necessarily come back as the economy starts to normalize.

    I think it’s also interesting to look at southeast Asia, especially Singapore and Taiwan and to a certain extent South Korea, where I think some of these countries certainly have been bending the infection curve, really slowing down the spread of the disease. And I think over there it’s really a bit of a combination of some this pretty aggressive public health response alongside a more gentle way of keeping the economy going and it’s actually notable to see that Singapore has never stopped its schools from opening. So I think there’s probably a bit of a middle ground as different countries which are trying to search for a solution for the coronavirus that I think there is going to be a tradeoff between a very aggressive public health response alongside with a need to keep the economy going.

    Oscar Pulido: As Jeff mentioned, China’s economy is beginning to show signs of coming back online, as are other countries in Asia. Our sixth question: What indicators are we looking at in China to show an inflection point towards recovery?

    Jeff Shen: I think we can think about the leading indicators in two categories. The first category would be around the political development and the second would be really sort of tracking the overall economy. So in the first category of the political development, I think the two things that we are tracking are, number one, for President Xi Jinping to visit Wuhan, which has certainly been the epicenter of the virus infection and President Xi did visit Wuhan in the earlier part of March so that certainly is a good sign to see. The second indicator that we’re tracking is also to see whether children are going back to school or not. The kids in China certainly have stopped going to school right after the Chinese New Year given the virus breakout. But that’s also an area that we actually have seen pretty encouraging signs, not necessarily in some of the major cities yet, but kids, slowly and surely, are going back to school.

    I think on the economic front, we certainly track both on the supply side but also on the demand side. And on the supply side, we do look at industrial activities but also some of the satellite-image driven metallic content on the ground just to get a sense of whether there is actually more industrial activities around some of the manufacturing centers. And over there, we certainly see traffic is picking up and there is more metals moving around on the ground and that’s consistent with some of the other high-frequency economic indicator that we see. Things are certainly coming back towards normal. And on the demand side, clearly things are going a little bit slower. We track credit card transaction information and we also track some of the search information and that certainly seemed to indicate a slow, gradual recovery. But I’ll say that to the supply side, the recovery seems to be leading, while the demand side recovery has been slow, but it certainly has been there.

    Oscar Pulido: Jeff mentioned some encouraging signs coming out of China. And as Kate and Mike mentioned earlier, central banks and governments both have implemented rigorous and coordinated policies in response to the coronavirus. Our next question: What should policymakers be thinking about on the road ahead?

    Jonathan Pingle: So looking ahead and thinking about the policy response, what needs to happen, two things are crucial. One, policymakers need to make up what I’m going to call the lost income, and second, they’ll need to ensure the safety and soundness of the financial system.

    Oscar Pulido: That’s Jonathan Pingle again.

    Jonathan Pingle: The reason for that is we don’t want to go through the kind of deleveraging and credit contraction that leaves us in a position – we’ll have this acute, severe shutting down of the economy due to the social distancing and trying to prevent the spread of the virus – but on the backend of this, we do not then want to come out and have no credit provided, businesses failing, a default cycle, and the corresponding deleveraging that goes on with that and that could take quarters if that kind of feedback loop is unleashed.

    So policymakers, certainly the Federal Reserve, have moved quickly to provide credit to banks and other non-banks, broker dealers, etc. to continue to keep the flow of credit moving to households and businesses. Crucial, crucial link. For the last several weeks, it’s sort of been the mantra I’ve had with our portfolio managers internally is, corporates are going to lose earnings, households are going to lose income, building owners are going to have people missing rent payments. Policymakers need to move up the lost income so that the small business that closes down reopens; so that the household that loses the paycheck can return to spending when things clear up.

    Oscar Pulido: Jonathan mentioned the struggle that businesses and households will face in the months ahead. In particular, he mentioned the impact on companies. We’ve seen this come to life through weeks of stock market ups and downs that caused the 11-year bull market to come to an end. With the markets at a low, does this actually paint a buying opportunity for equities? We asked Kate Moore for her view.

    Kate Moore: I’ve been watching commentators and CNBC and Bloomberg and even regular news channels debate whether or not this precipitous decline in the equity market is really opening up a buying opportunity for stocks. And my gut instinct is yes, especially for people with longer term time horizons. And time horizon really matters here. But I would caution anyone about getting too cute about trying to time the market at this point or spending too many of their chips before we have much clarity on the duration of this crisis. We don’t know the length of this crisis, we don’t know the depth of the crisis, and we don’t know the efficacy of policy. And those things make it really difficult to say in the very near term that we’re going to have a big pop. I also just want to issue a little bit of a warning about people who are talking about the market being cheap at this point. Cheap is a really tough term, in particular because we actually don’t know how to price assets or how to forecast earnings in this environment. Longer term, we can say we might return to a trend revenue or trend earnings profile, but in the very near term, analysts and strategists and portfolio managers can’t forecast earnings. And I want to see widespread slashing of earnings estimates, and people pricing in more recessionary outcomes before I can say we’re starting to find real value in the market. So, a buying opportunity longer term but you have to be, what I would say, very disciplined and average in to higher-quality assets instead of trying to put all of your money to work just because we’ve had a 30% decline.

    Oscar Pulido: As Kate mentioned, a long-term investment horizon is key. We asked her a follow-up: Where does she see opportunity in the stock market?

    Kate Moore: Okay, so here’s what I would be doing right now, and this is what I am doing, which is asking myself, what is this experience telling me about behaviors, where am I witnessing discontinuous change in the way individuals are interacting with each other or with their technology, and what are the companies and industries that are going to be positioned to take advantage of that change once we come out of this crisis? There are three areas where these opportunities are fresh in mind. The first is around technology. Most of us, like myself right now, are working from home. I’ve got my golden retriever next to me and she is acting as an incredible wingman on this podcast. We are testing out new software. For many companies, as so many of their workers work from home, we are actually finding vulnerabilities in the system, so I think there’s going to be increased spend on cybersecurity. I would look at software and cloud names and then also companies in the 5G space that have the opportunity to really facilitate fast and seamless connections as really interesting for the future. The second area is healthcare infrastructure. We have renewed focus on making sure we have not just the physical infrastructure in healthcare, but also the right types of drug investment and pipeline to really serve and help populations when we face these types of crises. And the third thing I would look at is kind of overall global supply chains. I think the experience that companies have been having when country borders are closing and they may be impaired in terms of their supply chain, I think that experience is leading them to think about their investments and bringing things closer to their end market, and that may lead to a lot of really interesting opportunities. So, those areas around technology, healthcare and supply chains are where I think we should be doing work, and not necessarily trying to get too cute around impaired sectors that may deserve to be trading at a discount and lagging behind others.

    Oscar Pulido: Kate talked about the potential opportunity in stocks globally. But what about emerging markets more specifically, including China? We turn back to Jeff Shen for our tenth question from our clients: Given the gradual reboot we are seeing in emerging market economies, is there an opportunity in emerging market stocks, or should we be more selective?

    Jeff Shen: I think we need to be more selective in emerging markets. Certainly, it’s true that emerging markets have declined significantly given the coronavirus. At the same time, I think there are three elements for us to think about being more selective in emerging markets. I think number one, clearly, is that the coronavirus would have a global impact. No country is really immune to it. At the same time, I think different countries are certainly adopting slightly different public health responses and the fiscal flexibility alongside with monetary policy response can be different across different emerging market countries. And I think that’s going to drive quite a bit of a differential in terms investment performance across different countries.

    I think a second thing that we probably haven’t talked about enough in different media is that oil prices certainly have dropped significantly during this period and that is having a huge differentiating impact to different countries depending on if you’re an oil importer or exporter, certainly that makes a huge difference given the drop in oil prices. I think that’s the second lens that we can think about how we can be more selective in emerging markets.

    Last but not least, I do think that as we adjust to this new reality that’s unfolding in front of us, I think the importance of technology, the importance of you know the ability to work virtually, is here to stay. I do think that there is going to be a lot of evolution and changes and impact coming from technology that is going to probably speed up given the current coronavirus crisis. Alongside with biotech development, which certainly is quite important. So I think technology is probably another angle when we think about emerging market in the sense that the companies or the countries which are actually producing additional technology IP versus countries that actually need to import some of these technologies into their respective countries. I think that’s also going to be another wedge to drive some of the cross-country differences.

    Oscar Pulido: On the equity side, one thing that Kate and Jeff both mentioned is the importance of industries that are helping to drive this new normal, particularly technology. Turning to the fixed income side, we’ve seen that volatility in the stock market has driven investors into bonds as a safe haven. As a result, 10-Year Treasury yields have slipped below 1% in the U.S. for the first time in history. The Federal Reserve also cut interest rates back to zero. Question number 11: With market volatility continuing, could we see negative bond yields here in the U.S.?

    Peter Hayes: That’s not something I ever foresaw, but I think given the economic uncertainty and how different this scenario is, unlike anything we’ve ever seen before, it seems it’s entirely possible.

    Oscar Pulido: That’s Peter Hayes, Head of BlackRock’s Municipal Fixed Income Group.

    Peter Hayes: Just think about what the Fed is doing with their balance sheet, buying Treasuries, mortgage-backed securities, etc., and taking out securities from the market and adding another source of demand into an area where we’re seeking long duration safe assets. So I think it is possible when you look globally, around the world, when you look at the potential for further slowdown in the U.S. economy, when you look at what the Fed has done in moving rates back to zero, I think at some point in time we actually could see negative bond yields here in the United States.

    Oscar Pulido: Beyond driving lower bond yields, the coronavirus has impacted the fixed income market in other ways. In particular, social distancing will likely impact the municipal bond market, or bonds that finance government-owned projects like roads, schools and airports. We asked Peter our next question from clients: How will social distancing impact municipal bonds?

    Peter Hayes: I think the timing is very key here. I think some things will certainly have a short impact, I think other things we may change our behaviors, we may change the way we interact, there’s a lot of implications to that in terms of longer-term credit in the municipal market. And some of that ultimately will be dictated by how fast they can get a cure or some type of vaccine to market for the broader population and give people certainty that they won’t be impacted. Some of the less vulnerable areas that we identified are states, school districts, utilities, single family housing, electric, we all think are actually quite safe in the long term. Some of the more vulnerable, places like mass transit, small universities, smaller cities, even, especially those that are very dependent on a concentrated tax base that is likely to be eroded here in this environment. I think one thing to really impress upon people here is the fact that this is not going to be a systemic downturn of the entire municipal market. Are we likely to see defaults? We are, but they’re going to be isolated to the high yield part of the market, which is a natural part of that sector to begin with. So I think it’s important to really be able to distinguish the lower credit quality part of the market from the higher credit quality part of the market. And even in that segment of the market, there will be winners and losers. But I think it’s important to realize that what the government is doing, the tax base, the momentum the U.S. economy had going into this, will all ultimately lead to a positive outcome for municipal credit.

    Oscar Pulido: So with this in mind, where is there opportunity in the municipal bond market? We turn back to Peter.

    Peter Hayes: There are clearly going to be winners and losers. I think credit research is all more important today given the economic uncertainty than it was a month or two ago or a year or two ago. I think structure and liquidity will be a very important in the market. We saw a severe bout of illiquidity in the market, and we are probably likely to see more of those as this story begins to unfold. I think you need up in quality, more liquid securities, I think the structure of your securities is very important, and clearly, yields are higher today, more so than they were even a month ago. For those searching for income, that’s a better opportunity. I will say that munis continue to be a good ballast to your equity risk, when you look at the longer term.

    Oscar Pulido: Peter talked about the opportunity in the municipal market, and we heard from Kate and Jeff earlier about opportunity in the equity market. But we posed our 14th and final question to all of our guests: What’s the most important thing for investors to know?

    Kate Moore: The most important thing for investors to know right now is that this too shall pass, and this is not the time to lose your overall investment focus. You know, there’s that famous investor Jessie Livermore who said that money is made by sitting and not trading, and not trying to get too cute with the market right now. And I would say that no one is smart enough to time the bottom, but if you are calm and focused and disciplined and continuing to do your research, you’re going to come out the other side a much stronger investor with a much better portfolio.

    Mike Pyle: This is an unprecedented time. This is a time of extreme volatility. But it’s also a moment to keep a level head and make decisions with the long term in mind. So we’ve said a couple of things. One, while we pulled back our recommendations to be overweight stocks and credit markets which we had in place at the beginning of the year, a little more than a month ago, this is a moment to stay invested, to stay near those longer-term allocations; your benchmarks, your strategic allocation, what have you, and to see it through from that home base. As you rebalance, as you get back to those home bases, this is exactly the moment to be thinking about stepping into sustainable exposures for the long term. This is a moment to be opportunistic, to not necessarily be taking outright calls on equity markets or credit markets over the next 6-12 months, this is a very uncertain time still, but there are certain themes that are emerging. We think countries like the United States and China which have more policy capacity and the willingness to use it are relatively attractive exposures versus some parts of the global economy where that’s less so: Japan, Europe, emerging market exposures further away from China. We think that some of the higher quality, lower volatility factor exposures, you know like I said, just quality, minimum volatility, these are important resilient exposures for the moment.

    Peter Hayes: I think the most important thing for investors to know right now is simply that market volatility does happen. I mean, this is difficult to describe just as market volatility. I think there was a lot of irrational pricing of assets, a lot of bad news was priced in assets for a period of time because the market was so irrational. But you go back historically, if you have a long-term investment horizon, typically these periods of volatility end up being very good buying opportunities from a long-term standpoint, and I think that’s the way it has to be viewed.

    Jonathan Pingle: I think there’s going to be better days ahead. I don’t know how bad the economic data is going to get, my guess is it’s going to get extremely bad, and that we’re going to have months of bad data, but I do think that 12 months from now, we are going to be back to going out to dinner, I am certainly going to want a vacation, I think we’re going to be back to our stores and buying and what we want is to ensure that the businesses and workers that provide us with services and create economic activity and households and families, that we’re all going to go back to more normal behavior 12 months from now. So in any case, I do think there are better days ahead, and I think that’s an important thing to keep in mind as we go through what’s probably going to be a very difficult few coming months.

    Jeff Shen: Eventually given the policy responses, both on the public health front and also on the monetary and fiscal front, I do think that there is going to be a recovery on the horizon. I think that recovery is probably a little bit further down the line than people would like. I’m not sure that we’re going to go back to the normal operating mode that we knew before we were coming into the crisis. I do think that the world is going to be quite different going forward and I think two potential areas that can be quite different, I think that number one is that, on the geopolitical front, this is clearly an event that has huge geopolitics implications. I think the world is going to be probably less likely to be globalized versus into a bit more nationalistic and also deglobalization is certainly more on the horizon. The second big trend that I think we need to think about when we go through the recovery phase is certainly around technology. And I think the fundamental challenge that we face through the coronavirus certainly shows how important technology can be. There’s going to be a lot of changes ahead.

    Oscar Pulido: So despite the turmoil in markets caused by the coronavirus, what have we learned? Market volatility can be unnerving, but having a long-term perspective is the key to working through it. On our next episode of The Bid, we’ll continue to explore how the coronavirus is impacting global markets with our country heads across Asia, Europe and the U.S. We’ll see you next time.

  • Oscar Pulido: Welcome back to The Bid's mini-series, “Sustainability. Our new standard,” which explores the ways that sustainability – and climate change in particular – will transform investing. Earlier this year, BlackRock announced a series of changes regarding sustainability. Exiting business that present high risk across ESG, such as thermal coal producers, launching new products that screen out fossil fuels and increasing transparency in our investment stewardship activities.

    Today, we'll speak with Andrew Ang, head of factor investing at BlackRock. We'll start the conversation by talking about what factor investing is and how it relates to the recent market volatility. Then we'll hear why Andrew believes sustainability and factor investing go together like tea and biscuits. I'm your host, Oscar Pulido. We hope you enjoy.

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

    Andrew Ang: Thank you. It's a pleasure to be here.

    Oscar Pulido: You're a renowned expert in factor investing. For a number of us though, we don't really know how to think about factors. So, let's start there. What are factors?

    Andrew Ang: Thanks, Oscar. I think about factors as being the soul of investing. All the great active managers have always wanted to buy cheap. They've wanted to find trends, find high quality companies, gravitate to safety, and find smaller, more nimble companies. And these are proven sources of returns. And I'd like to share a little analogy with you just to think about factors in a modern-day context. So, Oscar, you've got a phone, right? I certainly run my life on my phone.

    Oscar Pulido: Absolutely.

    Andrew Ang: And you use a camera?

    Oscar Pulido: Absolutely. Just like everybody else.

    Andrew Ang: You check in on flights. You use Uber or Lyft. You read a newspaper. You watch TV or videos. And you go shopping. All of those things, we had 20 to 30 years ago. They're not new. But the ability to put those onto a phone has transformed my life and I think yours as well. And that's what factor investing is. Everybody wants to buy cheap and find trends and find high-quality names. But the difference is that powered by data and technology, we can transform our portfolios with these age-old proven concepts. So, it's not really actually the sources of return that are different. It's doing it transparently at scale, doing the same concepts in a multi-asset context in fixed income, in commodities, in foreign exchange and of course in equities, combining these and putting forth new portfolio solutions to meet objectives like defense, like where we are today, or to enhance returns. That's what factors are.

    Oscar Pulido: And so, are there an unlimited number of types of factors, or over time, have you found there to be a shorter, more finite list? And if it is in fact a shorter list, how do we define what some of these factors are?

    Andrew Ang: Great question, Oscar. And I like to think about factors as broad and persistent sources of returns. Broad that they affect thousands of securities, thousands of stocks or thousands of bonds, and we've known about them for a very long time, decades in fact, with six Nobel prizes. And what makes a factor are four criteria. You want that economic rationale. It has to have a long history. We want to be able to have differentiated returns, particularly with respect to market cap indices in equities and bonds, and we want to pass on low costs to investors, so we have to be able to do these at scale. And after these criteria, we really have half a dozen macro factors and half a dozen style factors. The style factors are value – buying cheap – momentum, or trends. We look at smaller, more nimble securities and small size strategies. We gravitate to safety in minimum volatility strategies and we look for companies with high-quality earnings, or quality strategies. And on the macro side, the big three factors are economic growth, real rates and inflation. And we like to think about three more, which we believe to be important: emerging markets, credit and liquidity. How many factors are there? Half a dozen macro factors, half a dozen style.

    Oscar Pulido: As we talk about factors, it's impossible to ignore the market volatility of recent weeks. And you mentioned defense and minimum volatility. So, as we deal with the market environment, are factors performing in a way that you would have expected?

    Andrew Ang: We're right at the point where we've just had a bear market, that 20% decline since the peak. And factors, actually, unlike the general market conditions, are performing exactly in line as what we would expect. Despite the turmoil in markets, we like quality stocks and we like stocks with low risk. If we take the time just as we crossed that bear market threshold to be at that minus 20%, right, so the S&P ended down 23% right after that happened. If we look at how minimum volatility strategies have faired, well actually they're down less. It's minus 18%. And we also see this internationally. International markets are down 25%, at that bear market point. And if we look at minimum volatility strategies, they've also outperformed there. So, we want defense with quality and minimum volatility. One of the surprising things, though, more recently, has been the outperformance of momentum. While the S&P went down 23% and it breached the bear market threshold, if we look at the performance of momentum, it's only been down 16% to 17% at that point in time. And we usually think of momentum as being a procyclical factor. That is, it does kind of really well when the market ramps up. But momentum actually can do well as long as there are trends, trends up or trends down. And this is a really good illustration of where momentum has done well actually in a falling market. We believe that momentum is an attractive factor today, and we've seen that in the performance year to date.

    Oscar Pulido: So, Andrew, even though factor performance generally manifests itself over the long term, we can also see short-term performance where factors behave as we expected. Is it fair to think of it that way?

    Andrew Ang: Right on, Oscar. And as we come in into this very late cycle and we've entered this bear market, value strategies and size strategies have underperformed. Value has actually had a tough time for several years now. We expect value to underperform in a late economic cycle. A value stock is typically something that's, it's a little bit staid, a little bit old fashioned. It makes things. It's got factories and production lines. It's got a lot of fixed assets. And it's got business models that are very efficient, but it's hard to change what you manufacture on your factory floor overnight or produce another service. Not surprisingly, value stocks tend to underperform during a late economic cycle because you'd really want to be doing something else, but you just can't. The best time for value stocks is coming out from a recovery, where those economies of scale, well, you get large efficiencies and operating leverage, not financial leverage but operating leverage and value stocks tend to do very well then. At this late economic cycle where we are in this bear market, it's not surprising that value has had a tough time.

    Oscar Pulido: And so, if this volatility continues, and you've touched on this a little bit, but it sounds like there are some interesting opportunities presenting themselves for investors who want to think about integrating factors into their portfolio where perhaps in the past they haven't.

    Andrew Ang: This is precisely the time that I think general investors should be thinking about incorporating factor strategies. And it's actually for defense. We can employ factors also on the offense, but let's concentrate on how we can employ factors defensively. And I want to talk about three things. Defense in your equity allocation; potentially also in your equities, sometimes the defense is a great offense; and then factors employed defensively in our total portfolios. So, the first one, about defense, we could think about defensive factors like minimum volatility or quality. And I think right now during this bear market, this is a time that we want stocks with low risk. These stocks will have, over the long run, market-like returns. But we're going to have reduced volatility. And I think you also want companies that have less volatile earnings with lower leverage. I think that's just prudent where we are in the business cycle today. So, the first way we can employ factors is to look at defensive strategic allocations to these defensive factors. Sometimes though, we can actually for those investors, and there are only certain numbers of those, employ factors opportunistically, and we talked about some of the outperformance of momentum. And so, the time variation of factors offers some investors some opportunity to take on time-varying factor exposure potentially as an incremental source of returns. And then finally, while we want to hold diversified portfolios in a multi-asset context, in there, we want diversification across all of those macro factors. So, while equities have gone down, by in large, fixed income has done quite well over the first few months of 2020. If we look at balancing out those macro factors, we can obtain some defense in our total portfolios, too.

    Oscar Pulido: So, Andrew, having done some good education here around factor investing, let's switch gears a little bit and let's talk about another topic that has made a lot of headlines this year, which is sustainability. And throughout this mini-series, we've talked as a firm at BlackRock, that we are very much at a pivotal moment when it comes to sustainability. We've talked about the fact that climate risk is investment risk. So, when you think about factor investing, a space that you've been associated with for many years, how does that relate to everything that's going on with sustainability today?

    Andrew Ang: You know, Oscar, I grew up in Australia, and so I'll use this little phrase that I think of factors and sustainability as tea and biscuits. They just go together so well. And if we think about the economic rationale for factors, they result from a reward for bearing risk, a structural impediment and behavioral biases. And certain sustainability criteria and data fit those as well. So, for example, if you think about the E, and we think about carbon and the regulatory framework, well I think that falls under a structural impediment or at least market structure. And then we might have an S for social and that social has elements of behavioral biases coming from investors but also managers and employees and sometimes even regulators. And then finally, we might have G, governance, which I think if done properly might actually reduce risk. So, it actually fits into that reward for risk category. But what's really important is this economic rationale, because for those sustainability signals that do fall into these categories, some, but not all, we're absolutely going to use them to generate alpha, to have higher returns and to reduce risk for investors. And Oscar, I'd love to share some of the latest research that we've had on using ESG or using sustainability metrics in factors.

    Oscar Pulido: That'd be great. I know that one of the questions that often comes up is the reliability or the quality of the data that investors can access around, you touched on E, S and G, environmental, social and governance considerations. So, how do you obtain that data and then how does it play into factor investing?

    Andrew Ang: Yeah, let's start off first with that. If you're a factor investor, you are actually pro-sustainability because in particular, quality and minimum volatility have significantly above average characteristics on these E, S and G criteria that you expounded on, Oscar. But we can go further, and I think the most exciting frontier is to incorporate those ESG data or signals into the factor definitions themselves. So, let's give you two examples. We've started to incorporate green patent quality. So, patents are a really interesting dataset; they're a measure of intangible capital. They monetize intellectual property. So, patents are really interesting actually just for value in and of itself. But you can go further, and patents are filed in different fields. And there are various classifications of patents and green patents are fields that fall under UN sustainable development goals. It turns out that if you look at the companies that are filing green patents and being awarded them, that has incremental predictive power. Now is that sustainability? Absolutely it is. But we can also incorporate that in a value factor. What's the intuition? I think these UN sustainable development goals are not only really important problems for society, but they represent highly profitable opportunities for corporations, too. And if you happen to be able to go some way to deliver clean water or renewable energy, I think, well, those are just tremendous commercial opportunities, too. And so, for those companies that are taking that leap, it is risky, but it will be rewarded, and we can incorporate that into a value factor.

    Oscar Pulido: And just to clarify Andrew, so what you're saying is that there are a number of ways in which we can identify characteristics of value companies, but green patents would just be another one of those characteristics that we can look at and that also happens to be a way to think about E, S, G investing as well?

    Andrew Ang: That's right. A second example is looking at corporate culture. And culture absolutely matters. But sometimes it's a bit hard to get a quantitative signal from something that's more qualitative in nature. But I think everybody would agree that culture matters. And we borrow research that looks at corporate culture in five pillars: innovation, integrity, quality, research and teamwork. And we use machine learning techniques, we go through textual documents, we look at the 10,000 broker-dealer reports that BlackRock receives every year, and we build a dictionary from these machine learning techniques, a dictionary that captures all of these five pillars of corporate culture. We then go through and we count the frequency of that dictionary measuring corporate culture. We make some adjustments like for the total length of the document and for some other things, but at the end of the day, we come up with a quantitative signal for corporate culture. And that's a non-financial version of quality. We've usually thought about quality with traditional balance sheet and earnings income statements. But now we can think about more qualitative, sustainable versions of quality, too.

    Oscar Pulido: So, you've mentioned value and momentum and quality and these terms for factors, so are what, is what you're saying that ESG itself is a factor? Can we think about if I invest in a manner consistent with high ESG scores, that I, too, will earn a premium in terms of return over the long term, the same way I have with some of the factors that you've studied for many years?

    Andrew Ang: That's a great question, Oscar. And I view it that we can use certain ESG information to enhance and improve the definition of factors. But the factors themselves have to meet these various criteria. They have to have an economic rationale. They have to have long time series. We want differentiated returns and we want to offer them at scale, these four criteria that we talked about earlier. And not all of these sustainability metrics will fit those criteria. To the extent that we can incorporate those with sustainable data, of course we're going to do it. But sustainability by itself, well, not all of the sustainable data will fit these same criteria as factors. Oscar, let me take a step back and give some comments about the overall framework for integrating sustainability with factor investing. Factor investing, the first seminal work on this was Graham and Dodd in 1934. And they were two accounting professors at the institution that I taught at as a professor for 15 years, Columbia University. And in that book, Security Analysis, they actually talked about E, S and G. Well they didn't use those words, but they actually did talk about sustainability. They talked about the character of management. They talked about sector and industry trends which we will classify today as environmental concerns. And they also talked about S, which in their language was conservatism. They didn't have a way to think about quantitatively measuring these. So, ESG has been with us for a very long time, but what we're doing with factors is that we always want that economic rationale. We look at value, quality, momentum, size, minimum volatility, but we're going to do it with the latest research. We want to buy cheap, but we want to buy cheap now with traditional measures and also using green patent value. And we want high quality companies, but we want to look beyond the earnings and maybe also look at the quality of management. And so, there's a natural evolution. Factors have been always at the forefront of incorporating big data and new research techniques and now we go to AI and machine learning. Factors and sustainability, they're like tea and biscuits.

    Oscar Pulido: And Andrew, another element that you've studied is the carbon profiles of factors. And obviously carbon is a big part of the sustainability discussion. So, what have you found with respect to this topic?

    Andrew Ang: Yeah. These are really interesting. So, again, if you're a factor investor, generally speaking, if you take these multi-factor combinations, diversified across these style factors, you actually have below average carbon emissions. So, already, if you're a factor investor, you're green. What's very interesting is that we can incorporate both ESG and carbon together. Let me give you an illustration of that. So, we want to improve ESG. We want to lower carbon. What's the first kind of company that we might want to select? Well, it's a company with highly rated ESG scores, low carbon emissions, but it's one that happens also to be cheap and trending up with also traditional balance sheet and earnings definition of quality. And if we had to remove one company, say, because that company had ESG scores that were too low or it was emitting too much carbon, then the first sort of company we might consider excluding from our portfolio would be a company that's really expensive and probably is very volatile. And it has low quality earnings. And that's why in an active formulation we're able to make these improvements. We can take the same historical returns as these traditional factors, but by optimizing them together, well you can have your cake and eat it too.

    Oscar Pulido: So, what's next for sustainability in the factor universe?

    Andrew Ang: We want to continue pushing, incorporating by research, these sustainable data and insights into our factor definitions. Let me give you one more. It's on deceptive language. And when companies make statements, they make public statements in their earnings calls, they have communications, sometimes that language can be a bit evasive or deceptive. And we can pick that up again with modern machine learning techniques. And the companies that are more transparent with less deceptive language, they tend to outperform.

    Oscar Pulido: I want to come back and ask you about your career, because you've been involved with factors for quite a long time. In fact, you wrote a textbook on factor investing. It's 717 pages. I looked it up. And there's going to be a lot of folks working from home over the next couple of weeks, and they might want to pick it up off the shelf. But what got you interested in this topic in the first place?

    Andrew Ang: Thanks, Oscar for reading all 700-plus of that book. I was born in Malaysia and during the late 1960s and early 1970s that country went through a series of pretty bad race riots, and my parents were searching somewhere safe to bring up their family, and they migrated to Perth, Australia. And we were one of the first Asian families in this wave of migration there. And I was just different. For many years I was only non-white kid in class. You have to question like why and what difference does it make and what should you do about it? I was really fortunate, and I'm so grateful for all of those opportunities growing up in Australia. Proud to be Australian and proud to be American, too. And that questioning of why led me to become a professor. And I left Australia. I did my PhD at Stanford and that was where I fell in love intellectually with factors because it looked one level deep to not the color of the skin that you have or the shape of your body, but to your character. And that's why I describe factors as the soul of investing. It's what really matters, what drives returns.

    Oscar Pulido: And since coming to BlackRock, you recently starred in a number of different videos with celebrities from different industries, so Danny Meyer, the restauranteur, Idina Menzel, the actress, and basketball coach, Doc Rivers. Who would be on your list to speak to next?

    Andrew Ang: Well I think the dream person would be Oprah. You can't get another person with that same, I mean, the business that she's built, the leading light that she is, TV personality, award winning actress, and just the integrity of her person.

    Oscar Pulido: Well knowing your ambition Andrew, I'm sure it will happen at some point in the near term. We're ending each episode of our mini-series on sustainability with a question to each of our guests, which is, what's that one moment that changed the way you thought about sustainability?

    Andrew Ang: Well I have two kids, Oscar, and just thinking about their future and we're also in the business of building futures, not only for ourselves, but for future generations. And of course, we have to think about sustainability, but it's not only for the sake of being sustainable. It's also about being able to create better outcomes for our clients. And factors and ESG, they're like tea and biscuits. We can do both.

    Oscar Pulido: Thank you so much for joining us Andrew. It's been a pleasuring having you on The Bid.

    Andrew Ang: Thanks so much.

  • Jack Aldrich: Last week, the coronavirus drove a massive market sell-off. The S&P 500 saw its worst week since the Global Financial Crisis and the yield curve inverted for the third time since October of 2019.

    Welcome to The Bid. I’m your host, Jack Aldrich. Today, Mike Pyle, BlackRock’s Global Chief Investment Strategist, walks us through the global impact of the coronavirus and why it’s changed our market views for the year.

    Mike, thanks so much for being here.

    Mike Pyle: Thanks for having me.

    Jack Aldrich: To put it in very technical terms, last week was a bad week for markets. Walk us through what happened and why.

    Mike Pyle: My basic assessment as to what occurred was up until the very tail end of the week before last, markets were effectively discounting coronavirus as a China-specific public health challenge that had global economic repercussions, but fundamentally something that was contained to China and the region; and then propagating out as an economic matter. And I think what we saw at the very tail end of the week before last, and certainly throughout last week, was a growing reassessment of that underlying assumption from market participants as it appeared as if the dimensions of the public health challenge were spilling over out of China into other parts of the world, including increasingly Europe and other developed markets. And I think that that reassessment from a China public health challenge to something with regional and global economic implications to a global public health challenge with even larger global economic implications, potentially, is really what drove that reassessment and the very extreme market moves we saw.

    Jack Aldrich: So markets have been at all-time highs up until very recently, and there’s been debate as to whether we’ve been due or even overdue for a market correction, or an instance in which markets fall ten percent or more from a recent high. That obviously happened last week, with markets falling into a correction quicker than they ever had in history. Do you think that’s just the coronavirus driving this or are there other market factors at play?

    Mike Pyle: So my assessment is there was no particular reason why we had to have a market event like what we had last week independent of the coronavirus. This continues to be an economy where the underlying health is quite strong; no particular alarm bells out there ringing in terms of recession risk, absent the coronavirus. And so to my eyes, yes, can there be air pockets and what have you that markets hit from time to time? Of course. But the underlying momentum of the economy was quite strong, and so it didn’t feel like this was due in some important way. But I think in my eyes, the real emergence of this different phase of the coronavirus challenge really was just that core driver across really the course of last week. You might add, a little bit, I think we’ve been saying for some time that the U.S. election presents a headwind to markets in 2020, in particular, U.S. markets, principally in light of just the really divergent potential outcomes on the table in November between the two parties. I think maybe we saw that step in a little bit last week, because I think markets are beginning to pay more attention to what is happening around the Democratic primary election, but I don’t want to overstate that. To me, just the overwhelming driver last week was this new phase of the coronavirus challenge.

    Jack Aldrich: And you mentioned how we were thinking about the markets beforehand, our base case being generally that global growth would edge higher this year. How have recent events changed that and how has this coronavirus development affected that view?

    Mike Pyle: I think our view coming into the year exactly as you say was growth was going to edge higher, led by some of the more cyclical aspects of the global economy: trade, capex, led by places like the emerging markets and Japan. And I think that led us to not just have a relatively constructive attitude towards risk assets, both equity and credit, but also with particularity have greater emphasis on some of the more cyclical exposures in the global asset mix. And so, I think what the past week has shown is that is not really an environment that’s operative any longer, and the coronavirus and its impact has really changed that. So, we wanted to offer a reassessed view of what the global outlook looks like, and I think it looks like a couple of things. One, the coronavirus challenge is very clearly now globally a quite material economic event. We think that economic growth is likely to take a step down in level terms across the course of 2020, so this isn’t a world of growth edging up; it’s a world of growth taking a downshift. That said, our base case, to talk constructively for a moment, is still that this is a temporary shock of uncertain duration, but temporary, and when we get to the far side of this shock, we should see the global economy reaccelerate quite rapidly and financial markets follow behind. Secondly, it continues to be the case that we don’t see as our base case the U.S. or global economy falling into a recession; we see the expansion continuing in our base case. That may be a little bit different for Europe, for Japan, some of these places that were already a little bit in the doldrums. But the underlying momentum in the U.S. was quite robust entering this challenge. And we think that that still matters. Third, I think we’re going to see a pretty meaningful policy response from central banks and fiscal policymakers globally around liquidity support, around monetary easing, around fiscal easing, we’re beginning to see that conversation come together. I think there are some risks as well. I don’t want to belabor my answer here, but I do think it’s probably worth talking through some risks too.

    Jack Aldrich: And what are those risks?

    Mike Pyle: One, the base case that I articulated was one of a real slowdown, but ultimately, a trajectory that because of policy intervention, because of the underlying momentum in the economy, because of ultimately we think the temporary nature of the shock and the re-acceleration on the other side of it, keeps the U.S. and the globe out of a recession. But I think it’s important to highlight some of the key risks that can mean there’s a downside year, outside that base case. The first is the one I just pointed to, we’re really focused on what is the duration of this shock going to be? And I think the best evidence early on is going to be, is China successful in bringing its economy back online without having the secondary outbreaks of a sufficient scale that cause them to have to pause or reverse? The second is just how big is the economic shock itself going to be in the major developed markets? Obviously, we’re seeing significant outbreak in Italy, other places in Europe now, early reports of growing cases in the U.S., how significant does that end up being? And importantly, what is the magnitude of the public health response necessary to bring the outbreak under control? That will go a long way towards determining how deep the impact is. And then third I think goes to the policy response. How effective are agencies of government in terms of actually effectuating a policy response? And then, how effective is it? I think reasons for both optimism but also reasons for a bit of pause on both of those sides. On the optimistic side, I think we are going to see real activism from policymakers around the globe. Central bankers are pointing in the direction of significant new easing, it looks as if there should be real liquidity support put in place for businesses, and other actors in the economy that are strained because of the abrupt falloff in cash flows or income, what have you. And then importantly, also going to see real change in fiscal policy. We’ve already seen that from China, we’ve seen it from Hong Kong, I think we’ll hear announcements from other countries like Japan, Korea, Italy, even Germany, it wouldn't surprise me if we ultimately saw something from the United States. The degree of policy response and the degree of its effectiveness, particularly around this question of making sure that companies especially small and medium companies, and firms that face this abrupt falloff in income from the economic shock, have the tools available to get through the crisis. These are often times very healthy businesses that have just run into a once-in-a-century storm, and we need to make sure that fundamentally healthy businesses aren’t taken offline permanently because of that. And that to us is the way this turns into something quite a bit more pernicious if these liquidity and cash flow challenges that could arise, could be abated with effective policy, aren’t effectively abated with policy, that is a world where you can see a much more vicious cycle take hold.

    Jack Aldrich:  We’ve been talking about how this has moved recently and rapidly from being a local phenomenon to now one of global proportions: it originated in China, the world’s second-largest economy. How are you thinking about the growth story in China and how what happened there might flow through to the rest of the world?

    Mike Pyle:  I think it’s wise to look at China for a slightly different reason than was the case a couple of weeks ago. The reason to look at China a couple of weeks ago was principally because this was the epicenter of the coronavirus outbreak; because we were mapping the way it flowed through from a very abrupt economic slowdown in China through, on both the supply and the demand sides, to the global economy. And I think we heard a fair amount about this from a number of sources, but one illustrative one was Apple, which gave revised guidance a couple of weeks ago. So that effectively, what we’re seeing in China is going to pretty meaningfully impact our Q1 results, it’s going to matter both in terms of the supply side, our ability to get product done, because so many of our supply chains are deeply embedded within China; and also is mattering on the demand side, the demand for our product, because China is such a significant global market for us, it’s also taking a big hit. You see that manifest in a bunch of different ways including things like corporate earnings. I think the conversation today is still about that clearly, but it’s also about, can we take any lessons from what the shape of the economic shock is going to look like in other countries that have to confront significant coronavirus outbreaks, by virtue of what we’ve seen in China? And there I’d say a couple of things. One, it seems as if one way in which economic activity is really impacted is by the public health measures that are taken to confront an outbreak. And while I think it is extremely unlikely that we would see measures of the kind taken in China able to be taken in other parts of the world, nonetheless, that basic insight prevails that beyond the outbreak itself, the measures taken to combat slow economic activity. The other thing that I think is worth keeping an eye on is now that China looks to be – and the WHO made this consensus last week – now that it has really changed the trajectory of the outbreak in China, how are they going to go about restarting their economy and how successful are they going to be at that? I think we have the view that they should be able to re-accelerate relatively quickly with the big risk that as they do so, are there secondary or tertiary outbreaks that mean that they have to slow back down and put restrictions back in place? So that in our eyes is one of the key things we’re looking at, as China restarts, are they successful in doing it? Or do they have to put the brakes on again?

    Jack Aldrich: And to that point, I’m struck by how much uncertainty there is in this coronavirus outbreak in terms of the path and trajectory of the disease, in terms of the world really having not seen something like this before in such a globalized era. As you just think about how much we don’t know and how uncertain this coming period will be, how do you think about markets; how do you think about investing?

    Mike Pyle: This is obviously the most important question for our investors financially, and the advice that we’re giving, this is a moment to be cautious, but this is not a moment to panic. It’s a moment to stay invested for the long term and see that through to your financial goals. This is a moment to be back at your home base in terms of the benchmarks that you have in your portfolios around equities, credit, other risk assets. Now as I said, we articulated a view coming into the year around being pro-risk and being more cyclically oriented. That world isn’t the world we’re in anymore. And so, what we’ve done in our own portfolios is bring those risks back to benchmark weight to reflect the changed world. Like I said, we think that on the backside of this shock, there is going to be a pretty significant re-acceleration in economic activity and financial market activity. And the dislocations that we are seeing now are ultimately going to provide investors with pretty significant opportunity. And so what we’re spending the next period of days, weeks, as we go through this shock is, being in regular contact with our investors, shaping that debate here within the firm, and identifying the best opportunities for our clients to come out the other side of this, all the stronger. But again, I think the important message is, this is a time to be somewhat cautious and back at the home base, but it’s also an important time to be really focused on staying invested, staying in markets, and recognizing that our goals are long term, not the next 30 or 60 days.

    Jack Aldrich: Absolutely. So, you talked about thinking about this over a long time horizon and there being some opportunities. Could you describe some of those opportunities that you’re seeing?

    Mike Pyle: Yeah. Like I said, our overweight into risk assets was really around some of the more cyclical exposures out there: emerging markets, Japan, high yield, what have you. We pulled back a few of those, both Japan and emerging markets in particular on the equity side, and are looking for some more resilient equity market exposures and it’s things like the minimum volatility factor exposure, the quality factor exposure, companies that have really high quality balance sheets, cash flows, that look set to be resilient against a storm. Those are places that tend to have really good runs of performance in difficult market environments. And lastly, I think it’s important to say that even with the rally we’ve seen, U.S. Treasuries continue to perform this really core ballast role in portfolios and standing by the allocations that you have right now, is an important thing to do while these challenges are working their way through the system.

    Jack Aldrich: Fantastic. Well Mike, you’ve given us tons to think about here, and I think we would love to be talking with you more as these developments continue and as we here at BlackRock continue to keep our eyes on this. Thanks so much for being here today.

    Mike Pyle: Thanks for having me.

  • Mary-Catherine Lader: What do you think of when you think of emerging markets?

    Well if portfolios are any indication, many investors actually shy away. Emerging markets, or EMs, are unfamiliar territory to most. And that fear of the unknown may be enough to create cold feet for some investors. So what makes a country emerging and why are we talking about them? More than two dozen countries are classified as emerging markets, but no two are exactly alike. They often come with more risk, and they can be a source of growth and certainly diversification in a portfolio.

    On this episode of The Bid, we'll speak with Gordon Fraser. He's Portfolio Manager for Emerging Markets within BlackRock's Fundamental Active Equity Group. We'll discuss the outlook for emerging market stocks broadly in 2020, where he sees opportunity and why we think now is the time to take a closer look. I'm your host, Mary-Catherine Lader. We hope you enjoy.

    Mary-Catherine Lader: Gordon, thanks so much for joining us today.

    Gordon Fraser: My pleasure to be here.

    Mary-Catherine Lader: Gordon, you're an emerging markets portfolio manager and many people probably think that they understand or know what exactly an emerging market is. But it's maybe not as intuitive or exactly what people think. How do you define it?

    Gordon Fraser: Many people think an emerging market is about wealth. They think rich countries are developed and the poorer countries are all emerging. That's a bit of a misconception actually. It's not really about wealth. In emerging markets you've got some very rich countries like Qatar or the UAE together with quite poor countries like India or Pakistan. And it's also not about technological development, which a lot of people think. In emerging markets, Korea is extremely developed from a technological standpoint. What really defines an emerging market is actually how developed the stock market is. Index providers look at things like how liquid the market is, how well-established the settlement systems are, the custodial systems are. The things that kind of really make the market function. And they analyze that and they classify markets into different buckets. The markets in the world that are the most developed are called developed markets, places like the U.S. or Canada, parts of Europe, even Hong Kong where I hail from and Singapore are developed markets. The ones that are a little less established from a market standpoint fall in the emerging market bucket. China, India and Brazil are some of the well-known ones, but also some smaller ones like Colombia or Peru. And the least established markets are actually frontier markets. These are the ones that are very illiquid. Some countries in Africa would fall into that bucket, like Nigeria, Kenya, or even Vietnam in Asia. So that's how we look at it. It's by index classification and it's about how well a market functions, not how rich or poor the people are.

    Mary-Catherine Lader: And so how a market functions might also affect the information that's available on it or how you can engage in coming to views about it. What are some of the ways that you think investing in emerging markets is different than investing in developed markets?
    Gordon Fraser: I've been an EM investor all my life, so I can't really tell you how it is investing in developed markets. But from my perspective, first of all, there's a lot more countries. Emerging markets is 25 countries in the index. They've all got their own currency. So unlike in Europe where a lot of countries have a euro, they all have their own currency. You've got big commodity exporters like Brazil or Russia. Big commodity importers like Turkey. It's a really varied set in emerging markets. And all of these countries have their own economic cycle. So the first point is that really EMs have their own cycle and you actually can add a lot of value in emerging markets through choosing which country you're going to invest in, doing so-called asset allocation. That's the first difference to developed markets where that doesn’t really matter as much. The other thing that's really interesting, MC, about emerging markets is it's just much more stock level dispersion. In emerging markets, there's an amazing statistic that three quarters of companies, so 75% of companies, see their share price move by 40% in the year. Just an incredible level of dispersion of stock returns. So more country dispersion; more stock dispersion. All of that is great for an active investor and that's why I'm glad that I'm an EM investor and not a developed market investor.

    Mary-Catherine Lader: And emerging market companies are pretty different than developed market companies in terms of disclosure and probably the context in which they operate. So how does that shape the kind of research you can do and what do you see as the major differences between covering companies in EM?

    Gordon Fraser: I guess, in short, you just need to do a lot more research. You're quite right. Most developed market companies, if you think about it, they don’t have a controlling shareholder. They've got a lot of institutional and retail shareholders. They're typically run by an independent board. If you contrast that with emerging markets, usually most companies are run by a first or maybe a second-generation entrepreneur. They will typically control the board. They will drive most of the strategy of the company. They will be responsible for hiring the management. And that's just a pretty different proposition. It means they tend to be a little bit more racy, a little bit more aggressive. They might also be a little bit more economical with the truth frankly. I often tell a funny story to people that I keep a whole lot of business cards in my desk of management that have kind of misled me over time. So there's a good and a bad side of that. They're more aggressive, but sometimes they also might mislead you. Because of this, there's less information. So you need to do a lot more research. That's the opportunity as well as the curse.

    Mary-Catherine Lader: As you talk about the extra research that you have to do to effectively cover emerging markets companies, it sounds like a good investor really could have an edge. In developed markets we're increasingly concerned or active investors are increasingly concerned that there isn't much edge left to really create alpha or excess returns. But actually emerging markets haven't performed that well in the past few years, so what's the deal?
    Gordon Fraser: Yeah. That's a fair observation. The last decade has been pretty tough for emerging markets. But investors with a slightly longer memory will remember that the early 2000s were absolutely sensational. So 2000-2010 was fantastic for emerging markets. The 2010s were pretty poor with not much overall return and very much overshadowed by the performance of developed markets and in particular the S&P 500. So really there's been a couple of things going on, especially lately that have been a problem. I characterize it as sort of two key headwinds. The first one was just how well the U.S. economy was doing. The U.S. economy was growing so strongly. The Federal Reserve was hiking interest rates because the U.S. was doing so well. That was leading to a lot of pressure in emerging markets because emerging markets are actually quite big borrowers of dollar loans and dollar debt, both the countries themselves and also the companies. When U.S. rates go up, that's like an increase in your cost of borrowing and at least a fall in demand. So that was one big issue, which is potentially easing away. The other one was trade. Emerging markets still have a very export-led growth model in general. And the pressures that were happening on trade because of the trade war between the U.S. and China was really hurting demand in EM. It was causing corporates to maintain very low levels of inventory. It was causing corporates to hold back on their capital expenditure plans. And these two things were really depressing demand and causing an issue for EM earnings. So those are the two kind of major headwinds we've been fighting in EM over the latter half of the last decade. And potentially actually both of those headwinds are starting to fade.

    Mary-Catherine Lader: So you mentioned that you see trade headwinds lessening, and we as a firm see that in 2020. It seems like trade tensions have sort of moved sideways, and so we've talked about how this would cause sectors in markets that were beaten down by trade tensions last year to actually recover this year. How much of a stressor is the U.S./China trade war to emerging markets broadly right now?
    Gordon Fraser: I think it was more than the actual war itself. It was fear of something bigger. Uncertainty is always the worst thing. So the tariffs that were imposed so far and have been slightly rolled back on Chinese exports weren't the biggest problem. It was a fear of much higher tariffs and more onerous restrictions in the future that was holding back investment, making companies keep those inventory levels lean. So that was really the problem. And as you said, as that kind of trade war paused or we had a détente, you see companies start to restock. You see them start to start investment again. And so you can spot that actually in a number of indicators, things like technology capex, tool orders, even the price of some industrial commodities will show you that these pressures were starting to ease. And that's why as a firm we're more optimistic on growth heading in to 2020.

    Mary-Catherine Lader: You mentioned that we're optimistic on growth, but we're seeing slightly slowing growth in China. Given that China is the largest representation in emerging markets indices, what extent does its fate determine the direction of the space overall?

    Gordon Fraser: China is pretty important in EM for sure; it's about 30% of the equity index. Some countries really rely on China. I think China has been seeing slowing growth and maybe in the first half of this year growth will also disappoint because of the recent coronavirus outbreak. But I think absent that, you would have actually started to see a pickup in China for those reasons discussed on the improvement on trade and improvement on capex. So we were expecting to see growth pick up in China and that might now need to be deferred to the second half of the year. But China is not the be all and end all. There are lots of emerging markets that really have very little interaction with China. Take South Africa. That's the tip of Africa really has nothing to do with China. Turkey, very independent of China for instance. And actually there's some big winners like Mexico. Mexico has been winning share of U.S. imports even before the new USMCA trade deal has been signed. Mexico's share of U.S. imports has gone up by one percentage point over the last two years, taking share from China. It's not a deal breaker that China has been a little slow and we'd expect China to start to actually pick up maybe in the second half of the year.

    Mary-Catherine Lader: Shifting gears a little bit to talk about your experience as an investor in emerging markets, I'm curious what do you think are sort of the major pitfalls that some investors fall into in this space?
    Gordon Fraser: I don’t know if I'd use the term pitfall, but maybe the biggest misunderstanding perhaps about emerging markets is that people think they're buying growth. When people think of emerging markets, they really think about that sort of poorer country narrative catching up with the rest of the world. That's not really what they get nowadays. People think they're buying growth, and they sometimes get disappointed when the economic growth that they see reported in the newspapers doesn’t translate into the market returns. When people are buying emerging markets, what they should really be thinking about is buying the potential to add a lot of alpha. And by alpha I mean outperformance versus the index. Why can you do that? You can do that because you have all of these different countries that have very different macroeconomic cycles. You can allocate capital to countries in the early stage and take away capital from the late stage and add value that way. You can make money out of an incredible level of stock dispersion. When we look at emerging markets, we don’t see some kind of great airy-fairy growth story. We just see a lot of potential for alpha or outperformance, and that's what really excites us. And we think some people don’t really understand that opportunity fully.

    Mary-Catherine Lader: So you've been investing in emerging markets for 14 years. And what's changed in the asset class over that timeframe? Do you see more people who sort of understand what it's all about now than you did when you first started?

    Gordon Fraser: It's changed a lot actually, MC. When I first started, I'd say it was really about access. Let's call that emerging market version 1.0. Version 1.0 was all about get me exposure to these fast-growing markets. I don’t really care too much which country I'm buying, which kind of stock I'm buying; get me in. And the economic model was actually about kind of growth convergence. It was very much that kind of poorer country becoming richer economic story. Copying what has happened in the developed world, trying to do it faster, quicker, better. And when I look at emerging markets today, I look at alpha. But from an economic standpoint, the business model has changed. It's really actually about innovation and leadership. Whereas emerging markets were just catching up with what was happening in the developed world, it's actually now starting to take leadership. And my absolute favorite example about this is payments in China. So if you imagine I'm in Beijing with my family let's say for a holiday and we get a taxi ride. We go to a restaurant, maybe I take my kids to get a haircut, and then we go to the cinema, and we go back to our hotel having taken in some of the sights. We can do all of that without using a single note and without using a single piece of plastic using WeChat Pay or AliPay or one of the other payment mechanisms. China has just actually skipped the plastic age, which is really incredible to think about. And just to throw some kind of stats around that: the total value of payments through these payment platforms in China in the last 12 months was $31 trillion U.S. dollars. That's actually five times the amount that Visa and MasterCard process in the U.S. It's dramatically bigger. And it's all digital and it's all instant. So China has actually leapfrogged, you know, where America is as one of the most technologically-advanced nations in the world. The exact same payment stuff is happening in India. It's happening in Indonesia and all these countries are just skipping straight to the digital age. So EM has changed in that respect. It's about innovation. It's about leadership. And it's not just about copying the West anymore.

    Mary-Catherine Lader: It sounds like it's a pretty interesting time, to your point, to be investing in emerging markets. And what are some of the other reasons that we're talking about this now? You mentioned some of the opportunities created by technological advancement. What else?

    Gordon Fraser: Yeah. I think it's an interesting kind of structural argument and a cyclical argument. We talked about a cyclical one a little earlier on. There's been a couple of really strong headwinds for emerging markets: trade, U.S. monetary policy. And both of those are turning around. So the cyclical story is I think quite strong. But there's a really interesting structural story as well. And just to unpack this a little bit, it's about essentially the share of corporate profits as a percentage of GDP. I'll explain this a little bit. If you think about an economy that produces a certain amount of output, you've got two ways of producing that output: labor and capital. If you look at the developed world, the share of the economic output that is accruing to capital and the shareholders of those companies is really high. It's actually at a 20-year high. The share of corporate profits, the GDP in the developed world is at a record high. In emerging markets, it's actually at a record low. It's never been lower. And just to explain why that's the case, it goes back to our discussion earlier, MC, about the last decade for emerging markets. During the boom times, it built so much capital up in emerging markets, so much money came in that when demand disappointed, companies left with excess capital and the profitability fell and the margins fell and the corporate profits to GDP fell. That's really interesting because you had 10 years of work out of this and you're buying potentially into assets where the profitability is below the long-term potential. So if you combine that kind of long-term structural argument for buying these earnings let's say “cheap” in inverted commas, together with some of the cyclical tailwinds, that's why it's an interesting time to be thinking about emerging market allocations quite seriously.

    Mary-Catherine Lader: You mentioned that emerging markets have made a more volatile asset class and the sort of ups and downs. What helps manage those ups and downs?
    Gordon Fraser: Oh, it's tough. There's two types of volatility that we face day to day. The first one is the volatility of the overall index. So just thinking in terms of the drawdown, so the amount of decline from peak to trough during the year, almost every year you get a drawdown of about 15, 16, 17% in emerging markets. That's almost every year. There's big index level volatility. And really the only way to manage that is by trying to outperform those events and trying to deliver a better outcome through selecting the right securities, through to managing your exposure to the market. So let's call that the bad volatility, MC. The good type of volatility is the dispersion. So that's the Country A doing a lot better than Country B. That's Stock A doing a lot better than Stock B. And that dispersion between the countries and the variation of returns between the stocks is good volatility because that's your kind of feeding ground for active investors. So one type is bad, at least a higher volatility for investors. The other type is good because it gives you the potential at least for adding value and outperformance.

    Mary-Catherine Lader: We could keep talking about this for so much longer, but I'm going to end with a rapid fire round of quick questions. Are you ready?

    Gordon Fraser: Yes, I am.

    Mary-Catherine Lader: Okay. So emerging markets sound very eventful. What's been your scariest moment in this space?
    Gordon Fraser: I think it's probably my wife's scariest moment rather than mine. It was after we had kids I've got to say, so I feel a bit guilty about this now. But I went to Ukraine twice during a conflict with the Russian rebels and the Ukrainian government when the Russian-backed rebels invaded Donbass. I went there twice to try and figure out what was going on. And I had an armed guard each time. I actually got to play war correspondent. I dialed into BlackRock's daily call live from Ukraine with an on-the-ground update. One of the scariest moments, but probably also one of the highlights as well.

    Mary-Catherine Lader: It sounds like you've met a lot of memorable people in this area. Who's the most memorable?
    Gordon Fraser: I've met Tayyip Erdoğan, the president of Turkey. He's pretty memorable. But I think probably the one I was happiest to meet was actually Bill Clinton who's definitely not an emerging market person. But he did attend a conference in Russia and I had the opportunity to shake his hand and talk to him for a few minutes. I was privileged to get a photo. I had one copy and it's a funny story. I actually gave it to my grandfather who was in hospital to kind of cheer him up, and he had dementia. Towards the end of his life, the staff would ask him, "Who's in the photo, John?" His name was John. And he'd say, "That's Bill Clinton." And he had no idea who the other person was, which was me of course. It's a sad and funny story that he remembered Bill rather than his grandson towards the end.

    Mary-Catherine Lader: And how many emerging markets have you been to?
    Gordon Fraser: I think I'm in the mid-thirties, 35, 36 I think, if I haven't forgotten one or two, which I think pretty much covers all of the emerging markets with a decent functioning stock exchange. I guess what's more interesting is, as I mentioned earlier, I've got some kids. I've got three children. And they're now old enough to travel to emerging markets. I take my four-year-old, my seven-year-old, and my ten-year-old around emerging markets. I think they've done ten, which is something I'm pretty proud of as a parent.

    Mary-Catherine Lader: Especially if you're under ten years old. That's pretty impressive.

    Gordon Fraser: Yeah. That's pretty impressive.

    Mary-Catherine Lader: Thanks so much for joining us today, Gordon. This has been a pleasure.

    Gordon Fraser: It's been a lot of fun. Thank you, MC.

  • Catherine Kress: Geopolitics, and trade tensions in particular, were key economic and market drivers in 2019. But in 2020, we see trade tensions moving sideways, giving the global economy some room to grow. A number of recent developments underscore our view. Over the past month, we've seen the signing of an initial, albeit limited, trade deal between the U.S. and China. We've seen the ratification by the U.S. of the U.S. trade agreement with Mexico and Canada. And we've seen a significantly reduced risk of a no-deal Brexit in the UK.

    But despite these positive developments, a number of other geopolitical risks still loom and could undermine growth. Tensions between the U.S. and Iran remain elevated. Technology competition between the U.S. and China is likely to persist. And 2020 could see one of the most consequential elections in modern U.S. history. This is all taking place against a backdrop of geopolitical fragmentation and heightened levels of political polarization.

    On this episode of The Bid, I'll speak to Tom Donilon, Chairman of the BlackRock Investment Institute and former U.S. National Security Advisor. Tom outlines the key geopolitical risks on our radar and his view for how they're likely to evolve. I'm your host, Catherine Kress. We hope you enjoy. 

    Catherine Kress: Tom, thanks so much for joining us today.

    Tom Donilon: Thank you, Catherine. Nice to be here.

    Catherine Kress: So today I'd like to discuss a number of themes for our geopolitical outlook for 2020. And one of the core themes to our market narrative in 2019 was global trade tensions, particularly tracking the issues between the U.S. and China. So thinking about global trade tensions broadly, and the U.S./China specifically, should we expect more of the same in 2020?

    Tom Donilon: So in 2019, we had a situation where in fact geopolitical issues—especially trade tensions, as you mentioned—weighed on markets. And we think towards the end of 2019, we saw some relief in that area. So we had the Phase One trade agreement between the United States and China entered into and then signed by President Trump and the Chinese representative in the United States. We had the Congress pass and the President sign the United States, Canada, Mexico arrangement, succeeding the NAFTA deal. And we also had in the United Kingdom the election of a conservative government with quite a good margin and with the prospect that it could be in place for an extended period of time, taking away some of the concerns around Brexit. So we had some relief, which we think provides some breathing room for an uptick in growth in 2020. Now on trade specifically, we did have essentially in the Phase One agreement a pause in the trade tensions and the trade escalations between the United States and China. We had a two-year period where, on a regular basis, we had a lot of disruption in the markets as a result of the trade war, if you will. And now we have an agreement which essentially brings us to a pause and provides an opportunity for de-escalation and provides markets with more certainty with respect to the U.S./China trade relationship. We expect implementation of that agreement in 2020. It did, however, leave key issues for negotiation and a second phase, a Phase Two agreement. And those issues are really important and, in some ways, much tougher than the issues that were addressed in the initial agreement. Those issues include subsidies and cyber rules of the road and the role of state-owned enterprises going forward. The specifics with respect to the Phase One agreement between the United States and China include steps that are focused on conduct by China with respect to its treatment of foreign companies, especially U.S. companies in China. It provides for significant increases in purchases by China of U.S. goods and services — 200 billion dollars more over the next two years. And it had some trade relief, essentially a pause in implementation of tariffs. But also it’s important to note that the United States and China have left in place, from the U.S. side, tariffs on $360 billion worth of imports. So we're still in a situation where there's a lot of tariffs on both sides. The bottom line, I think here, is that there's a pause. But the truth is, we're in a competitive phase in the relationship between the United States and China. And in my judgment, it's going to take years to work that out, frankly, as we work through a new era. And as I mentioned, we do have a new North American trade agreement entered into, which is a positive for the North American and for the global trade markets. We are watching, and we will watch this year, the U.S./EU trade relationship. There are a number of issues which are on the plate between the United States and the EU. There have been agreements at the Davos meetings between the United States and the EU to begin some discussions. That's one we'll watch for 2020.

    Catherine Kress: Right. And I think between the U.S. and Europe, one of the key issues that will be really important to watch is whether and how European nations, or together as the EU, move forward in potentially implementing a digital services tax. 

    Tom Donilon: Yes.

    Catherine Kress: But Tom, you mentioned that we are in a more competitive phase in the U.S./China relationship. So I'd like to build on that a little bit. You mentioned that the U.S. and China will move into a Phase Two negotiation that could begin to address some of the more structural issues. But one of the themes that we've been paying attention to is technology competition between the U.S. and China. How should we be thinking about this more competitive phase in the U.S./China relationship?

    Tom Donilon: Catherine, I think in many ways, the technology competition between the United States and China is an even more important issue going forward than the trade negotiations. It's important to get stability in the trade negotiations, and we'll see how it gets implemented. But at the very same time that the United States was entering into this important Phase One agreement on trade between the United States and China, we are involved in a pretty aggressive set of steps on both sides with respect to technology competition. And essentially what you have is the United States seeking to extend its technology lead and leadership, and China trying to move up in terms of its leadership in technology. And it's really a competition for the commanding heights, if you will, of the technologies and industries of the future. There are limits on investment and close review of investments by China into U.S. technologies. There are being considered right now more restrictions on the export of technology to China. There are specific steps that have been taken with respect to companies like Huawei where the United States has significant security concerns, and it's had an aggressive global effort to try to address those concerns. And it's met with mixed success around the world. You have a review of people, scholars and researchers coming in and out of the United States from China. You have had some companies sanctioned by the United States because of human rights concerns. So on the U.S. side, there's been a number of steps with respect to China and technology. And on the Chinese side, you've had President Xi and his government talk quite frequently and take a number of steps to try to, in their words, achieve more technological self-sufficiency in China. So you do have really a significant competition underway between the United States and China. Now that raises the concern about whether or not the Chinese and U.S. economies are decoupling, which is kind of the word of the day. The U.S. and China economies are not going to decouple. We're much too integrated for that to happen. But I do think that you do see some signs of decoupling with respect to the technology sector. And we'll be watching that for concerns about differences in ecosystems and governance and standards, which could be quite significant for the global economy going forward, including around the question of whether or not we see some elements of de-globalization.

    Catherine Kress: Right. It seems like this is going to create a much more uncertain environment for countries and companies to navigate. You mentioned decoupling as the word of the day. The other phrase that I've seen a lot is “new Cold War.” Would you go so far as to frame this in that light?

    Tom Donilon: I don’t like that phrase “Cold War” because it's really freighted with a lot of history. We're not in a new Cold War between the United States and China. The Cold War between the United States and the Soviet Union, which lasted for many decades, doesn’t bear a lot of resemblance to this. In that case, we had a very minor economic relationship with the Soviet Union. For example, I think these statistics are close to right. I think during the latter part of the 1980s, the total economic activity between the United States and the Soviet Union was about $2 billion a year. That's about what we do in a day between the United States and China right now. So these economies are much more integrated. We aren’t in some sort of existential contest with respect to each other's systems. We're not involved in some sort of global containment effort or military confrontation globally with China. But there is intense competition around this, and I do think what you could see is maybe some virtual walls with respect to technology between the United States and China. That leads to concerns, which we'll be watching quite closely, with respect to whether or not you see two technological ecosystems developing. And flowing from that, whether you see different standards and governance systems with respect to technology going forward. And that presents challenges for the global economy. It presents challenges for countries and companies around the world that have to navigate it.

    Catherine Kress: So it will be very important for us to continue monitoring moving forward. 

    Tom Donilon: Yes.

    Catherine Kress: One of the other risks that we've highlighted as having the potential to be a significant market driver and, in fact, has driven markets are tensions in the Gulf. We saw developments between the U.S. and Iran over the course of the past months. What's the current state of play between the U.S. and Iran in the Gulf, and how should we expect this to develop moving forward?

    Tom Donilon: There have been significant tensions in the Gulf; really since last spring they began to escalate, but especially into the fall where there were a number of significant events that took place, which increased tensions in the Gulf and particularly between the United States and Iran. You had, on September 14th, the Iranian attack on Saudi Aramco facilities inside Saudi Arabia, which is a significant attack at Abqaiq on a very significant part of the global energy infrastructure. You had an October 6th disruption where the Turks, after a phone call with President Trump and President Erdogan, came into Northeast Syria and pushed in, causing a lot of disruption in Northeast Syria. On January 3rd, you had the acknowledged attack by the United States on General Qasem Soleimani of Iran, the head of the Islamic Revolutionary Guard Quds Force. On January 8th, you had the Iranian response, right, with missile attacks against two facilities in Iraq including the Al Asad Airbase out in Western Iraq. After that event — because tensions were building quite significantly – you did have a pause and a pullback after the events of January 8th where President Trump said that no U.S. casualties have taken place. There were no U.S. deaths as a result of it, and we had kind of a pullback, if you will, I think from direct confrontation. That doesn’t mean, however, that there's not going to be, I think, continued tensions between the United States and Iran. And we could look to Iran to undertake some asymmetric steps challenging the United States going forward. But we have pulled back at least for the moment from a direct confrontation, an all-on kind of military confrontation between the United States and Iran. Now we have had concerns raised about security in the region with respect to facilities. There are concerns about what this means in terms of ISIS and its resurgence. The reaction with respect to oil has been fairly modest. I think recognizing that we're not in kind of a full-on direct military confrontation and also the structure of supply globally. But there remains a high level of tension and potential volatility. 

    Catherine Kress: Sure. So you mentioned that Iran could continue to take a number of asymmetric steps. What do you mean by that?

    Tom Donilon: Well the Iranians have a lot of capabilities. They have a set of proxy militias and other organizations in the region whom they have used in the past to undertake actions against their enemies, including the United States. The action that caused the United States, a proximate cause for the United States attacks on Shiite militias in Iraq was an attack by a Shiite militia group against a base in Kirkuk. So they have proxy forces in their region that they have for many years used to carry out their goals. Indeed, one of the projects, if you will, over the last two decades that General Qasem Soleimani worked on was the development of these proxy groups around the region from Hezbollah towards the Mediterranean, across the region including a number of Shiite militia groups inside Iraq—number one. Number two—Iran is an adversary with fairly sophisticated cyber capabilities. Those are the kinds of things which we've seen them use in the past with respect to asymmetric engagements. So there's a number of steps I think that they can take that would be short of direct confrontation with the United States, which would not be in their interest, I don’t think, given the United States preponderance of power. But you could see them engaged using some of those kinds of tools over the coming year, I think.

    Catherine Kress: Tom, picking up specifically on the cyber point you mentioned, how are you viewing cyber risk in 2020? I know we've highlighted some of the risks around rising tensions with cyber-enabled adversaries. 

    Tom Donilon: I think that we actually have an increased risk with respect to cyber in 2020. I think we have a really increased risk, or threat, of highly disruptive attacks in the United States against U.S. infrastructure and electoral systems and individual companies. Why do I say that? Number one, because I do think that there will be a lot of risk around the 2020 elections. The U.S. intelligence community has pointed to that risk and the intention of outside forces to try to disrupt the 2020 election via cyber techniques. Second, is that we have increased tensions with countries in the world that have quite a bit of cyber capability, including Iran, as we talked about earlier, and China and Russia and North Korea. So we have adversaries with whom we have increased tension that have significant cyber capabilities. Third, is that we've seen cyber bad actors, criminals really moving against some of the weak links in our infrastructure in the United States. And they include especially cities and states that might not have the sophistication or the resources to do the kinds of defense that you need to do. And we've seen that in the case of so-called ransomware where you have criminals coming in from around the globe and shutting down the systems of cities and states, and demanding in order for those systems to be put back online again or for material to be returned that those states and cities pay them ransom. The other thing I'm concerned about frankly with respect to cyber is there is really, what some commentators in the field have called, a revolution in deceptive technologies, so-called deep fakes, which is where I essentially can take your voice or your image and manipulate it so that you're doing or saying something that you didn’t really say or do but the observer can't tell the difference. Those technologies have really increased in terms of sophistication, and I think present a danger going forward, both in terms of our political discourse but also in terms of risk to particular companies going forward.

    Catherine Kress: So it really seems like risk is heightened across the board. You started with the U.S. elections, and this seems to be kind of the question of the day. What is your outlook for the November elections? We're about 10 months away.

    Tom Donilon: Well I'm not really here prepared to make a prediction on the election 10 months away from now because that's an eternity in politics, having been involved in most of the major elections in the United States since 1980. But I can say this. What do we see going forward? First of all, the U.S. elections are a major event—and it’s really a series of events—for investors globally to watch and assess going forward. Second, is that I do think we're in for a tumultuous election cycle. And that's in a very polarized nation. And I think that's demonstrated by the fact that the first event in the election cycle for 2020 are the impeachment proceedings. That's only the third time in American history that we've had a U.S. president put in front of the Senate in this kind of highly-stylized trial proceeding. On the elections generally, I think all things would point towards a close election. Typically, United States incumbents have a lot of advantages here, but the current state of affairs I think is that it points towards a close election. Most of the national polls in the United States point towards a close election. And indeed, most of the polls where it really counts is in a number of key states in the United States, and those also look quite close at this point. The second thing I'd say about the election in the United States—it's going to be highly engaged. Most of the models and analysts that I follow indicate now that they expect one of the highest turnouts in the modern history of the country in the 2020 election. And that's the strong feelings I think on all sides. The third thing is that it will be a consequential election. The policy differences and approaches between the two parties—between the Republican Party incumbent, the President, and the Democratic Party candidates—the gulf between their policy preferences and proposals are really substantial. So we'll be looking as we go along here—making assessments—as to what we think the outcome might be because the outcome will be quite consequential in terms of policy, which will obviously be quite important to investors globally.

    Catherine Kress: Tom, we've just covered most of the world over the course of our conversation. Are there any risks or areas that we haven't discussed today that you're particularly worried about?

    Tom Donilon: Well, there are always the kinds of risks that can emerge that can affect markets, like the coronavirus that's emerged out of China, which has had some effect on outlooks with respect to global growth. I think that one that we've been paying close attention to is the ongoing protest movements around the world. They've been fueled by rising income and wealth inequality, weak government performance, environmental concerns in some cases, climate change concerns. And those protests have taken place against a backdrop of a pretty positive economic environment, at least on a macro level. And one concern that we're focused on and thinking about is what happens in a downturn. What kind of reaction are we going to get in a downturn? Because many governments are ill-equipped to respond with limited monetary and fiscal and political maneuvering room. So we are focused on that. And, of course, the proliferation of social media has exacerbated and facilitated a lot of these protest movements. So we're focused on thinking about and monitoring what happens as particular nations, countries, governments move towards a softer economic environment when they've had a lot of this kind of unrest in a more benign economic environment.

    Catherine Kress: And it's interesting bringing all these different themes together. It seems like not only will we face some constraints on the fiscal and monetary side, but in a more competitive geopolitical environment—in some cases a more polarized domestic environment— even the political capacity to respond to a potential downturn could be more limited.

    Tom Donilon: I think that's right. As we said, you have more limited tools than you had for example in 2008-2009, with respect to central banks and monetary policy. You have more polarized political environments inside countries, which will make it challenging to develop the fiscal response that you need to develop. But more importantly, we also need to look at internationally, are we in a position—and we should be thinking hard about how to get in this position—where we can work internationally in a global way to address economic challenges. We were able to do that, by the way, in 2008 and 2009—working with other countries from around the world to have a unified response to the Great Financial Crisis.

    Catherine Kress: Tom, I'd like to conclude with a rapid-fire round, if that's okay. So just three really quick questions for you. Number one, which country have you traveled to the most?

    Tom Donilon: I think that I've traveled to Israel the most times in my diplomatic and business career. I think I've been to Israel 26 or 27 times.

    Catherine Kress: And which country do you like going to the most?

    Tom Donilon: Well the country I like going to the most is returning to the United States. That's the country I like coming to the most after my trips. After all these years, it's still the best place to go to and come back to.

    Catherine Kress: So you were the National Security Advisor to President Obama. Does that make you the highest ranking former national security official in your family?

    Tom Donilon: I don’t know technically if that's correct. My wife is an ambassador. My wife’s name is Cathy Russell. She was the Ambassador-at-large at the State Department for women’s and girls’ issues. So I'm not the highest ranking former anything in my family.

    Catherine Kress: She might have a leg up on you there. Tom, thanks so much for joining us today. It's been great having you.

    Tom Donilon: Thank you.

  • Rich Kushel: I’d like to think that in ten years there really isn’t any focus on sustainable investing, it’s just investing.

    Mary-Catherine Lader: We're just a few weeks into 2020, but it's already starting to look like sustainability is going to drive conversation this year unlike previous years. So today we're continuing our mini-series, “Sustainability. Our New Standard,” exploring the ways that sustainability – and climate change in particular – will transform investing. In our active business, which represents 1.8 trillion dollars, we’re exiting businesses that present high risks across ESG – environmental, social and governance risk – such as thermal coal producers. We’re launching new investment products that screen out fossil fuels; and we’re increasing transparency in our investment stewardship activities. For our second episode, I went to London to talk to Philipp Hildebrand, BlackRock's Vice Chairman, and Rachel Lord, our head of Europe, Middle East, and Africa. On the heels of announcements from BlackRock about how we're putting sustainability at the heart of our firm and business, the three of us talked about how sustainability has been at the forefront of finance for some time, but why there's a lot more to come in 2020. I'm your host, Mary-Catherine Lader. We hope you enjoy.

    Mary-Catherine Lader: Thanks so much for joining us today.

    Rachel Lord: Thanks MC, great to be here.

    Philipp Hildebrand: Thank you, it’s very good to be here.

    Mary-Catherine Lader: We at BlackRock just announced a number of changes putting sustainability at the center of our investment approach. We are increasing transparency around stewardship, expanding our product set, and doing a lot in technology and analytics as well. And as part of that, we’re doing this podcast series, “Sustainability. Our New Standard.” Philipp, you oversee sustainable investing at BlackRock among other responsibilities. What is making sustainability standard mean to you?

    Philipp Hildebrand: Well let’s focus on the climate piece, which is the most important part of it. It’s not the only part, but it’s the most important part. The physics are pretty clear. We have a global warming problem that I would argue is the most significant challenge we face as humanity over the next decades. If we want to stay to the global warming path of one and a half percent of warming over the next decades, we will need to reduce, significantly, CO2 emissions. In other words, we need to go by 2050, let’s say, to a net zero CO2 emission economy. That means we have a very significant transformation of the global economy ahead of us with a long transition path, but it’s decades, it’s not hundreds of years. That will lead to very significant changes in the way the global economy operates, which will require very significant changes in global capital allocation. That in turn leads to relative changes in prices, and that of course greatly impacts any investment portfolio. And so from that, it’s very clear that as a fiduciary, it is our responsibility to help our clients navigate this because literally every significant portfolio worldwide is very likely to get affected by this change in capital allocation and the change in relative prices which will be inevitable as part of the transition to a much lower carbon emission economy. Second piece I would say is it’s pretty clear when you look at the research and the analytics that we have today that integrating sustainability factors into your portfolios ultimately will create better risk-adjusted performance. So again, from a fiduciary responsibility, it’s pretty clear when you look at it this way that we have an obligation to step forward and get ahead of this.

    Mary-Catherine Lader: And we’ll come back to whether what we’re doing needs to be one component of a broader set of solutions, but first, Rachel: Philipp talked about how this is really rooted in our clients’ needs and our obligation to be a fiduciary to them. You spend most of your time with our clients, particularly in Europe as the Head of EMEA. What have you heard so far as you’ve heard responses to this announcement?

    Rachel Lord: The conversation we’ve been having with clients really over the last number of years actually has accelerated every few months. The amount of conversations we have grow and grow and grow, and so we were very interested in what would clients say once we make these announcements. I think there are a few key points that are worth making. One, here in Europe, the overwhelming response is positive. Our clients are pleased that we have been so thoughtful about the actions that we have said we’re taking. But interestingly, they’re all looking for help. And so whether it’s private wealth clients or institutions, really the whole spectrum of clients, we’ve had a lot of feedback and comments that actually they’d like us to come in and help them think about, well, how are they going to themselves implement more sustainability in their portfolios, how can they analyze the price of carbon, what is that going to do to assets that they hold? How can they think about transitioning from one strategy to a different strategy? And so, it feels like we’ve tapped into a real need on behalf of clients to have a very thoughtful, deep, intellectual conversation about okay, what does this mean for them and how should they respond themselves going forward? I think it’s been very positive.

    Philipp Hildebrand: I think now we have come out with some major announcements, which will raise expectations; our clients will expect us to deliver. But also, the external world is going to look carefully at what we’ve set out and make sure we deliver. Internally, I think this is certainly a great rallying point. We’re talking to all employees worldwide and everybody will be keenly aware of the fact that we have raised the bar and we now need to deliver, and clients will expect us to help them really navigate these very difficult challenges.

    Mary-Catherine Lader: And these difficult challenges are also in some cases hard to quantify. We’ve spent a lot of time thinking about climate sustainability in part because there are more established ways of measuring some of those elements; some emerging ways of measuring social and governance factors. Let’s start with the E part of ESG first: how do you think we have a responsibility and an opportunity to have an impact in evolving the impact of climate change? For example, what role do you see finance playing in the energy transition?

    Philipp Hildebrand: I think it’s very important to restate over and over again that climate change is probably the defining challenge we face as mankind over the next decades. In the end, it’s going to have to be governmental policy that will have to solve this. It will require global cooperation, it will require regulation, laws, action by governments. This is not a problem that can be solved by the private sector, so we should have no illusions about that. And what we’re doing, what other firms are doing, should in no way be an excuse for governments to take a back seat. What we can do as the financial industry, I think we can be an accelerant, we can be a catalyst for positive change, we can be an amplifier. The power of capital that moves is a very significant force and so the financial sector, and I would say buy side asset management in particular, can play a very important role. For finance, I believe personally, having gone through the Crisis as my seminal career moment, that this is also an opportunity for finance – for our own industry, in a sense – to come out of a terrible decade where in many ways, as an industry, we have failed our clients; we have failed our societies. A way you can think of it is redeeming ourselves as an industry if we get this right. I think the stakes are very high; it will require close partnership, close cooperation between the public sector and the private sector. But the private sector has an important role to play and I think in particular asset managers and asset owners.

    Rachel Lord: I completely agree with everything Philipp said, and I think one of the things that is powerful in particular for BlackRock is that we have a very loud voice. People listen to what we say and actually, we’re using our voice for good. And so, we are not in and of ourselves going to solve the problems of climate change in the world. I completely agree this requires cooperation globally; it requires regulations, laws and everything else. What we can do is use our voice to amplify the messages, to make sure it’s heard, to put this on the agenda and make it absolutely at the center of conversations around finance. And I think that is where the actions we take, one, this is the right thing for clients. Climate risk will reduce the returns clients get in their portfolios, so as a fiduciary, that is our obligation. But two, I think it’s actually good for society. We are raising the stakes, raising awareness, and when we talk, people listen.

    Mary-Catherine Lader: And to the point that people listen when BlackRock speaks, in some form, they certainly pay attention to how we vote, and part of this is increased transparency around our voting approach and the votes themselves. What’s the context for our current thinking about stewardship?

    Rachel Lord: I think if I’m critical, we probably underestimated how much clients want to have that transparency. Now obviously clients who have assets with us know what we’re doing, but I think it’s more than just clients. It’s stakeholders in general, society in general. We’re going to be reporting on the engagements we have. We will be giving details of why we vote in a certain way in what we consider to be key votes. Often those are climate related, but they're not just climate related. I think that is going to help and that is being applauded. I think the skeptics are saying well that’s great, but we want to see you do it. So they applaud the fact that we intend to do it, but they want to see it happen in action. So it’s really on us to make sure we carry this through.

    Mary-Catherine Lader: And that will take time.

    Rachel Lord: Yes, of course. Votes don’t happen every day, big votes don’t happen every day.

    Philipp Hildebrand: One other constituency that we should not forget: our own colleagues internally. One of the things that struck me just talking to people is the enormous sense of motivation and in a sense, excitement also, that we as a firm are taking the steps, that we have in a sense put a very specific and a clear dimension to the purpose discussion that Larry launched a couple of years ago, and I think this is a very important initiative in terms of not only motivating our own colleagues but also attracting the best possible talent we can. And ultimately, that is going to be the ingredient that makes the success of this company in the long term.

    Mary-Catherine Lader: Right, I think we all got phone calls, text messages, emails from people we knew. Do you have a favorite message or response that either of you got?

    Rachel Lord: My 15-year-old daughter when I went home, my 18-year-old was studying for her marks but my 15-year-old was being lazy and doing nothing. So I said, well you need to read, go on my website and read Larry’s letter and read the client letter. And so she read them, she complained about how long they were, which actually some other people complained about. And she said, Mom, this is really cool. Most of what you do is irrelevant, this actually looks really good. If you can make your children proud of what you do, I think all of our employees want to feel proud, whether it’s their children or their parents or their friends, or whatever it happens to be. Doing things that you believe have a positive impact on society, actually are the things that make you lift up and proud to work at BlackRock. So yeah, that was my mine.

    Mary-Catherine Lader: Looking ahead, this is a rapidly evolving space, but what do you hope will be different in sustainability?

    Philipp Hildebrand: I would expect that one of the things that this will do, it will put enormous pressure on other asset managers to follow in their own way, adapt it to their own business model. They’re not the same in many cases as we are; but I think the dynamic here for asset managers to step up to this challenge on all fronts, whether it’s the analytics, the product offering, the voting, this will be a change that we’ll see evolve very quickly over the next couple of years. It will simply be too hard and too disadvantageous from a commercial perspective, from a reputation perspective, not to follow up here.

    Rachel Lord: To pick up on that, obviously we signed up for Climate Action 100. And it was fascinating the feedback we had from some of the major players in Climate Action 100. They were very happy we’d signed up. It was partly because of the assets that we have, mainly because it gives them access to some of the thought leadership that we have, we are seen by these people as the leaders of stewardship. And so they want to have that engagement with us about how we’re thinking about voting in particular. But probably the most important point they raised was that this will change the game in the States. And so we are the first of very large U.S.-led global companies to sign up for Climate Action 100 and that was seen as a pivotal moment that may shift the approach of some of our competitor/partner firms in America.

    Mary-Catherine Lader: And so that is one example of still pretty much private sector coordination and collaboration, right?

    Rachel Lord: Yes.

    Mary-Catherine Lader: As we think about the importance of engaging the public sector, Philipp, particularly given your previous life as a central banker, what would you hope to see in the next year or two from the public sector or public/private coordination on this topic?

    Philipp Hildebrand: Well, I think we’ll need to see where the legislative journey goes. And of course, at the moment, there is a big elephant in the room that you have divergence between the U.S. and Europe on this, which creates a set of challenges. The world is as it is, so we will have to live with that. Markets will have to adapt. The more of a common ground we see over time, whether it’s carbon pricing legislation or other regulations and laws, the easier it will be for the private sector to adapt. So I think the principle question will be, how do the major jurisdictions legislate and set regulatory requirements around climate change and indeed other sustainability-driven issues? The other one I think that is important is that I would expect you are going to see a number of private/public sector initiatives to tackle some of these. The overarching economic requirement is significant investments in order to tackle climate change, in order to facilitate this transition to a low carbon economy. And that is going to require both public sector incentives, public sector participation, but it will also require private capital. And in fact, one of the things we announced was this climate finance partnership with the German and French government and some private foundations, that would basically galvanize private sector capital together with the public sector into infrastructure projects that would enhance sustainability. I would expect we’re going to see more private market public sector cooperative schemes to direct capital particularly into the infrastructure area where there is going to be an enormous need of capital if we want to transition towards a low carbon economy. In some ways the hardest piece will be emerging markets, that’s where have the most significant challenges with regard to the transition. And indeed, one of the elements of the climate finance partnership is actually that we do have an allocation to Africa which is very important to the French government and I think that is the right thing to do. Now these things will be difficult. We know that it’s not easy to source good projects, to execute them, to have good governance and rule of law. So there are always challenges involved in this, but these are the types of challenges that we will have to rise to in the years and decades to come.

    Mary-Catherine Lader: That means we, the French government and the German government will essentially be investing in on-the-ground renewable energy, clean energy projects in Africa, emerging markets.

    Philipp Hildebrand: Exactly, together with private foundations, so again, it was very important that we had this private/public sector combination in this climate finance partnership.

    Mary-Catherine Lader: As we think about what implementing those regulatory regimes that you mentioned looks like, it might be daunting for our clients frankly, or for a lot of financial services. If we think about the last major change in financial services regulation coming out of the Global Financial Crisis, we all had a sense of what the problems were. The plans and changes were years in the making; all institutions had a lot of time to digest what that might mean for them. What do we think this is going to look like as we start to talk about rules and regulations that different organizations are going to have to comply with? And what do you think, Rachel, it will really take for all of us to be ready over the next year or two?

    Rachel Lord: So if I think about it from an industry perspective, I think we don’t even have a taxonomy around the language that we use to describe even the basic principles of sustainability, ESG, impact, responsible investing, and that is something that regulators and industry groups are working on. We certainly don’t have, yet, broadly established tools and an analytical framework that really does help you go deep into that analysis. That’s one of the reasons we've highlighted, and Larry’s highlighted, the need for SASB reporting, the need for TCFD reporting. But there is a lot more to be done, things like carbon pricing tools are critical. I think you will see that area of data and analytics evolve over the next 18 months quite significantly. Clients want to be able to assess in detail what are the risks that they’re facing in their portfolio because pension funds, their members are asking them for this. It’s very important to everyone. So I think that’s an area to really watch, I think that will change over 18 months, but we won’t be at perfection in 18 months.

    Mary-Catherine Lader: Right, it’s an ongoing journey.

    Rachel Lord: It’s an ongoing journey.

    Mary-Catherine Lader: What do you think will be different about the conversation in 2020?

    Philipp Hildebrand: Well, I think the first step is really transparency disclosure, because without that, it’s very hard to even know what you’re dealing with. That’s why these disclosure standards that Rachel mentioned are very important. We as a firm, by the way, are also going to do this. The more data we have, the better we can then develop analytical tools. A lot of progress has already been made on this. Academia is now very much involved in this data analytics challenge in a sense. One of the reasons we have much greater comfort today and confidence that risk-adjusted performance will actually be better if you incorporate sustainability-related dimensions into your portfolio is because there’s been a lot of work done in academia with long time series that begins to show this. Three or four years ago, it wasn’t so obvious, and so in many ways, if I think back ten years ago, it was a niche industry that you did because you had certain values. Today you could do it very much from a capitalistic perspective. The next big round will be stress testing of the banks, that’s a significant regulatory development that has begun in many ways in this country. Christine Lagarde has made it very clear early on in her new tenure that she wants to look at this carefully as part of the review in Europe, so I think we’re going to see very quickly banks needing to basically stress test their portfolios to climate risk, their balance sheets ultimately. That will open up an entire new field of activity both on the regulatory side as well as on the advisory side. So I think those will be some of the early developments, then there will be things like definitional issues, what is considered green, what is not considered green. And I think finally the big piece of it will be carbon pricing and we’ll see to what extent we get some kind of global convergence on that. That remains a difficult challenge as long as the U.S. government pursues a different approach on these things. But it won’t stop – Europe is the largest economic area in the world so Europe will move ahead on this front irrespective of the U.S. in many ways.

    Mary-Catherine Lader: You’re both very steeped in these issues. It’s obviously apparent talking to you in part because of your roles; but you’ve also personally been very involved in the firm’s agenda overall, across not just those areas that you run and oversee. What were the personal turning point for you in the sustainability journey where either you realized how and why this was going to be so important or that shifted your thinking about it?

    Rachel Lord: I did a town hall in September, and I was asked a question by someone in the audience around how do we reconcile our holdings in fossil fuels with index and why don’t we get out of fossil fuels? My response wasn’t good enough and I don’t think our response to these kinds of questions was evolved enough, and they didn’t necessarily hang together. So my takeaway from that was okay, we have to change what we’re doing or change how we talk about what we’re doing, because what we’re saying is no longer relevant to our people. So I started from, what do our teams say? And yes, clients were asking us questions but one-on-one with clients, we could answer those questions very well. It was really our own people asking questions around our practices, how do we think about this, how do we reconcile what are difficult, conflicting positions. And I didn’t feel we were doing a very good job of actually being able to explain ourselves. So that was what I wanted to achieve out of the work we’ve been doing recently.

    Mary-Catherine Lader: What about for you, Philipp?

    Philipp Hildebrand: Well, my interest in environmental legislation and how it interacts with the private sector goes back actually to my dissertation on this in terms of European legislation, but to me the pivotal moment in a way was the Financial Crisis. Because what we went through, of course, in Switzerland and globally was this extraordinary damage that was done because the financial sector chose to completely ignore risk-adjusted perspective on returns. So the Crisis was in a sense a story of maximizing leverage, getting high short-term returns and then suffering an enormous accident with far-reaching consequences that ten years down the road, we’re still, in a sense, digesting. And so it became clear to me that this mistake of ignoring risks – in this case it was leverage, now it’s climate change – will ultimately produce an enormous accident in a way, and as I started reading the data, the research, I started to realize these are not just theoretical risks down at some point in the future; these risks are now manifesting themselves in financial assets. And if we ignore them, it’s going to be at our peril, and we’ll repeat as an industry the same mistake that we made in 2008. And then like Rachel, traveling a lot all over the world, and particularly here in Europe, I realized we just as an industry didn’t have good answers to very good questions from our clients and this was for me evolving over the last two, three years, where I saw we needed to make a major shift in order – both as an industry but also as an enterprise – to live up to the expectations from our clients.

    Mary-Catherine Lader: Thank you both so much for joining, it’s been a pleasure talking to you.

    Rachel Lord: Thank you.

    Philipp Hildebrand: Thank you. It’s been great.

  • Mary-Catherine Lader: Since the Global Financial Crisis, major central banks like the Federal Reserve in the United States and the European Central Bank in Europe have taken unprecedented steps to support the record-long economic expansion. Short-term interest rates are negative in Europe and Japan and interest rates are below 2% in all major economies. So unconventional policy has become conventional and yet that’s still not enough. When the next downturn happens, most central banks will not have the same ammunition, specifically lowering short-term and long-term interest rates, to support a recovery that they had in the last downturn.

    On this episode of The Bid, Jean Boivin, head of the BlackRock Investment Institute, talks about the challenges for central banks in dealing with the next downturn. Jean wrote about this exact topic in a recent paper published by the BlackRock Investment Institute. It stirred a lot of debate among academics and policymakers. So today we'll talk about why central banks are reaching those limits and what's next for them and governments alike. I'm your host, Mary-Catherine Lader. We hope you enjoy.

    Jean, thank you so much for joining us today.

    Jean Boivin: Great to be here.

    Mary-Catherine Lader: We're talking today about central banks and their role in the next economic downturn, but you and the BlackRock Investment Institute have actually said that you don’t anticipate an economic downturn this year in particular. Why are we talking about this now?

    Jean Boivin: So for 2020, we're not too worried about an economic downturn. In fact, we are expecting some pickup in growth. So you're absolutely right. This is not in itself an issue that's going to play out in 2020. However, we have been going through a whole generation of investors that have been in an investing environment where central banks were basically the only game in town. And the assumption that whenever there's going to be a significant downturn, central banks will be able to do something to support the economy and markets. And we think we're getting to a point where this should be starting to be questioned pretty fundamentally. Central banks are reaching some limits, and so as a result, even if there's no downturn imminent, that question will come to the fore in advance of the next downturn. And I think we've seen a glimpse of that in August of last year, 2019, where we've seen some intensification of trade tensions that were questioning the outlook. And we've seen in our view an outsized response of investors flying to safety, and that is a manifestation in our mind of a growing realization that it's not clear what kind of support would be next. So that's why we think this is an issue that is relevant now and is actually driving markets now.

    Mary-Catherine Lader: So your view is that there's not enough space for monetary policy to help us deal with the next economic downturn. Why do you believe that and why are we at those sorts of limits right now?

    Jean Boivin: Yeah. I mean that view is not necessarily consensual or there's some debate around that. But the main reason why we think we're pretty much exhausted with central banks’ support with the current toolkit is not necessarily like is there an ability to ease over the next quarters. I mean there's some more room, but in terms of dealing with like a recession or a real slowdown, we think that it's going to be very difficult for central banks to support and provide the stimulus needed. And the main reason is that everything that central banks do and all the tools that they have, have to work through some interest rate. They have to lower some rates. Conventional policy is about lowering the short-term policy rates, but the innovation of the Crisis was about tools that allowed lower longer-term rates throughout the yield curve. And at the level that rates are right now, even the long-term rates, there's not a lot of room to lower them much more than where they are right now. If rates cannot go much lower, all of these tools are kind of short-circuited in terms of their impact.

    Mary-Catherine Lader: How is that different in different regions? Because in some places rates are already negative, so there's really no space then. How do you see this playing out differently in different countries?

    Jean Boivin: Yeah. In the U.S. we are at rates that are somewhat higher, positive territory. And so there is some more space in the U.S. and that's why some people are arguing that there's a sense that there might be some room to respond to a recession. But even in the U.S., in our view, we've seen in August how quickly we can eat into that space, and we've seen rates going very quickly down to historic lows in the U.S. In the U.S. there's more room, but even there we are skeptical. And then if you go to Europe or Japan, then that clearly is even more obvious that it's going to be very difficult with negative rates.

    Mary-Catherine Lader: Let's take Japan as an example. An economic downturn happens. What's your recommendation?

    Jean Boivin: The response in our view like no matter what will have to involve some kind of more fiscal policy support. The immediate way to do that would be just to do straight, conventional fiscal policy. So that would be for governments to expand spending or cut taxes, for instance. So these are a measure that we think would be more direct and effective. And there's certainly a lot of scope to do that in the current environment, given that rates are very low. It's very easy for governments to finance their deficits. And in fact, it's possible to raise your deficit without increasing your debt as a fraction of your economic activity because rates are so low. We think that that's the next step, but there's a big question around this, which is if it's so obvious, why hasn’t that happened? And throughout the recovery since the crisis, in our view we've seen an over-reliance on monetary policy, even though a mix towards more fiscal would have been desirable. It hasn’t happened. It makes us a bit skeptical to think that it's just going to happen naturally and we're going to see a fiscal response. And that's why we've been exploring more explicit coordination between fiscal and monetary policy as a potential solution.

    Mary-Catherine Lader: Let's come back to that in a moment, but just a question: before, you say we haven't seen that much in terms of fiscal policy. You know, we did see tax cuts in the U.S. Are there any lessons to be learned from there or do you think that all of the fiscal policy changes we've seen have been either in isolation from this sort of monetary policy or too minor to really have any meaningful conclusions for your thesis?

    Jean Boivin: There's been some fiscal support in the U.S. more than elsewhere, but even there the mix I think has been over-relying on monetary policy. My statement was a global statement; overall, I think we've seen an over-reliance on central banks. I think central banks have been almost the only game in town to deal with the recovery after the Crisis. That doesn’t mean that it's been normal from fiscal policy. We've seen a big package after the Crisis in the U.S. And we've also seen tax cuts more recently. But the tax cuts in the U.S. are also interesting in that they came very late in the cycle. This is the kind of ammunition that you would want to use to deal with the slowdown, not necessarily at the peak of an expansion. But those kinds of measures could be the idea for dealing with the next downturn. And elsewhere we've seen basically easing from central banks at the same time that austerity was being implemented by government. We've seen like a situation where we're pushing on the accelerator on one hand and on the brake on the other for a big part of this recovery.

    Mary-Catherine Lader: As we think about the different actors in dealing with an economic downturn, you said central banks have been the only game in town for a little while. The traditional role or the typical role of a central bank versus legislation or an executive branch that might have control of our fiscal policy may sound really obvious to an economics student, but actually today they're not necessarily as one might have learned in university. So how do you see those roles having evolved, the role of a central bank and the role of those fiscal policymakers? And what do you think makes sense for our next economic downturn?

    Jean Boivin: It's very important. One thing that hasn’t changed and I don’t think should change is that there's a clear reason why a central bank needs to have independence in their ability to provide liquidity and control the amount of liquidity that is in the system. That's very important. This is how you avoid high inflation regimes. And there's nothing of what we're envisioning that should change that. However, we're not in a world that is as simple as we thought we were until recently or a few years ago. And what I mean by that is that the tools that would be required are not splitting themselves easily between a central bank and a fiscal authority. I think we're going to need going forward to find ways that will not rely on the interest rate to go lower. So we've been labeling that going direct, finding ways to put money in the hands of people that can spend it more directly. And any tool that's going to do that will have an element of it that is monetary policy in flavor or central bank authority. And there's an element that is a transfer of resources in the hands of some people, and that's a fiscal measure. That's what fiscal authority should be deciding over. The problem is any of these going direct measures are blending these two into one tool. And that raises important questions about what's the role of central bank versus fiscal authority, which are not as simply falling into silos. And I think it's going to have to do with not about the tools being one of the central bank or the fiscal authority, but it's going to be more about what aspect of that tool should be overseen by the central bank and what aspect should be overseen by the fiscal authority. And then jointly deploying that tool or measure. So in practice, like what we've explored in our analysis or work, is you could envision that the quantum of liquidity that the going direct transfer will involve as being determined by the central bank. And you could envision the central bank deciding when is the right time to deploy that. But determining who is getting the transfer would be a decision made by the fiscal authority. So that's an example of like one tool, but having two keys and different elements being decided by different authorities.

    Mary-Catherine Lader: So that's a little bit of a snapshot of how you see this fiscal policy and monetary policy coordination working in practice, right? This kind of like check and balance almost approach. What other arguments have you gotten in response to this view? What have been some of the counter arguments or concerns that have come up?

    Jean Boivin: Well I mean, the concerns are if you start from the world we thought we were in where central banks were independent, they had their own tools, and fiscal authorities had a separate set of tools, it's easy to think of how to maintain that separation. In a world where we're saying, well it's not as simple as that and there's a gray zone and you're going to have the two authorities that will need to work together, it raises questions about how do you maintain central bank independence? How do we ensure that the political side of things will not overtake central bank decisions? Why would a politician let the central bank decide on the size of these measures by themselves? This is where the pushback is coming from. Correctly so, emphasizing that it's not a trivial thing to do in practice. But the point I would add to this is that while we completely agree that this is tricky and complex as a problem to solve, ignoring it is not an option in our view in any case, and moreover —

    Mary-Catherine Lader: Ignoring what? Ignoring coordination; coordination is a necessary future condition in your mind.

    Jean Boivin: So saying that the argument that this raises complex governance issues, we agree with that, but it's not a reason for not trying to solve this or figure out what that means. That's point number one. And point number two is we think that one way or the other, when faced with the next significant slowdown, the temptation to move in that direction of some form of coordination that blurs the distinction between monetary and fiscal policy will happen. And then the big risk for us is it can happen like in an improvised fashion, which could be very dangerous or it can happen in a more deliberate fashion if we have an open discussion about where the guardrails should be around that coordination.

    Mary-Catherine Lader: And those guardrails are really tactical and specific. So we can think of examples around the world today where we have some political leaders making comments about central banks where certainly there may not be independence threatened in reality, but in terms of rhetoric we're seeing new kinds of pressure for example on central bank policy from political leaders. How do you think we have that discussion? Who needs to take part in that conversation to make real these kinds of governance mechanisms and what brings that about?

    Jean Boivin: That dialogue I think is already happening. So where are we going to be having those discussions and dialogue? It's happening during the context of even the U.S. election. There's a lot more, to my surprise, attention that is given to theories like what is known as modern monetary theory, which some people have quipped that it's neither modern nor monetary nor a theory. It’s a view that you can actually finance spending by government by essentially printing money. So you can have the central bank that would be financing directly the spending of the government and they can do that basically without real restrictions or limits. It's a pretty, nonstandard, unusual, non-orthodox economic view that is pretty dangerous in itself because if you believe that you can finance the deficit by just simply printing money and there would be no consequence on inflation, it opens the door for uncontrolled fiscal spending. And I would not have conceived five years ago that there would be serious people discussing that, and yet now it's on CNBC. And to me that speaks to the fact that we are seeing this drift. I mean modern monetary theory is an example of a bad form of fiscal and monetary policy coordination. Those are the kinds of things that we think we should be avoiding, that we should put guardrails against. So some of it is happening through the political debate. In my view it's really about government and central banks having discussions on a contingency plan in advance of those things happening. It's not clear to which extent this is happening necessarily in the public discussion, but there needs to be work by officials to think through these issues, have some kind of contingency plan.

    Mary-Catherine Lader: You mention that we're hearing this in the election cycles for example or in political debates. Right now we of course have an election coming up in the U.S. What's your view as to how that fiscal policy conversation is shaping up?

    Jean Boivin: Yeah. What we've been discussing here is really about when we see the next downturn and slow down. We are not too worried about recession in 2020 or even like beyond that in the near-term. Absent a real sign of slowdown, we don’t see the actual coordination discussion getting traction.

    Mary-Catherine Lader: Although everyone always likes to talk about when the next recession is coming, right, especially an election cycle to sort of say, here's how I would deal with this or here's my thinking on where the economy is headed.

    Jean Boivin: So there might be some broad discussion, but it won't be where the rubber hits the road really. But where the discussion though is around how much more fiscal expansion we would get without leaving the central bank aside. And that is of course one of the big questions around election in the U.S. There's questions around taxation that would be part of this. And I think more broadly, even more broadly than in the U.S., there's been somewhat of a big change over the last couple of years where we move from a global mantra around austerity, which was the starting point for most governments around the world, from Canada, the U.S., in Europe. Whereas there's now much less of that austerity narrative. And while we don’t expect much more support in 2020 from fiscal policy, the narrative around it is changing and that could lead to some upside surprise where fiscal policy plays a bigger role.

    Mary-Catherine Lader: So how do you see all of this impacting the investing landscape today?

    Jean Boivin: It impacts it I think in a pretty powerful way, even now. Even though we were talking about the next downturn and we don’t see a downturn now, this is contributing to I think investor anxiety. The fact that there is no clear game plan for how we're going to be dealing with this next downturn and we have doubts about the efficacy of the current toolkit, I think it's contributing to this risk aversion or anxiety that investors demonstrate. I think the best example of that is in August of last year, we've seen a flare-up in trade tensions. That was contributing to views of slowdown in the economy. And then there's been a very significant flight to safety from investors. We've seen flows to fixed income, they are very significant at that time. If we had a good sense of what the game plan would be in a recession, the anxiety would not be as high. And I think going forward, if we were to move to a world where we rely less on monetary policy and more on fiscal or some version of going direct, in that world I would expect less pressure on rates to go down. And so that could be pretty meaningful in terms of asset allocation. Right now it is pretty engrained in the investors' minds and market participants that rates are low forever. That could change in a world where we rely less on monetary policy going forward.

    Mary-Catherine Lader: If there is more of a shift of fiscal policy though, do you then have an expansion of the tools that are used and sort of greater degrees to which they are used and therefore you could have more uncertainty for investors than in our previous regime where there's a little bit more of a straightforward approach to a recession or no?

    Jean Boivin: That's a good point. We have a clear framework around how central banks are operating. They have a well-tested communication approach that is not always perfect as we've experienced, but it's within a framework that investors are used to dealing with. That would be different. And fiscal policy is not as nimble as monetary policy. Calibrating it and fine tuning is not an easy thing. And that could create more volatility or uncertainty. So at least in a transition as we might be shifting towards more or less reliance on monetary policy, it could create a more difficult environment for investors to read through what's happening.

    Mary-Catherine Lader: Right. Until norms sort of develop, for example. Wow. This world you are suggesting sounds very interesting and potentially kind of different. Speaking of interesting, you just came from the World Economic Forum in Davos, Switzerland. What were the most interesting topics of conversation there?

    Jean Boivin: Well sustainability is a big topic, and I would say more broadly I think we've been spending the last five years or since the recovery framing the discussion around markets, around when is the time to the next recession. And the game has been about is it going to be in 2020? And I think what's changing is it's not necessarily about whether we're going to get to a recession or not, but the fact that there are a series of structural limits in our mind that are now kind of playing into the near-term and intersecting with short-term market movements. But those are really about the limits to central banks, which we've talked about. The second is around geopolitics, populism, and those dynamics that are reaching their own form of limits. And then the third one is around globalization and that is also reaching some form of limits. And the trade tension between China and the U.S., how these two powers will be managing their strategic kind of competition is another form of limit that changes structurally how we think about the outlook. And then sustainability is kind of the fourth limit of structural limits. So these four used to be seen as long-term issues, but that are now affecting investor decisions. I think Davos this year was less about recessions, what's going to be the macro outlook and more about these structural phenomena now being relevant for investors and business communities.

    Mary-Catherine Lader: I'm going to end with a rapid-fire round. Are you ready?

    Jean Boivin: Yeah. Well we'll see.

    Mary-Catherine Lader: Okay. Who's your favorite economist?

    Jean Boivin: That's one to get in trouble with. There is a lot of very insightful economists. I was just listening to another podcast.

    Mary-Catherine Lader: We're the only one. How dare you?

    Jean Boivin: Almost as good as ours, called “Cautionary Tales.” And there was this contrast about John Maynard Keynes and Irving Fisher. And I have to say that after listening to that I knew that John Maynard Keynes a lot, but the evolution of his career, being a public servant, very influential, being the Second World War and after the First World War trying to bring economics to investment community and trying to learn that you didn’t have an edge and then figuring out how to go from there. And then being such an important figure of the last century, I think he has to be somebody that is very impressive without necessarily being fully econesian at heart.

    Mary-Catherine Lader: What's the most aesthetically interesting currency design in your view?

    Jean Boivin: It has to be the Canadian loonie.

    Mary-Catherine Lader: Is that like your bias as a Canadian?

    Jean Boivin: Of course.

    Mary-Catherine Lader: What about the most overrated or underrated economic crisis?

    Jean Boivin: I think that the Global Financial Crisis might be — it's not that it's over or underrated, but over time we might forget how big a deal it was. I'm talking about 2008-2009. And the reason is things could have gotten a lot worse than they have been. I think we had a play there, the dynamics that could have led to a Great Depression and the fact that we have avoided it, it's easy to forget what it could have been. So I think that's one element of it. And I think a lot of the dynamics we're facing right now around populism, some backlash globally around globalization and so on I don’t think would be as acute if we had not gone through the Financial Crisis. Now we go back and we say it's about globalization and longer-term trends, but I think absent that crisis I don’t think we would have these kind of existential discussions about politics that we're having right now.

    Mary-Catherine Lader: And looking ahead to 2020, an economic headline you think we might not yet be anticipating?

    Jean Boivin: Inflation is in my view the most underappreciated near-term risk. It's not like inflation is going to be picking up in an uncontrolled fashion, but the market is assuming so little inflation that it's ripe for a surprise in my view for 2020.

    Mary-Catherine Lader: Well thank you so much for joining us today, Jean. It's been an absolute pleasure talking to you.

    Jean Boivin: Thank you very much.

  • Mary-Catherine Lader: Climate change will impact more than just the environment. It’s also going to have a lasting impact on global economic growth and prosperity, particularly as more and more investors around the world demand more of the companies they invest in and take action like moving money into sustainable assets. 

    The bottom line? We believe it’s going to reshape finance and investment management.  That’s why we’re starting a new podcast mini-series, “Sustainability. Our new standard.” We’ll explore the ways that sustainability – and climate change in particular – are poised to transform investing, and how BlackRock is preparing for that transformation.

    Today, we’re kicking off this mini-series with some significant initiatives that we at Blackrock have announced around sustainability, putting it at the center of our investment approach. In our active business, which represents 1.8 trillion dollars, we’re exiting businesses that present high risks across ESG – environmental, social and governance risk – such as thermal coal producers. We’re launching new investment products that screen out fossil fuels; and we’re increasing transparency in our investment stewardship activities.

    A few days ago, I sat down with Rich Kushel, BlackRock’s Head of Multi-Asset Strategies and Global Fixed Income, to talk about these changes. We talked about why sustainability is at a tipping point and what it all means for investors. I’m your host, Mary-Catherine Lader. We hope you enjoy the first episode of this mini-series, “Sustainability. Our new standard.”

    Rich, thank you so much for joining us today.

    Rich Kushel: Thanks for having me.

    Mary-Catherine Lader: So we’re talking about sustainability today and one of the primary messages is that we, BlackRock, are discussing, is that climate risk is investment risk. What exactly do we mean by that?

    Rich Kushel: We believe that the focus on climate risk and the focus on broader sustainability issues is really having a profound impact on the financial markets. And we’re seeing that in two principle ways. One, is that we believe there are a lot of mispriced risks in the market. Investors are fundamentally not taking into account some of the risks associated with sustainability in general and climate change specifically. You see that in physical risks, such as the impact of fires or rising temperatures or lower crop yields on different parts of the economy. You’re also seeing that in the form of underappreciated impacts from a transition to a low carbon world. And that’s having positive impacts on parts of the market that are focused on providing low carbon services and products; think electric vehicles. And negative impacts on those in carbon-intensive industries. Secondly, there is a large-scale reallocation of capital going on in the markets today, away from broad market exposures to indexes and other things focused on sustainability. That’s going to have a profound impact on valuations, negatively impacting companies and issuers that exhibit negative externalities and positively impacting those that are seen to have positive externalities in the market.

    Mary-Catherine Lader: So you oversee many of our investment teams, what does this mean for them?

    Rich Kushel: Well, we’re seeing them really do a couple of things. One, over the last several years, we’ve had a pretty intense focus on integrating environmental, social, governance, ESG if you will, risk factors into our portfolios, of really making certain that that is an integral part of our investment process and that we’re evaluating those risks. Second, there’s been a large focus on making certain that we are providing choice to our clients. That those who want to build sustainability into their portfolios in a very explicit way, that we can give them the tools and techniques and services to be able to do that. And then lastly, we’ve seen some very large changes, even very recently in valuations and risks, coming in many respects from climate change but also from other sustainability factors that our portfolio managers are now reflecting in their portfolios. We just announced that as part of this we are moving out of our thermal coal investments. When we look at what the risks associated with thermal coal production are, we’ve just concluded that it’s not a good risk-return profile for our clients. By the middle of this year, we will have eliminated those exposures in our active debt and equity positions across the firm. 

    Mary-Catherine Lader: So a lot of this was laid out in two letters, one from Larry Fink, our CEO, and the other to clients with this message, climate risk is investment risk, with the intentions for how the investment teams are going to change what they’re focused on and how they think about ESG. What else are we going to do? So I’m thinking particularly of how we engage with companies around their climate practices and their ESG practices.

    Rich Kushel: One of the things that we’ve called for is for companies to report on sustainability measures and specifically, we’re advocating them using the SASB principles, or Sustainability Accounting Standards Board, as a reporting standard, as well as providing reporting along the TCFD standards, or the Task Force on Climate-Related Financial Disclosures, as well. And look, we understand, that’s not an easy thing to do. I would tell you that BlackRock still has work to do along that. But it’s something that we’re asking all the companies that we invest in to report on and I think we’re going to hold people to a pretty high standard on this. It’s an important part of what we do in terms of being stewards of capital, being engaged owners, focusing really on the long term. We’re committing to a real focus on that, we’re committing to a high level of transparency with respect to our voting and our engagements. And specifically, actually, not only listing the companies with whom we are engaging, but also the subjects on which we are engaging them on.

    Mary-Catherine Lader: So SASB, TCFD, these voluntary disclosure regimes have been around for a few years, but they haven’t gotten huge traction. What do we think it’s going to take for more companies to start to do these sorts of voluntary disclosure in addition to just our endorsement and request that they do so?

    Rich Kushel: It’s going back to my earlier comments about the role of sustainability in portfolios. It’s going to be really important for investors to understand how focused management is and how focused companies are on sustainability. One of the ways that we, as investors, are going to be able evaluate that is through these disclosure regimes and unfortunately, if we’re not given that information, we’re going to have to assume that we’re not behaving in a way, and they’re not managing their businesses focused on long-term sustainability. That’s going to have an impact on our view of valuations.

    Mary-Catherine Lader: So not only these regimes been around for a while but we, and you specifically, have been at this for decades, so why now for focusing on sustainability? Why are we calling for these changes at this point in time?

    Rich Kushel: I think we’re at a tipping point in a number of dimensions. One, is that the acuteness of the risks associated with non-sustainable behaviors are becoming very, very apparent. We’re seeing that around the world, and we’re seeing it in the way that people are evaluating companies and allocating capital. Secondly, it’s really important to our clients. Whether you believe that these risks are mispriced or not – and reasonable people can disagree, we have strong reason to believe that they are – but even if you don’t, I think you have to accept that there is a large-scale reallocation of capital towards sustainability that is going on right now and it’s not just in a narrow part of the world; this is global. It is a global phenomenon. Some say it’s associated with younger people now becoming CEOs and CIOs, with a more acute focus. Some say I think it’s just people understanding these things better. But because of that, that reallocation of capital is having a profound impact and we believe it’s going to have a profound impact on valuations. Given what our job is, to produce the best long-term returns for our clients, we have to be focused on it now.  

    Mary-Catherine Lader: And so when you say it’s important to our clients, what are they saying exactly?

    Rich Kushel: Our clients are saying two things. One is they want the best returns that they can have and given that most of our clients are saving for long term goals, like retirement, their time frames are extended out there. You know, there’s been a lot of focus on what’s the impact of a two-degree world. What happens in 2050? 2050 is now 30 years away. 30-year mortgages, 30-year bonds go out to 2050. Then is now. We have to be taking these into account in the investments we’re making today. Secondly, some of our clients want their portfolios to reflect their values. And we’re committed to providing them the tools to be able to do that and the ability to choose to do that in their portfolios. But what’s important is that that is precipitating a significant reallocation of capital. That’s going to affect the flow of funds around the world, not just to private market issuers, corporate issuers, but also to sovereign issuers in public markets. As fiduciaries and as people who are looking to create alpha for our clients in our active portfolios, we have to take that into account and that’s providing a great opportunity for us but it’s also putting risks in the portfolio that we need to be closely attuned to.

    Mary-Catherine Lader: So you’ve talked a lot about how active investing is going change. What are we going to do differently on the passive investing or index investing side?

    Rich Kushel: As an index manager, our duty is to replicate the returns of the indexes that our clients choose to use. And the reality is, those indices reflect the broad markets and have companies that exhibit both sustainable and non-sustainable behaviors. One of the things that we’re committed to doing is creating a series and a full spectrum of sustainability-oriented index exposures. And whether that’s through screening, eliminating exposures to things like fossil fuels or just optimizing around ESG exposures and looking to have a better ESG profile, those are a series of products and strategies that we’re going to be offering to our clients. We talk about that in the letter. What I’m personally excited about is our ability to use those in the solutions that we create for clients. The reality is most of what BlackRock does is as a solutions provider. We put together different capabilities from around the firm, or sometimes outside of the firm, to create the best possible outcome for our clients. We are really advocating that our clients employ sustainable versions of their broad market index exposures in their solutions and we’re going to be creating a series of capabilities for them to do that in a very easy and consumable way.

    Mary-Catherine Lader: Sustainable often signals the environmental and the climate components of it. How do you think about the other dimensions, whether that’s the S and the G in ESG or other things beyond sort of physical climate risk or the transition to a lower-carbon economy?

    Rich Kushel: Look, I think we’ve always been focused on the G risk, the governance risks. That’s probably the single most important thing in evaluating a company, is how good the management and board are doing about running their business and when you see problems, whether those problems manifest themselves in financial ways or reputational ways, it’s almost always a failure in governance at the root cause. So that’s something we’ve been focused on for a long time. You know, around the social side, it is important. And you’re seeing today, a much higher level of focus around what I call the social license to operate. And the companies that lose that, either because of bad behavior, not demonstrating equality, not respecting their employees or the environment, are getting punished in the market. That’s changing valuations. So there’s a lot of focus around environment and climate, it’s particularly acute and frankly, it’s among the easier to measure. But the S and G are at least as important.

    Mary-Catherine Lader: What is our advice to those companies that are at risk of losing their social license to operate, where we don’t see that kind of behavior? We’re not investing in you, how exactly do we have those conversations with management teams?

    Rich Kushel: Well look, we engage with over 2,000 companies a year through our stewardship team and then, thousands and thousands more where our investment teams are meeting with management. Part of what we’re doing is evaluating those things and really understanding it. But my message, which I think is a pretty simple one, is that these are important things that people need to be focused on. We’ve seen that in the markets. And, if the markets aren’t telling you that, your employees probably are. So I think people are focused on it.

    Mary-Catherine Lader: So as you think about risk, we have frameworks, we have formulas that investors use to think about risk, this is an emerging area. Is there a consensus, do we have standards yet, how important is that for our investors as they’re thinking about how to take this into account in their investment process?

    Rich Kushel: Well, MC, I think one of the most important that we need to be doing as investors is getting better information and better data. And one of the things that has changed over the last couple of years, is we’ve progressively gotten better and better and better about analyzing sustainability risks and really understanding which ones are relevant to which issuers. So one of my hopes, over the next couple of years, is that we continue to improve the quality and the relevance of the data that we have. And so, no, today there isn’t a really great set of standards. There are a number of providers out there who do a good job. But I’m always surprised at how little correlation there is on some of their analytics. That’s why one of the things that we’re really committed to at BlackRock is doing our own research and developing our own thoughts on these matters. But looking forward, I think you will see more standardization. I hope that BlackRock will be a leader in that way. What I think clients can expect from us are one, us integrating these things into our investment processes in an even greater extent and two, I think clients are going to appreciate this, is being able to report back to them how to measure, how to monitor, how to think about these sustainability-oriented exposures in their portfolio.

    Mary-Catherine Lader: So that they can understand on an ongoing basis where they stand on these different metrics.

    Rich Kushel: Absolutely, and look, there’s no easy answer, it’s not like there’s a single number that’s going to do that and for different types of instruments in different industries, you’re going to have different things that are relevant. But importantly, the ability to report to our clients and that’s one of the things we talked about in the letter, is really a commitment around sustainability-oriented reporting that I’m very excited about.

    Mary-Catherine Lader: So you say that’s one thing you hope will change in sustainable investing in the next sort of 5-10 years, what else do you hope will be different five years from now, ten years from now?

    Rich Kushel: You know, really, I don’t think it’s going to be in five years, but in ten years, maybe we’ll just be talking about investing and that all investing will be sustainable. We won’t need the adjective. I’d like to think that becomes the standard. You know markets change overtime, and so, I’d like to think in ten years there really isn’t any focus on sustainable investing, it’s just investing.

    Mary-Catherine Lader:  So, finally, sustainable investing – fad or here to stay?

    Rich Kushel: Oh, MC, I think this is a, this isn’t a fad. This is about, if you will, the ultimate in long term risk and returns. And to the extent that most of our clients are focused on saving for long-term goals, sustainability is something that’s going to be around for a long, long time.

    Mary-Catherine Lader: Thanks so much Rich for joining today.

    Rich Kushel: Thanks for having me.

    Mary-Catherine Lader: That was my conversation with Rich Kushel on how sustainability is changing our investment approach at BlackRock. And just a reminder, throughout 2020, we’ll continue to focus on sustainability on The Bid through our mini-series, “Sustainability. Our new standard.” We’ll talk about how sustainability is evolving and how it manifests in countries and investment opportunities around the world. So stay tuned throughout the year for more.

  • Oscar Pulido: It's 2020: a new year, a new decade, an opportunity to look back at the year that was and to look ahead at the investment opportunities that lie ahead. Will China trade tensions persist? Who will win the U.S. election? And will stock markets continue to hit new highs?

    On this episode of The Bid, we'll answer those questions with Mike Pyle, BlackRock's Global Chief Investment Strategist. We'll walk through the three themes that he sees shaping markets in the year ahead and talk about his New Year's resolutions for 2020. I'm your host, Oscar Pulido, we hope you enjoy.

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

    Mike Pyle: Awesome to be here, thanks for having me Oscar.

    Oscar Pulido: So Mike, it's the year 2020, which sounds very energizing to say.

    Mike Pyle: A new decade according to some, according to some.

    Oscar Pulido: Well, it also suggests to me that we're supposed to have perfect vision of where the markets are headed. Why don't we start by reflecting on last year versus this year? What were your main takeaways from 2019 and what do you see ahead in 2020?

    Mike Pyle: Yeah. I think even getting perfect vision on the past is sometimes a challenge enough. So, 2019 was a year that was really characterized by two big drivers. First, we saw this big uptick in geopolitical risk, principally around the U.S.-China trade tensions. And secondly, this very unusual, very powerful late cycle pivot from the global central banks, most particularly the Fed, towards a much more dovish posture. And basically, those two things were in tug of war with one another through the year. At the end of the day, it looks to us as if the central banks won out. They preserved the expansion, they kept the recovery intact, and that basically drove a lot of what we saw in financial markets as well with obviously both stocks and bonds up on the year. But I think as we move into 2020, what's really noteworthy is that both of those things that really dominated in 2019, both look to be receding into the rear-view mirror in 2020. And so something is going to have to pick up the baton as we go into the new year. We think on balance, that thing is going to be growth; that even if we're not going to see a big acceleration from here, that this edging higher back towards trend for the globe, for the U.S. is really going to be enough to push global stock markets somewhat higher and cause credit and other risk assets to have a decent year as well.

    Oscar Pulido: So you mentioned geopolitical risk; you couldn't escape that in the headlines in 2019. And then you mentioned this dovish posture, this pivot, which effectively was essentially banks, particularly the Federal Reserve, cutting interest rates last year and then that helped stock and bond markets as well. If you had to sum up the outlook in a few sentences, what would you say about 2020?

    Mike Pyle: 2020 is likely to be a year where growth edges higher globally, where what leads growth globally are places like manufacturing and trade that were beaten down in 2019.

    That has two implications for portfolios. The first is that we think that against a backdrop of the expansion continuing, against a backdrop of market prices, valuations, looking basically reasonable, we think stocks and credit are likely to be modestly rewarded over the course of 2020. Secondly, we think that some of the more cyclical parts of the global market, places like Japan and emerging markets that have particular upside exposure to manufacturing and trade, we think that those have more upside than some of the more defensive parts of the market that have been rewarded in the past couple of years. So the bottom line is, we like a modest tilt into stocks and credit and within that, see some of these cyclical asset classes that again kind of have higher exposure to trade and manufacturing as having some upside that hasn't been apparent in a while.

    Oscar Pulido: You mentioned manufacturing rebounding. That sector had a very tough 2019. What is it that would cause it to have a better 2020?

    Mike Pyle: I think partly it can have a better 2020 in part because it had such a bad 2019. But more specifically, if we looked at what caused that bad year for global manufacturing, global trade in 2019, it really is attributable to a significant extent to the frictions and instability that we saw in the world's largest trade relationship between the U.S. and China. Looking out across 2020 on the back of the phase 1 trade deal that got struck, we see that relationship as going more or less sideways across the course of 2020. That should take a real pressure off of global manufacturing and trade going into 2020 in ways that could allow it to bounce back modestly but meaningfully off the lows that we are seeing here in 2019.

    Oscar Pulido: So as we go into 2020, I know that many times when BlackRock talks about the outlook, we talk about themes, and there is typically three of them as there is for 2020. So why don't you tell us a little bit about what the three themes are for this particular year?

    Mike Pyle: Absolutely. So the three things that we're talking about in terms of the big drivers of 2020 are first what we call policy pause, and that is in effect saying that the two big things we saw drive markets and economics last year, as we were just talking about, are more likely than not to recede into the background in 2020. That's true of the trade instability that we saw, not that there won't be bouts of turbulence here and there. Also central banks, we see them as well basically being on hold throughout the year and the Fed is at the top of that list. I think listening to Chairman Powell, he made it very clear that the Fed is pretty comfortable with where they are at, and the barriers to additional cuts from here are pretty high. The second big theme is if policy is not going to be driving 2020 and economics and markets, what is? And I think what we expect to see is a bit of a hand-off from policy to growth. And not that we're going to see a big runaway year of global growth, but I do think that 2019 was a year where we saw growth slow sequentially quarter over quarter on a global basis and 2020 is a year where we expect to see growth bottom and then sequentially pick up across the course of the year. And then lastly, the third theme is around rethinking resilience. At the top of the list, thinking about the way in which the world could be quite different ten, fifteen, twenty years into the future around climate and sustainability risks, making sure that portfolios are increasingly reflective of and resilient to those risks. That also means resilience in a more traditional sense: being focused on finding places for our portfolios to stand up to the different scenarios that can unfold. And one thing that we're thinking about for example is while we don't anticipate that inflation is going to move much higher from here, it's also the case where the conditions are right for there maybe to be an upside surprise. And given what inflation can do to stock bond correlations and to the balance of portfolios, we think we need to be resilient to that outcome.

    Oscar Pulido: So you mentioned a lot there, I want to go back to policy pause and growth edging higher up. It feels like a long time ago, I remember taking a few classes in economics and what we learned was that if the central bank cut interest rates, there tended to be a lagged impact on the economy. Therefore, is what the Fed did in 2019 and the reason you see growth picking up in 2020 a function of those interest rates cuts starting to make their way into the real economy and thus giving the economy a bit of that boost that it sounds like you're talking about?

    Mike Pyle: That's exactly right. I would say first we have begun to see some of that monetary stimulus flow through the economy. I think one of the places that was strongest in the U.S. economy in late 2019 was the housing sector, for example, both around activity and sales, and that is exactly where you'd expect to see monetary stimulus show up first. But I think one of the things that we're particularly taken by when we look at the data is traditionally our measure of financial conditions, usually that index moves pretty closely with changes in global growth, global activity. In 2019, we saw pretty big divergence open up between those two things, the amount of activity that was being forecast by the level of financial conditions and the actual activity that we observed in the economy. We think that divergence was really an overhang from the geopolitical and trade tensions that we saw. And as that overhang dissipates, we expect those financial conditions to flow through and allow growth to pick back up, closer to what would be forecast by these financial conditions.

    Oscar Pulido: Financial conditions is a variety of different indicators that we look at; it's not just one, for example.

    Mike Pyle: Exactly. It's basically things like interest rates, credit availability, stock market levels, the dollar, basically an amalgam of indicators that taken together suggest how available credit and a sense of wealth is within the overall economy.

    Oscar Pulido: And so we talked about the Fed having cut rates. In Europe and Japan, interest rates are already at levels that I think no one in the financial industry expected to see in their lifetime. So it doesn't feel like central banks have much more room to cut interest rates if they needed to. So what other levers do central banks have to pull if for some reason we run into some difficulties in 2020?

    Mike Pyle: Yeah. I think that what you point to is one of the reasons why we think finding resilience is increasingly hard for portfolios outside of the United States and other developed markets. The distance between the effective lower bound and where interest rates are now in Europe and Japan is, by historic standards, very, very, very low. And that means there is just a whole lot less room for interest rates to move lower, for bonds to rally in the face of a growth shock or an economic shock of some kind. And that means in Europe and Japan, bonds are just to a much lesser extent than has historically been the case providing that basic cushion and stabilization in portfolios.

    Oscar Pulido: So what you're saying is if there is an event of volatility in the markets, government bonds historically provided some diversification in your portfolio, but it's unclear how much they can provide just given the low level of interest rates that you're starting from in the first place.

    Mike Pyle: Yeah. And again, that's true in Europe and Japan; that's much, much, much less true in the United States where there is still a fair amount of cushion in terms of where interest rates are. But in Europe and Japan, I think you're exactly right. This then asks a set of questions about, okay, in the face of economic or financial risk, how would policymakers, central bankers in particular, respond? The types of tools that are going to have to be reached for in the future probably aren't just in the hands of central banks, and we really need to look to places like fiscal policy to provide an overall boost to aggregate demand that is coordinated with additional monetary policies.

    Oscar Pulido: What does fiscal policy mean? Does that just mean tax cuts or is that a broader term that could mean a number of other different actions that governments could take?

    Mike Pyle: Yeah. I think what it means is the net contribution of resources to the aggregate demand in the economy from changes in either tax policy or spending policy. I think, for example, in Europe right now, you hear a lot of talk about a big effort around investments in green infrastructure. I think there is a lot of talk about that, though a little less far along in the United States. Certainly the most recent example we've seen of a significant demand side stimulus was the tax cut bill in the United States back in 2017, but I think it's just as likely moving ahead that additional stimulus doesn't take the form of tax cuts necessarily but really does take the form of these types of investments and green energy, green infrastructure, what have you, going back to the point around climate and sustainability.

    Oscar Pulido: We are taking about fiscal policy, it turns out you worked in Washington DC in your prior life, and so you may have heard there is a presidential election this year. I don't know if you have read the headlines.

    Mike Pyle: I've been told.

    Oscar Pulido: I'm not going to ask you who you think will win, but what I would want to ask you is can you frame what the issues are that investors should think about if there is a Democratic-led White House versus a Republican-led White House?

    Mike Pyle: Yeah. So I would say that a couple of things to bear in mind are first, investing on the back of a belief about what is going to happen politically is pretty dangerous game to get into. Sometimes even on the day of elections, expectations are thwarted. And I'd say secondly, and we saw this in 2016 as well, forecasting how assets are going to move on the back of a particular outcome is also very difficult. With respect to the election itself and how that might play out for investors, I think I would make just a couple of observations. One, I do think that we think that it is going to be a headwind for U.S. risk assets in particular – stocks and credit – in 2020, largely because the range of outcomes out there is really high. We have President Trump running for reelection. I think he'll largely be running on a very similar platform to what he ran on in 2016 which for economic purposes, likely means a significant ratcheting higher of trade pressures if he were to be reelected. And on the Democratic side, I think we're seeing a set of very ambitious proposals across a number of different dimensions of economic policy, ambition at a scale that we probably haven't seen since 1960s or 1970s. One place that I would point to precisely because it's one of these few places that we're seeing some overlap between Democrats and Republicans is that it does seem as if the direction of travel on regulation of technology and large technology firms is going to move in a more meaningfully aggressive direction regardless of who is in charge. That could take the form of anti-trust or privacy or tax or a number of other things. But I do think that for this handful of large firms that have been very important drivers of U.S. equity markets, the direction of travel on regulation looks to be a lot tougher regardless of who is in Washington. But perhaps with a bit more energy on the Democratic side.

    Oscar Pulido: And on that last point, technology has become a major component of U.S. stock markets, just given how well that sector has done in recent years. So if I look at the outlook, actually the uncertainty around the election is what has caused your view to become a bit more neutral on U.S. equities in particular, U.S. stocks, and has become a little bit more favorable towards a more cyclical what I'll call assets; so things like emerging markets or things like Japan.

    Mike Pyle: Yeah. I think that is basically right. I would say our outlook for the U.S. isn't negative. We think the global equities at large are going to have a positive year in 2020. We think that U.S. equities are probably going to perform basically in line with global equities. So it's not a forecast that is going to be a bad year for U.S. stocks. But I think what it is to say is after a number of years in which we've seen the U.S. outperform versus the rest of the world, this looks to be a year where it's going to be more in line, and I think you've exactly pointed to the reasons why we think that is so.

    Oscar Pulido: You mentioned inflation earlier and this possibility of inflation moving higher. I feel like all around us, prices are going down. We get things for cheaper than we used to whether it's clothes or the way we buy media, our cable, so what do you mean by the risk of inflation moving higher? Is it that you think it'll move significantly higher or just from a relatively low base we could start to see some inflationary pressure?

    Mike Pyle: Yeah, much more the latter. I think our base case is for inflation to remain broadly subdued across 2020 and tick a little bit higher towards trend. I think that is largely a function of the fact that we really are now seeing some wage growth flow through to the economy given where labor markets are and where the cycle is. And then I'd say lastly and I think potentially most importantly, it's something that is under-emphasized in the broader market narrative is, some of the supply side dynamics around the protectionism that we've seen to date and where we think the trade war between the U.S. and China could go down the road, the unwinding of global supply chains, the decoupling between the two biggest economies in the world, that introduces some inefficiencies into the global economy that could also be reflected in the lower productivity, lower growth, but also somewhat higher inflation. So I think our view again is not that we're going to run away into a much different world but we just in the base case, we could see inflation tick back towards trend. And in a risk case, which is low probability but higher impact, we could see it go somewhat beyond that. And it's high impact precisely because any move in the inflation complex challenges the negative stock/bond correlation which is just such a cornerstone of multi-asset investing; and again, this point we were raising earlier about bonds offsetting or cushioning equity market volatility.

    Oscar Pulido: Basically if inflation did in this low probability scenario that you outline surprise to the upside, you could have a scenario where stocks and bonds are both suffering at the same time. Doesn't happen often, but certainly one of the things we would just have to think about?

    Mike Pyle: That's absolutely right, and I think the importance or takeaway for that for us is things like Treasury Inflation Protected Securities are a really nice asset class to be building an allocation to alongside nominal treasuries. Precisely because they're pretty attractively priced right now, and in a sense, they're doubly resilient. That if you see the types of growth slowdowns or geopolitical shocks that allow nominal treasuries to rally and cushion portfolios, those same shocks cause TIPS to rally, a little less so, but they still rally and provide cushion to portfolios. But with upside inflation surprises, you don't get any real resilience out of nominal Treasuries, but you do get definitionally that resilience out of TIPS.

    Oscar Pulido: Let me ask you about China because you talked about the two largest economies in the world being the U.S. and China. China has seen its growth rate actually come down over many years. What was once a 10, or 11 or 12 percent growth rate for that economy is now more in the mid single digits. Should we be concerned about that, or was that a natural progression of where that economy was headed?

    Mike Pyle: Yeah. I would say China is on a natural trajectory towards slower, but I think hopefully higher-quality growth. This is certainly the direction of travel that the Chinese leadership wants to take that economy in the direction of. And what I think that is likely to mean in 2020 is that we see stable growth out of China, a continuation of the slow deceleration trend. We won't see a big insertion of stimulus into the economy like what we saw in 2011, 2012, 2015, 2016, in an effort to really deliver a big growth surprise out of China. And that's a different place than the global economy has been versus past moments where there have been these slowdowns that we then come out of. And I think it is part of the reason why to go back to the themes, we talk about growth edging up, not growth rebounding. The fact that China is not going to be putting a lot of stimulus into the system means that the ability of the global economy to come back and move towards trend or a little higher is real, but the upside of it is capped precisely because China doesn't want to flood the system with stimulus like they have in the past.

    Oscar Pulido: So Mike, you've mentioned a number of interesting things, and if you had to sum it all together, what is the thing that you think the markets are paying too much attention to and then what's the thing that they're not paying enough attention to?

    Mike Pyle: Perhaps surprisingly given what we talked about a little bit ago, is I do think at some level there is a little bit too much focus on the U.S. election as a big risk event in 2020. Like I said, I do think that we see it as a headwind that is going to impact U.S. equity market performance across the course of the year. But I think that we're also seeing a lot of noise both in the political system and in the market commentary around just how big of an event this is likely to be. And I think in reality the U.S. economy looks quite resilient at this stage, that will ultimately flow through to the strength and resilience of the U.S. equity market. In terms of what is not hyped enough, I think that EM, emerging markets, are underdiscussed. We talk about policy being on pause; I think the one place where that is not likely to be true is around emerging market central banks, where a number of EM central banks outside of China are likely to continue cutting across the course of 2020. And I think that backdrop of central banks cutting rates plus growth edging higher on a global basis is a pretty attractive backdrop, certainly for emerging market debt but probably also for emerging market equities as well.

    Oscar Pulido: And Mike, you have an impressive background, I alluded to the fact that you worked in Washington DC.You spent some time in the White House, you came to BlackRock and earlier this year you became the Global Chief Investment Strategist. So tell us more about that role and what it entails and what your day-to-day looks like?

    Michael Pyle: At some level, my job in my old life was to get up every day and try to figure out the global economy, and my job today is to try to get up every day and figure out the global economy, which is what I enjoy doing. In the past, it was about helping advise the president and the senior team about how to chart a course of policy that would navigate through what we saw out there in the global economic environment. I find tremendous satisfaction in much the same way talking to our clients day in and day out. Whether they are individual retirees or pensions or life insurers, helping them think through how to navigate a difficult world to make the decisions for them that's going to get them where they want to go, that feels very purposeful, and so that is a really cool thing about what I get to do.

    Oscar Pulido: I hope we all get to have the same passion in our job that you have in yours. So Mike, we usually end these podcasts with a rapid fire round. Since it's the new year, we're going to talk about New Year's Resolutions. You tell me which one you think is more likely. Are you ready?

    Mike Pyle: Yeah. Bring it.

    Oscar Pulido: Okay. More likely to sign up for a gym membership or cook at home every day?

    Mike Pyle: So I would say I am more likely – probably not a gym membership – but more likely a yoga membership, the coming year, would make my family very happy with me.

    Oscar Pulido: And that will give you a lot of time to have clear thoughts on the market and global economy.

    Mike Pyle: Yes.

    Oscar Pulido: Would you spend less time on your cell phone or spend less time on Netflix?

    Mike Pyle: I would in fact spend more time on Netflix and way less time on my cellphone.

    Oscar Pulido: Are you more likely to drink less coffee or less carbonated beverages?

    Mike Pyle: The fact of the matter is, I'm likely to continue consuming a lot of both, but I would say maybe hopefully a little less coffee.

    Oscar Pulido: And the last one here, are you more likely to read more books or listen to more podcasts?

    Mike Pyle: Recognizing the danger of this answer, I'm going to say that I really hope that I read more books in 2020. Twitter has destroyed my attention span, and I need to rebuild it. My hope for 2020 is that books are going to be a key part of the strategy for rebuilding my attention span.

    Oscar Pulido: All right, well we appreciate your candor, but you're no longer invited back to The Bid podcast. I'm just kidding, thanks Mike for joining us today, we look forward to see how your outlook pans out in 2020.

    Mike Pyle: Thank you for having me. Fantastic to talk.

  • Mary-Catherine Lader: In 2019, fintech became more than just an buzzword used by insiders; it went mainstream. That was in part due to the growth of startups that bring tech to financial services in totally new ways. But also because the world's largest financial services firms and tech companies – Google, Amazon, Facebook, for example – started to work together to bridge the worlds of finance and technology. Though a lot of this happened this year, some of us have been in fintech for a little longer.

    I'm your host, Mary-Catherine Lader, and I'm also the chief operating officer of Aladdin Wealth, a wealth technology business that builds software to simplify managing money for retail investors. Today, I'm going to talk to Sudhir Nair, Head of the Aladdin Business which focuses on institutional money managers: sovereign wealth funds, insurance companies, pensions and the world's largest owners of assets. Aladdin was started at BlackRock at the time of the company's founding, and today, is an operating system for managing money.

    On this episode of The BID, Sudhir and I will talk about what we are seeing in fintech for both big money managers and consumers, and what we think the future looks like – from the need to scale to a growing demand for sustainability. So, let's get to it.

    Thanks so much for joining us today, Sudhir.

    Sudhir Nair: Thanks MC, I'm happy to be here.

    Mary-Catherine Lader: So, fintech is very hot right now, and it's probably going to stay that way for a while, even though, well, you've actually been in it since before fintech was even a term. One indicator of how hot it is: venture capital-backed fintech companies raised $40 billion in 2018. That was up 120% from the year before. And this year in 2019, it would probably be even more. And most of that focused on consumer fintech or at least that's what, you know, listeners when they think fintech probably think of like challenger banks or –

    Sudhir Nair: Payments.

    Mary-Catherine Lader: Payments, robo-advice and the like. But you're in a pretty different part of the Fintech world, which is enterprise and specifically technology for asset managers, sovereign wealth funds, pensions, insurance companies, the world's largest managers of money. What is technology do for them and why does it matter to them?

    Sudhir Nair: It's critically important for them, because at the end of the day, managing money is an information processing exercise. And I would say that across the board, around the globe, there is definitely a reinvention happening. And everything from customer expectations and the types of products and services customers are looking to buy, to how they would like it delivered, to what they're willing to pay, is changing out from under the typical asset manager. I think one of the changes we're going to see is that there is going to be less and less full stack asset managers. And by full stack, I mean organizations that can really competitively and afford to focus on manufacturing, portfolio construction, distribution. Today, there are many of them, but what we're seeing is that oftentimes they are not able to deliver the value differentiation and scale in order to properly compete. So, what we're going to see is just a shift where every organization is going to need to pick their areas of specialty and focus in some ways, like picking your major in college and making sure that they are doubling down on their focus and attention there in order to improve their capabilities while at the same time, partnering with others to help them in places where they are not. I think people are really just starting to wake up and realize that they can't do everything themselves, and this is going to require a whole new level of cooperation and in some cases, coopetition, where asset managers, asset servicers, banks, and broker dealers are all going to need to find new ways of working together to create a seamless end-to-end experience for the client, but at the same time through partnership and integration.

    Mary-Catherine Lader: I mean, you could argue that wherever there's Excel spreadsheets, fax machines, or phone calls, there is an opportunity to have some interconnectivity, and it's a matter of just figuring out that we have the right partner or there's like a software product on the other end of some interaction, that you can link to, that creates like a next-generation sort of technology-enabled experience. What are some other examples? Is it like accounting? Is it trading? Is it linking the client reporting, all of the above?

    Sudhir Nair: I think you're absolutely right. The barrier in my mind has never been the absence of the technology. It was always the willingness of the participants to collaborate. So, there's an opportunity now to collaborate and work together, but it's that spirit of partnership that's really fueling the acceleration, not because some new magic technology has been created.

    Mary-Catherine Lader: It's interesting that you mentioned that collaboration and willingness to cooperate is like the most important thing. I think that's part of why distributed ledger technologies and blockchain haven't really gotten off the ground, right? Many people who were so excited about the potential a couple years ago at the beginning of that hype cycle were like, “Oh my goodness, there's so many antiquated practices and financial services operations. Could we revolutionize it?” But getting consensus around what kind of governance you would have for an entirely new technology was just too hard. And so, we found that people are too slow to want to have an entire new system. Perhaps there's more opportunity if you're incrementally changing something that you already use, like Aladdin for example.

    Sudhir Nair: I think that's right. I also think that, you know, at these points of friction there's usually somebody making money off of it.

    Mary-Catherine Lader: Yeah. Right.

    Sudhir Nair: There sometimes a lack of interest or inertia around making things too efficient.

    Mary-Catherine Lader: Right.

    Sudhir Nair: And I think it's really when the industry comes together and recognizes that, you know, this needs to change, it's in the best interest of customers, and by collaborating on a technology, we can get there faster that we really see momentum.

    Mary-Catherine Lader: That dynamic between what's in the best interest of customer and what's in the best interest of the provider is such an interesting one. In the example of WeatlhTech, a headwind for digital advice is that often advisors had been nervous about this intermediating themselves potentially losing some of their business if they deliver too smooth of a user experience; it allows an end investor to interact too simply with their money and make investment decisions. So, we've actually seen on the WealthTech side a lot of anxiety about the best user experience, which for most technology products user experience is the business, right? You develop the best product; you have a business because you get traction where people want to use it. How do you think about user experience on the institutional side, where for example, your customer doesn't go to an app store and download Aladdin versus an Aladdin competitor. They're sitting at their desk and their employer has chosen Aladdin and they don't really have a choice about what software to use? How do you think about how important it is to deliver, you know, user delight if you will?

    Sudhir Nair: It's incredibly important. It's no different with institutional organizations in the business that I'm a part of than it is anywhere else. And I think at the end of the day people vote with their feet and while enterprise technology is sold at the enterprise level, we have tens of thousands of users who interact with our technology in 70 different countries around the world, each and every day. We have really got to not think about, you know, these big organizations; we've got to think about individual users and the segments that they most relate to. So, traders think about issues and workflows and concerns related to traders. Portfolio managers are very different, risk professionals, compliance officers. So, when we design the technology, we really focus on, “What is the individual end user journey? What are the jobs and the task that he or she are going to look to do using our technology each and every day, and how can we create as seamless and unified an experience as possible? Now, don't get me wrong. I think the state of enterprise technology and user experience are in the very early innings. Admittedly, we're very far behind where I think consumer technology is today. But I think there's an incredible opportunity to play catch-up, and a lot of the partnerships and collaborations you've seen between financial services and big technology companies had been around combining the best of both worlds. Taking great investment capabilities and combining it with a slick, modern way of engaging end clients.

    Mary-Catherine Lader: Totally. And 2019 saw a lot of those partnerships that you just mentioned. So, you know, Apple, for example, launched a credit card with Goldman Sachs, Amazon has continued to grow a small business lending in partnership with JPMorgan and a few other banks. Facebook, not so much in partnership perhaps to their detriment in isolation, tried to launch a global currency. We partnered with Microsoft. So, there's a lot of this partnership between technologies, companies that have mastered user experience, customer acquisition and financial services firms. Is that relevant for institutional investors and do people, your clients that you are talking to, do they care?

    Sudhir Nair: I think they absolutely care. It's tough for me to speak on behalf of all of them but, you know, less so about any individual partnership, moreso about the concept because at the end of the day they're trying to get very close to their end clients and to provide the best level of service in the most modern tech experience. And I think these partnerships are going to accelerate that. So, some of these organizations, they have hundreds, if not thousands of internal technologies. You may ask yourself, “What do they get out of partnering with someone like Microsoft?” And it goes back to that not everybody has the same level of expertise, and it's all around combining where you have scale and expertise relative to where somebody else might in order to build something unique differentiated and ultimately faster to get to your end client.

    Mary-Catherine Lader: Switching gears just a little bit but in the same spirit as recognizing where you have expertise versus where someone else might. You're right now in the middle of integrating eFront, which is a private market fintech company. BlackRock had some game in that area but recognizing the opportunity, they decided to acquire eFront to sort of get ahead of the game and build on their significant global platform. So, how's the integration going and what are you learning about how fintech for a private market investing is any different from public marketing investing?

    Sudhir Nair: Great question. So, before I jump in into the integration, let me set a little bit of context around what's happening with portfolios and private markets in general. And it goes back to the point I made a moment ago around, “How much is changing?” If you look at the average portfolio and where assets are being allocated, there's an increasing need to allocate assets towards the private markets. So, what does that mean? It means as opposed to and in addition to traditional assets like stocks and bonds, things that trade in liquid markets and/or on exchanges because of the return profiles of those asset classes in order to meet a future obligation. For example, the needs of a pensioner, you know, 20 years out. There's a recognition that we need to be investing more into some of this more illiquid and private asset classes, whether it's private equity, real estate infrastructure. The challenge is that the technologies available are really suited towards public markets. So, as a result you have this imbalance between how an investment organization or a pension fund can view their public assets relative to their private assets. With eFront, we're very excited because even seven and a half months in, we see tremendous opportunity to combine everything we've been doing for the last 30 years with Aladdin largely focused on the public markets with everything that our new partners at eFront have been focused on for the last two decades with private markets. We're working on something called the whole portfolio view which, exactly as its name suggests, is really a way to show someone who has 50% of their portfolio invested in stocks and bonds and 50% of their portfolio in private equity, real estate and infrastructure, a single integrated view of risk, leveraging all of the great data from eFront in a way that shows them risk exposure, risk contribution and stress testing, public and private all in one place.

    Mary-Catherine Lader: And to someone who doesn't work in this field that might be surprising that doesn't exist but it really doesn't exist, right? So, like the data for example just to be able to provide that risk view on the private market side is like it's difficult to come by much less the integrated approach, right?

    Sudhir Nair: Totally different. In fact, just the data, the workflows, the transparency in some ways the private markets are a decade plus behind where the public markets are in terms of the level of availability and transparency. I guess the word private is there for a reason. And we see every organization and trying to tackle at themselves, which I think creates an opportunity, and we're not the first here but hopefully with our new partners we'll be, you know, increasingly to making progress towards trying to build industry standard ways of talking about these portfolios and industry standard ways of collecting data that every organization can share.

    Mary-Catherine Lader: To that point it's kind of amusing that these companies that are investing in the technology companies in the future, all are so lacking in technology themselves, venture capital firms, private equity firms. Moving to a different trend, ESG or environment social governance factors and investing strategies. This has been around for a while. I actually started my career covering renewable energy when clean tech was just first booming like over 10 years ago. ago. But it's getting that much more attraction now particularly in Europe as investors increasingly thinking about what their money is doing for them whether they're sovereign wealth funds or individuals. How's that sort of filtering through on the technology side? What are you hearing about ESG interest in terms of the technology and data from clients?

    Sudhir Nair: You know, if I were to sum it up, there's an enormous supply demand imbalance between the demand interest level of discussion around ESG relative to the supply of what's available in terms of data analytics technology capabilities, and I think there's a race in the market place to sort of tighten that up. But at a minimum I think the definition of what investors in the investment process are looking for is quickly evolving in a positive way. ESG is quickly changing from being a type of investment mandate to a fundamental component of every investment process. It's yet another lens to think about portfolios and asset allocation. It's like thinking about the portfolio from a market risk perspective or credit risk perspective. So, because of that there's a pretty profound change of what that means in terms of the data that people will ultimately need and the technical capabilities that they want to have access to in order to properly unlock the data. What do I mean by that? ESG is no longer going to be an analytic on a report. It's not a score in isolation. It's a framework that will bring standardization and access to new datasets in a way that lets every organization iterate and build their own capabilities so that way they can have their own propriety view of where ESG should be allocated or not.

    Mary-Catherine Lader: It sounds like that all of that is so qualitative. It sounds like getting to a framework approach will be really tough, but the demand is there, so we have to get there as an industry basically.

    Sudhir Nair: But I think there's also – and this goes back to thinking about our end clients, you know, creating a common way of investors – for investors to think about ESG, I think it's critically important. Right now, there is too much dispersion and too much variation, and I think it's important that we as an industry use technology and use common datasets to bring some standardization and then allow every asset manager to bring their own flavor to the conversation.

    Mary-Catherine Lader: Right. I mean you could perhaps think back to when there was some dispersion and how people thought about risk, right, and there's been standardization there, so perhaps it's not that –

    Sudhir Nair: It's very similar.

    Mary-Catherine Lader: Yeah. So, we've hit a couple of trends, looking ahead to 2020, it sounds like you think there's more focus on ESG, sort of standardization ESG data, what other trends do you think we'll see in the next year in fintech?

    Sudhir Nair: I think there's three that we're very focused on. They're not new trends but are ones that we certainly see accelerating. One is this concept of the whole portfolio and the increased importance on portfolio construction; what investors are looking for in terms of delivering portfolio outcomes or investment outcomes. What do I mean by that? We're seeing the entire industry, whether it'd be the institutional side, or wealth managers, focusing less on individual products, focusing more on having thoughtful conversations around retirement. “How much money will I have when it's my time to retire? Will I be able to afford to be able to send my kids to school?” So the emphasis and the focus on portfolio construction is going to continue to pick up, and the need to have technology that allows you to bring asset classes together to build better risk-adjusted portfolios will become a requirement and table stakes. I think the second big trend is along those lines in terms of increasingly wanting to get closer to your client. We talked a minute ago about user experience and how there might be some hesitance to sort of provide a more digital experience with a view that it might erode the value proposition. I think the general sense is that clients and customers are ultimately going to redefine where they find value. And the definition of service can't be delivery of a report. Clients need to feel empowered. They want to use technology to be able to self-service where appropriate and I think it creates an opportunity for the right organizations to have a differentiated conversation with clients about the portfolio, about the future and about risk; not solely about providing them delivery of reporting and data. And then the third major trend is really this concept of end to end. You know, really thinking about the beginning of the investment process all the way through the investment process and making sure that you have a seamlessly integrated and highly efficient workflow to get there. That's going to require relying on you know, creating the right interoperability and the right connectivity between your risk management, portfolio management, trading and operations all the way through to fund the county in custody. That doesn't exist today, and certainly there are several organizations, Aladdin is one of them who are on a mission to try and create that seamless link.

    Mary-Catherine Lader: That theme of interoperability and how technology like APIs, Application Programming Interfaces is allowing embedding services in different platforms, taking a step back in consumer tech, I think that's something we'll see in 2020, that we'll see payments, we'll see microlending embedded in more consumer services. So, you're not just going to a financial services platform to actually engage in financial services. We're seeing more and more of these companies that are a like debit card as a service credit card, a service lending as a service. And so, it's possible that we'll see more that embedded in retail for example on the consumer side, which I think for our wealth management and bank clients calls into question how they take advantage of that opportunity and shift. To sum up, where do you think asset management is today in the digital transformation journey? I just mentioned banks, relative to banks who've been investing in “digital transformation” for over a decade now, where do you think asset owners are?

    Sudhir Nair: I think still early on in terms of the transformation, but at the same time recognizing, it's not an industry that hasn't focused on technology. I've almost think of it as sort of three chapters. I've been doing this for close to 20 years. And when I started, it was all around you know, the model of best of breed. You know, lots of different systems, each of which with some competency or capability, lots of Excel spreadsheets, and asset managers needing to figuring out all the wiring and the plumbing to connect it all in place. Over the past probably decade, there's been a dramatic shift towards consolidating, simplifying, and landing on, you know, a handful of larger systems where they were looking to do more in one place. And now we're entering what I think is really a third chapter, which is really going back to a much more flexible, option-oriented approach where there are different systems, different technologies that are fit for purpose. There's an increasing need in desire to sort of innovate yourself and build your own propriety technology, but through these data standards and APIs, connect them back to centralized sources of data. So, I think the next five to ten years is going to be all about you know, having the ability to differentiate yourself on both the investment process as well as how you interact with your clients, but having a really strong foundation of both workflow and data sitting at the core.

    Mary-Catherine Lader: So, you mentioned you've been doing this for 20 years, you joined BlackRock in 2000?

    Sudhir Nair: I did.

    Mary-Catherine Lader: And that that time, Aladdin had, what, three clients? Now, it's a billion-dollar business that you run. What brought you to BlackRock?

    Sudhir Nair: Well, when I studied in school, I focused on two things. One was finance, the other was information systems. And you know, a part of it --

    Mary-Catherine Lader: So prescient of you.

    Sudhir Nair: Yeah. So, you know, I was sort of built for BlackRock, I guess.

    Mary-Catherine Lader: Yeah.

    Sudhir Nair: And when I joined here, I was just fascinated both with the quality of people that I was working with but the type of work that I was able to focus on at a very young age. And you know, just wanting to feel like what I was doing was making a difference and seeing how, because of the way we work with clients, because of the deep multi-year partnership, you sort of get on this journey with an organization and you're with them through all of the ups and downs, and you see how the technology ultimately unlocks business transformation. I think that's very different from working at a software organization where you know, you sort of deliver the technology and then sort of lose touch with where it goes next. For us, having done this for my entire professional career, it's been incredibly rewarding just to see how organizations have evolved, and I believe improved as a result of working alongside us.

    Mary-Catherine Lader: And so, when you joined 20 years ago, what was Aladdin? Where was it at that point? How many people were there? What did you do all day?

    Sudhir Nair: It was a much smaller organization. Sadly, I think I did the same thing all day, very similar to what I do today, which was spending a lot of time with clients and thinking about what the product needed to do next. And I think that Aladdin was very similar in terms of its core mission of connecting people and providing end-to-end capabilities; but at the same time since that time, it's grown quite a bit. And a big reason for that is just with every new client, we get the benefit of so many new perspectives and ideas. We've used the term over the years collective intelligence, and for us, the feedback loop that you can create from all these organizations around the world, the ideas, the perspective, the constructive criticism, the complaints that you get is what ultimately fuels what we do and makes the technology better each and every year.

    Mary-Catherine Lader: Rapid fire round, so I'm going to ask you a couple more personal questions.

    Sudhir Nair: Sure.

    Mary-Catherine Lader: You're going to answer yes, no, or quick answer. Are you ready?

    Sudhir Nair: Yes.

    Mary-Catherine Lader: Your favorite app?

    Sudhir Nair: Uber.

    Mary-Catherine Lader: Good answer. Where would we be without it?

    Sudhir Nair: I also used the Chick-fil- A app over the weekend.

    Mary-Catherine Lader: Did you really?

    Sudhir Nair: I did. It was incredible. I was in the office sadly enough on Saturday –

    Mary-Catherine Lader: That is sad.

    Sudhir Nair: – and my kids had friends over visiting from Philadelphia, and I got this phone call like they all want Chick-fil-A and I'm like, “Okay. That's good. Let me know how it goes.” And they're like, “When you leave, come by and pick it up, because there's one on 23rd Street.” And keep in mind, we've never gone to this Chick-fil-A, we just know it's there. So, I downloaded the app, in the taxi heading down the 23rd street, placed the order, which was five kids' meals. And then you walk in, there's a kiosk, you type in a code, you walk to the side, you don't talk to anybody and then they just call out your name and then, boom, there's your bag of food. I didn't have to deal with the line or any of that stuff.

    Mary-Catherine Lader: Did they say, “Yes, sir and yes ma'am?” because I think that's like the highlight of Chick-fil-A. They have such good manners.

    Sudhir Nair: It's a wonderful customer experience.

    Mary-Catherine Lader: An app or technology that you wish existed?

    Sudhir Nair: I think we'll get there eventually, but I wish there was a way to translate what was in my brain into text, so I could stop texting.

    Mary-Catherine Lader: So much safer for drivers too.

    Sudhir Nair: Yes, yes. It's easier on my hands.

    Mary-Catherine Lader: I feel like the U.S. government should invest in that. Favorite TV show?

    Sudhir Nair: We are watching Peaky Blinders right now, which I know has been around for a while but my wife and I are really into it.

    Mary-Catherine Lader: And your go-to karaoke song?

    Sudhir Nair: Easy, Rolling Stones, “Paint It Black.”

    Mary-Catherine Lader: I have heard you sing that. That's why I asked you. It is extremely impressive.

    Sudhir Nair: It's vocally challenging enough and it always gets the crowd going.

    Mary-Catherine Lader: It was very impressive.

    Sudhir Nair: Thank you.

    Mary-Catherine Lader: It's been such a pleasure having you here.

    Sudhir Nair: Thank you MC, lots of fun.

  • Mary-Catherine Lader: 2019 is nearly over and investors can breathe a sigh of relief. Though we're in the late stages of a bull market cycle, we've avoided an economic recession. The consumer sector is strong, and though we went into the year anticipating interest rate hikes from the Federal Reserve, we actually saw a series of rate cuts. The S&P 500 Index of large U.S. stocks is on track to close the year with double-digit gains, unemployment is low and wages are up just a little bit.

    So is this as good as it gets? And what does that mean for investors in 2020?

    On this episode of The BID, we'll speak with Tony DeSpirito, Portfolio Manager and Chief Investment Officer for BlackRock's U.S. Fundamental Active Equity Group. We'll talk about the outlook for markets in 2020, how tech and data are changing what it means to be an active stock picker, and his take on what exactly happens to markets in election cycles. I'm your host Mary-Catherine Lader. We hope you enjoy.

    Tony, thanks so much for joining us today.

    Tony Despirito: Thanks for having me, it's a pleasure.

    Mary-Catherine Lader: So in your day-to-day professional life, you're a stock-picker, to use an old fashioned term. But you're also, of course, a personal investor. You're managing for your own retirement, for your daughters' college educations. Is how you operate as a personal investor different than what you do as a professional one?

    Tony Despirito: It's actually quite well-aligned. I always start with time horizon. Are you investing for the next year or are you investing for three, five, ten years out? I'm a long-term investor, and I think that's important because the longer your investment horizon, the better off you are in equities. I think academics have done investors a disservice because they talk about risk in terms of monthly volatility. But as an equity investor, you're not investing for next month, you're investing for the next three, five, plus years. And so we've done a study looking at volatility over extended periods of time for equities and what you find is the longer your horizon, the lower the volatility of the equity returns. Basically it tells you the longer your horizon is, the more you belong in equities. The other thing I think about is okay, given the market opportunity today, what is better: stocks or bonds? And we are at a really unique point in time where you can actually get more income in some cases from stocks than bonds. So if you look at the 10-year Treasury as we're recording this, it yields about 1.7, 1.8 percent. The dividend yield on the S&P 500 is 1.9 percent. So a little higher. But if you look at a more dividend-oriented index like the Russell 1000 Value Index, that has a yield of two and a half percent. Now if you think about the income over the next 10 years on the 10-year Treasury, it's fixed. Whereas in equities, if things go according to plan, the income from equities should roughly double over the next 10 years. That's a very big difference for investors. And then the last point I think about is alpha. I want my money to work as hard as it can for me without taking undue risk. We're shooting to perform above average and that's an important concept. And so when I create my own personal portfolio, that's what I'm talking about, when I create portfolios for our clients, it's the same thing.

    Mary-Catherine Lader: So when you say long time horizon, how long is long?

    Tony Despirito: Generally three to five years. When we look at companies CEOs are doing three to five year business plans. And so we look at the investments the same way as a CEO would.

    Mary-Catherine Lader: So speaking of longer time horizons, you've been in this business for nearly 25 years. And a lot has changed over that time. Back then passive investing was really just getting started, big data wasn't a thing. And so as each of these things has come to fruition, how has that changed how you think about investing?

    Tony Despirito: Yes, so a lot has changed, but most of the principles are the same. So one is information. Historically there was a dearth of information and your job, my job as a young analyst was to find information. But increasingly we live in a society of information overload, and the key to good sound investing is knowing which information applies to long-term opportunity and value of a company versus short-term noise. And discarding that and not paying attention to it is actually the challenge. And I think that goes to market efficiency as well. I think the market has become hyper-efficient at the short end. If there is a piece of news out there, the market reacts really quickly. So I think it's a fool's game to try to trade around that. On the other hand, the market has become so obsessed with short-termism that that's left an opportunity at the longer end, and that is where we as fundamental investors play. I like to think of it as time horizon arbitrage by having a longer time horizon than most investors. You can spot opportunities that a lot of them are discarding. That's actually better today potentially than historically. And then finally you point out data. I think there is a real need to evolve as an investor. If you're doing the same thing today that you were doing three years ago, you're falling behind. We're putting together a mosaic of information, reading SEC filings, we're talking to company management, we're doing field research, we're looking at data. And we've always looked at data, but as a society, we're collecting more and more data and we have more and more computer processing power.

    Mary-Catherine Lader: So let's talk a little bit about those new types of data. I'm particularly curious for your view on ESG data. So environmental, social, governance factors basically, evaluating companies based on their performance against certain key performance indicators. It's really a nascent field. The data to support an ESG score is collected with a pretty blunt instrument today, like questionnaires, voluntary company disclosures. So how do you think about the quality of for example ESG data?

    Tony Despirito: I think we're in the early innings and that is what is beautiful from an investor point of view. So there's a lot of data, some of it is inconsistent, there is no regulatory standards around it. There are different data providers that come up with different answers for the same companies. And that gives us a real place as fundamental investors to make judgments about where companies stand today with respect to these ESG factors, but also where they are going in the future and where they can improve on those factors, and therefore improve as companies. It's become a very big topic and I think what we'll see is the cost of capital changing. If you're a good ESG company, the cost of capital will be lower; and if you're a bad ESG company, the cost of capital will be higher.

    Mary-Catherine Lader: Switching gears to talk about the markets: looking back a year from today, we saw huge volatility in equity markets and a significant dip in December of 2018. So as you look back at 2019, how does it compare?

    Tony Despirito: Yeah, to understand 2019, you have to really go back to what happened at the end of last year. And what we saw was a Fed that was very hawkish, that was raising rates. At the same time, we had global growth slowing. And so that created a near-term panic I'll say in the markets. And we saw both stock markets and bond markets under performing and that is pretty unusual actually that they both underperformed together. Then at the beginning of this year, the Fed switched to a more dovish stance and has cut rates subsequently and that has provided a real boost to the market. And so what we've really seen is just a correction of what happened last year. In terms of 2020, we look at the economy and we are in the later innings of an economic cycle. But we're not at the end of an economic cycle. So we don't foresee a recession in 2020, and therefore, we expect markets to continue to grind higher. But given that we're near the later innings of an economic cycle, we do think prudence is important, right, you really better like what you own in your portfolio. And we have been emphasizing resiliency, which means more quality in the portfolio.

    Mary-Catherine Lader: So in talking about resilience, you mentioned quality, and quality is extremely subjective, so what exactly does it mean to you?

    Tony Despirito: It is. It does involve a lot of judgment. And for us, it means a couple of things. A quality business is one that earns significantly more than its cost to capital over the course of a cycle. A cyclical business can be quality, right, so it doesn't necessarily correlate 100 percent to stability. We also look a lot at balance sheets. When times are good, no one cares about balance sheets. But when times are bad, a strong balance sheet becomes incredibly critical. That's what provides resiliency. We also want improving free cash flow and earnings trends, and finally, you don't want to overpay. You could have all the quality in the world, but if you pay too much for it, your returns are going to suffer, so we want quality at a good price.

    Mary-Catherine Lader: So in what areas of the market do you see opportunity in 2020?

    Tony Despirito: I like to think of the portfolio in two buckets, stable earners on one hand, and cyclical businesses on the other. On the stable earners side, a number of stable earners have been bid up in price. Those high prices create a risk. Think min-vol stocks, think bond proxies. So when you think about minimum volatility stocks, you should think about stocks with low price volatility and bond proxy stocks that people are buying for yields. Good examples of these are utilities and also publicly traded real estate companies. On the flip-side, within the stability bucket, healthcare really sticks out. It's one of the few stable areas that trades at reasonable prices, and then when you look at the underlying earnings, it's pretty impressive what you see. The demand for healthcare should only grow; it's almost a demographic certainty. We are aging as a society; as you get older, you consume more healthcare, so the demand is rock solid. The question is how do we pay for it? It's tough because healthcare is growing as a percent of GDP. There is a lot of political debate about how we're going to pay for it. But if you look at history, we've been debating this since at least the early-90s if not earlier, and ultimately, every time the government has tried to impose some kind of price controls, gridlock has prevailed. So I think this is a ripe area to continue to grow. On the economically-sensitive side, we really like the money center banks. There's a real muscle memory in the market, the market remembers what happened to the money center banks in the Global Financial Crisis. But these banks have really changed their stripes quite a bit. Most notably, I'd point to capital ratios; the amount of capital cushion that they retain is roughly 60 to 70 percent higher than it's ever been. That makes them safer and sounder, and we think that makes them a good investment. And you look at the free cash flow, the free cash flow yields are eight, nine, ten percent, that's extremely high particularly in a world where bond yields are sub-two percent. And that's through a combination of dividends and buy-backs, and so we think that is also a very fertile area for investment.

    Mary-Catherine Lader: So healthcare, financial services. These are huge topics for presidential candidates right now. When do you think we'll see markets start to react to the election?

    Tony Despirito: Well, we've started to see some, but the market does tend to focus on only one or two things at a time. I think that will definitely heat up at the beginning of next year. We have our first primaries and then ultimately the presidential election. So I think there will be a lot of talk, there will be some volatility around that, but I think the volatility will create buying opportunities.

    Mary-Catherine Lader: Looking back at previous elections, what's the conventional wisdom on their impact on markets?

    Tony Despirito: So we've looked at the presidential cycle as it relates to stock returns going back to the 1920s. And there is a real pattern, and the pattern is the stock market does well in all years, except for the second year of a president's term. And that has totally corresponded to what's happened during the Trump presidency. As we pointed out earlier, 2018 was a tough year for stocks and that's exactly what the data on the presidential election cycle would show you. The same data would tell you 2020 will be just fine.

    Mary-Catherine Lader: Why do you think that is?

    Tony Despirito: Well, the conspiracy theory would be it behooves all of the politicians, both the president and Congressional members who are up for reelection, to really boost the economy in that final year so they all can get reelected.

    Mary-Catherine Lader: Looking back in terms of headlines creating volatility, a persistent theme in 2019 was U.S./China trade tensions. So as you look back at the last 11 months, to what extent do you think that really did move markets and what was the ultimate response?

    Tony Despirito: Global growth has definitely been slower because of trade tensions. Unfortunately, I see this as a long term issue – the competition both economically and politically between China and the U.S. – and I don't see it going away. I do think that we will get a deal but it will be a deal with a small D and it won't resolve all of our problems. That being said, if you look at the history of investing, over the last 10, 20, 30, 50, even 100 years, there's always been something like this for investors to focus on and worry about. But in general, corporations adjust, profits still grow, the economies still grow, and markets go up. And it really speaks to the importance of staying in the market, being a long term investor, and don't trade around events like this.

    Mary-Catherine Lader: So one last question, what are the biggest unknowns for you going into 2020 and how does that impact your investment approach?

    Tony Despirito: So I think an interesting unknown is the potential for greater inflation. We've been in an environment of low for longer for about a decade now. Fewer and fewer investors remember what it was like to have inflation in the United States. I don't think it's a huge risk, but if you look at the number of strikes we've had this year, it's actually the most since I think about 2004, so you're starting to see that happening. You're starting to see some wage pressure. Unemployment is sub-4 percent and has been for a while. So I think that could be the unexpected event of 2020.

    Mary-Catherine Lader: Okay. So I'm going to end with a rapid-fire round of more personal questions, are you ready?

    Tony Despirito: Okay.

    Mary-Catherine Lader: So I gather that you're the youngest of 40 grandchildren, which is incredible, what's the best lesson you learned from your grandparents?

    Tony Despirito: Yeah. So it's the importance of history actually. Three out of my four grandparents were born in the 1800s believe it or not. So there is a great Winston Churchill quote that it makes me think about, which is the further back you look in history, the farther forward you can see in the future. That really applies to my investment philosophy and style.

    Mary-Catherine Lader: Okay. So looking forward, what advice do you give to your three daughters about investing?

    Tony Despirito: We talked about data and how that is growing in importance. I think math is an incredible skill, and so I've encouraged all three of my daughters to study hard and to excel in math, because I think that with more data over time, math just becomes more and more important.

    Mary-Catherine Lader: What's your favorite way to spend a day when you're not in the office?

    Tony Despirito: So I love being outside it's a great way to rejuvenate. I spend a lot of time walking my dog Pepper. We also as a family spend a lot of time in the Adirondacks and that is both summer and winter. So in the summer, we're out on the water, on a lake, in a boat, swimming, hiking, and then in the winter, we do a lot of skiing, snow-shoeing, even ice fishing.

    Mary-Catherine Lader: So I'm going to guess that when you take Pepper for a walk, you're sometimes listening to podcasts.

    Tony Despirito: I do, I do.

    Mary-Catherine Lader: Okay. So what are your favorite podcasts?

    Tony Despirito: So I'm a big podcast fan, also Audible, audio books. So obviously The Bid is at the top of the list –

    Mary-Catherine Lader: Great answer.

    Tony Despirito: I also like Columbia, the MBA program has a pretty good podcast, and then personally I also like Tim Ferriss. I love life hacks and that's what he is about.

    Mary-Catherine Lader: Totally, I love that one too. Thank you so much for joining us today Tony, it's been an absolute pleasure having you.

    Tony Despirito: Thank you. The pleasure was all mine.

  • Jack Aldrich: Previously, on The Bid:

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

    Jack Aldrich: Welcome back to The Bid. On our last episode, we heard from BlackRock’s Vice Chairman Philipp Hildebrand and others on key issues stretching the market environment today: inequality, monetary policy, globalization and sustainability. So if markets are at or approaching limits across these dimensions, what does this mean for how we invest?

    Today, we’ll continue our discussion from the BlackRock Investment Institute’s 2020 Outlook Forum. We’ll hear from members of the BlackRock Investment Institute, like Jean Boivin, Elga Bartsch,and Mike Pyle, as well as investors like Tom Parker, Tony DeSpirito and Bob Miller. We’ll talk about the path forward for global growth, the limits on monetary policy and interest rates, and what this means for stock and bond investors. I’m your host, Jack Aldrich. We hope you enjoy.

    We’ve been in a bull market for over a decade, and our base case for 2020 is that the global economic expansion can continue. We see growth stabilizing and inflation, or the rising prices of goods and services, firming. There’s been a lot of worry from markets that we’re late in the cycle, but we believe the risk of a full-blown economic recession remains contained.

    But the global growth story has many moving parts, from geopolitical issues like trade tensions to the economic trajectory of China, to how consumers are feeling across the world, particularly in the United States. To get a better sense of what’s at play, I talked to Elga Bartsch, Head of Macro Research for the BlackRock Investment Institute, and Tom Parker, Chief Investment Officer of Systematic Fixed Income.

    Jack Aldrich: Elga, to pick up on one component of our discussions around growth generally: tariffs and geopolitics. How are you thinking about those things in the context of growth?

    Elga Bartsch: Yeah, so I do think that the growth outlook is very strongly influenced by these factors. Especially if you have such a material escalation, with geopolitical and trade tensions in particular as the one that we had over the last twelve to eighteen months. So that was clearly a major headwind, a protectionist push, if you like. The question is whether that will continue into next year. I think there are a number of indications on why that might not be the case, and that could allow the global economy to pick up a little bit of pace, allow investment spending to also sort of normalize a little bit, global trade to normalize. But I do think that there will potentially be other factors that give especially corporates making investment decisions time to pause and maybe hold back. And I think there will be a lot of focus on domestic politics here in the U.S.

    Jack Aldrich: As we’re talking about geopolitics, let’s talk about China. Tom, how are you thinking about particularly growth in China?

    Tom Parker: Well, China has been extremely important for growth really in this whole post-financial crisis period. If you think about the rallies that we’ve had, we’ve had the combination of monetary policy with a big boost from China spending. And so each of the upticks that we’ve seen, even the surprise one in 2016, really had this China dimension to it. And so it becomes a really key variable as we talk about whether this slowdown will be kind of an L-shape or if it’s going to start to move up the other way. And I think a lot of it’s going to be very dependent on, does China stabilize? Or does China start to move up to some extent? I think we believe that this is a little different in kind, in terms of the nature of the stimulus and how internal it is to China, rather than they’re trying to save the world again and save their customers. So we don’t really expect as much for the economic rest of the world. We think it’ll be good for China, it will help stabilize China, but we’re not sure that it really helps the rest of the world as much as previous stimulus did.

    Jack Aldrich: I wanted to draw back the conversation from China to the U.S. Thinking about the U.S. consumer, a signpost for growth in the past: Elga, how are you thinking about the U.S. consumer?

    Elga Bartsch: I think the U.S. consumer is currently in a very good state. It’s really what keeps the U.S. economy growing. Because we can see that the manufacturing sector, notably investment spending, is really struggling. So it’s really consumer spending, which has a high service component, that is really keeping the U.S. economy moving forward. And that’s sort of a reflection of really strong fundamentals. You have a strong labor market with still a very robust pace of job growth. We have an increasing pace of wage increases and still relatively modest inflation. And indeed, leverage that at least for the consumer sector overall, is still gradually coming down. So all in all, very solid fundamentals.

    Tom Parker: Yeah, it’s been interesting from a market perspective. I think it is the underpinning of why the U.S. economy has been better than expected. And certainly every time we see job growth seemingly slowing, it seems to have a second life to it. And certainly the rate of decline is much lower than I think any of us would have predicted at this point in the cycle, which is making the consumer stronger. The watch things are to see if that starts to change. If we’re seeing this weakness perhaps in profits and in corporate spending start to result in things that seep their way into the consumer. There’s some preliminary signs, but not much. So it’s really more a worry right now than something that you’re actually seeing. I do think the consumer has benefited from the stimulus that nobody’s really talked about, which is the huge drop in rates that we had when really the whole 10-year collapsed. 

    Jack Aldrich: And from a markets and particularly an investment perspective, how should investors be thinking about these trends and factoring them into their 2020 plans and outlook?

    Tom Parker: Yeah, I think everybody is kind of centering on this slow growth, slow inflation. Which has actually been a very conducive environment for carry in the credit markets, and for equities. The environment hasn’t been as conducive under the surface, as we’ve had a lot of factor rotation go on, and huge returns to momentum with a momentum crash, and then a value crash. And so we’re seeing a lot of money moving risk on, risk off. And in my mind, a lot of that is driven by the fact that the economic volatility is actually quite low. And so policy matters more, and we’ve seen a lot of policy volatility with trade and now with the election. So I think that’s my biggest kind of worry into 2020, that we’ll probably see the same. 

    Jack Aldrich: You partially answered my question, but I was going to ask: What keeps you up at night?

    Elga Bartsch: What worries me from an economic perspective is really the long-term impact of the sort of unwind of globalization, partial unwind of course. Because I do think that it puts some sand into the engine of the global economy. And what that means in terms of the long-term growth outlook, in terms of the long-term inflation outlook, the mix between growth and inflation is not clear. And if we had a less favorable combination of growth and inflation than we have had in the last several decades, so where you have maybe continued growth disappointments, as well as inflation overshoots, that could be a very difficult environment for investors to navigate.

    Jack Aldrich: So we’re seeing two sides to the story: on the one hand, global growth is continuing, and a strong U.S. consumer has underpinned an especially strong U.S. economy. On the other, policy is uncertain, and globalization may be unwinding.

    Tom mentioned one driver of growth: interest rate cuts. In 2019, we’ve seen that central banks have been able to pull this lever as a way to keep the economy going. But interest rates have been testing limits on how low they can go. The U.S. has seen three rate cuts this year, and around the world, interest rates have even dipped into negative territory. We’re nearing the limits of how effective monetary policy can be.

    To get to the bottom of this, I talked to Jean Boivin, Head of the BlackRock Investment Institute, and Bob Miller, Head of Americas Fundamental Fixed Income. I asked them how they’re thinking about the challenges ahead for central banks, and what these limits might mean for bond investors.

    Jean Boivin: I think we need to distinguish what’s happening now, versus what’s going to happen over the next few years. 

    Jack Aldrich: That’s Jean Boivin.

    Jean Boivin: And I think one of the biggest questions for us is over the next couple of years if we do have a significant downturn, what really can we expect from central banks in terms of policy response? And I think we’re coming to the conclusion that it’s going to be pretty tricky. There’s not much left in terms of the conventional ways and even unconventional ways of central banks to stimulate the economy. We think the interest rate channel is getting exhausted. And that raises a bigger question about what’s coming next. I don’t think we’ll be working to respond to the next recession, so then that requires venturing even more boldly into new spheres. All of that involves some more coordination between central banks and the government in terms of spending and finding ways to support that through monetary support.

    Jack Aldrich: And when you think about the year ahead, what key signposts will you be looking out for? 

    Jean Boivin: Yeah, so I don’t know if Bob agrees with this, but I think it’s not about central banks. We’ll be watching what the Fed is doing of course, and we’re in a pause now and we need to see what’s coming next. But I think the bigger question for me will be what the budget authorities, the governments will be doing. Because that’s really where the biggest lever will be. I think markets will be very excited to see if there’s more action on that front, and if it’s not coming, then that’s where the disappointment will be coming from.

    Bob Miller: I think that’s precisely the point. It’s less about the near-term reaction from central banks. It’s much more about the degree to which we get broad policy cooperation. So government and central banks working more closely together, which you could argue is a decline in central bank independence. At least in a strict definition of the term. But I think this is critical to the next several years. Not necessarily next year, but over the next several years, into the next decade. I think we’re going to be facing situations where central bank policy, as Jean described, has been exhausted to differing degrees. There’s a substantial amount of policy space left in the U.S., not necessarily relative to history, but relative to other central banks. But there’s broad policy space. So the combination of fiscal and monetary, and perhaps regulatory, or even immigration policy, et cetera. Because if it’s not occurring, I think we’re going to see very stressful situations in markets. If it is occurring, depending upon the composition, you can definitely – at least it opens up the possibility of more elegant solutions.

    Jack Aldrich: And actually to segue into the market component of this, how do you see all of this reading through to fixed income markets? Particularly, how are you thinking about opportunities in the year ahead? 

    Bob Miller: It’s really tricky. As Jean said, the traditional interest rate channel, i.e., the factor that determines the return of your bond investment, the interest rate channel has been largely exhausted in a number of places around the world. And the question is, how negative can rates go in Japan or in Europe? And will we have negative interest rates in the U.S.? In other places outside the U.S., rates are already low and/or negative. So the benefit of your bond portfolio providing your diversification – your offset when stress is high and equities are under pressure – it’s increasingly unclear that your bond portfolio is going to behave the way it has traditionally behaved in providing that type of protection. I still think it’s very valid in the U.S. It’s considerably less clear that it’s a valid investment tool outside the U.S.

    Jean Boivin: Yeah, I completely agree. I think on a strategic basis, you need to be a lot more selective and granular about the place where you get your exposure in fixed income and protection. And I think the U.S. case is still there, and I guess you get more conviction saying how far European rates have gone, so there’s more room. But you want to maybe rethink carefully European and Japanese exposure.

    Bob Miller: Yeah, and one just small but important caveat with respect to the U.S. It works particularly well for a U.S. investor. For a non-U.S. investor, you’re required to take the currency risk if you want the pure duration benefit of a long bond appreciation in a stressful environment. The fixed income diversification properties outside the U.S. have declined substantially.

    Jack Aldrich: Bob, Jean, what keeps you up at night?

    Jean Boivin: One thing I would highlight given where we started the conversation, is we both seem to be on the same page that we expect over the next few years more coordination between central banks and governments. That can happen in a deliberate fashion, which would be what we hope is going to happen. But there’s a big risk around that, and one of the big risks is if it happens on a slippery slope without a plan, where we open the door for monetary financing, or financing budget deficits with central banks’ money, without proper guardrails, that could be a pretty scary world. And that’s about undermining central bank independence. And given the populist waves we’re seeing, I don’t think we can discount that from happening.

    Bob Miller: I would strongly echo that point. In the long history of the U.S. and other large economic engines globally, the deliberate, thoughtful, optimized approach to policy coordination rarely occurs outside a stressful situation, right? So most of the time, the decision-making process only gets to the point of making really difficult decisions when under tremendous stress. So I worry that we have to get into a higher volatility, more stressful economic regime in order to motivate the decision making process to the get to the point that we’re talking about. 

    Jack Aldrich: Jean and Bob noted the challenges ahead for bond investors: With interest rates exhausted around the globe, bonds may no longer be able to offer the returns or the diversification benefits that they once did.

    How about stocks? Large public companies have shown near-record profitability across geographies in 2019. This is a result of lower input costs created by global supply chains and new technology, declining tax rates, and expansion to new markets. This has created winner-take-all companies, particularly in tech, that have delivered hefty gains since the financial crisis.

    But can greater profitability and stock market gains continue in 2020, or are these trends at risk? I spoke to Tony DeSpirito, Chief Investment Officer for Fundamental U.S. Active Equities, and Mike Pyle, BlackRock’s Chief Investment Strategist, to find out.

    Tony Despirito: Well, Jack, without a doubt, corporate profits have been rising over the course of the cycle. 

    Jack Aldrich: That’s Tony Despirito.

    Tony Despirito: That’s not atypical, that usually happens in a cycle, although we’re at historic peaks. It’s been driven by a number of things, whether it’s global supply chains, whether it’s low interest rates, low taxes. All of these things have conspired to increase profit margins at companies. That’s been a good thing for investors. The expectation is for that to continue. I think that’s a risk; I think as an investor you want to look skeptically at that. And I think that’s where individual stock picking comes in. So while I don’t see a lot of upside for the market for margins from here, I do see a lot of specific companies that can grow their margins, either though pricing power, cost cutting or through capital deployment. I think the opportunity is much more at the stock-specific level than at the market level.

    Jack Aldrich: Let’s talk about valuations. How do you define them and how are you thinking about them?

    Tony Despirito: We look at valuations in multiple ways, but I think the most common way to think about valuations is P/E multiple. Price divided by earnings. At first blush, valuations look on the high side. The market’s about 17 to 18 times earnings. Historical average is 15, although we’ve been certainly way higher at different points in history. But I don’t think you can look at valuations in a vacuum. I think you have to look at them relative to returns on other assets. Interest rates, for example. So we’re in a low rate world. We have been since the global financial crisis. With the 10-year Treasury at less than two percent, I think that tells you that the returns you can earn from equities, even at these valuations, is quite attractive. I look at the yield on the stock market, on the S&P 500 it’s 2%. That’s higher than what you can make on a ten-year Treasury. And, of course, the income from a 10-year treasury is fixed over the next ten years, whereas the market, if companies do their job, that income, that dividend should grow over time.

    Mike Pyle: Yeah, I would add to that. Precisely because interest rates appear to be so structurally low, that means that equilibrium valuations for risk assets, or really assets across the spectrum, are going to look different than they have in history. Comparing the PE today to the PE 20 or 30 years ago is not necessarily the best way of thinking about valuations in today’s context, with the structure of today’s economies and markets. I think, not unlike Tony, I view risk assets, equities as kind of fair to sort of a little on the north side of fair. But so long as the expansion remains intact, so long as there continues to be both economic growth and that growth sort of flows through to growth in revenues and profits, feels like a still sort of constructive attitude to take towards equity markets.

    Jack Aldrich: As you look towards 2020 what key signposts will you be looking for in the markets? 

    Tony Despirito: One is monetary policy has been loose, financial conditions have been strong. Those have all been supportive to the market. I expect that to continue, but that’s certainly critical. The economy continuing to move forward. We expect low growth, but we expect positive growth to continue. So those are all positive things that we’re thinking about.

    Mike Pyle: I think we expect financial conditions to remain easy, but also expect that the change in policy, the sort of dovish turn is largely behind us. And that dovish turn has driven a big expansion of multiples, or the number of times over earnings the price is trading at, in 2019. I think we’re also, as Tony said, expecting growth to continue. I think a little bit of the question for 2020 is with the expansion of multiples kind of maybe mostly behind us from this dovish turn in central banks, can we see a handoff to earnings growth again? That may not be the type of growth in a lower growth-world that sort of supports the types of gains that we’ve seen this year. But, again, I think that backdrop of supportive financial conditions, positive even if low growth, and valuations that still look in the range of reasonable suggest to us a pretty constructive attitude towards risk assets in 2020.

    Tony Despirito: Investors should have positive expectations for the market, but muted expectations. Kind of mid-single-digit returns from here forward I would expect to be more of the norm.

    Jack Aldrich: To that end, what keeps you both up at night when you think about risks to this scenario?

    Mike Pyle: I do think after two days of discussions seeing the extent to which it’s a shared assumption that as we go into 2020 there may be some temporary peace on the trade side. Obviously that supported the rally and risk that we’ve seen over the last month or two. Until that plane lands and we get that piece I think it’s something I’m going to be a little concerned about.

    Tony Despirito: I think risk control is incredibly important at the portfolio level, to always be thinking about what your risks are. We spend a lot of time thinking about stress tests, various scenarios that we can imagine and how portfolios would react in those scenarios. But I also think one of the things that’s most important is to stay invested in the market. I can draw you a 40-year graph of all the things that you could have worried about over the last four years. And if you use that as an opportunity to exit the market, huge mistake. 

    Jack Aldrich: So there’s still opportunity in stock markets, but with some risks and a healthy dose of skepticism. But Tony mentioned one thing that’s key: the importance of staying invested. Yes, we are seeing limits to markets ahead, but we also see the expansion holding up. 

    So where did we net out? Growth and inflation are set to become key drivers of markets in 2020. Monetary easing from central banks is largely in the rearview mirror, and a temporary trade truce looks likely. We see global growth making a shallow recovery in the first half of the year, and don’t expect a recession. This causes us to be moderately pro-risk when it comes to investing.

    But markets will be tested in 2020. The U.S. Presidential election looms large, with a wide range of policy outcomes. China seems less willing to stimulate its economy. Corporate profits face challenges ahead, like rising wages and increased regulatory scrutiny. And negative or ultra-low bond yields make government bonds less able to act as a as portfolio stabilizer in stock market selloffs. These and other issues will be critical to the year ahead.

    Thank you for joining us on this episode of The Bid. We’ll see you next time.

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

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

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

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

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

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

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

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


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

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

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

    Catherine Kress: Sure.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  • Oscar Pulido: This year, millennials, or those currently aged between 23 and 38, have passed baby boomers as the nation's largest living adult generation. And this isn't the only shift that's under way. Thirty-five percent of the American labor force is millennial, making it the largest working cohort. Eighty-eight percent of millennials live in metropolitan areas. They're also the first generation to spend their formative years, many of them their entire lives, on the Internet.

    It's The BID's one year anniversary and to celebrate, we took at a look at what topics our listeners have liked best so far. Number one: megatrends. Earlier this year, we talked about the five megatrends shaping our future: technology, demographics, urbanization, climate change and emerging global wealth. So we decided to revisit the theme with Nora Vonier. Nora leads Product Marketing for Megatrends in the U.S.

    Today, we'll talk about how when it comes to these megatrends, there's one group that's sitting in the driver's seat: millennials. I'm your host, Oscar Pulido, we hope you enjoy.

    Nora, thank you so much for joining us today on The BID.

    Nora Vonier: Thanks for having me.

    Oscar Pulido: Well, it turns out it's our one-year anniversary of The BID and megatrends are a topic that our listeners are really interested in. So we spoke about this topic a few months ago, let's do a quick refresher. What are the five megatrends and why are we watching them?

    Nora Vonier: That's a good of place as any to start, so megatrends are the long-term, transformational shifts that are changing the way we live and work. And we're watching them because they'll be impacting our economy and society for many years to come. To quickly roll through what they are: first is technological breakthrough. So this is the fact that technology is driving exponential progress really across all industries. Second, within demographics and social change, people are living longer and are adopting more modern lifestyles by the day, and this will change medicine and consumer habits in the future. Third, rapid urbanization. More and more people are moving to cities, which will require infrastructure within them. Fourth is climate change and resource scarcity. This is the increasing demand for sustainability that will advance energy and conservation efforts that we're hearing about all throughout the news. And last but not least is emerging global wealth. This is the newly affluent consumers that are emerging in Asia and across the developing world.

    Oscar Pulido: And just out of curiosity: when you say them, they sound rather sensible and obvious, but how are these megatrends determined? Who said these are the five?

    Nora Vonier: Yeah. And these trends as you can imagine were not determined lightly. They were a result of a collaboration across the globe, right, so from BlackRock investment teams, researchers, and external clients and partners who are experts in these areas of innovation that we were looking to tap into.

    Oscar Pulido: We can't talk about megatrends without then also talking about the millennial demographic. This is the cohort of the population that grew up using technology. We know they're demanding more of the companies they purchase from, they're raising their voices about issues like gender equality and climate change. It turns out this demographic is actually a big engine of these five megatrends, so talk to us a little bit about that.

    Nora Vonier: You are absolutely right, the millennial cohort is 100 percent impacting these megatrends. I think some of the ways they're doing so are pretty intuitive, the stereotypes we hear about all the time. But there are some you may find a bit more surprising. So to answer that specific question, let's take the trends one by one. First, within tech breakthrough, one area that millennials are all too familiar with is cybersecurity. Just five years ago, there was one cybercriminal on the FBI's Most Wanted list. Guess how many there are today?

    Oscar Pulido: I'm going to say more than one?

    Nora Vonier: That's a safe answer, and you are trending in the right direction: 42. That's a large increase. And because millennials have seen and lived through data privacy issues, they'll want to be a part of the solutions that keep us safe going forward. Within demographics and social change, millennial consumer spending habits are increasingly focused on fitness, health, self-care, and that translates to a global health and wellness market that is worth over $4 trillion dollars, with a T. So this is largely a product of millennials seeing their parents and grandparents living longer, as well as the increasing stress and tax of the busy and always-connected lifestyles that we live. Athleisure would actually fall into that category, which I'm sure you've heard a lot about as well.

    Oscar Pulido: Right, right.

    Nora Vonier: Within emerging global wealth, there is no surprise that emerging markets are rising, but what may surprise people is how much the younger populations are influencing that growth. So if you look at China, millennials make up 25 percent of that population and that number translates to about 400 million people. That is more than the U.S. population in total. And this cohort makes up half of the consumer spending that we're seeing in China alone. Within rapid urbanization, millennials are flocking to once-considered small or mid-sized cities, turning areas into tech hubs overnight. A few of them we've heard of in the U.S., you have Denver, Colorado, Austin, Texas. Tallinn, Estonia is another one more globally. And if you think about the preference of millennials for renting over owning, whether it's your apartment or your car, the barriers to pick up and move are so much lower than they've been in the past, people can relocate easier and faster. And last but not least, climate change and resource scarcity. Millennial habits are changing to address the impacts of a changing climate, whether it's opting to drive an electric vehicle or figuring out how much meat they should be having in their diet. Millennials are considering these things and really not caring if they pay a little bit more – they pay a premium – for this way of life if it's going to be better for the environment. I think the shift toward plant-based foods is one that is becoming very quickly not a fad, The Economist even dubbed 2019 the year of the vegan. A quarter of millennials actually say they're either vegans or vegetarians, and being a resident of San Francisco, I can say honestly that I think if you're a restaurant that doesn't adjust your business model to cater to that, you may not survive.

    Oscar Pulido: I'm not quite there yet with the vegan or plant-based meat, but I'm also not a millennial; I fall right outside that cohort. So let's dive a little deeper on, you mentioned urbanization specifically, and I've recently read about this term youth-ification. How would you define youth-ification?

    Nora Vonier: You can think of youth-ification as really just the effect that the influx of millennials moving to a new area has, given the incomes that they're bringing with them and the jobs that they have, that's really at the highest level of what the term youth-ification means.

    Oscar Pulido: And how would the younger people then moving to the cities impact the economies of those cities?

    Nora Vonier: I think you see it in a lot of areas. The most direct impact is on the makeup of the job market, and what I mean by that is the supply of young workers and the skills and work preferences that they have. So companies will need to adjust how they attract and retain talent, and in some cases, reinvent their business models. So what are millennials looking for? One thing for certain is flexibility. It's remote working, it's tech-enabled ways of doing their job and automation. It's experiential work spaces, whether it's the co-working spaces, whether it's the social activities you can have at the office, and it's flexible hours. Gone are the days of nine to five clocking in and out. Another is purpose driven organizations, and this is becoming more and more table stakes. One recent study showed that more than 60 percent of the millennial population said that the primary purpose of a business should be improving society instead of generating profit. And entrepreneurial opportunities. In the U.S., millennials make up the largest portion of the freelance population. Similar to the search for flexibility, people want that flexible schedule. They have a number of tools at their disposal so they can get in jobs that are contracts, they can have the gig economy activities that we're seeing. And because of that, you're seeing a lot of self-employment and people being entrepreneurs who maybe didn't have the platform to do that a few years ago. When you start putting all these things together, this has a much broader impact on career paths and retirement, which is to say that there is this mentality shift. Millennials today don't think of retirement necessarily as an end state, it's more fluid. So instead of working with the goal to one day have a retirement party, sail off into the sunset on your yacht and that's it, now a lot of people are taking up side hustles, while they are in the job force, or exploring alternative ways to build their wealth. So it's these three things, flexibility, purpose driven organizations and entrepreneurial activities that are really becoming a trend as younger people are moving into cities and impacting urbanization.

    Oscar Pulido: So it's clear they're rewriting the rules of the job market, because you just went through a ton of really fascinating real life, this is what's happening, right, but what other areas of the economy might be affected other than just the job market by this cohort?

    Nora Vonier: Other areas of the economy that impacted are sectors like transportation and real estate. It may sound boring compared to what we just went through, but bear with me here. So in transportation, the pervasiveness of ride share options has implications for really all existing transit systems, in rural and urban areas. Whether it be from the well-known brands such as Uber or Lyft or whatever the next scooter startup will be that we see in San Francisco. It's not unlikely that in what, ten, twenty years, it will be normal for us to be waiting for our driver-less vehicles as they roam around the city taking us from point A to point B and we won't bat an eye. Within real estate, I think millennials' preference to rent versus buy really means that the housing markets and pricing will fluctuate and change depending on how quickly that shift moves in one way or the other. New construction that will be under way in real estate will also have to appeal to millennial renters from housing units to what amenities that these buildings have and also sustainable urban planning.

    Oscar Pulido: Now as we talk about urbanization, does the effect of urbanization depend on whether a city is located in a developed market versus an emerging market? So do I see the effects of urbanization differently if I'm looking at a city in the U.S. versus a city in China, for example?

    Nora Vonier: Absolutely. I think the biggest difference we see is the speed at which urbanization is taking place. When comparing the countries you just mentioned, there is more infrastructure that already exists in the U.S. when compared to China. So therefore, the investment needed to build and create those growing cities is also going to be a lot higher. Another thing to keep in mind is the population growth in the developed versus emerging world, right. So in cities like Beijing or Mumbai, population growth is in the 20 percent range call it, whereas developed cities, New York, LA, Tokyo, they're in lower, single digit growth percentages and sometimes in the negative range. That impacts just the sheer scale at which development and overhauling existing areas really needs to be considered. We also have to think a little bit bigger than current metro areas. There are actually plenty of entirely new cities that will emerge that don't exist today. Take the current news from Saudi Arabia Public Investment Fund which has expectations to create a city that doesn't yet exist. I think that is pretty fascinating. That will cost $500 billion dollars to build from scratch: something we just thought of seeing in a movie a few years back.

    Oscar Pulido: Nora, you talked about the spending habits of the millennials earlier, so how does this compare to the spending habits of other cohorts? For example, I think we talk about the retired and the baby-boomer population, and we refer to their spending as silver spending, that's another term I've recently learned. So what is the version of that for millennial spending?

    Nora Vonier: To explain a little bit more what silver spending is, since it might be a term that is not as widely used as we think, you can think about that as what the retirees and older demographics are spending money on later in their life. That's cruises, leisure activities, financial services, retirement planning, healthcare costs, and in some cases, anti-aging products; and then you flip towards millennials, right? It'll reflect the fact that we're in a young age bracket, but it will also reflect the fact that we've grown up in a generation that is just so tech-enabled from day one. So in practice, this looks like paying for experiences, traveling, dining out, entertainment activities like concerts, interactive classes. Those are all things that millennials derive joy from versus just a physical good. Subscription services is another area. Netflix, Spotify, meal kit plans: all these things that you can sign up for and then pay for as long as you want. I, officially, it's very exciting, joined the cohort of millennial cord cutters last month. I thought I was super-unique, but then realized over 20 million Americans have already done the same. Have you cord cut yet?

    Oscar Pulido: Not quite and I'm once again proving I'm not in the millennial cohort, but--

    Nora Vonier: Well, I found there's also cord-nevers, maybe this is your kids, but people who have grown up never, ever having cable. So that's more Gen Z.

    Oscar Pulido: This is also, I hear that some millennials don't even want a driver's license, so I think there are all sorts of terms that we're going to have to start inventing for this cohort.

    Nora Vonier: Yeah. First it was not learning stick shift, now not getting a driver's license at all. Another area is the emergence of the sharing or gig economy activities that millennials are all on board with, with ride sharing, AirBnBs, Task Rabbits, millennials want to share and rent legitimately everything it seems. It's not just cars and houses, but you can rent power tools, clothing, jewelry and furniture. And then last but not least is education. Millennials carry over a trillion dollars in student loan debt, so paying off those expenses is really a priority for this age group.

    Oscar Pulido: So let's talk about technology which seems to be a common factor that I'm picking up across all these different topics that we're talking about. And we see it with people's addictions to cellphones, although there I do start to feel like a millennial as well. Maybe it's all cohorts have that issue. So how is technology changing millennials' daily lives and their outlook on the future?

    Nora Vonier: There is no escaping that technology and automation have baked themselves into every part of our routine in some way or another. So just take this morning, I asked my dear friend “hey Google” what the weather was going to be. I ordered and paid for my coffee from my phone, I checked my email and work texts on my walk to work, and if I had woken up on time, I would have gone on a run and used my Apple Watch. And fun fact, Apple recently reported in their earnings that their wearables division, so the watches and air pods, reportedly had the same sales as Starbucks globally. Although I don't know the exact portion of buyers of the Apple Watch that are millennials, if I had to guess, I'd say it's a pretty large portion. To bring it a little higher level, though, millennials have different attitudes on the value that technology brings to the workforce. Over 70 percent of the population is actually really optimistic about technology such as AI, robotics, that they're creating jobs. Versus when you talk to older generations, there is actually more of a sentiment of fear about technology taking jobs away from the market. Leisure and consumer spending I think is another area where tech is just continually enabling us to get things faster and in a more convenient way, and that is now our expectation of how we interact with brands and buy goods. And another area to mention is fintech. I think it's democratizing how we save, how we invest, but despite new companies and apps rolling out into market at what feels like a daily rate, the one thing I do find really interesting is that half of the millennial population is still worried about their financial situation to even think about the future, which is a higher percentage than baby boomers or Gen X.

    Oscar Pulido: And why is that to jump in—we have more access to information now than we ever have but yet, the millennials feel uncertain about their financial future, maybe they're not making that investment decision. It seems like a paradox, it should be the other way around, if they have all this information accessible, right?

    Nora Vonier: It seems very much like a disconnect, right. I think we're at this place of information overload and that coupled with not knowing which sources to trust and not, it's going to take some time and effort for us to really solve the problem of why. I'm optimistic that in this generation we can figure that out. It's just going to make sure we are taking the innovation that we have and using it for good to create and change the habits.

    Oscar Pulido: And so since we're talking about investments, as you think about these megatrends, you've talked about how they're shaping the economy and how it affects people's day to day lives, but if you're an investor, what are the most exciting ways to tap into these trends?

    Nora Vonier: So a lot to choose from, but if I had to pick, I personally think the areas related to medical breakthroughs are the most exciting. I'm not making any promises, but it's not crazy to see millennials and Gen Z'ers living and thriving well into their 100s. To that end, I think immunology and genomics are two fascinating areas within this space that are helping detect, prevent and treat diseases that we're currently seeing loved ones go through. We're going to see that in our lifetime, the product of that research and development. Another area is clean energy and the need for solutions that improve energy efficiency and alternatives, whether it's solar, wind, hydro. All of these things are becoming more common and the cost to produce them is declining. So it's making these alternative sources of energy more accessible, and we see that from over 80 percent the price of solar has dropped for people to access that type of renewable energy.

    Oscar Pulido: I want to ask you one final question which is, will the millennials in ten or twenty years be talking about different megatrends than what we're talking about right now?

    Nora Vonier: That's a great question to think about. The basis behind the megatrends that we've talked through is these will persist into the long term, right, five, ten, twenty years down the line. So we expect the megatrends that we've talked about to stay steady, but what I do think will change and evolve is the underlying themes within each of those trends. So they're going to have to evolve as consumer needs change and societies' needs change. I think the central theme is that change is happening at a faster rate now given the impact of technology. If you take a look back, it took 35 years for telephones to reach a quarter of American households, 25 for TVs. When you fast-forward to the early-2000s, it only took four years for Facebook to reach that same amount of the population. So that's what I am most excited about in this area of the market, there is a lot of history to be written and figuring out how to harness and invest in these opportunities is a really inspiring challenge that I think we all have before us.

    Oscar Pulido: Nora, you've given me a ton of fun facts to use at the next cocktail party I go to, but let's go to the rapid fire round. What I want to do now is ask you whether you think the following things will happen in five, ten, thirty years or never, are you ready?

    Nora Vonier: Hope so.

    Oscar Pulido: Life expectancies in the developed world surpass 100?

    Nora Vonier: 30. Since it's currently in the 70s, I think that's attainable in 30 years.

    Oscar Pulido: Which means you're going to have to save for retirement if in fact you're going to live that long. E-sports entirely replace real sports?

    Nora Vonier: Going to have to go with never. Surpass, maybe. But after watching my home team win the NCAA basketball championship this year, I have a really hard time believing that e-sports will in fact replace the real experience entirely.

    Oscar Pulido: I tend you agree with you on that one. I'm very jealous that your team won the championship. Remote working surpasses office jobs?

    Nora Vonier: I'd go with ten years. I think that the tech capability already exists, it's more the adoption of companies to really determine when that switch will happen.

    Oscar Pulido: People regularly travel to outer space?

    Nora Vonier: I'm going to split the difference between ten and thirty and go with twenty here. The first space tourism company began trading on the stock exchange, so I think we're trending in that direction.

    Oscar Pulido: It just feels funny to even say that, to think I'm going to outer space for a trip. Our last one, we shift our focus from self-driving cars to self-driving planes.

    Nora Vonier: Thirty. Although based on the space travel question, why stop at planes? I look forward to seeing the first self-steering rocket ship in my lifetime I think.

    Oscar Pulido: You're thinking ambitiously. Nora, thank you so much for joining us today on The Bid, it was a pleasure having you.

    Nora Vonier: Thanks so much for having me.

  • Mary-Catherine Lader: In the wake of the financial crisis, a number of entrepreneurs and some bigger companies decided that they would try to use algorithms to manage our money. When these products, which are now called robo-advisors, first launched, the expectation was that they would soon take over all of investing, and that all of us would have our money managed by algorithms soon enough.

    That hasn't happened. Now in 2019, there are hundreds of billions of dollars around the world, particularly in the U.S. and Western Europe, managed by robo-advisors. But demand has been slower than expected.

    But they have driven adoption of investing among millennials, many of whom might be sitting in cash if they didn't have such a simple way to invest their money. At a high level, robo-advisors digitize the process of investing. They give you transparency into how your investments are performing, and basically make the decisions for you. But of course, there's more to it than that. So how do you build a robo-advisor, and what's underneath the hood?

    On this episode of The Bid, Adam French, a founder of Scalable Capital, joins us to answer those questions. Scalable is Europe's fastest-growing digital wealth manager. Adams talks to us about the challenges he faced in building Scalable Capital from the ground up, how he's sought to increase transparency and trust in the investment process, and why he thinks we're all really just living in a virtual reality world. I'm your host, Mary-Catherine Lader. We hope you enjoy.

    Adam, thank you so much for joining us today.

    Adam French: Thank you. It's great to be here.

    Mary-Catherine Lader: So you're the CEO of Scalable Capital in the UK. It's Europe's fastest-growing digital wealth manager. Can you quickly tell us about what Scalable Capital is and how a digital wealth manger is different from a traditional wealth manager?

    Adam French: So we would call ourselves a digital wealth manager, and by that we really think about it as how you would build a wealth management firm today. It's about being where your clients actually exist in an online world. We want to be in the apps, we want to be on their social networks, and so it's about how you build a wealth manager as if you have no legacy whatsoever. And that's not just the apps, but it's the processes as well. So we're talking about automating investment management, automating the client reporting, and ultimately engaging with clients in an ongoing way, which is way more convenient than it would be if they had to deal with a traditional financial advisor who would have to meet them face-to-face maybe once a quarter. We can make sure that we're getting information to our clients in a contextual way, in a timely way, in a relevant way. And because a lot of it is automated, we can lower the cost of the provision of the service as well, which means that you've got something which is very convenient and also lower-cost than what clients would have access to through traditional means. But there is also another huge difference, which is that our service is way more accessible. Traditional financial services, traditional financial advice was only available to a tiny sliver of people, what we would believe to be the top one percent. And now we're delivering financial advice and investment portfolios for the masses, which is something that the traditional world had not been able to offer. And that's an area that we think really differentiates the world of digital wealth management.

    Mary-Catherine Lader: So all of that makes a lot of sense, but not everyone has decided to start a digital wealth manager. So what were you doing when you decided to start Scalable Capital and why did you decide to start it?

    Adam French: So I've got a background in traditional financial services and it was there, along with my cofounders, that I think we all faced the same problem. And it was a problem that we had personally but also a problem that was brought to us from family and friends, which is the question around, what should I do with my money? And for some of us that was around not really having the right options available. I wanted something which was low cost, because I understood that if there are high costs to the investment process, then you're likely to reduce your investment returns. So for me, it was not being able to really find the right thing. But for others, it was around not even having access. We were also quite lucky as well because we worked in an area within our old professions where we were very much aware of how technology was impacting the institutional world of investing, and how it had made that way more automated, way more efficient, and ultimately, you could drive efficiencies through cost savings, et cetera. And yet, we hadn't seen that enter the world of wealth management. So it felt like we had as a team of co-founders, the right set of skills to be able to bring the technological angle to be able to try and build this firm from scratch, but then also understand the client challenge. And that is something that when we look back over the last five to six years when we started this journey, that wouldn't have been possible ten to fifteen years ago. Because of things like the cost of cloud computing coming down to ridiculously low levels so we can actually compute and personalize our client portfolios at scale, to the development of the ETF market which allows us to obviously invest our clients' funds into very low cost, diversified vehicles. And it really felt like the right time to go on such a journey was over the last five or six years when we decided to leave our jobs and give Scalable Capital the launch pad that it needed.

    Mary-Catherine Lader: So since you started this journey, six, seven years, ago, what's been hardest, contrary to your expectations, harder than you expected?

    Adam French: Other than normal pains of trying to grow a business from scratch, the hardest thing has been actually integrating into incumbent financial services firms. We made a few good decisions early on, which I think we've benefited from. For example, we decided very early on that we wanted to make it an international platform, so we provided it in the beginning to UK and German clients. And to do that, we had to find local providers to help us with custodial banking services, with payment provision, with trading, with brokerage. And finding those local partners that had the open technology that we needed to connect to was really, really hard. We're talking about months and months if not years ultimately of the initial work and then the ultimate refinement of those integrations with other providers. But now that we've done it, we've obviously got a platform which is really flexible, and this is where our whole flexibility came from when we're working with B2B partners. So we right now have about five implementations live of Scalable Capital-style businesses that we're working with, either financial institutions or corporate and obviously our own implementation with our own consumer brand. Looking back: fantastic decision. Going through that process: really painful. Because it made it such that we had to put in a lot more time and effort and obviously development costs before being able to actually get something live in the market and to learn and iterate and test with clients.

    Mary-Catherine Lader: Well that investment in making your platform scalable – lowercase S, no pun intended – to work with incumbents makes a ton of sense, because that's been so much of the challenge in the U.S. The promise of digital advice hasn't necessarily played out, in part because legacy technology platforms are really challenging, clients want different things, and the reality is that a lot of customers aren't really moving from their traditional bank. They may try a digital app, but they're not going to move all of their accounts. So with that in mind, what do you think we'll see in terms of customer behavior? Where will people be banking and investing in two years, five years, ten years? Only with Scalable, only with digital entrants like that, or with some traditional banks too?

    Adam French: So I think it's really hard to give you a definitive answer. But that's also been the Scalable strategy. We have a direct-to-consumer business where we currently have about 40,000 client relationships where we manage their money, we talk to them on the phone, they understand who we are and they're engaging with us as a brand. But we also power the investment services of the incumbent world and also more and more digital challengers who are coming to market who would also like to have a Scalable solution as part of their, let's call it, digital banker. So right now, we're not sure who is going to win that. If anything, maybe actually there is space in the market for all of us, but what we're very aware of is the fact that with our own brand out there, we get to talk to clients every day, we get to learn from them, and we get to develop our platform in line with their needs and their wants and desires. And we categorize them quite broadly as smart professionals, who really are digitally native and trust new firms to be doing financial-related stuff online and there are no real other attributes that we see. It's not an age thing.

    Mary-Catherine Lader: What is the average age?

    Adam French: The average age is just in the mid-40s. It's not a millennial thing.

    Mary-Catherine Lader: Right.

    Adam French: A lot of people assume that the online investing world is something for young people, first time investors; that's not actually the case. But it's definitely such that we have more 35-year-olds than we have 55-year-olds. So there is a slant towards people that are younger, but it's more to do with digital savviness more than anything else.

    Mary-Catherine Lader: And how much of that was deliberate versus what you noticed transpired in who actually was getting traction with your platform?

    Adam French: So we were lucky that we weren't the first; it meant that we could learn from the mistakes of others. One mistake that we felt was being made by the initial cohort of companies coming into the market was that they were providing a service for the broad mass market. And that's a really hard market to conquer. So we made sure that when we launched the platform, that our whole identity was focused on a group of customers that had a higher level of financial savviness, because they're the ones that came to us and said, this is exactly what I'm looking for. And that is how we got our first 1,000 clients, 5,000 clients, 10,000 clients, and to be honest with you, our identity hasn't changed much since. Because we're not going after the one millionth and first client, we're really still in a very early stage of our business and they are the clients that have resonated well with our business. And then, obviously, there is the whole element of trust to lay on top of that. These new online propositions, especially in the early days, no one had heard of the term “digital wealth management” or “robo-advice”; the press hadn't really started to talk about these businesses. And one unfortunate thing that I keep noticing time and time again is a lot of these businesses only have the resources to do digital marketing, and the problem with digital marketing only as a distribution strategy or marketing strategy is that you're competing against quite spurious investment propositions as well. And we saw that most prominently last January or so when crypto-currency was at its peak. It obviously meant that you were competing against firms that were selling rather complex and risky investments to the same type of investment group. So for us it was about trying to build a brand that people could trust within a smaller cohort, and then also being willing to use marketing methods outside of just the digital landscape. So we supplement a lot of what we do with the offline marketing world. So be that face-to-face meetings, we host seminars where we invite 100, 200 people in a room. They get to meet the founders, they get to meet the team and ask questions. There's a lot of value in the traditional way of actually marketing these businesses, especially in the beginning, where, like I said, we're not looking for the one millionth customer.

    Mary-Catherine Lader: This theme you touched on about trust and whether it's correlated with established brands or with technology or not is something we talk a lot about on The Bid, particularly because we increasingly trust these very personal services to massive companies who do things with our data in a really evolving regulatory regime. So particularly in financial services, as you're at the forefront of new ways of interacting with our money and technology, what have you learned about what builds trust with consumers? What works and how applicable do you think that is in this new world?

    Adam French: I think that you're spot on. Trust is one of the biggest challenges that we've had as a start-up, and we try to engage clients on that topic as much as possible. It's not something that we want to shy away from. For ourselves, it's getting ourselves directly in front of clients as much as we possibly can. People still trust humans more than they do algorithms, even though it's been scientifically proven in some areas that algorithms can beat humans for decision making purposes. At the end of the day, we still want to hear a story, we still want to speak to people. I've heard clients say before that they want to see the whites of my eyes before making an investment decision. The more we can do that in the early stages, it then allows us as we start to scale to have built that early trust with that early group of users. Then, we have to focus less and less on that over time as we become more of a brand and bigger than the individuals. We continue to run about 200 face to face events a year across the UK and Germany.

    Mary-Catherine Lader: Wow.

    Adam French: The other element as well – and it's again to do with the fact that people trust humans way more than they do technology for certain areas. It's being present for customer services reasons. Yes we are a robo, and yes we automate as much as we can where things can be automated, but we have an award-winning client services team that provide really high-quality customer service-related solutions to our clients, be it in an app, be it on the phone, be it via email. But it's unfortunate that we actually get the ability to compete there, because I think financial services has done such a poor job historically at customer service that just by staffing a relatively small but high quality unit that can really help our clients with whatever needs they have. There is a lot of value there. And we obviously monitor all of these statistics, we're continually optimizing the solutions that we have. So be it the way that we have integrated chat within our app, the way that people engage on the phone, collecting as much of that data as possible and running analytics on it, and then ultimately integrating that with the product development process that we have. We have a smaller organization that can really think about how we can integrate certain solutions into the product that we're ultimately building as well. And that is a different organizational structure, but that's a different topic altogether.

    Mary-Catherine Lader: Last question, so you have all of this data and analytics on what people are doing with their money. You have a digitally savvy, comfortable group of customers. How has Scalable changed, if at all, how people engage with their money? Are they more likely to sell quickly, are they asking more questions, do they engage more often?

    Adam French: What we do see is that in the beginning, people are very untrusting of what we're doing, and I measure this in how many times they open the app in the first week or the first couple weeks of being a client. And it can be sometimes up to several times a day. Because they're just uncomfortable or not as comfortable with the process in the beginning, because this is the first time they've seen what we're doing. Over time, you see the amount of times that people are opening their app, looking at what is going on, decrease to a frequency of once a week, once a month. Around that, we supplement the app with a huge ongoing engagement strategy around what is going on in their portfolio, what's going on in the market, which is also personalized to the way they interact with the service. So even though we're providing a lot of automation, the service also provides a lot of personalization because we can measure the way that you behave, the way you are logging in, what you're doing when the market is performing in different ways. So are you selling, are you buying, are you canceling a monthly payment that you might have coming in? And as we all know, investing for the long term is really where you get the best compounded returns, and so we do the best we can to try and get people to reduce the bad behaviors and ultimately increase the good behaviors. And since we've started measuring the effectiveness of some of those campaigns, you can see that clients are undertaking those behaviors less and less. So for us, it's all about these marginal, incremental gains that we can do to try and help our clients to make the right decisions.

    Mary-Catherine Lader: Well, that's extremely hard change to be driving. We also have similar efforts and I know how hard it is, so congratulations on that, and lots, lots more to come. So let's wrap with a quick rapid fire round. Sound good?

    Adam French: Shoot.

    Mary-Catherine Lader: Okay. So how do you manage your money?

    Adam French: Through Scalable.

    Mary-Catherine Lader: There can't be a different answer; that is the right answer.

    Adam French: Any other answer would be wrong.

    Mary-Catherine Lader: In the spirit of technology, are you pro virtual reality or augmented reality?

    Adam French: I'll flip the question a little bit, what's not to say that we're not already living in a virtual reality?

    Mary-Catherine Lader: So heavy, serious question. You had me speechless here for a moment.

    Adam French: That's what Elon Musk believes, right.

    Mary-Catherine Lader: Exactly, exactly. Favorite lunch meat?

    Adam French: Chicken.

    Mary-Catherine Lader: Okay. So that was a trick question, I hear that your wife has a sausage shop.

    Adam French: That is true.

    Mary-Catherine Lader: Why aren't you a supporter of her sausage shop?

    Adam French: I ate too many sausages in the last two years when she's been on the journey, so unfortunately, I can't say that anymore truthfully.

    Mary-Catherine Lader: And in ten years, what will robots be doing and not doing?

    Adam French: I struggle with the ten year one because we typically underestimate how much change is going to happen in the next ten years. So if I was to say ten years, then maybe robots will be living and breathing and walking among us.

    Mary-Catherine Lader: Nice Bill Gates reference there. And a good answer. It's been such a pleasure talking to you, thanks so much for joining us.

    Adam French: And thanks for having me.

  • Catherine Kress: On September 14th, a series of airstrikes hit two Saudi Arabian energy facilities with at least 17 points of impact. Who was behind the attack? In the immediate aftermath, Houthi rebels in Yemen claimed responsibility. Iran denied it and the U.S. and Saudi Arabia both refused to lay blame. But after a series of investigations, it became clear that Iran was responsible.

    This was the most significant attack on energy infrastructure since Iraqi forces set fire to oil fields in Kuwait at the end of the Gulf War in 1991. Ten or twenty years ago, an attack like this would have sent oil prices through the roof for quite a while; and this attack looked like it would follow suit. It caused the largest single day increase in oil prices in history, but within a few days, oil prices came back down to only a few dollars above pre-attack levels.

    On this episode of The BID, we'll talk to Amer Bisat. Amer leads a team at BlackRock that manages a $20 billion portfolio of sovereign and emerging market bonds. But Amer's experience goes beyond financial markets. He also taught at Columbia University and spent about 10 years at the International Monetary Fund negotiating the fund's highest profile programs.

    In today's episode, Amer will help us unpack the events of September 14th and the days following: what happened, why it happened, and why oil markets didn't react the way we would've expected them to. We'll also talk about other current events around the world, including Turkey's military invasion of Syria and elections in Argentina. I'm your host, Catherine Kress, we hope you enjoy.

    Amer, thank you so much for joining us today.

    Amer Bisat: My pleasure, Catherine.

    Catherine Kress: I'd like to zoom in on Iran but before we do so, let's quickly level set on the region. There's a lot that we should be thinking about, whether it's conflicts in Yemen and Syria, economic crisis in Lebanon, protest in Egypt and Iraq, and of course tensions in the Gulf. How should we be thinking about all of this?

    Amer Bisat: Listen, I've been watching and looking at the region for more years than I'd like to admit. And I honestly have never seen it as tense and as, dare I say, even dangerous as currently. Anything from the Iran-Saudi, the more recent Turkey-Syria incursion. You have civil wars still in two very important countries in Yemen and Libya, and those civil wars don't seem to be coming to an end. Street protests that are becoming increasingly tense in Egypt, in Iraq, in Sudan. And they are threatening potentially regimes that are important for us. We have economic crisis looming in Lebanon, in Jordan, a potential implosion is not out of the question in either of these two countries. And finally, importantly as well, you have this perpetual Arab-Israeli conflict that even though it's simmering right now could, God forbid, potentially trigger a more violent turn in places like Gaza or even Southern Lebanon. Sadly, all of this does matter. It matters for the oil market, it matters for global growth, it also matters because each of these risks could draw in external powers and could move from being regional to something broader than that. So, it's currently a very delicate and tense moment in the Middle East.

    Catherine Kress: And you mentioned you've been covering the region for a long time so it makes sense that these issues are kind of top in mind for you. Do you think markets generally, or investors broadly speaking, are paying enough attention to these risks?

    Amer Bisat: Yes and no. These are risks that are sometimes intractable. They seem to be there in the background. You know they're important, but you don't know how to handle them. And every now and then, you get a flare-up, you get a break-out that tends to play out in two markets: the oil market and the energy market in particular, and in U.S. rates as a safe quality, safe haven trade. So, whenever these crises explode in a more dangerous way or a more violent way, you see higher oil prices and lower U.S. rates.

    Catherine Kress: Got it. And so, you mentioned that one of the key risks as you're kind of surveying the various tensions in the region is that some of them might escalate in such a way as to bring in external actors. So, with that, I'm thinking about some of the events in Saudi Arabia that we've seen recently and kind of the role of the U.S. The events we saw in Saudi Arabia in September were truly extraordinary. I'd like you to walk us through your take on how they played out. I know there's a bunch of a different stories out there, so I'm curious what your views are.

    Amer Bisat: First of all, let me make two very important observations, or larger observations. The first is that the attack on the oil processing field in Saudi Arabia was truly unprecedented. Until now, most of the tensions – even the military tensions between Iran and Saudi Arabia – have tended to happen through proxies. They tend to happen through other cold wars elsewhere. We have not seen a direct attack by the Iranians onto Saudi Arabia before. This is unprecedented. The second important observation to why the event back in September mattered is the magnitude. In one fell swoop, 10% of the oil production of the world disappeared. We never thought that something of the sort could happen, that the magnitude of the shock could be as large. For these two reasons, we started paying significant attention to that event.

    Catherine Kress: So, this event was unprecedented. However, it did follow what seemed to be a summer of escalating hostilities by Iran in the Persian Gulf region. Iranian aggression over the last few months has been largely focused on disrupting shipping, reducing compliance with the nuclear deal. What is driving this escalation of hostilities or kind of increased Iranian aggression in the region?

    Amer Bisat: That's a great question. The reality is I'm going to be slightly longwinded here if you don't mind. We need to understand the background to this. The first point is that the tension between Iran – and I'm going to call it the Sunni alliance led by Saudi Arabia – but the Sunni alliance more broadly, is really not new. This is decades old. Some people would go as far as say that this is a centuries-old tension, right. This is a long-term regional struggle for dominance and influence. Second observation is that there was a fleeting moment there during the Obama administration in which we thought that tension was going to recede as a result of the signing of the nuclear deal between the U.S. and Iran. We thought that maybe there's a rapprochement, some sort of détente, between the West and Iran. The removal or the withdrawal from the Iran deal by President Trump re-awakened that tension one more time. The third observation is that, and as you pointed out, this tension didn't come out only with the attack on the Saudi oil production. It's been going on for a year now through a bunch of proxy wars. We saw them in the Yemen War. We saw it in Iraq. We saw it on the taking over of number of oil tankers in the Persian Gulf. So, this is something that has been brewing that eventually led to that explosion or that attack on the Saudi production facility. And finally, we have to keep in mind that the U.S., in the last two years, had been pursuing this so-called maximum pressure campaign on the Iranians by introducing extremely tough and onerous sanctions, arguably putting the Iranians in a corner and providing them with no exit ramp. So, what you end up here is, to sum up, you have a historical tension that got re-awakened by the withdrawal from the nuclear agreement that has been festering through all these proxy wars and eventually was exacerbated by these extreme sanctions that pushed the Iranians into a corner and forced them into, or arguably incentivized them, to do something dramatic along the lines of the attack on the Saudi oil facilities. So, the background matters to understand what's going to happen in the future.

    Catherine Kress: Right, and you can almost pinpoint the exact moment earlier this spring at which point it seemed like hostilities really started increasing, and that was with the refusal to extend the sanction waivers on Iranian oil exports. So, it almost seemed kind of like a, “We'll take your exports because you took our oil exports.” That kind of tit for tat maximum pressure campaign.

    Amer Bisat: Absolutely. And this sort of variation of the same theme. There was a political decision that seemed to have been taken by the Iranian regime that there's a need to escalate the tension and create a painful consequence on the other side in order to maybe incentivize the U.S. and Saudi Arabia to reduce the sanctions. So there was a, dare I say, they took from the playbook of the North Koreans in that they felt that if they can push hard enough, they could maybe release the pressure on them. And the question is, will they succeed? Time will tell.

    Catherine Kress: And on that point, what was really interesting to me is the response after the attack, or rather lack there of a response, by the U.S. and Saudi Arabia. Given the significance of the attack, you mentioned it was unprecedented, of an incredible magnitude. And I'm not an expert in this, but I would have expected some form of retaliation by the two nations, namely U.S. and Saudi Arabia. But that didn't really happen. Do you have a sense of what's going on there?

    Amer Bisat: There are a number of factors that I think played into why the reaction by the Saudis and by the Americans ended up being less severe than we thought. The first is from the U.S. side, let's not forget that the policy of disengaging from military presence in the region is a position that President Trump has taken from day one. This is not new, and this should not be surprising us whatsoever that he wants to avoid military conflict. He has always said that. Also, there are domestic political issues in the U.S. itself, where there are distractions. Clearly, the impeachment effort, the election calendar. This is a distraction that is hard to ignore. From the Iranian side, the Iranians have been quite good at knowing where to draw the line. The absence of a human casualty, and particularly among American personnel, is clearly a choice. So, they're pushing as far as they can, but they're not pushing to the point where it makes it inevitable to get an aggressive reaction. So, from both sides, the incentive seems to be that neither side wants to go into a military escalation that becomes violent. The Americans, for ideological and domestic reasons and the Iranians, because clearly, they're worried. I mean, the military superiority of the U.S. is so clear that they really would prefer not to have a war. So, the incentives for pushing it just far enough, but not too far, seems to be the modus operandi currently.

    Catherine Kress: That makes sense. And so, speaking of things not really responding the way that we would've expected them to, oil markets also had a relatively muted reaction, I noticed. We saw prices spike in the first day, but that was a relatively short-lived response. How do we make sense of this?

    Amer Bisat: Three reasons, right, and they're all equally important. The first reason is, structurally, the oil market has undergone a radical revolution in the last 10 years, and that revolution is the introduction of shale oil in the U.S. Just to give you some numbers. Oil production in the U.S. has gone up from 5 million barrels a day to 12 and a half million barrels a day in less than 10 years. The U.S. has moved from needing more than 10 million barrels a day in imports to currently no more than 3 million barrels a day. We're not at self-sufficient yet, but we've become very close to self-sufficient. The oil market is significantly easier than it used to be because of the introduction of U.S. oil. We're not going to be able to see the kind of explosively higher oil prices with that kind of new supply, reason number one. Reason number two is that demand for oil is very weak, right? We've gone through—and this is independent of what happened in Saudi Arabia—we've gone through a significant slowdown in global growth in the last year. Global growth has down shifted by more than a percent and a half in the last year and half, and it's very much driven by the manufacturing sector. And that's probably because of the trade tensions between the U.S. and China. But demand is weak, and when demand is weak globally, oil demand is weak as well. So, the attack on Saudi Arabia was happening at a time when U.S. production was very high and when demand for oil was low. But then there's a third reason which is quite important and to their credit, Aramco, the Saudi oil company, was extremely aggressive in bringing back production and brought back production much faster than most people had thought. Within a few weeks, oil production is back to normality so that was also a surprise. So, weak demand, large supply, and quick recovery of oil production explains why the muted reaction in oil prices.

    Catherine Kress: So, is there, I guess, given those factors at play, is there something that could happen or what would it take to cause a more sustained reaction in the oil market whether it be in the Middle East or elsewhere?

    Amer Bisat: The first thing obviously you need and the most important, you need the markets to become tight again, right. You need inventories to start being drawn down and the way you do that is mainly through if demand picks up. So, if global growth recovers – and there is a question mark on whether growth will recover in the next few months now that the trade tension may have de-escalated – then that could make the oil market more vulnerable to the next shock. The second thing that could lead to a bigger shock than the one that we saw is if the attack obviously was larger, and the ability of Aramco to bring back production ends up being less than the previous time. So, what would take an outsized reaction would be an environment of strong demand and the larger than expected oil supply shock.

    Catherine Kress: So, we've been talking about oil primarily because oil prices historically have been sensitive to tensions in the Gulf. We've seen that with our BlackRock geopolitical risk indicators tracking some of the relationships between asset prices and the indicators themselves. Are there other areas of global markets that we should be paying attention to in light of all this, kind of beyond the oil market?

    Amer Bisat: Yeah and I would emphasize, too, U.S. interest rates. That asset class has been the most sensitive to global risk aversion that comes from geopolitical shocks. There are two reasons for that. The first is that that's the safety instrument. That's the one the people run to whenever there's uncertainty. So, I would keep an eye on U.S. rates. The second reason is that this is happening at a time when the Federal Reserve has been easing interest rates, so it's been making the path of least resistance of lower rates that much easier. So, the safety valve—the safe haven status of U.S. duration—as well as the fact that you have a central bank right now that seems comfortable easing interest rates, explains the strength of U.S. rates and the strength of U.S. Treasuries. The second area that I would focus on is what we call, more broadly, risk assets, equity markets. I would throw in equity markets, credit products like bonds, credit bonds of corporate issuers. Those have so far been resilient and, some would even go as far to say, complacent to the geostrategic shocks that we've seen recently. So, that's an area I would watch carefully if there is another shock.

    Catherine Kress: Let's bring it back to the politics. We've seen some de-escalation intentions and small indications of willingness to negotiate. What's your outlook for how this plays out moving forward?

    Amer Bisat: You have to believe that the baseline right now is of the status quo continuing, which is tensions that are high but neither escalating to a point of violence nor easing to the point of a ceasefire. The baseline right now is we stay where we are for the next year, presumably until the U.S. elections goes through. That seems to be the calendar moment that people are looking at. What are the scenarios around that baseline? There is the negative scenario where those tensions -- there's an accident. There's a mistake. There's something that is unexpected and we move from a cold war to a hot war. Probabilities are low, but one should not fade that as a risk whatsoever, and it could take a number of forms. It could take, God forbid, casualties, actual human casualties, an unprecedented attack that has impact that is not easily recoverable. On the other side, there's a positive possibility and a positive scenario which is something that particularly the Europeans and within that, particularly the French presidency, President Macron has been emphasizing which is, “Let's use this opportunity of maximum tension to bring the parties together and have a negotiating discussion.” And he's trying very hard to bring the U.S. president and the Iranian president to talk to each other. So far, the Iranians have rejected that possibility. They're asking for prior demands. They want things before that meeting starts. The Americans seem more open to the idea, but that is something that we know that the Europeans are working very hard on. My sense is that that's also a low probability, but it's not something that we should dismiss as a possibility.

    Catherine Kress: Two follow-up questions I guess related to each of those scenarios you laid out. In the first one, you mentioned that tensions kind of continue simmering. In that case, is there a risk that markets could potentially become too complacent in response, if they just think of this as business as usual, tensions continue simmering in the Gulf and then, perhaps, underappreciate or are underprepared for a potential accident?

    Amer Bisat: Very much so, and that's more of a portfolio management, or investing thought here, and we spend a lot of our time thinking about this, when we feel that the risk that is in the market is below our own perception of the risk, we always look for cheap hedges. We always look for assets that we think are inappropriately priced for what we think is a probability of risk emerging. So, let me give you an idea. There are moments in which the price of oil in the forward markets become too low for our own perception of where the risks are, and we end up selling that forward. So, there are ways in which you try to assess the market's perception of the risk, versus our own views on that risk, and we try to find asymmetric hedges.

    Catherine Kress: On the second scenario you laid out, the potential return to negotiations. Earlier in the conversation, you talked about how these tensions have kind of a long-running, deep-seated backdrop, that the tensions that we're seeing in the region have been underway and have been building for some time. So, even if we see a return to negotiations, do you actually see these issues as going away, or do you think that they're likely to stay with us for some time?

    Amer Bisat: The bar for permanent peace in the region is very, very high. Let's start with that, and it's for all the reasons that we've been talking about, not least of which is how historically deep they are, right. So, thinking slightly away from the Iran-West tension, the Arab-Israeli conflict. I mean, how many times has there been attempts of trying to solve that problem, and it just never seems to work. The bar is very, very high. However, never say never, right? Let's not forget that Iran used to be an ally of the West until 1979 and was the closest ally of the West, until 1979. It was at the core of the Western alliance in the region. It's an anomaly that they haven't been. Now clearly, there are reasons for it, not least of which the Islamic Revolution in ‘79, but could we go back to a world in which Iran gets closer and gets brought back into the fold, in a way that the Obama administration clearly was foreseeing as part of the nuclear agreement. Long story short, the bar is very high. I'm not that optimistic, but it's happened in the past. Why can't it happen again?

    Catherine Kress: Amer, in your role as a portfolio manager, you cover a variety of other markets around the world. Staying in the neighborhood of the Middle East, let's start with Turkey. What's your view on what's going on there?

    Amer Bisat: This is one very complicated situation. The first thing you want to keep in mind, Catherine, is that the tension in Northern Syria, Southern Turkey, which is where the conflict is emerging recently, is not a new conflict. And that conflict has been between the Turkish government and the Kurdish population of Northern Syria, that has always had desires for autonomy and independence. That war had been ongoing for decades, often very violent in nature. Over the past five/six years, that war went into a bit of a hiatus, a bit of a detente, and the reason is because an unholy alliance between the Turks, the Kurds, but also with the West, the U.S. that had presence there. There was an alliance to fight a common enemy. And the common enemy in that case was ISIS, that was emerging as a very powerful military presence in the region around the 2014 to 2015 frame period. Two things happened since then, right. The first thing that happened is that ISIS was defeated. So, the need for the alliance became less important. The second thing that changed, as well, is that President Trump, as part of the strategy of disengaging from the region and removing the U.S. military forces in the region, opened up a vacuum that allowed the Turks to come back and re-engage in their fights with the Kurds: (a) they didn't need them anymore; and (b) now that the U.S. has withdrawn, they felt a vacuum has opened. That strategy of allowing the Turks to incur and even invade Northern Syria, was also a decision that was not uncomfortable for the U.S. administration, because it permitted the Turks to play the role of the policeman of the region (a) to avoid the re-emergence of ISIS, but also to be the buffer between the Assad regime, the president of Syria, which is in the South, and the Turkish government. So, it was important to see the Turks as a buffer, that ensures that ISIS does not come back, but also to ensure that the Assad regime in Syria itself remains quite weak. This, unfortunately, may not be playing out the way the desire of the plan was, right. And it's not playing out for two important reasons. The first is that ISIS appears to be re-emerging. A lot of the prisoners that were kept in Northern Syria seem to be released, and they seem to be remobilizing again. It's going to take effort to re-arrest them. The second unintended consequence is that, now, the Kurds have shifted alliance, and now, they are part of an axis with the Syrians, the Iranians, and the Russians as well. So, now you've lost an ally and you gained an axis, a more powerful axis, against you as well. It's a very fluid situation, extremely uncertain. In an ideal world, the Turks act as a buffer, but this could play out into a significantly deteriorating situation, if that means the re-emergence of ISIS and the strengthening of the Assad regime in Damascus.

    Catherine Kress: Shifting hemispheres to another relatively-volatile situation, Argentina. Argentina's president, Mauricio Macri, was defeated in the presidential election by opposition leader, Alberto Fernandez and his running mate, former president, Cristina Fernandez de Kirchner. Macri had been elected in 2015 with the hope of reforming the economy. What does his defeat mean for the economy and markets in your view?

    Amer Bisat: So, the Macri administration was known and characterized by its very market-friendly approach. There were two things that they wanted. They wanted to tighten the government's spending, reduce the fiscal deficit, fight inflation—so all these things that we call macro. They wanted to do macro stabilization. But at the same time, they also wanted to do deregulation and allow the business sector to become more potent, and as a result—in their vision, restart the economy growing. Unfortunately, that game did not play out, and instead, the country went into a severe crisis last year of a proportion that is comparable to the U.S. Great Depression in the 1930s. The economic implosion of Argentina is of a very rare magnitude. That opened up the door for the opposition, and the opposition is—you would call it—left leaning. You would call it populist. It certainly has a strong linkages to the previous regime of the Peronists, the Kirchner regime before Macri came. If anything, to be clear, the vice president of President Fernandez now is Cristina Kirchner herself, who used to be the president before Macri. So, it's a difficult situation, the country has enormous economic challenges that now are being dealt with, or now being governed by a new government that does not have the same market credentials. There are two issues that we're going to be watching very carefully. They need to do something with the debt. They're going to have to restructure the debt; the debt is unsustainable. And the second thing we're going to be watching is their negotiations with IMF. Will they stay with the IMF, or will they go alone by themselves? So, their approach to the debt reprofiling/restructuring and the relationship with IMF is how we're going to be judging the new administration.

    Catherine Kress: What other markets are you thinking about today? Or what other issues should we be keeping top of mind looking forward?

    Amer Bisat: The things that are interesting us right now are, in Latin America, we're very interested in what's happening in Brazil. There's an important number of reforms that have been recently embarked upon that seems to be putting the country on an improving economic path that we're excited about, and we're watching quite carefully. We're watching South Africa as a country that has significant challenges, and they're not easy ones whatsoever, especially on the growth side. How can they restart growth? This economy has been in an anemic weak growth for years now, they have a new president who is reform-oriented, the question is will he be able to implement the reforms that he has in mind. We're watching Indonesia quite carefully and very positively inclined in that this is a country that is very healthy, low debt, strong growth, fiscal prudence, and attractive valuations, so we're excited and interested in it.

    Catherine Kress: Amer, this has been an incredible tour of the emerging market universe. I'd like to end now with a quick rapid-fire round.

    Amer Bisat: Go for it.

    Catherine Kress: So, first question: to manage such a large portfolio of sovereign and global bonds, you must travel a ton. How much time would you say you spend on the road meeting with government officials?

    Amer Bisat: I spend more time than I would like, at least more than my family would like. But the only way you could do and manage emerging markets is being on the ground, talking to the government officials, getting a good feel for the challenges and the issues. So, on average, I'm on the road at least once a month.

    Catherine Kress: How many countries would you say you've visited in your career?

    Amer Bisat: I have been to 64 countries in my career.

    Catherine Kress: Oh my.

    Amer Bisat: My objective is to get to a hundred, but I think I'm going to die before I get to a hundred, so.

    Catherine Kress: Every continent?

    Amer Bisat: Every continent. Except Antarctica I should say.

    Catherine Kress: Do you need, when you travel, to speak the local language of the countries you visit?

    Amer Bisat: It helps, Catherine, it really does. But it's not absolutely necessary. Not least because English has become the lingua franca. Most government officials, if not all government officials, we talk to are very fluent in English. Not least because most governments we deal with are countries that have a strong presence in the markets. So, English has become sort of a language where you can carry most of your discussions. Does it help to know the language? Of course it does, but it's not absolutely necessary.

    Catherine Kress: Final question, moment of truth: how many languages do you speak?

    Amer Bisat: Fluently three of them. And I have spent my life learning the other two. So, I speak English, French, Arabic quite fluently. And I've been trying for years, trying to learn Spanish and Russian, unfortunately not that successfully. I can handle them, but that's not my fluency. However, and that's important, the team that manages the money we manage, speaks 14 languages. So, we have enough people to speak 14 different languages.

    Catherine Kress: Wow, that's far more than I can claim. Amer, thank you so much for joining us today, it was a pleasure having you.

    Amer Bisat: Completely mine, thank you very much, Catherine, for the opportunity.

  • Mary-Catherine Lader: For the past 10 years, investors have been riding a bull market in the U.S. Growth in the stock market has been relatively stable. But are ripples are starting to show beneath the surface? Trade and geopolitical tensions have created uncertainty. Easy monetary policy could be coming to an end. And demographic changes are creating more demand for income around the world. With these shifting dynamics, following the stock market could not be enough for any of us. So where should we look now?

    On this episode of The BID, Rick Rieder, Chief Investment Officer of Global Fixed Income and Head of Global Allocation at BlackRock, talks about why he thinks we underestimate the impact of technology on markets, just how many bullets are left for the world's central banks to use in monetary policy, and the secret to sleeping only four hours a night. I'm your host, Mary-Catherine Lader. We hope you enjoy.

    Rick, thanks so much for joining us today.

    Rick Rieder: Thanks for having me.

    Mary-Catherine Lader: You're the CIO of Global Fixed Income and you recently became the head of our Global Allocation Investment team as well. You're now responsible for about $1.7 trillion in assets. As that number has grown, has your thinking as an investor changed?

    Rick Rieder: I mean it has. I mean I think as an investor, you grow with the years anyway, you think about what investing is as opposed to what trading is and, you know, thinking about where are we going and how do you get there? So, I think it evolves quite a bit. And particularly in today's markets where volatility is higher, you think a lot about, “What's my core conviction? What do I want the portfolios to look like?” What is your big picture thinking, make sure your portfolio looks like that.

    Mary-Catherine Lader: So, for the past 10 years, we've been in a bull market, a stock market that's on the rise, and it's created a lot of confidence. It seems like you can invest in almost anything and make money. There's a persistent question now as to how long that will last. So, what's your view? How long do you think that will last, and can the bull market keep running?

    Rick Rieder: I think the world is changing quite a bit. Part of what I find energizing about markets now is, like you say, we've lived for years in this dynamic, that two things have happened. You know, post- I would say the financial crisis, economies were growing a bit. China was growing a tremendous amount, creating this tailwind for the world. People underestimate how big China is, particularly for Europe and how it was creating this extraordinary veil of growth is pretty good, and then simultaneously, interest rates came down dramatically. Central banks, any time you had a blip, the central banks were there underneath the surface. And like you said, this has been an environment where you just bought beta. Beta meaning, the upside or the sensitivity to the market. One of the things that the markets move based on the S&P 500 and then how sensitive you are to how the general market will move as opposed to idiosyncratic or an individual company's performance or security's performance. It was just, “Get me beta. Just get me upside potential.” All of a sudden, that's coming to an end. I mean not to say, I think markets can still do well and I think markets, particularly equity markets will continue to do well, but it's all about dispersion of what I call, “Where do you want to be versus not want to be?” And it's quite frankly, as an investor, what's the most exciting thing you could do is not just making one decision, “Are we risk on? Do we like risk? Or risk off and temporarily not?” Now you think about a whole myriad of things that you could do in a market which is a lot of fun.

    Mary-Catherine Lader: And so, what indicators are you looking at today that you think are particularly meaningful? There's a lot of concern as to whether some data is a little less positive than it had been more recently, what that might mean for the economy for example?

    Rick Rieder: Yeah. Let's start with what I'm not looking at. Traditional economics used to focus on manufacturing data and say, okay, the manufacturing PMI was this, and that's what was the influence on the economy. It's 12%. Arguably, it's less than that in hiring, it's less than that. It's been negative hiring for the last 20 years. But the thing that I watch really carefully is sort of the service sector and how that's doing. The service sector hasn't been in recession since the Great Depression. But I particularly watch the consumer. And the consumer is in really, really good shape historically. Net worth is up and income is up, inflationary conditions are lower. Consumption can change, sentiment can change, and people can pull back particularly in the equity market, but I watch that consumer data really closely and watch things like auto sales, housing starts in the U.S. And then globally, I watch China quite a bit and I think people underestimate how big it is in terms of global trade and particularly manufacturing and things around commodities, iron ore, et cetera. Anyway, those are the things that I watch pretty carefully.

    Mary-Catherine Lader: As you're watching the consumer in the most developed economies, the consumer is generally aging, demographics are changing. So, what implication does that have for you as an investor?

    Rick Rieder: So, I'd say there are two influences that I think are the biggest ones and I think if you just got these two right, it's the key to investing going forward. It's demographics and technology. Let's start with the demographic as you described. The aging consumer or the aging individual in the world, the fertility rate is not high enough, and so what does it mean? It has huge ramifications. Global growth can stay low for a long time, these interest rates will stay low for a really long time. Central banks have to keep rates low because you don't create enough organic growth, you can't pull forward growth like you used to. That's a really big deal. Second, we're in this amazingly historic period of time. The demand for income is extraordinary and it's not going to change any time soon, whether it's because of the aging dynamic. Pension funds, insurance companies, individuals need the income as they approach retirement because they have liabilities. That is a really, really big deal and I think people underestimate that's going to be with us for at least the next 10 years, 20 years. By the way, in this asset-like, capital-like world away from goods and manufacturing, we're not creating enough income. You just think about all the middlemen we used to have over the years in manufacturing processes and otherwise, the world's not creating enough income for the requirements.

    Mary-Catherine Lader: So, let's just get a little more granular. What does that mean for the aging consumer and how do they get that income? They're paying more and more for less income?

    Rick Rieder: Yeah. You take the fixed income market, usually typified by the Global Ag. I think the number is it's 25 trillion to get 700 billion, I think is the number offhand. It takes three times as many assets as it did 10, 12 years ago. That's a really big deal. Again, I think for a consumer generally, it's make sure that you're in the right industries, make sure you're in the right places. Make sure you're in those places that are not going to get disrupted because technology is changing so darn fast. The next five to 10 years, what people I don't think spend as much time with on technology, is technology does not grow in a 45-degree angle like a smooth graph. It stays low and explodes higher. Data transmission has created this unbelievable usage of internet GPS technology and now there's more to come. And so, be really careful about are you in – I call the fast rivers of cash flow, the places that benefit from technology and benefit in the right industry – but be really careful. Because if not – look at places like energy or hard retailing today. You've got to be really careful in going forward and that's not going to be any easier for the next five to 10 years.

    Mary-Catherine Lader: You mentioned fast rivers of cash flow. What exactly do you mean by that?

    Rick Rieder: There is something really different than anything you've seen in history that certain industries, you get this dynamic that they're doing well, they're at the right side of the technology spectrum and then because they're doing well and they're creating profits and cash flow, they can reinvest in their business and they can put money into R&D and innovation and go into different areas that are tangential to what they do. And so, every day we're trying to figure out, are we in the industries, whether it's technology – you know, things around the consumer are doing really well, parts of the healthcare market, managed care, et cetera. The businesses that are actually operating in, (a) the right technology, (b) attached to demographics or the right sector today. Your ability to continue to grow is tremendous. And then if you're on the wrong side of it, it's really hard today.

    Mary-Catherine Lader: So, thinking about underestimating the power of technology as you mentioned, we've had a couple tech IPOs lately that have been disappointing. So, how do you think about what is and isn't technology, where those fast rivers of cash flows are or may not be?

    Rick Rieder: I hear a lot of people saying that tech is now overvalued or what are people going to pay for future growth. Some of those recent IPOs, maybe there was the assumption that the valuation was high and you'd grow into it and the markets are saying, you know what? The economies globally are more uncertain in the ability to pull forward that growth or growing into those valuations is a bit harder. But boy, I don't think it changes the dynamic around technology and it doesn't change the efficiencies. I look at companies; their returns exceed their cost to capital, look in Europe. And there's a huge amount of companies where the cost to capital, where their equity market is, even the debt costs are low. So, it means they can invest in R&D, they can invest in capex. So, I still think technology is changing the world and the amount of, I mean as we get into 5G, I think people are underestimating how big that transition is going to be and how big the winners are. By the way, you look at the cable companies and broadband and what they're able to generate today. If you do it in scale and you're in the right technology, your ability to garner cash flow is historic. And, just make sure you're getting into what I call those fast rivers.

    Mary-Catherine Lader: That's largely been concentrated in a number of really, really big companies. So, how do you think about the expansion of that opportunity set, of the number of companies either new entrants or existing companies who can take advantage of that rapid growth and fast rivers of cash flow generated by technology?

    Rick Rieder: So, I think there are a lot of those big companies making an awful a lot of sense. And you've got to keep an eye on regulation and you've got to keep an eye on how those businesses are going to grow and thrive going forward. But then I think they're all, we talked about cable companies, who is the supplier? Who is alongside of them in that dynamic? I think is really important. By the way, you look in the consumer sector. There are a lot of companies that are really proactive about -- have gotten themselves into the right technology. And I look in the retailing space and there are some companies that are cutting edge in retailing and all of a sudden you just see their share continues to grow and grow and grow, and then others that may still have the same similar, tired business model, and you just watch the chasm between them, is going to expand and continue to expand going forward. So, I don't think it's just the traditional technology companies as who is (a) in and around those big tech names, and (b) who are industries that have just figured out, “This is where my price point has to be, here is how I get there efficiently, here's how I brought my cost structure down,” alongside of it. I don't think we've hit the end on new developments around technology, whether it's autonomous driving, whether it's things like drone technology and what it means for different businesses. Gosh, I think there's so many cool, exciting things that are still coming down the pike.

    Mary-Catherine Lader: So, it's not that you think we should avoid utilities, energy, industrials altogether. It's rather, who is adjacent to that growth who can take advantage of that growth, is that right?

    Rick Rieder: I think one of the most exciting things for investing for the last few years -- you think about what happened, last year's interest rates came down. People looked at equities and said, “Gosh, my utility stocks have done well” or, “My staples have done well.” That's because interest rates came down dramatically. Should I be financing utilities and staples in equities or should I save my equity appreciation to the companies that are in the fast rivers of cash flow? Should I save them for tech or consumer or parts of healthcare? And again, some political risk, but into places like healthcare. And on the bond side, their bonds are cheaper. In places like utilities and staples, their bonds are cheaper. Why wouldn't I just buy those companies in bond form? And you think about the places like utilities are regulated industries. They're unbelievably stable and their bonds are cheaper than technology companies. Why would I lend to a technology company? I like the upside and I'll lend to a utility, I'll lend to a consumer staples company, and that makes a lot more sense. You can create efficiencies, build income in your portfolio, places that are stable, and then get your upside in places that have upside, have embedded organic upside in them.

    Mary-Catherine Lader: So, you've mentioned equities and bonds. What other asset classes do you think are perhaps misunderstood right now and how are you looking at them?

    Rick Rieder: For the first time in a long time, many years, we're actually excited about gold again. People don't realize, there's only $6 trillion worth of gold in the world. There's only enough to fill two Olympic-sized swimming pools. Actually, there's not a lot and it has no industrial purpose which is perfect because it's got a history as a currency, and when you depreciate the currency in other parts of the world because you just print money or negative interest rates, gold tends to work really well. I think there are parts of the real estate market that I still think are really attractive. I think the residential real estate market, whether it's a direct investment, whether it's tangential in a homebuilder. The equity in people's homes is the highest its been in years and years and years. You've got a consumer that's in great shape. So, anyway, that's another place that we think is exciting today.

    Mary-Catherine Lader: What about geographically, which markets are you particularly interested in? It sounds like some of what we're talking about sounds a little specific to U.S., but for example, that demographic trend in homebuilding, that could be a lot of different countries?

    Rick Rieder: Yeah, totally. The best demographic in the world sits in India. We've spent some time in India and it's not without risk. And whatever you go into, whether it's political or fiscal, India just cut the corporate tax rate. It's the best demographic and I'm convinced demographics -- they're not necessarily the trade for the weak, but they tend to win. Parts of China, you always think about risk-reward. Take some pieces in China. China, particularly in technology, is at the cutting edge and arguably beyond the U.S. So, there are some things to do there. Europe is tricky. There's no organic vibrancy to that economy. I was looking at the number of unicorns in Europe in the last few years, has been close to nothing. So, be a bit careful there. And you know, Latin America, I like the rates market in Latin America. I think Latin America is going to continue to grow. Brazil has done some things on fiscal reform, Mexico as well. So, some opportunities in LatAm are going to come up, definitely on the rates side today. They're going to keep cutting interest rates.

    Mary-Catherine Lader: Focusing on monetary policy for just a moment. We've talked a lot about rates on the chase for income. It sounds like your view is that monetary policy can't continue to be the salve for the economy. What's your view as to the extent to which governments and central banks can continue to cut rates and how effective or ineffective that will be?

    Rick Rieder: I think it depends where you live. I don't think Europe and Japan can do much at all on monetary policy. I think it's over. I think negative rates is the dumbest invention in the history of the planet to start with, and I wish they'd go away. And I don't know how they're going to go away because it's so hard to come back from when your economy is not going growing that fast and your debt is too big. So, they need to get fiscal, particularly Europe, and I think you'll get a transition to some fiscal, but it won't be satisfying. I think the Fed has a lot of bullets left. When people said the Fed is out of bullets is because we're close to zero interest rates, it's not true. A) We're not at zero interest rates. The Fed still has a number of moves they can make. They can do them quickly too and you can shock the system by moving quickly when you move rates, particularly as you get to the zero bound and particularly when you're easing, you want to be fast and aggressive. And then people forget the Fed's balance sheet is only 19% of GDP, the ECB's is 40% and Japan is 104%. The Fed could buy a lot of assets. You know, it's within the Feds' purview to buy municipal bonds. People think, “The Fed buying munis?” But if you want to stimulate infrastructure in this country, the Fed could turn around, buy munis. I mean the Fed could buy trillions. I mean you have a $20-trillion economy; the Fed can buy a lot of assets. So, I think the Fed has become the central bank to the world and it's part of why I think the dollar is so critical to economic conditions globally. When the Fed stops raising rates, starts cutting them all of a sudden, emerging market countries can then cut rates, it's a really big deal. But I think more and more Jay Powell has a lot more on his shoulders because the other central banks, particularly in the developed world, are out of tools and it's a really big deal.

    Mary-Catherine Lader: So, it sounds like you sort of think the bull market is going to continue in the U.S.?

    Rick Rieder: I don't think when people say the equity market is high, it's not high. I mean you may think it's going down, but it's not high from a free cash flow multiple, it's not high from a P/E ratio. P/E ratio, meaning price-to-earnings for a company or roughly what you're paying valuations-wise for their current earnings and their future earnings flow. On a P/E ratio, it's about average versus where it's been, but it's also interest rates are the lowest they've been by hundreds of basis points. So, I think that what's happening, because there's not enough bonds in the world, because there's not enough income in the world, I think you can continue to see the equity market appreciate. It's going to be a straight line? No. And personally, I'd actually like to see it go down first to get some better valuations and to buy some things, but I don't understand. There's no doubt, earnings are going to be flattish, not terribly exciting. Margins may be under a bit of pressure because of wages. But I don't think we're going into a deep recession and people have suggested we're going into a deep recession, stay away from equities for a while. Am I okay taking some equity risk? For sure.

    Mary-Catherine Lader: So then, what would be a sign to you that a recession might be on the horizon?

    Rick Rieder: I mean it has to be the consumer. Let's just say whatever reasons, an exogenous shock, a geopolitical event, a political event, and the equity market goes down 15, 20%. That would hurt sentiment and you'd get the consumer pull back saying, “You know what? I'm just going to wait for a bit. My net worth has come under a bit of pressure.” If all of a sudden, they really increase the savings rate because they were worried about what was happening around them, that would be something that would give me some concern. Otherwise, people say, “Manufacturing is coming under pressure” so the next thing that happens is you'll see layoffs. Manufacturing doesn't hire anybody these days. It's in a secular decline, so that doesn't impact my thinking. But the service sector, healthcare, education, leisure, business services generally have been pretty buoyant in terms of hiring people and income levels are good, but that is service sector consumers, I'd watch quite a bit. The U.S. is also a closed economy, and not that tariffs wouldn't hurt the consumer, they will. But people say, “Look at what's happening to trade or the global economy.” The U.S. is incredibly, of the top 20 countries in the world, it's the most closed from a trade perspective. Meaning, the U.S. can still grow if the global economy is soft.

    Mary-Catherine Lader: So, you think these concerns about the impact of trade on the stock market for example are a little overblown?

    Rick Rieder: Well, if the stock market is still -- I mean, we haven't traded off that much in stock. People talk about it a lot, but when you sit at close to the highs, I don't know. I think it's weighing on sentiments. One thing I will say about trade that is important is we do live in a world where we have an open global system and China is so darn important and Europe is certainly important in the global economy. If the global economy was moribund, it wouldn't hurt the U.S. from a growth perspective, but it would be something that we'd worry about a bit, but more from China and the impact of China in trade. You have to keep an eye on it for sure.

    Mary-Catherine Lader: So, just listening to you talk about global markets, different asset classes, it sounds like a pretty exciting time to be an investor. How would you characterize what makes this time different from the many other decades, the periods in which you've also been managing money?

    Rick Rieder: Exciting also means blood pressure rises at times. It's certainly not a straight line and it's certainly not without volatility and certainly not – your operating environment, whether it's trade or issues, people about the president or Brexit or the global economy slowing, it's not like there are not things that are out there that don't concern you. This is a different time for a couple of reasons. One, with interest rates where they are, you got to figure out how do I get income in the portfolio. Create balance, create balance, create balance. We're not going to be like we were certainly at the beginning part of this year, where rates worked well and equities worked well, we got to create balance in the portfolio. You got to get income in the portfolio and do it efficiently. And then within a market, that's jumpy, I don't believe when people say, “We're at the end of the cycle, end of the cycle.” We've been saying we're at the end of the cycle for four years. And I don't really believe there's a business cycle, like a traditional manufacturing, close the output gap, inflation rises. But growth is slower, we had a big fiscal tailwind, now it's a headwind to some extent. You have a big election uncertainty with incredible dispersion of opinion and policy. You have to have balance in a portfolio because anybody tells me, “Here's what the election will look like,” not just in this country, around the world. They'd be lying if they say knew. Anyway, it's why we like balance.

    Mary-Catherine Lader: Sounds straightforward but very hard to execute.

    Rick Rieder: Day in and day out is hard for sure. And quite frankly, it's hard separating yourself from the news flow, whether it's social media or Twitter or what have you. But anyway, you just got to commit to, “This is where we're going to be,” and you know the portfolio will work out well. Just keep that corpus of your portfolio head in the right direction.

    Mary-Catherine Lader: I'm going to end with a rapid-fire round of slightly more personal questions. Are you ready?

    Rick Rieder: Yeah, I think so. I'm not really good at rapid fire, so I'll try and keep them brief though.

    Mary-Catherine Lader: So, you notoriously only sleep about four hours at night?

    Rick Rieder: Yeah.

    Mary-Catherine Lader: What's the secret? Is that nature or nurture, and if it's nurture, what have you done?

    Rick Rieder: Nobody tells me it's a good thing. I just think every year, I take another half hour off. There's so much going on, I feel like sleep is a waste of time. I'm sure have a lot of medical people, including my brother, who's a doctor tell me I'm crazy, but I know I feel like there's a lot going on and I have a lot of energy.

    Mary-Catherine Lader: That's pretty inspiring. So, you're also a technology buff?

    Rick Rieder: Yeah.

    Mary-Catherine Lader: What's your favorite gadget?

    Rick Rieder: So you know, actually, the new one I've gotten into, I've talked every time about obviously phones and AirPods and autonomous driving, but I've gotten into this WHOOP that I wear now. I think the physiology of the human genome is really interesting about how days, you talk about how I'm not sleeping. Well, some days I don't sleep at all and that tells you. But I think monitoring your insides, in terms of whether it's blood flow or dispersion or you're having a good day, not a good day, I've really, really become intense in trying to think about what drives performance in any given day. It's why you're seeing a lot of athletes now that are monitoring their daily conditions to determine what their exercise regimen should be, et cetera. I mean we've done it with machines for years, why can't you do it with humans?

    Mary-Catherine Lader: Have you noticed any trends? Is there anything you do differently now that you know?

    Rick Rieder: Well, it's actually horrifying when I look at how many nights I don't sleep at all because I'm up watching markets. Particularly, I noticed that on the weekends, I get considerably more deep sleep than during the week. There's something going on there, particularly when the news flow is high. I figured I've got to sleep more in the weekends.

    Mary-Catherine Lader: What's the book at the top of your recommended reading list right now?

    Rick Rieder: I'm reading a book called Factfulness. I just started it, but I think it's a pretty good book, it's a pretty optimistic view of things. But my favorite book that I've read in the last five, 10 years is one called Capitalism without Capital that tells you so much about the economy that we don't need capital, we don't need hard assets, et cetera. But to give you some sense for why certain countries grow, why certain don't, why certain industries are going to thrive, why others aren't. Anyway, it's fantastic.

    Mary-Catherine Lader: So, one of the many perks of your job is that you get to meet a lot of extremely interesting and really famous people. Who's the most interesting or perhaps most famous person you've sat next to at a dinner?

    Rick Rieder: Larry Fink.

    Mary-Catherine Lader: That's the right answer.

    Rick Rieder: I enjoy sitting next to Larry actually. I don't know who's the most famous. Two people I've gotten to become friends with that's been a huge honor for me are Paul Ryan. We debate social issues all the time, but I find him fascinating economically and thoughtful. And I've gotten become friends with Rory McIlroy, the golfer and he's got a lot of tips for me since I can't seem to fix my golf game and he's had a great year.

    Mary-Catherine Lader: One last question. Most exciting or scariest, you choose, moment of your career as an investor?

    Rick Rieder: '08. I mean if I live for 50 years, going through ‘08 was incredibly daunting and how it played out and scary -- if you think about what could have happened or what did happen. Since then I would say, as the business has changed, we don't get a ride every day, but there's some neat things we're doing in building analytics and technology around it. Some using artificial intelligence that I thought, gosh, would never use in investing. There's some really cool things going on right now that in the next few years could be not without risk, but a lot of fun.

    Mary-Catherine Lader: Thank you so much for joining us here, Rick.

    Rick Rieder: Thank you. That's fun, thank you.

    Mary-Catherine Lader: It's been a pleasure.

  • Oscar Pulido: It was the bubble to rival all bubbles. In March of 2000, the tech-heavy NASDAQ Stock Index hit its dot-com era peak. It rose from under 1,000 in 1995 to over 5,000 just five years later. But by the fall of 2002, it was nearly all gone, along with many of the once high-flying dot-com unicorns. Even the well-anchored blue-chip companies weren’t unscathed. Industrial losses were in the trillions.

    It would take 15 years for the NASDAQ to reclaim the 5,000 mark. And today, it sits near 8,000, an 80% increase in just five years. Tech stocks are back in the headlines as the sector to keep an eye on. But with euphoria around tech having backfired once before, is it time to take the money and run?

    On this episode of The BID, we speak with Tony Kim, Portfolio Manager and technology sector lead for Blackrock’s Fundamental Active Equity group. We’ll talk about what makes today different from history and why tech is a breeding ground for innovation. I’m your host, Oscar Pulido. We hope you enjoy.

    Tony, thank you so much for joining us today on The BID.

    Tony Kim: Thank you for having me. I love podcasts, pleasure to be on it.

    Oscar Pulido: Well, we’re happy to have you on. And Tony, I was reflecting back on my own investment experience. I think I bought my first mutual fund back in the late ‘90s, and it was a mutual fund that targeted companies that had high growth rates. And in retrospect, they probably owned a number of tech stocks, because that’s what was growing. And the late ‘90s boomed, turned into the bust of the early 2000s. So for me personally, it’s been really interesting to see tech back in the headlines here over the last couple of years. How does the tech sector differ today versus what you and what I invested in two decades ago?

    Tony Kim: I think tech has permeated all aspects of our society. And so when you look back at 2000, it all seems kind of primitive today. When I really think of it, it’s this notion of order of magnitude change. And so, let’s just compare back 20 years ago to today. In 2000, there were half a billion internet users, there’s now close to five billion, so that’s 10x. The number of computing platforms, there was one really, the PC, couple of hundred million. Now, there’s PCs, there are smartphones, there’s IoT, and there is cloud. So that’s over ten of billions of things in the platform, sort of devices. So that’s 100x at least. The number of wireless networks, you had 2G, now you have 5G. That’s three generations of cellular. The transistor density, which is the measure of the density of the performance of the transistors in a silicon chip. Tens of millions back then, now tens of billions so that’s like 1000x, and the leading chip geometry of 130 nanometers is chunked down to 7 nanometers, so that’s 18x. So when you think of that, you put that in totality. It’s this order of magnitude change within 20 years. And as an investor, that’s translated into a sheer explosion in the number of companies, the diversity, the dynamism, and the sheer ambition of these companies is pretty unprecedented.

    Oscar Pulido: It’s clear you have to be good at math if you had been following the tech sector for the last two decades just given the order of magnitude, I think was the term you used, of the change that we’ve seen. It feels like a lot of that change has been a result of the FAANG stocks which is often used to refer to Facebook, Apple, Amazon, Netflix, and Google. They really get the bulk of the attention, but take us beyond FAANG. There must be other companies that are a part of this bigger tech movement?

    Tony Kim: I think for the last 10 to 15 years it’s definitely been all about FAANG and they have personified the market capitalization of tech. I’d also add Microsoft and Alibaba and Tencent, and maybe call it the Super Eight. But like you said, tech is a lot more than these eight companies. There are nearly 1,300 public tech companies globally that I’m looking at and then there are hundreds of late stage private companies that I’m also looking at. So you’re talking well over 1,600 plus companies in tech beyond these Super Eight. So the diversity of companies that are out there, the shared number is a lot more prevalent than in the past and the amount of funding that’s come in to the sector. But I think we also take a step back and look at tech by era. And if you look back in history, every decade generally has been kind of defined by a new era. In the 1990s, it started in the mainframe and a lot of Japanese companies. In 2000, it was the PC and the fiber optic boom, telecom companies. And then in 2010, it was the smartphone and internet companies. And today, it’s about cloud and we also see the emergence of some of the large Chinese companies. And so this diversity of over 1,500, 1,600, 1,700 tech companies out there, something is going to emerge. There is no doubt about that. So I think there is a diversity of companies and history has shown there will be new leadership.

    Oscar Pulido: And when you talk about new companies and new leaders, the word disruption comes to mind. It feels like that word is in our vocabulary these days largely due to the tech sector. So, what in your mind is the next big thing that we can expect from tech and perhaps, as an add-on to that, what do you see the impact of technology being on other sectors of the economy?

    Tony Kim: It seems one of the defining era for the next 10 years is going to be AI in data. I think disruption to me, a lot of it is built on incremental layers from past foundations of tech of what you see is disruption today are really set on prior investments. So we go back to the 2000 era. I mean, that laid the foundation of the rails of the internet that built up the telecom and fiber network. And once you have that, along with that came continual development in silicon and that led to the smartphone and then you had these 3G, 4G networks which build wireless networks on top of the linking the fiber networks with the parallel development in chip computational power, which then led to new software and new architectures, which then led to the cloud. And then finally, if AI is defining the next decade, you know AI research has been around for 30 or 40 years, but it needed fiber networks, it needs the cellular networks, it needs the computational power and you need a new software. All of these things coming together right now seemingly in a big bang, you could call it. And in terms of tech moving beyond, you brought up the notion of tech beyond other sectors. Two paths of evolution for these companies or for looking at tech, one is kind of the core tech and then other is what I called applied tech. Within the core tech, it’s silicon and software. And it’s in this applied tech where you’ll see a lot of these new industries. These are taking these core technologies and applying them to things like transportation, autonomous driving or construction, kind of reimagining value chain for real estate, reimagining the value chain using tech. You kind of build new models for healthcare, farming, customer service on and on. And so you see this expansion of what I call taking these core technologies and applying them to new industries.

    Oscar Pulido: In listening to you talk about AI, this seems to me that there are a number of different parts of this value chain, a number of different companies that are involved in the broader AI investment opportunity because you mentioned silicon, you mentioned software, you mentioned data. Is it fair to say, there is no one company that does all this, you sort of have a –number of different ways to invest in this theme?

    Tony Kim: Yeah, that’s correct. This is a concerted effort, all of the component parts need to be kind in unison. You have dozens, hundreds of companies working on software, different parts of software. You have got new companies in silicon. This is the first time in 20 years I’d say in Silicon Valley that I’ve seen kind of this explosion of new silicon startups. I mean, there have been so few semiconductor companies that have become public but you’re seeing a new creation, a new Cambrian explosion, if you will, of compute. And then you have all of these companies that are using the AI. Obviously, you have got probably over a dozen autonomous driving companies and et cetera. So, there is no one answer and then AI is going to be use in kind of everything.

    Oscar Pulido: Tony, let’s switch gears. I want to ask you about cloud computing because I know that you feel that cloud computing will take over or could take over the traditional sort or on-premise infrastructure that companies use for technologies. What are the advantages to cloud computing?

    Tony Kim: I think there are many different aspects as to what cloud computing is, but I think one of the core tenants of cloud is this notion of not having to do it yourself. There is this DIY nature of IT that has been the case for the last 30 years as least, where companies all around the world that have kind of build their own technology data center, their own stack and then had armies of people building and running their own IT. And I think with the advent of cloud, one central advantage is that you can shift a lot of this do-it-yourself nature to kind of a rental nature where you can outsource a lot of this infrastructure to the cloud. This is a concept that has been around for a long time in other industries, i.e. the utility industry, but now it’s come to tech. That’s one advantage. The other is, once you have this kind of infrastructure in the cloud, the applications that run on top of this cloud infrastructure, the ease and speed in which the flexibility to make changes and get software up and running, this is kind of foundational to cloud and it’s really just opened up beyond just the application and the infrastructure, just kind of how software is written. I think there’s been a kind of a revolution you could say and an explosion in software in terms of how it’s built, how it’s developed and how it’s consumed and deployed. And the cloud has enabled – I think Marc Andreessen coined it, “Software is eating the world” and I think the underpinnings of this new cloud infrastructure has enabled this to really blossom and accelerate even.

    Oscar Pulido: And as you mentioned this, the word that comes to mind is efficiency. It seems like cloud computing helps companies become more efficient. As I also think about efficiency, I think about the 5G conversation. It feels like the physical infrastructure to support this technology really has a ways to go. So how close are we to the broad deployment of 5G, and is there a way now to invest in the opportunities that 5G is going to create?

    Tony Kim: I think 5G deployment is imminent. We started with end of last year with Korea and Japan, and now this year, it’s U.S. and China, and then later it will be Europe, and then later after that, it will be emerging markets. We’re very much in the very early stage of deployment. If you look around, I don’t know too many people with a 5G smartphone. I like to deconstruct 5G. I often like to also work backwards, like I often think when will we have a 5G phone and do something with it? I think that really comes in earnest end of next year. I always think Apple will kind of define that, and I do think Apple will have a 5G smartphone by next fall. And if we work back in order, so if that’s when real consumers really get access to 5G phones at scale, when can you start investing in this? Actually, it started last year. You’ve got to first test the network. You got to test all the equipment that you’re going to put into the network. Carriers don’t want to be spending tens of billions of dollars on equipment that is not ready, so you got to test it and then you got to have the fiber and the interconnect and the networks all built out. And then you put in these 5G base stations, and then you’ll have phones, and then those phones will be running and that will lead to more network loading, and so then you’ll need to build more towers, more data centers. And then eventually, you’re going to have all of these new use cases for 5G, all of these new 5G IoT or self-driving cars. So I kind of break it down that way, and then I’ll say, “Well, how do we invest?” We need to invest in, I think what I call the first phase, the building of the infrastructure before we can have that. And then you can have the phones and then applications come on top.

    Oscar Pulido: Well, it’s interesting when you said that you think Apple might have a 5G phone by the end of next year, I started to work backwards myself and think about how far in advance will people be lined up outside the Apple store to get their hands on a 5G phone. But you touched on the U.S. and China as being sort of next in getting the deployment of 5G. Isn’t there a rivalry between the U.S. and China when it comes to 5G? Is there something there that we need to be aware of? Does this have an impact on tech stocks at all?

    Tony Kim: That’s an interesting question. I think there is a “rivalry” in the press on 5G. Actually it’s more deeply rooted than just 5G. 5G just so it happens to be kind of the political football. The core root of the problem is this notion of IP ownership and IP protection. The U.S. wants China to observe international laws and IP rights and protection, and stealing of IP. On the Chinese perspective, I think China covets independence. They don’t want to be dependent on the U.S. And again, it goes back to silicon and software. Let’s deconstruct this, what I call the IP hole that China has if for example for 5G. When Huawei was banned or put on the Entity List, the U.S. government banned the key suppliers to Huawei. This crippled Huawei. So what do you need to ship a 5G phone or a 5G base station for Huawei? Well, you need processors, that’s Intel and ARM and AMD, and that’s not Huawei. Then you need these things called FPGAs that are often in base stations. These are U.S. companies: Xilinx and Intel. And then you need radio frequency chips that go into these base stations for 2G, 3G, 4G, 5G RF. Again, those are U.S. companies: Skyworks, Qorvo. These are not Chinese companies. You need AI acceleration, you need silicon for GPUs and AI accelerators. Again, most of these are U.S. companies. And then to make these chips, you need semiconductor capital equipment and these are lithography, etch, deposition, process control. These are U.S. companies. These are Dutch companies. Some Japanese companies, not Chinese companies. And then you need operating systems to ship around the world. You need Android or iOS. Again, these are dependent on the U.S. And then you need memory, and again, these are Japanese and U.S. companies. And so when you tie it all up together, they have massive holes in IP in a lot of these areas. And when the suppliers are not able to ship to Huawei, this cripples them. And so the Chinese do not want to be put in this situation, so they’re trying desperately to build their own capability. But the problem is it’s not just money. China has money, they have will, they have ambition. The question is, “Do you have the IP to do it all?” And so, again, I think this is kind of the give and take here. It’s this battle of IP ownership, IP protection. China wants some of these things but they need to play by the rules and the U.S. is playing hardball. And so that’s how, in a nutshell, you asked me about 5G and 5G is just kind of the tip of the spear of what the root issue is in my opinion.

    Oscar Pulido: And it feel like a good time to ask you, Tony, with everything you’ve said, if you had to sum up the tech sector in one sentence, what would it be?

    Tony Kim: If I were to answer that question, Oscar, I’d say tech is about creative destruction. I think tech is like biology, like nature. You grow fast, you mature and then you die and there’s always a new company coming to take your spot. In fact, I’ve tracked in the last five years over 200 IPOs in tech globally. History has shown us that there will always be new companies. And so I think it’s my duty to continue to find and seek those companies out.

    Oscar Pulido: Survival of the fittest, I think is what I’m hearing you say.

    Tony Kim: Constant evolution, yes. You need to constantly build the new. And I look back in the last 40 years, Microsoft has kind of done that, for example, as a company that’s been around. Maybe not 40 years, 30 years. But that has constantly evolved. You’re seeing that with some of the FAANG companies as well right now. So the speed and your ability to be flexible and change and evolve, because there’s one thing that we do know about tech, it will change.

    Oscar Pulido: Okay so constant evolution is key. Tony, I’m going to end with a rapid-fire round where I’m going to ask you some more personal questions if you’re ready.

    Tony Kim: Sure. Go ahead.

    Oscar Pulido: Okay. So you’re a self-professed podcast nerd, besides The BID, what other podcasts are you listening to right now?

    Tony Kim: You can take away the term “podcast nerd”. I am just a nerd, a geek, whatever you want to say. I was looking at my phone, I think I have 115 podcasts on there right now. I like history, so I listen to “Revisionist History,” Malcolm Gladwell, love that, listening to this thing called “Noble Blood.” And I love these two podcasts, Napoleon Podcast and The Life of Caesar. These are magnus opus, you know, 50, 100 podcasts long, specifics on those guys. I listen to some things in tech, a16z, This Week in Startups, and then maybe a sports one, I listen to this “Transfer Window” on European football and the economics of it, I guess. So, it really varies.

    Oscar Pulido: I think you made it through 10% of your list. If you had to start a podcast, what would it be about?

    Tony Kim: My own podcast, wow! I don’t want to recreate so many great history podcasts that are out there. I mean, I don’t have a PhD in Roman architecture or whatever. I guess I love documentaries and I’m a deconstructionist, so I’d love to maybe do a documentary style episodic series maybe on economic history, like, “What was the spice trade between England and India?” or like, “Who funded the renaissance?” Even maybe mix it with something modern, like to talk about deconstruct like an autonomous car company, what really would that entail?

    Oscar Pulido: So you’re the kind of guy that takes the computer apart to see how it works, which I can assure you is the opposite of what I do. And Tony, speaking of other interests, you’re also a history buff. I understand you own an Enigma machine, which I’ve seen the movie, this was used by the Germans during World War II to transmit coded messages. So how did you acquire one of these and do you actually use it?

    Tony Kim: I don’t have the original German thing, but I did find one that was a kind of modern reinterpretation with some opensource software so you can actually program it. And I did buy it because I think this machine – obviously, the Germans used to encrypt messages, but it was also kind of the spawn of the computer. This is what, as you saw in the movie, when Alan Turing built Christopher to decode this German encryption machine in World War II, which led to basically the dawn of computing. But I did buy it so that I could teach my children maybe the basics of encryption.

    Oscar Pulido: And on that note, what one piece of old technology do you think will make a comeback? I don’t know if it’s the Enigma machine, it feels a little antiquated. Is there something else that comes to mind?

    Tony Kim: Yeah, in general, tech things don’t really come back. I’ll go back to World War II. The British used radar and I think radar is coming back. It’s coming back in self-driving cars. Every Tesla has a bunch of radar and all these cars will have radar in it. And I’ll make another one. This is again, it’s a thing that’s been around: the periodic table of elements. You will continue to see a lot of these rare earths, these exotic materials, composites. It has big impact on kind of some of the extensions of where silicon is going in some of these alternative non-silicon materials. So material science is back. It’s already been back.

    Oscar Pulido: Well, Tony, you’re wealth of information. Thank you so much for joining us today on The BID. It was a pleasure having you.

    Tony Kim: Thank you for having me.

  • Mary-Catherine Lader: Nearly one in six people worldwide don’t have the physical documentation they need to access healthcare or housing or to vote. But what if you didn’t need that piece of paper or plastic? What if it was all digital?

    What if the act of voting itself was digital, too? Instead of driving to a local school or polling center, you could help shape your government within seconds from your own home, saving time to worry about the myriad of other things you have to do on your to-do list. And what if you wanted to order takeout food? Imagine if you could trace each menu item back from its origin to its supply chain to your plate, and have full transparency into what you’re eating and where it came from? All of these things, digital documentation, voting and transparency into our food, they’re all example of ways we could use blockchain to enhance our daily lives. But there is so much that isn’t well understood about blockchain.

    On this episode of The BID, BlackRock’s blockchain lead, Robbie Mitchnick, will walk us through the evolution of blockchain and cryptoassets, and how blockchain could change the way we live and work. I’m your host, Mary Catherine Lader. We hope you enjoy.

    Thank you, Robbie, for joining us today.

    Robbie Mitchnick: Yeah. Thanks for having me.

    Mary-Catherine Lader: So you spearhead our blockchain initiatives at BlackRock. Let’s start with a level set for those people who might be a little embarrassed to ask. What is blockchain in one sentence?

    Robbie Mitchnick: Well, to start with, I know The BID audience is very familiar with you, but they may not know that you actually were the initiator of BlackRock’s blockchain exploration –

    Mary-Catherine Lader: That was not anticipated, but thank you for mentioning that.

    Robbie Mitchnick: It’s true. So that was of course long before I got here, but to answer your question, blockchain at its core is a special type of database that instead of relying on a central trusted intermediary to authenticate transactions and keep records, you rely on cryptography, i.e., math. And what that enables is a single golden copy of record that can be shared across a network and is perpetually reconciled and from a practical standpoint, is impossible to tamper with.

    Mary-Catherine Lader: That is related to crypto-currency but also not necessarily related to cryptocurrency, how?

    Robbie Mitchnick: Well there is a lot of ambiguity out there on that point too. Cryptocurrency is one application of blockchain. To date, it’s the most famous and most successful, but there may be many others out there that gain traction that do not involve cryptocurrencies that are applications of blockchain, particularly in an enterprise context.

    Mary-Catherine Lader: So speaking of enterprise blockchain, now we can start using the buzzwords for those who do follow it, before you came to BlackRock, you worked at Ripple. And they have a token or a crypto-asset called XRP. You also wrote a paper on the theoretical valuation or the theory to value cryptoassets which is a much debated topic. So what brought you to BlackRock?

    Robbie Mitchnick: Well, the early days of blockchain and crypto were very ideological. There was this ethos of the idea that centralized institutions were fundamentally untrustworthy and you had to rip the system down and replace them. And what you’ve seen in the later evolutions of the industry are the people that have come in later in the game, whether they be technology or finance people, is a much different philosophy; one that sees this really as a technological innovation story, an economic opportunity and something that enables new capabilities. So I consider myself part of that, and my philosophy has always been that rather than rip out the existing financial institutions, that the best way for blockchain to get adopted was to be embraced by them. And the slower competitors that don’t adopt will be replaced.

    Mary-Catherine Lader: So I’m clearly biased because I also work here, but I’m a little bit jaded in this area, because as you mentioned, I also started working on this a long time ago, in 2015, when BlackRock started our activity on blockchain. And since then we haven’t really seen a lot of concepts in production, we haven’t actually seen a lot of blockchain adoption at scale among financial institutions. So why do you think that is and why are you still hopeful?

    Robbie Mitchnick: I think it’s really not so much a story of people overestimating the usefulness of the technology as it is one of people underestimating the difficulty of implementing it. There are a number of reasons for that. One, decentralized governance is a whole new paradigm that doesn’t have a lot of precedence, doesn’t have –

    Mary-Catherine Lader: Can you explain what decentralized governance is? And how it is different from distributed for example?

    Robbie Mitchnick: Right, so in a decentralized model, you don’t have a single entity that controls authoritatively how a network should run, and does not own the data or the technology behind it. And so that is a lot more complicated when you have to have multiple parties working together and agreeing on what that framework looks like. And in an enterprise context, you don’t have a ton of templates and examples to work off of. So that’s been a challenge. Secondly, the need to line up many ecosystem participants, each with different processes and standards, all simultaneously and get them to adopt a new network, a new technology paradigm at once is really difficult. And then the last thing is this is something that’s still not that well understood by a lot of large institutions, and the scale of disruption is broad. You’re talking about in many cases, taking multiple disparate legacy systems and replacing them with a single blockchain-based model. That is going to take time.

    Mary-Catherine Lader: So what do you think is least understood? You say that it’s not that well understood today. There is no shortage of blogs, Reddit threads, at this point even documentaries about blockchain technology, so what are people still missing?

    Robbie Mitchnick: There is a narrative out there that was once true, really three to four years ago, that I would say is not anymore, which is that fundamentally, blockchain can’t scale. And it was a limitation for sure three to four years ago. But the space has come a long way since then, thanks to the massive amount of human and financial capital that’s come into the industry. Now scale is still a limitation for certain decentralized, permission-less networks. Because it is a fundamentally difficult tradeoff to have decentralization, speed and security all at once.

    Mary-Catherine Lader: And why is that a tradeoff, just because the way technology works?

    Robbie Mitchnick: Right. You can have speed and security, but the best way to get that is to have a centralized pool of validators who control the network that’s efficient. To have true decentralization requires sacrificing on those so that you have a broad pool of validators working on a network. There is no clustering of power, but as a result, you rely on other methods of generating consensus, which tend to be slower and more difficult to scale. And so, if you’re willing to sacrifice on true decentralization, and have a predetermined set of institutional validators, which in many use cases is a perfectly reasonable tradeoff, then actually speed and scale can be orders of magnitude higher.

    Mary-Catherine Lader: So when is centralization a reasonable tradeoff? I’m thinking, for example, in a regulated financial services context, where financial institutions, as you said, who have a huge amount of opportunity they could realize if they adopt blockchain technology perhaps. They want to control who takes part in their network, and they are accountable for things that happen in their systems. So is that a situation where centralization makes sense, or is it not so much about the actors but maybe the use case in what you’re doing?

    Robbie Mitchnick: The way I like to think of it is the difference between trust-less and imperfect trust. So if we’re talking about an environment where you have to assume that your counterparties are completely anonymous and you assume that they would act with pernicious intentions if given the latitude to do so, then decentralization often is important and is an intrinsic good.

    Mary-Catherine Lader: So that’s the bitcoin/blockchain thing where you have no idea if the Russian hacker is in the system–

    Robbie Mitchnick: Exactly.

    Mary-Catherine Lader: Or if it’s your grandmother trying to send something to Nicaragua.

    Robbie Mitchnick: Totally.

    Mary-Catherine Lader: Okay.

    Robbie Mitchnick: And the system has to be able to work there, assuming the worst intentions from your counterparties. Now in a financial institution context, if we’re building a blockchain network with a bunch of other ecosystem participants: counterparties, brokers, clients, vendors, et cetera, there is a different trust environment there. That’s what I call imperfect trust, where there is a reputation and there’s a sense that these institutions are going to for the most part play fairly, but you still have to navigate the complexities of having differing incentives, and still being able to marry up a single shared ledger that is effectively the binding golden record.

    Mary-Catherine Lader: That is a very helpful explanation of how to think about these sorts of tradeoffs, what systems lend themselves to different elements of the governance. What are the use cases that you think are the most exciting to you, and then which ones do you think will have the most disruptive impact on financial services?

    Robbie Mitchnick: There is such a breadth of use cases within finance that are being explored. And I actually think it’s held back some of these projects, to your earlier point, from going into commercialization, because it’s sort of fragmented the attention of the major actors in the space and made it difficult to align on priorities and resourcing a couple of key blockchain projects that could become a utility for the whole industry. But in general, I would say wherever you have data siloed across multiple systems, and you have multiple parties that need to interact, to read and write to that data, then you have a recipe for potentially an impactful blockchain use case.

    Mary-Catherine Lader: That’s like most of finance, right?

    Robbie Mitchnick: Yeah. Right. Exactly. So it’s things like of course payments, KYC trade finance derivatives, proxy voting, bank loans, securitized lending, REPO, and then beyond that, there’s this whole emerging trend of tokenizing financial assets, and other real world assets on a blockchain. So all of those will be very much interesting to watch.

    Mary-Catherine Lader: And how, if at all, is tokenization different from digitization?

    Robbie Mitchnick: Well, I think you can have digitization without tokenization but you can’t have tokenization without digitization. So, in many ways, tokenization is a great catalyst for the digitization of financial services, even though it’s not strictly a requirement.

    Mary-Catherine Lader: So for example, equities today are basically digitized, I can trade them on any app on my phone, it’s essentially information that is passing over the internet in certain systems. Whereas, real estate for example, not as digitized. So there is a digitization necessary to then make them tokens. Why does it matter to even make them a token? What is the benefit of a cryptoasset in that context?

    Robbie Mitchnick: Well real estate, you’re right, is one that people spend a lot of time on from a tokenization standpoint. And the promise is really, if you can migrate the entirety of that asset onto a blockchain and enable certain of the administrative components of it to be done automatically, then that is actually a really powerful proposition in terms of liquidity, in terms of enabling access to more investors, in terms of being globally interoperable and in terms of just the ease of doing things like dividing, like being able to own a tiny sliver of a commercial property or residential housing unit.

    Mary-Catherine Lader: Do you think that kind of tokenization then has an impact for many of us in our day to day lives?

    Robbie Mitchnick: Well, it could, because what it could do is take a number of asset classes that have traditionally been off limits to most investors, whether it be just institutional investors or institutional plus accredited, and democratize those to a wider audience who can then trade and own tiny pieces of them.

    Mary-Catherine Lader: So what are some of the other ways that blockchain could influence people’s daily lives? There is a lot of talk around identity, putting identity like our driver’s license on blockchain, I think some Eastern European countries are trying to do that with property records. What examples do you think are real and have a lot of potential?

    Robbie Mitchnick: Yeah. Well, the identity is an interesting one that you bring up. There’s a lot of people trying to tackle that. But the problem is, if you don’t create a single system that effectively can be winner take all, then you’re going to have the same fragmented database problem that you have today. So it has to either be interoperable or you have to have one winner.

    Mary-Catherine Lader: Meaning, with the government?

    Robbie Mitchnick: The government. Exactly. So the government is a natural initiator of such a network. To date, we haven’t really seen that happen anywhere, but they would be a logical source of that. Now that would sound like anathema to a lot of the more puritanical early members of the blockchain community, that their concept had been hijacked by governments, the least trustworthy of all actors, to build a network like this. But we’ll see. In terms of day-to-day life impact, I think this is one of the areas where the hype for blockchain got most overblown. You had people at a certain phase in the peak of the euphoria claiming that blockchain was going to one day do your laundry and wash your dishes, and that was just never the case. When you boil down to it, there are many good use cases and there are many not-good use cases that have been proposed. I have two favorites, one is in payments. And people do talk a lot about this, I’m hardly the first to suggest that, but retail remittances, if you think of that, is a 700 billion dollar notional volume market. And–

    Mary-Catherine Lader: Of people sending money abroad to family members who live elsewhere?

    Robbie Mitchnick: That’s primarily what it is, yeah. And of course, many Americans have never quite had to realize how bad the international payments system is because they never have to send money abroad. Me being from Canada, I’ve experienced the pain that most people living abroad have of just how terrible that system is. But you have a 700 billion dollar notional market, and to send 200 dollars on average costs you 700 basis points today, which is an absolutely massive tax basically on people trying to send money back home; and not only that, but it’s slow. It’s three to four days, it’s lacking transparency, it’s high failure rates. And then you go to the corporate cross border payment market, and that is 20 trillion notionally. And so fees are not as high there, but they’re still high, and settlement is not as slow, but it’s still slow. And so you have this massive opportunity where blockchain—there’s potential, it’s not clear who is going to succeed in doing that, but there is certainly potential and a lot of people trying to build a network, which blockchain enables, of real time payments at near zero cost.

    Mary-Catherine Lader: So is your thinking about use cases that you have to identify where those conditions you talked about exist, like siloed systems, an opportunity to reduce cost for example, but also the incentive. For example, in payments, the example you just shared, there are not necessarily a lot of incentives for those who pocket that 700 basis points to reduce that. And if they own the rails, then we have to have an entirely new system come about to be adopted?

    Robbie Mitchnick: Right, right.

    Mary-Catherine Lader: So how do you think about where the incentives can be overcome, where you can have new systems and applications?

    Robbie Mitchnick: Well, for a while they’ve been able to be complacent because there was, as you described, a lack of incentive to move, but now with a number of blockchain projects trying to disrupt this, many with significant resourcing and some major institutions behind them, the pressure is finally on. And I think if you hadn’t seen it up until now, the banks realizing that they had to get their act together on this, you’re starting to see it. I think the Fed coming out with their plan is one example of a response that acknowledges that traditional payment infrastructure has to be better or it’s going to get displaced.

    Mary-Catherine Lader: So do you think central banks will start adopting blockchain at some point? You mentioned the Fed has come out with a plan, so what is your view on that?

    Robbie Mitchnick: Well, it’ll be another fascinating area to watch and there have been a ton of them obviously who have experimented in some form or another, with it, and specifically in many cases looking at central bank-issued digital currency, which on the surface has some pretty compelling benefits. If you talk about detecting tax evasion and criminal activity, but also just bringing the economy in a payments context into a digitally native format in an increasingly digital age. So I think we’ll see that continue to be a story.

    Mary-Catherine Lader: So you mentioned downside risks, and the ones people are most concerned about, five years ago, or 11 years ago when blockchain first came to be, were quite different than those today. Then it was hard to imagine that any central bank much less the Fed would think of adopting or experimenting with it. So what do you think those risks are at this point in time?

    Robbie Mitchnick: Well, I think in many ways, risks in this industry are similar to what they were, it’s just that the scope and scale has blown out. So whereas five years ago, in the early days of crypto, everyone was really focused on custody, but that was how do you keep exchanges from getting hacked, and how do you build secure cold wallets for individuals? Now, it’s still custody, but it’s how do you build bullet proof custody solutions that are institutional grade that large FIs can actually get comfortable with?

    Mary-Catherine Lader: FIs is Financial Institutions.

    Robbie Mitchnick: So, the difference is, the threshold is way higher in the latter case because I know that I’m not going to wake up tomorrow and find out that my Apple shares got hacked and went missing from the DTCC.

    Mary-Catherine Lader: And what is the DTCC?

    Robbie Mitchnick: That is basically the depository that keeps track of who owns what shares in the U.S. market. And that’s the threshold that the crypto and blockchain industry is going to need to get to, whether that’s for traditional crypto or for tokenized financial assets.

    Mary-Catherine Lader: So let me ask you one last question, and then we’ll end with a rapid fire round. So we talked about how there was a lot of enthusiasm about crypto in 2008 with the initiation of the birth of Bitcoin if you will. A lot of excitement in 2015, 2016, and then now people roll their eyes, it feels like blockchain is a tired buzzword. So where do you think we are in the hype cycle, and where do you think it’s going?

    Robbie Mitchnick: It’s been fascinating to watch the hype cycle in this technology because even though blockchain and crypto are fundamentally distinct concepts that may ultimately have different endings, the blockchain hype cycle has very much tracked Bitcoin’s cycles, and we’ve had three of those in its ten year history. The first being from inception basically through 2011 and the second peaking in late-2013, troughing in 2015, and then of course the third peaked in December of ’17. And for the last year and a half, that’s where this trough of disillusionment has really set in where people have started to tire of the buzz and question whether this is going to be anything. But just as is typical in that classic Gartner hype cycle, as that is happening, on the ground, fundamentals are actually improving. So speed, privacy, security, scalability. And real development is happening. Now that doesn’t mean we’re going to see widespread adoption. There is a lot that still needs to happen, but we’re certainly starting to see meaningful progress.

    Mary-Catherine Lader: That’s exciting, so a lot to come in 2020 and beyond.

    Robbie Mitchnick: I think so.

    Mary-Catherine Lader: So I’m going to end with a rapid fire round and I’m going to ask you some more personal questions. Are you ready?

    Robbie Mitchnick: Okay.

    Mary-Catherine Lader: Okay. So I know that you started a brewery before you came to BlackRock.

    Robbie Mitchnick: It’s a little different.

    Mary-Catherine Lader: Yeah. So what did you learn from that experience?

    Robbie Mitchnick: Well, a lot. It was a lot harder than expected and having some entrepreneurial experience—and this was a fun side project with some college friends that grew—but learning what it’s like to run a business and understanding that when you’re on the ground it’s organized chaos in a way that I didn’t appreciate when I was an investor, it was a lot.

    Mary-Catherine Lader: A lot, okay. What’s your favorite kind of beer to drink?

    Robbie Mitchnick: Other than Naughty Otter?

    Mary-Catherine Lader: Which is your beer, okay.

    Robbie Mitchnick: Well, I’d say and this is sort of heretical in the craft brewing space, but I do in the summer enjoy light lagers. But for the most part, Belgian witbeers would be my favorite.

    Mary-Catherine Lader: Okay. Speaking of other countries, as you didn’t name an American beer, you’re from Canada, what do you miss most about Canada?

    Robbie Mitchnick: Probably friends and family and Saturday night hockey.

    Mary-Catherine Lader: Even though you’re from Canada, you are a political junkie specifically for American politics. There is a lot of that going on at the moment, I know I see you following it all the time. If you were a candidate, what would your campaign song be?

    Robbie Mitchnick: Yeah. Well, American politics is certainly greater entertainment value than the Canadian version, but I don’t know if that’s ever going to be a thing, but probably Who Says You Can’t Go Home, Bon Jovi, because I wouldn’t be running in this country.

    Mary-Catherine Lader: Thank you so much Robbie for joining us today.

    Robbie Mitchnick: Thanks for having me.

  • Oscar Pulido: Picture this: you wake up in the morning to a grueling iPhone alarm, roll out of bed, and put together breakfast. As you walk to the gym, you dodge scaffolding and turn up your music to wash out the sounds of construction. After the workout, you head to the nearest WeWork to start a day of work.

    In just a couple of hours, you’ve interacted with just a few of the many ways real estate is changing. Cities from New York to new players like Denver and Seattle are growing and developing by the second. Brick and mortar stores are being replaced by e-commerce; e-commerce are actually opening brick and mortar locations. And co-working and co-living spaces are becoming the norm.

    So what will the cities of the future look like? On this episode of The BID, we’ll speak to Ben Young, Head of BlackRock’s U.S. Real Estate Business. We’ll talk about how real estate has been and will continue to be disrupted and what that means for how we live and work. I’m your host Oscar Pulido, we hope you enjoy.

    Ben, thank you so much for joining us today on The BID.

    Ben Young: Thank you for having me Oscar, happy to be here.

    Oscar Pulido: So let’s start with the basics on real estate. I’m thinking about a personal residence when I say the word, or the term, real estate, but it’s really much more than that I think.

    Ben Young: It is. And it’s a very good question. When we’re talking about real estate, what we’re really talking about is the building blocks of society actually. It’s the land and the buildings on it that are utilized to support the normal functions of the economy. It’s the four main categories we call the four main food groups. And the types of commercial real estate are office, apartment, retail and industrial. Together, these sectors actually account for trillions of dollars in U.S. property value. With millions of people employed in the investment and management of these properties.

    Oscar Pulido: And my suspicion is that the real estate industry like virtually every industry in the world these days is being disrupted. So when you think about what is disrupting the real estate industry, any themes that we should be aware of?

    Ben Young: Absolutely. What I would start with and say is look, the needs of people and businesses are constantly changing and the real estate environment’s needs tend to adapt. But most changes are gradual. Adding dog walks to apartment buildings or moving heaters away from the base building office walls to increase window height, but they are also major long term disruptions to real estate. I think the first that comes to mind, to myself, and probably everyone else is e-commerce. E-commerce is the main disruptor. But you can’t forget about a couple of more and those are the sharing economy and 5G.

    Oscar Pulido: So start with e-commerce, because you’re right, I probably have an Amazon package at home I have to pick up, so I’m guessing that’s where you’re headed with this.

    Ben Young: Exactly. We’re all aware of how easy it is to order something from Amazon as you just noted, and how the internet has made price discovery as simple as a few clicks on your cellphone or your iPhone. But what is interesting is consumers prioritize speed and convenience when shopping. Thirty-nine percent of consumers rank speed as the largest factor when choosing purchases online. Versus 23 percent actually say price was its determining factor. So this makes e-commerce competitive actually with traditional stores, allowing online sales growth to be actually quite rapid. This in turn is actually creating more what we call demand for industrial or logistical space around the United States to warehouse all of these products. Consumers are quickly being accommodated to ordering things and arriving really quickly. My daughter thinks if it’s not arriving there in two hours, there’s a problem.

    Oscar Pulido: For sure. We absolutely all need next-day delivery, so what are the demands on space that are required in order to be able to fulfill what your daughter wants?

    Ben Young: We’ve done some estimations and actually we think we’re going to need 28 football fields per week—think about that. 28 football fields per week of new industrial logistical space to be leased by 2021. It’s phenomenal. This is clearly resulting in healthy rent growth and price appreciation for the warehouse and industrial space. At the same time – and it’s important to complement this – that we’re not calling for the death of the shopping center. Centers anchored by grocery stores which are less susceptible to online competition. And experiential retailors such as restaurants and gyms are actually performing much better than malls or the large power centers that I used to visit and my daughter doesn’t visit these days. My daughter constantly reminds me that, dad, you can’t get your hair or nails done over the internet. So there is a place for retail, business models are a bit more defensive of this in this e-commerce economy. But one last component which is really interesting and puts a twist on retail: there is a new demand coming from an unlikely place, I’m going to come back to e-commerce. E-commerce companies are actually looking for storefronts. Companies such as Bonobos, Warby Parker, and even Amazon have opened up retail locations. So the goal is not just to have more store sales but to improve their customer loyalty, and then in turn, drive more online sales.

    Oscar Pulido: So you’ve done a nice job covering e-commerce, now let’s go to the sharing economy which you touched on earlier. And this is a relative new term really when we think about it. I was reading that by the year 2021, it’s estimated that 86 and a half million Americans – that’s almost a third of our population – will be using the sharing economy. So what are we talking about exactly when we use that term?

    Ben Young: The disruption of the sharing economy is absolutely happening in real estate. I would call this thing a unit, or as I would coin it, it’s a unitization of everything. And what do I mean by that? Think back to Apple, what they did and how they utilized technology. They figured out how to sell a single song from an album. It was revolutionary to break down the whole into its parts and meet consumer demands and even charge a premium on this unit basis. Today there are 35,000 flexible workplaces in the world. WeWork alone now accounts, believe it or not, to be the largest private lease holder markets, like New York, Boston, and Washington DC. And these flexible workspaces have broken down the office lease into these smaller units. In other words, you can rent an office space for a week, a day, or even hours. That was unheard of before. And a consumer, again, as I said, is willing to pay a premium for this individual unit to have that flexibility and experience, not unlike that individual song from Apple. But the office market is not the only space being disrupted by this sharing economy. There are companies that provide shared conference room space. There is even a company that is starting to unitize retail space, believe it or not. What does that mean? The asset class that many people thought is dead or is dying is being unitized where companies can lease space for a year, a month, a week, a day, or even an hour like the office space. And what is really fascinating as I sort of alluded to before, is that these e-commerce companies are starting to leverage this technology to lease physical space on a short term basis to improve their own sales. Go figure. E-commerce is helping physical retail.

    Oscar Pulido: And so you mentioned WeWork and I imagine AirBnB lives in this category as well, unitization. But there is also companies like Uber and Lyft that are conducting some form of unitization as you used that term before. How does Uber and Lyft affect the real estate market or does it?

    Ben Young: It does. But I would say on a longer term shift than rather a near term disruption on real estate. It’s an interesting statistic. If you think about it, less than 20 percent, believe it or not, of U.S. adults have ever used a ride sharing service.

    Oscar Pulido: Right.

    Ben Young: So being in New York, you think 100 percent uses it, but if you think about the economy, less than 20 percent uses that. So the rate of adaptation is clearly becoming shorter and shorter, so that will increase the size. But it’s still a long term asset class; it will take time to affect real estate. But ride sharing and the prospect of driver-less cars, meaning we need less parking, not more, this means space can be redeveloped into higher and better use. We were just talking about malls. Mall owners have real estate that is dedicated to parking. So you have to think about repurposing that. How can you reincorporate it and make it flexible? Think about parking decks. They’re typically slanted or inclined on every floor. Well what about making them flat and just having a ramp at the end to repurpose the space, altering parking decks to make better use out of that? And I think if you step back and think about cities, this is really an interesting statistic, is that cities in general, 20 to 35 percent of their land, is devoted to parking in general. Thinking about that massive redevelopment opportunity is pretty exciting from a real estate perspective.

    Oscar Pulido: I feel like my whole life I’ve felt like I wished I owned parking lots, because it just seems like a lucrative business but you’re making me think that maybe that’s not the way of the future. You also touched on 5G, by the way, as another disruptor. What did you mean by that as it affects real estate?

    Ben Young: Global urgency to deploy this 5G is heightening competition between governments, companies, and investors to achieve 5G leadership and capture a multitude of new market opportunities. Advances in technology such as these driver-less cars and even battery storage will have material implications for real estate, real assets in urban areas. And as I relate it to real estate from my perspective, we see it particularly in the construction industry where the use of drones, of how to figure out developing, taking pictures, how is an architecture design for how a real estate building is going to be designed is leveraging this 5G technology. Believe it or not, wearable technology is all transforming the way we construct buildings.

    Oscar Pulido: Ben, let’s switch gears here and talk about cities. It’s estimated that two-thirds of the world’s population will live in cities by 2050, which would be double the percentage of what it was in 1950. Personally, I’m actually raising a family in a city and I don’t feel like that’s odd anymore, so what is actually driving this move into cities and away from maybe the more rural or suburban areas?

    Ben Young: So am I in the city and I don’t feel either. This is clearly indeed a phenomenon that is going around not only in the U.S. but around the world. Cities have been leading the areas for job and wealth creation, Oscar. This is largely a function of where talent is choosing to reside. Young educated workforces have been drawn to this what we call, live, work, play environment. And it’s areas like New York City but it’s even areas like Japan. The overall population that I think a lot of people know is declining in Japan overall given the ageing population, but what people don’t necessarily realize is in cities like Tokyo, the population is increasing and increasing at a rapid rate. So it’s that desire to be in those major urban cities to have that live/work/play. But what is really important to remember is cities are going to need to adapt and be smart. They’re going to need to continue this technology and infrastructural improvements and the connectivity between this real estate in infrastructure.

    Oscar Pulido: And cities therefore, the landscape is changing. You and I both work in New York and anybody who has visited New York recently will not have missed the Hudson Yards project on the west side of Manhattan where there was previously I think just barren land, and now it’s sort of a city within a city. So do you see more of these micro-cities developing in the likes of New York and maybe Tokyo?

    Ben Young: No doubt, Oscar, no doubt. Hudson Yards is an example of a creative economic development. If you think about, Hudson Yards is essentially being built on newfound land in Manhattan. They basically are placing large plates above railyards that park many of the trains we use on a daily basis in the city. But the developers have been able to build on top of this. And what they’re really creating, to your point, is this micro-city within a city. We’ve seen even a similar development in Boston. You think about the build-out of the Seaport area and that Seaport District from an area of older industrial sites, to one of new offices, retail and apartments.

    Oscar Pulido: And speaking of apartments, recently in New York, there was some legislation that came across about rent affordability, and this have implications both for people who are looking to rent but then also implications for the landlords. So talk to us a little bit about what that legislation was and your view on it, and are we going to see more of this in other parts of the world?

    Ben Young: No doubt, and it’s an interesting question Oscar, as you talked about it from both an owner and renter perspective. Homeownership in many markets has declined for the last decade. This has happened for a couple of reasons: delayed family formation, high student debt — I’m facing that, my daughter going off to college, so I’m living and breathing that — and job growth occurring at higher rates in urban areas that I just talked about. So a key measure that we actually follow to understand how all these factors interplay with apartment demand is what we call rent affordability. Simply, a rent can only rise so high until the tradeoff between home purchase with a mortgage makes more sense. But in most markets, we see a favorable backdrop for apartment investors and renters; high tenant demand, rising incomes, but as mentioned, rent levels attractive relative to the cost of home ownership. Now in New York, to your specific question, it really has come into play. There was legislation passed I believe on June 14th and what it was called was Housing Stability and Tenant Protection. And the bill passed key reforms that really put much more stronger controls in place for rent stabilized or rent controlled multi-family units, and makes that deregulation from an owner’s perspective, whether it be for high income earners or improvements made to the unit, uncertain, right. So it looks like more rent stabilized units will stay there for longer. And it has affected, Oscar, over a million units in New York City. And look, while we expect there might be some modest hits to value from an owner’s perspective, we don’t expect market distress from an owner’s perspective because many are well-capitalized and low-leveraged. But demographically, the emergence of the millennial generation in the workforce has been a large lever of multi-family demand, and these millennials, highly educated with the jobs that we talked about, commanding strong incomes, are choosing to work in the cities. Housing costs are high but they’re able to afford it, they’re delaying it because of the student debt, they’re delaying family formation so that demand for these rents in these big cities are continuing. So it’s meeting both landlord and renter demand.

    Oscar Pulido: I was going to ask about millennials and they seem to be less interested in owning a home as opposed to prior generations. Is that a permanent trend, or will the millennials when they’re turning 40, 45, as opposed to the ages that they’re at now, we will see the homeownership rates increase?

    Ben Young: It’s an important cohort to talk about, but I’m also going to mention other cohorts because we need to put this in perspective. It’s interesting to see the decisions made by what we call Gen Y, which is the millennials, I’m actually Gen X, can’t believe it, but I am. And what the millennials are doing, they definitely show a preference for this live/work/play, no doubt about it, but it’s also important to understand where they came from, Oscar. If you think about their growth, they grew up in one of the great economic boom times of their generation when they grew up under their parents, and off to college, and now. But on the other hand, I think about my daughter’s generation, which is now going to be called the Gen Z. She’s 18 years old. And she grew up in families that experienced the Great Recession. Right, so think about putting that generation into that perspective, how are they going to view real estate and life given that backdrop? Will they be more conservative, will they think about the silent generation before the baby boomers and how they reacted to the economy? It’s all very interesting. Do I have the answer of how they’re going to affect real estate? No, but I’m absolutely confident about one thing. They’re going to embrace technology, and it’ll be a critical part of their lives.

    Oscar Pulido: It seems like the younger generations also care a lot about sustainability, we talk about ESG or environmental social and governance considerations. So, how does that affect real estate? I’ve seen buildings that say they’re green buildings: is that the way to think about it, or is there more to it?

    Ben Young: Yes, a bit, I’m glad you said that because they’re literally not green.

    Oscar Pulido: Right.

    Ben Young: But they’re involved in what we call environmental, social and governance, or ESG. And I think what is important to note is look, real estate provides a central services and tangible benefits to society, but the same time, as we talked about, they are physical structures occupying space in the communities that they serve. So naturally, they’re going to have an impact on the needs of society through this environmental and economic impact. The best thing I would say and to give you a description is, let me give you an example. We own a 1.8 million square foot office building in the Port of LA or the Port of Los Angeles. It’s a boring industrial asset if someone looks at it. But, what was really exciting given our intertwining with our real assets and infrastructure, we were able to look at the real estate value and say, how do we create value, not just as an owner but for the community and employees around? And long story short what we were able to do was to connect with one of the largest solar panel developers in the city of Los Angeles. And we leased out our roof to the solar panel developer and they installed over 50 acres of solar panels. It was the largest solar panel installation in the world until Apple’s headquarters came by, so now we’re the second-largest. So what did it do for us? It gave us a 3 and a half million dollar free new roof, it gave us income for ten years. But what else did it do? It created enough power to power 5,000 homes with renewable power, in the City of LA. That’s powerful. But it’s not enough. That renewable power mitigated 500,000 tons of what we call GHG or greenhouse gas emissions. If you put that in perspective, it’s approximately taking off 100,000 cars off the road in one year. Just as importantly, the rooftop was also installed by U.S. veterans who are now skilled in solar panel installation. Oscar, I call that a win, win, win, right? It’s a win for the investors, it’s a win for the residents, but just as importantly, it’s a win for the community.

    Oscar Pulido: It’s a great story of multiple facets of sustainability, and somebody in LA listening to this is hoping they heard that you actually physically took 100,000 cars off the highway, it would massively improve their traffic situation. But Ben, to think about your career in real estate, you’ve been doing this for over 30 years. What’s the one thing that has surprised you about the market and how it’s changed?

    Ben Young: First of all, thank you for dating myself, Oscar, I really appreciate that. But the one thing that I would say – and I think this is true for real estate but everything else is – the only think that remains the same is change. And it’s interesting. I recently read an article about the Koch brothers or the Koch family, for those who may not know of them, they’ve made a fortune on old school industries like oil and gas. But what they recently said about embracing technology is amazing. They said, do it, or you’ll end up in the dumpster. Totally shocking coming from that group. Billionaires who made a fortune by traditional means recognize that technology will disrupt every part of their life, and yes, what I would like to say, unitize everything.

    Oscar Pulido: And you’ve alluded to a lot of the things that are already changing in real estate, but if you had to look forward another ten years or so, what else do you see evolving in this sector?

    Ben Young: No doubt it’s technology. If you really think back, it wasn’t really until 2007 when the iPhone came out. That’s 12 years. Think about what technology has happened in those 12 years. All aspects of real estate are changing due to technology. New demand drivers, new threats, new tenant models, even new technologies to underwrite and analyze the management of properties. There has never been a time of more technological change in real estate than now.

    Oscar Pulido: Well thanks, Ben, I’m going to end with a rapid fire round, and in the spirit of looking ahead, I’m going to ask you tell me if you think the following things will happen in five, ten, thirty years or never, so are you ready for this?

    Ben Young: Sure, let’s go.

    Oscar Pulido: Brick and mortar is replaced with 100 percent online shopping.

    Ben Young: I’m going to go with never, Oscar. But it’s not in the not-so-distant-future that the share of e-commerce to total sales will be much higher. We think that is going to increase at a rapid rate. There will always be a place for physical retail, but the utilization of that physical space is going to be evolving like I mentioned before. More defensive retail, experiential, all will continue to support physical retail demand.

    Oscar Pulido: Autonomous vehicles surpass traditional vehicles?

    Ben Young: It’s a more difficult question. I’ll get to the timeframe at the end of my thought here, but the advances in technology are definitely accelerating in this space. Large investment is being made by automakers as well as governments that are trying to create new ways to connect and smarten the infrastructure. So really regulations may need some time to catch up to how quickly technology is going, but it’s funny. Back to your original timeframe. I think autonomous vehicles will be a significant part of our life in five years. But my daughter doesn’t think so. So who is embracing technology now?

    Oscar Pulido: Exactly. Scooters supplement traditional public transportation.

    Ben Young: I was actually recently on vacation back in July with my family in Paris, and we were just taking a tour down the River Seine and it was interesting. And so many people including myself used scooters to do some sightseeing down by the river. Within a couple of minutes, I figured out how to download the Lime App, how to sync it with the scooter and use it. So there is a place. I recently went on a property tour in Los Angeles, and Downtown Los Angeles there were scooters not only every corner, but every block, scattered all over the place. That’s a whole other question of how we fix that, but I do believe they will support public transportation. It will change over time, but it’s really in the near future; it’s this year and next year where it’s starting to support public transportation.

    Oscar Pulido: Well, and I can relate because the town that I live in has just had a whole army of these scooters unleashed on it recently, so I’m seeing the pros and cons to it. The last one for you is hyper-loops or what we know as high-speed trains between cities, come to fruition, again, five, ten, thirty years or never?

    Ben Young: Good question. The hyper-loop system is one piece of technology that has a real potential to disrupt a lot of key locations and bring cities together that either have high car volume traffic or even high air traffic, right. But while it’s an uncertainty and innovation that I think is going to occur, over the next century to give you a timeframe, Oscar, high-speed trains are an area where the U.S. definitely could see some benefits. But you’re going to need private and public stakeholders who are engaging this together, and the price tags are really steep. So it’s not just about technology; U.S. infrastructure needs a fair amount of improvement and a lot of money to bring the scalability to market. In 30 years, maybe.

    Oscar Pulido: Ben, this has been incredibly insightful. You mentioned your daughter a number of times, I think you said she was 18, which if I’m doing the math, means you’re going to be paying tuition and housing costs for a couple of years. So your real estate background is going to come in handy here. Thanks for joining us on The BID today.

    Ben Young: Thank you very much Oscar, and I think that I’m going to need another 30 years of experience for that.

  • Mary-Catherine Lader: Movies don’t exactly reflect reality. But there’s a lot they can tell us about how our society is changing.

    For example, in the 90s, as we were first mapping genes, Jurassic Park showed us an amusement park of dinosaurs brought back to life through the inconceivable magic of DNA. I’m not sure what it costs to map a dinosaur’s genome these days, but since that movie came out, the cost of mapping a human genome has dropped 99.9% from 14 million dollars to one thousand, and that’s enabled scientists to tailor breakthrough medical treatments to our individual DNA.

    Another example: The Terminator, or any other movie where robots threaten to take over the world. In a way, that’s right. Robots are a 15 trillion-dollar market worldwide. But they’re not a threat; many would argue they’re an opportunity. They help us avoid the dangerous jobs in resource exploration and manufacturing.

    On this episode of The BID, we’re discussing megatrends – topics once the stuff of science fiction but now becoming science fact. Megatrends are the long-term shifts in society that transform the way we live and work. They continue to capture our imagination on the big screen, but also every day, for example we see self-driving cars in San Francisco or read about China producing more billionaires than any other country in the world. They’re also changing the way we invest.

    Today, we’re going to talk about the five megatrends we see shaping the way we live, work and invest with Evy Hambro, Global Head of Thematic and Sector investing. I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Evy, thanks so much for joining us today.

    Evy Hambro: Thank you. It’s a great pleasure to be here.

    Mary-Catherine Lader: So, Evy, what makes a trend mega?

    Evy Hambro: The megatrends really are opportunities that we’ve identified, where we see significant structural, long-term drivers of change in the global economy that are matched to things that are fundamental beneath them. And what we think the output of that change is, that it would generate opportunities for companies to adapt and evolve their business, and new companies to start up, and they will benefit from the kind of tailwinds of growth that are driven by the changes and the trends that we see. So, as a firm, BlackRock has identified five key megatrends. One is related to technological breakthrough, the big shifts in demographics and social change around the world, the very rapid urbanization that we’re seeing of the global population. Clearly, climate change and resource scarcity are ones that are fronts of mind for most people. And the last one is obviously the big shift in wealth around the world, where there’s growing importance and emergence of the kind of middle class and increasing wealth concentrations in emerging economies.

    Mary-Catherine Lader: So let’s talk about urbanization for a minute. Infrastructure investing and infrastructure spending aren’t really new. So what’s different this time?

    Evy Hambro: The big driver is more people living in urban environments and the associated change with that. It can be related to infrastructure, so the obvious things that you would think about in terms of construction and so on. But, actually, you know one of the big trends of today’s world comes back to the concept of convenience and when we think about urban populations and the desire for convenience, one of the big shifts recently that we’ve seen with regards to eating habits is the reduced desire to eat out, and to have food delivered. That is a consequence of technology, which is one of the megatrends playing into or attaching itself to urbanization. So, the ability to be able to get cost-effective, efficient distribution of food to a point of consumption that is more convenient for the end-consumer, is clearly sitting at the kind of confluence of two big megatrends that are happening at the same time. You think about the concentration of people in urban environments and how they like to get around, whether it’s the sharing of mobility through different business models of ownership or transportation, whether it’s the evolution away from the combustion engine towards an electric vehicle, this is a huge subject.

    Mary-Catherine Lader: So, basically megatrends point to more food delivery. So, as a New Yorker, food delivery is a pretty familiar concept to me, but how is urbanization different in a developed country like the U.S. versus an emerging country or market like India or China?

    Evy Hambro: That, again, is a good question, and it varies hugely by country. If you think about the developed world and developed world nations, they have lots of infrastructure, lots of kind of traditional ways of doing things, whereas in the emerging world, there’s a desire not to be constrained by what they see in the developed world, but there’s an aspiration to have a standard of living that is similar. So, they didn’t want to go through all the iterations of development because they want to go to the best that’s available today, without trying to kind of put the historic infrastructure in place and then upgrade it, which is the burden that the developed world is having to carry. So, when you go to many of the emerging cities that are kind of under construction and evolving, you see phenomenal infrastructure being put in place immediately. The concepts to accommodate growth rather than the constraints of the fact that we used to have streets that were created because of the horse-drawn carriage and the weights that were attached to it. You know, they’re thinking about, “How do we get people moving around most efficiently, and what will that look like in the future?” So, I think there is a fundamental difference that we’re seeing playing out here between the developed world and what’s happening in the emerging economies.

    Mary-Catherine Lader: I’m curious how do you see the demographic change that you’re talking about playing out differently in different countries and markets?

    Evy Hambro: Yeah. So, this is a fascinating one and it’s a huge, huge topic. Longevity is clearly something that we’re all facing. It’s a benefit to us. The statistics say we’re likely to live for much longer than our ancestors did. There are consequences of that and there are benefits of that. The consequences is, it’s going to cost a lot more to sustain your standard of living throughout the duration of your life. And to go into old age with dignity is I think a desire for most people. So, you need to think about how you are invested, to be able to support your life post the most active periods of employment. You also need to think about the costs. What are the costs of living longer, whether likely to be, is likely to be a high-cost at the start, and it’s going to come with things that you aren’t incurring as a younger person. So, for us, as an investor, we need to think about what does that mean for business, what does that mean for the pharmaceutical companies, what does it mean for the care homes, how does society evolve? What does it mean for older people coming back into the workplace? What roles can they do? And we’re also thinking about it from the other thing, if I want to talk about the millennials or the younger population. How do they act as a consumer today that is different to how their ancestors acted as a consumer? Are they much more focused on not owning things? Do they want to go into the kind of restrictions of being committed to a mortgage and home ownership and everything else? Would they rather spend on an experience with technology or a luxury good? All of these things around the consumer and the shifts in pockets of the consumer because you have now a group of people that are living for much longer and you have at the other end of the spectrum a new group of consumers who are consuming in a different way.

    Mary-Catherine Lader: How is a demand for green solutions with the effects of climate change and other megatrend changing the way that cities are built?

    Evy Hambro: We’re definitely going to see change happening in that way and you’ve just got to travel the around the world to see that. You’re seeing much more renewable power generation being consumed and I think that’s a really great way for society to be thinking about the future. I think also, when you are thinking about the urbanization, you’re thinking about the impact of having more people living in a confined environment and how people are going to get on, how are they going to be transported, how are people going to act as consumers in that environment. Are we going to see changes in property prices? If we’re going to have a fleet of automated vehicles, we don’t need the parking spaces. What does that do for freeing up space in urban environments? So, I think technology is going to be impactful on the trend of urbanization. It’s going to allow us to live in a closer environment in a way that is different to the past and probably better than we would have imagined a few years ago when we look to the solutions of the future.

    Mary-Catherine Lader: So, it seems like technology underpins the five megatrends you mentioned, is that right and how do you think about that?

    Evy Hambro: So, we think about the megatrends as A, independent but also linked. Each one of them on their own is powerful. But when they converge is when you get the most change. So, technology is hopefully finding solutions to climate change. It’s changing the urban environment that we live in. But demographics are also driving urbanization. Demographics are also changing the way that we spend our money and changing how consumers consume and technology is also changing how people consume. So, the trends are identified on their own, but where they link up, it’s most powerful. And then when we think about the themes that we are using to play exposure to the megatrends, we think of three factors that are kind of the key parts of identifying a theme. The first one really is regulatory change. When we have governments coming into a business or to an industry and they are forcing change through regulatory powers, then that is an incredibly powerful kind of push factor that we see. When we have the next factor which is society, when society wants change, then you get two factors: that kind of pull factor coinciding with the push factor regulatory. And that will result in kind of the emergence of an inflection point for businesses to identify with. And then the last factor is really the economics. When the business today identifies a solution and they come up with something that is superior, either its lower cost or it does things better and you combine that with those other two factors, regulatory and society. When you get the convergence of all three together, you get to that inflection point of change in market share. And then you get these incredibly rapid growth rates that emerge. And that’s when the businesses really start to reflect the changes in the fundamentals that they’re seeing.

    Mary-Catherine Lader: So, you mentioned thematics, and the notion of being able to invest along a theme is so logical. How long has this been around, how big is it now, and why is it getting particular attention at this point in time?

    Evy Hambro: I think the main thing that I have noticed, as a result of this role, is that we couldn’t have done what we do today a few years ago. We just didn’t have the access to the data. It wasn’t available to us. We couldn’t identify the subthemes of revenue that we can now look at using the tools and information that we have right now. So, for example, we can, rather than looking at a company’s set of accounts and looking at one revenue line, we can now dig into that revenue line for a company and we can see the different points of sale, and we can break down that revenue line into a whole range of different subcomponents, and we can therefore see if we’re targeting a certain theme, how much a company is exposed to that theme as a percentage of its sales. That is an area that we’ve never had the level of visibility that we have today. We haven’t had that before and so, therefore, our ability to construct portfolios more accurately to give the desired outcome that we’re trying to solve for is just brand new.

    Mary-Catherine Lader: So, you talked about getting granular about revenue, you can probably also get a little more granular about cost. As companies are pushing for more automation and robots are getting more sophisticated, there is a growing narrative that there is an opportunity for a lot of cost saving and perhaps a lot of job loss unfortunately with more automation. On the flipside, an optimist could suggest that humans will just do more engaging work and robots can do the things that we don’t want to do anyway. What’s your view, data-driven or not on that particular question about the impact of AI and automation on work?

    Evy Hambro: Yeah, I think this is a very emotive subject and you can have a polarization of views here as you’ve said. You can have a landscape that looks quite scary with people being put out of work. Think about the automation of driving and what that does to transportation and the jobs that are attached to that. But I think one of the things that gives me a kind of more optimistic outlook is that we’ve seen increasing levels of automation and change over many, many decades, centuries and things going back into the past. Each time, the human workload hasn’t changed massively. There’s just been new roles, new jobs that are being created on the back of this, and new industries arise, people go into different skillsets. So, I think that rather than looking at it too pessimistically, I would think more optimistically and think about what are the benefits to society of automated driving? What will happen to the cost of transportation? It will probably fall beyond everyone’s imagination to incredibly low levels as cars get high utilization rates. You remove the cost of the driver, you reduce the cost of insurance because of the reduced frequency of accidents and so on, the increased safety on the roads. What does that mean for access? People who couldn’t afford the level of transportation that they were able because the cost was too high, can now get access to it at a much, much lower entry point. And so, what does that mean for their standard of living? How does that improve? So I think there’s a whole range of consequences that are incredibly difficult to forecast accurately when you’re thinking about very big subjects like this. But I would tend to look more optimistically because that’s what has happened in the past.

    Mary-Catherine Lader: That makes sense, it sounds good. So, some of this is driven by innovation and innovation doesn’t necessarily do a sustainable business. There’s plenty of examples of that in today’s market with lots of early stage funding and a focus on innovation perhaps over the business at times or in economics. Where do you see innovation not occurring? Are there areas that are overlooked?

    Evy Hambro: This is a question that often we raise in company meetings and we talk about it to management teams. We say, “What threats are you seeing as business?” Because innovation is both an opportunity and a threat, and if you are not ready for change as a business and as a management team, then you probably are about to be out of business. So today, we’re in an environment where the cost of technology is much lower than it was in the past. The productivity that’s going to come through technology is going to continue to increase. So therefore, that’s going to change people’s perspectives on how they can do business, the cost of doing business and what they can actually do and achieve. So, I continue to be incredibly excited about the benefits of innovation and when we think about it, everything is available to be changed, to evolve, to be disrupted. That’s what makes investing thematic so exciting because when you think about it from an active investment point of view, you’re always looking forward, you’re always trying to think about what’s next? You’re trying to think about which companies are going to grow faster? What opportunity sets are going to come along? You’re also thinking about which companies are going to be disenfranchised. And so having a portfolio that’s able to evolve as the markets evolve and hopefully before they evolve, because we anticipate that change and look to benefit from it, then that to me is a real source of true investment management.

    Mary-Catherine Lader: So much of what we’ve been talking about feels very contemporary, very current. I’m curious, do you see these megatrends as generational in some way?

    Evy Hambro: Yeah, I would say that the trends that we’ve described at the start of this are likely to be around beyond generations. We talked about demographics, demographics are multi-generational. Urbanization has been happening over many, many generations. I think resource scarcity, hopefully, we get to start solving some of the problems around climate change and resource scarcity so that we have generations in the future to look forward to. To live in a world that isn’t too badly impacted by the way we’ve been doing business in the past from an industrial point of view. So, I would like to think these megatrends are going to be around for a very long time.

    Mary-Catherine Lader: One last question before we wrap up with a rapid-fire round. What does this mean for the retail investor?

    Evy Hambro: I think there’s multiple things here. When I talk to kind of my parents about investing, they’re not interested when I start talking about long duration currency swapped products and things, you know, I don’t think they’re interested about factors and so on. When I start talking about, “Oh, my goodness it’s amazing young people today. They don’t want to go to a bank, they want to bank online. Or it’s likely that the next car is going to be an electric car, not a combustion engine.” It brings the themes to life, but it also brings the investments to life. You create stories that people can relate to and they say, “Oh, actually, I’m seeing more electric vehicles on the road. This has to be a growth opportunity. You know, I haven’t been to a restaurant this week because I had all my food delivered to me through some kind of delivery service.” When you can create a portfolio that allows you to invest directly in what you’re seeing and how it’s affecting your life, that really makes investing tangible and I think that’s incredibly powerful.

    Mary-Catherine Lader: So, I’m going to end with the rapid-fire round. I’m going to ask a series of questions, this or that questions related to some of the megatrends and themes that we talked about today. Are you ready?

    Evy Hambro: Yeah, absolutely.

    Mary-Catherine Lader: Real meat or fake meat?

    Evy Hambro: There’ll always be a market for real meat because there’s always a legacy market but I think the direction of travel is that people’s spending habits are going more towards the kind of the alternative because they are thinking about the impact, not just the cost but the actual impact of food production. Also, I think technology has allowed to create the alternatives. Having experienced some of these new products, they taste just as good. So, as a traditionalist, I know which way I would naturally lean but I’d been amazingly impressed by the alternative.

    Mary-Catherine Lader: Interesting, okay. Real assets or crypto assets or both?

    Evy Hambro: Yes. I’ve been skeptical of crypto assets for a very long time and I think that’s because they’ve been described to me in a very straight forward fashion with regards to crypto currencies. But I think the underlying technology behind them has a role to play and clearly, we’re seeing more and more business aligned in this way. So, I think the technology behind it is likely to be a winner, but I’m not so sure about the underlying coins.

    Mary-Catherine Lader: Combustion engine or electric car?

    Evy Hambro: We have to evolve away from the combustion engine. The world can’t continue in a way that it’s done so for the last hundred years. So, we have no choice but to move away from the combustion engine. I think the next step is electric and then maybe beyond that we have another alternative. Maybe it’s a fuel cell-driven vehicle or something like that. But the key to solving for this and for many of the other things that we are looking at with regards to, say, renewable power is cracking the chemistry of batteries.

    Mary-Catherine Lader: Last one, ownership or sharing?

    Evy Hambro: I would like to think that society wants us to move towards a more of a circular economy and it’s something that I’m very passionate about. I think we are in an environment where resources might not necessarily be scarce in terms of the true definition. But the cost of production isn’t just about the money, it’s about the impact of production. And if we can find a way of making sure that we’re getting the maximum out of the above ground resources, whether they are using a car today that sits still for 95% of its life, we can find a way of getting capacity utilization up to 50% and that has to be more efficient. It has to be better for the world. It has to be better for people and the costs of use. I am very much in favor of moving away from the kind of full ownership and going towards a much more circular economy and one of the areas that I would be sharing.

    Mary-Catherine Lader: Thank you so much Evy for joining us today. It’s been a pleasure having you.

    Evy Hambro: No problem. Thank you for the opportunity.

    Mary-Catherine Lader: Visit to find out more about megatrends and how to invest.

  • Mary-Catherine Lader: Here’s a story for you. A well-known home goods store starting selling a bread machine. When the bread machine first came out, sales were, perhaps unsurprisingly, slow. But then they put a deluxe version out that was 50 percent more expensive. And suddenly, the original started flying off the shelves. When it was put next to the new version, it was a bargain.

    Here’s another story. Duke students slept outside for weeks to get basketball tickets. Some students got tickets and some didn’t. The students who didn’t get tickets said they’d be willing to pay up to $170 dollars for tickets. And those who did, said they wouldn’t accept any less than $2,400 for their tickets.

    So humans are irrational. We learned this from Dan Ariely, behavioral economist and frequent user of that word, “irrational.” But when it comes to money, we’re even more so. We’re biased, we compare prices and the value of things relative to what is sitting next to them, and other arbitrary markers. We perceive what we own as more valuable simply because it’s ours. And when we have a chance to get something for free, we’ll wait in line, even if it means waiting for hours just to get it.

    On this episode of The BID, we’ll continue our discussion of behavioral economics with Emily Haisley. Emily leads BlackRock’s behavioral finance initiatives, where she focuses on how she can help portfolio managers and investors make better decisions. I’m your host, Mary-Catherine Lader, we hope you enjoy.

    Emily, thank you so much for joining us today.

    Emily Haisley: It’s a pleasure to be here.

    Mary-Catherine Lader: So on our last episode, we spoke with behavioral economist Dan Ariely. You are a specialist in behavioral finance. Now Dan defined behavioral economics as the study of how and why humans behave irrationally for various reasons, as opposed to the perfectly rational model that economists have historically worked from. So what is the difference between behavioral economics and behavioral finance, which you’re focused on?

    Emily Haisley: Well, they’re highly related topics. They are both obsessed with this distinction between what the economically optimal thing is to do versus what people actually do when you empirically measure them. And it’s just really that behavioral economics is more broad. It looks across all areas of economic life: savings, spending, altruism, incentives, negotiation, cheating, all things economic, whereas behavioral finance really zeroes in on the behavior of investors and how their individual biases might aggregate at the market level. But I’d say both of them really use psychology to explain this difference between what is economically optimal and what people actually do and may use psychology to try to fix it, to try to bring them closer together.

    Mary-Catherine Lader: So how did your team come about?

    Emily Haisley: The team has been around for about two and a half years, and it came about because of the co-heads of Risk and Quantitative Analysis had this realization that risks don’t only come from markets. Risks can come from investor psychology, the people making the decisions. So psychology matters, and when they looked around at the diversity in RQA, they found that there were very few people that had training in psychology and so they thought, ah ha, this is a risk, we have to get some of that talent in. And the burgeoning field of behavioral finance just has paper after paper after paper saying why psychology is important for investment decisions.

    Mary-Catherine Lader: What does that mean in practice? What does that entail?

    Emily Haisley: So, what we’re doing is taking all these biases identified in the academic literature, and trying to find them in our BlackRock portfolio managers and fund managers. And the idea is that if we can measure and identify their biases, we’ve struck gold because where we see a bias, there is an opportunity to either have them take risk in a more efficient way or to potentially improve their performance. Now, the way that we find these biases is we look at various different types of data, so we might just look at their fund history of holdings and transactions and performance. We may ask them to give us some data, so we have a trade diary project where we have some fund managers record their rationale, the time that they trade, and then we can do really cool analyses using natural language processing to take that free text rationale, put it into trade categories that can be analyzed, and link it to trade level performance. And then we also look at how they interact in groups, so we observe teams and look at data related to the team dynamics. And then finally, we even look into investor physiology, so we look for biases not just related to the brain but also biases related to the functioning of the body.

    Mary-Catherine Lader: So those are so many interesting questions. Of all those lines of inquiry, what finding has surprised you the most?

    Emily Haisley: Gosh, so I have to say that this is going to sound boring I think, but it’s just the variation. The natural variation that you see from person to person as individuals. I come from an academic background, and you’re just used to looking at experimental group 1 versus experimental group 2, and looking at average behavior. And so now I’m looking at individuals, so you get to know individuals on a really personal level, about their strengths and their weaknesses, the motivations for their decisions, and it’s just that no two people are alike. A bias one person may struggle with is not an issue at all for another, and vice versa.

    Mary-Catherine Lader: So one of the projects you’re doing is at the physiological conditions, and how that impacts an investor’s behavior. What are you doing and what have you found so far?

    Emily Haisley:  Yeah. Well, so far we’ve just ran very small pilots on this topic, but we are poised to scale right now. And what we do is we actually measure investor physiology using several pieces of wearable technology. So one is a ring. And this gives us investors’ sleep, stress levels, activity levels, on pretty much a daily basis. It takes really accurate measurements while they sleep. And we also use something that is worn on the upper-arm that gives us basically real time stress levels during the day as they’re making decisions at work. I should stress that this all completely voluntary. Just whoever wants to participate can, nobody is obligated to. And it’s also completely confidential, so everybody controls how their data is used and who sees it. And the goal is pretty simple, the idea is that we want to help employees succeed and if they take care of themselves, they’re going to perform better. We know that chronic stress drains performance, and moreover, chronic stress actually kills risk appetite, which is essential for investors to be able to take risks and be sensitive to opportunities in the market. As opposed to becoming insensitive to those opportunities, because their bodies are fatigued or stressed.

    Mary-Catherine Lader: So once you’ve uncovered a bias or a certain trait for an investor—it sounds like you work with both traders and investors, right?

    Emily Haisley: Mainly with fund managers, hedge fund managers, yeah.

    Mary-Catherine Lader:  Okay.  So once you uncover a bias that a fund manager might have, then do you work with them to alleviate it, to avoid it the next time?

    Emily Haisley: Absolutely, yeah. We’ll measure biases, we find one, and we can offer some help, some guidance. And then we show the evidence, they quite rightly kick the tires on it. We’ll then implement different interventions for overcoming the bias. And again, this depends on what exactly the bias is, it depends on if it’s coming from the individual or whether it’s coming from the team, so very personal in the recommendations we give.

    Mary-Catherine Lader: What other biases do you see in people who are managing portfolios and fund managers, and how do they come about? Are they earlier on in a career, do they get more pronounced after years of experience?

    Emily Haisley: I think that this is a really interesting question and one that deserves a lot more study. I don’t have an answer for every bias, but one really common bias is called the Disposition Bias. And this is related to loss aversion. Our brains are kind of wired to encode losses as twice as painful as an equivalent gain is pleasurable. And this is so hardwired, even monkeys show loss aversion when you let them use currencies and tokens that they can exchange for grapes and cucumbers, and let them gamble with coin flips and things like that. And what this leads to in investment decisions is sometimes if you buy a security and it doesn’t perform well, you may hold onto it for emotional reasons, rather than rational reasons. You may hold onto it because you don’t want to realize a loss, you don’t want to crystalize loss and feel that pain. So there is this tendency, particularly for retail investors, or everyday investors, or for more junior fund managers, to have the Disposition Bias, to not want to admit when they’re wrong, to not want to admit defeat. And then as investors get more and more experienced, they realize that in markets, you’re wrong all the time and if you’re slightly more right than you’re wrong, you can outperform. So they kind of get used to being wrong to accepting their mistakes, and they develop a discipline for cutting their losses. So the Disposition Bias tends to be one of the first ones that goes away.

    Mary-Catherine Lader: And do some biases come up at different times of day, different times of year? What kinds of context and external conditions can investors control?

    Emily Haisley:  Yeah. There are all different biases related to calendar effects and related to weather effects, things related to the outcomes of sports games. When your country’s team loses, the investors become more pessimistic. Over the course of the day, because we’re looking at investor physiology, one of the findings that we notice is that people have these natural rhythms through the day of when they’re having greater readiness or greater levels of energy, and then they typically kind of hit a trough towards the middle of the day, and then might come back. And there are individual differences, some people are more morning people, some people are more evening people. But what we notice is that investors’ conviction throughout the day—so how much conviction they have in particular trade also follows this diurnal rhythm, this intraday variation in readiness. So they maybe have les conviction in a particular investment idea, simply because they’re picking up on an internal signal from their body that may be a bit fatigued rather than information about the fundamentals of the company.

    Mary-Catherine Lader: These all sound kind of personal in getting to know these subjects, if you will, pretty closely. Do you find that people you are working with get a little defensive or don’t really want you to know so much about them?

    Emily Haisley: Well, I don’t really so much think of them as subjects as more like almost like clients. Like they are people that I’m there to help and to support however I can. And the more data they give me, the better I can support them. But in answer to the question about defensiveness, I was shocked that they aren’t more defensive. I’m really surprised—pleasantly surprised by the culture here, the fund managers. They have what psychologists call a growth mindset, in that they don’t believe that skill or intelligence is fixed, it’s not something you are just born with and then that’s it. They have the belief that through hard work and persistence, and constantly evolving their investment process, they can get better and better over time. And so they see behavioral finance as a way to do that, as a way to get an edge.

    Mary-Catherine Lader: Have you all found that biases ever result in better decision-making?

    Emily Haisley: I think that typically biases are defined by people making decisions that are not optimal in some way. Normally that’s in some kind of economically rational way. So it may be that if you define the outcome of a decision as, “Are you maybe happier?” maybe then biases can help you. But you’re typically poorer as a result. For example, the decision to play the lottery. Many people think that is related to a bias of overweighting the small probability of a win. So lotteries are clearly not great investments, they have a highly negative expected value, but they may bring you some joy. Some excitement, some entertainment value. But I will say that biases, while they generally don’t result in economically better decisions, the whole nudge literature is based on this idea that you take biases that normally work against people and turn them around to work for people instead. Let me give you an example. In some research I did in academia, we tried to use lotteries which are normally seen as playing lotteries as a bias. And we used them to supercharge incentives for preventative healthcare in a company that was trying to promote better healthcare in its employees. So we ran an experiment where we compared giving a financial incentive for participation in preventative healthcare program as a lottery, or you could have the expected value of that lottery for sure. And we found that there was much better participation with the lottery incentive.

    Mary-Catherine Lader: You’ve also run a study where employers emailed employees about contributing to their 401(k) and just like tweaking little bits of language here and there, a couple words had an impact.  So can you talk a bit about what you found there?

    Emily Haisley: This paper was called “Small cues change savings behavior.” And in this we found that by giving people either a high or low anchor as they were considering how much they should save for retirement, dramatically influenced how much they would save. So consider increasing your savings contribution, you could perhaps increase your contribution by 15 percent, a high number. Very few people actually did that, but it dragged up the amount that people were actually were willing to increase their savings contribution. And this was much higher than if you gave them a low anchor saying, consider increasing your savings contribution by say one percent. Then we actually dragged it down a little bit relative to control groups. And I think this really emphasizes for people who are trying to implement these nudge policies to really test their interventions, experimentally, scientifically, and make sure that they’re nudging people in the right direction.

    Mary-Catherine Lader: There are a bunch of nudges already incorporated in 401(k) plans; employer match, and automatic enrollment set up. So what are those plans doing right, and what could be improved?

    Emily Haisley: Well yeah, I think these plans have come a long way in terms of incorporating lessons from behavioral psychology. In terms of how they can improve it, I think that the use of technology could dramatically improve outcomes for people. And increasingly, they’re starting to use apps. So putting in the palm of someone’s hand the ability to really easily increase your savings contribution is really important. And particularly, if you’re going to deliver financial education seminars, everyone in the seminar might agree, yeah, I want to increase my savings contribution. But then when they leave, life gets in the way. And they may not have their log-in details and they may not exactly remember what it was they decided to invest in, et cetera, et cetera. So putting it right in the palm of their hands so they can take action immediately, I think the impact of that cannot be underestimated. And then moreover, you can incorporate all types of nudges into the app. So for example, you could give them high anchors, you could try to get them to do impulse saving. What is really successful is having people commit in advance to not save right now today, but to increase their contribution rate at the time of their next bonus or the time of their next pay raise pay raise.

    Mary-Catherine Lader: How does this apply to everyday investors, people who may trade stocks in their spare time, or who are planning for retirement, for example?

    Emily Haisley:  I’d say there are a couple of biases that are really important. The first is loss aversion, which we touched on before. The thinking about losses in the near term that comes when you begin to invest can really put people off investing. They tend to overestimate the probability of the loss and intuit that if they have a loss, it’ll feel really bad. And this can stop them from investing for their future. Economists often puzzle at why stock market participation is so low, so this idea of loss aversion can help explain it. Another example for everyday investors is that sometimes things that feel really safe are actually really risky. The safety is just an illusion. For example, investing in stocks from your own country, the country you live in, can feel less risky than investing abroad. Or investing in companies that you’ve heard of, like high street companies or household names, just because you know a lot about the company can make it feel less risky than it actually is. And so investors may under-diversify globally, or under-diversified within their stock portfolio as a result.

    Mary-Catherine Lader: And does something about our personal backgrounds inform those sorts of behaviors? For example, if you came of age during a recession or financial crisis, how does that affect peoples’ loss aversion or other biases?

    Emily Haisley: Yeah, absolutely. This is called the Depression Baby Hypothesis. And it’s this idea that whatever slice of financial history you experience is going to shape your risk preferences, your anxieties about inflation, and affect your investment decisions. In a really clever application of this, there is a recent finding that Fed bankers who set monetary policy, their forecasts, the hawkish or dovishness of their speeches, and their voting record is predicted by their birth year. By how much inflation there was over their lifetime.

    Mary-Catherine Lader: And what’s the science on bubbles for example? So I’m just thinking of other behavioral trends that have a historic impact on markets. Is there any science around massive buying behaviors that are divorced from fundamental value for example, that create bubbles?

    Emily Haisley: I think there are a lot of things that contribute to bubbles. You can think about herding behavior and this fear of missing out, and people talk about irrational exuberance. One of the funnest studies that’s looked at this is in this new field called neuro-economics, where they actually put subjects in fMRI machines, so they can see their brains. And in one study, the experimenters used an experimental trading market, where they knew bubbles tended to form, and they thought, okay, what’s leading to this irrational exuberance in their brains? And they expected emotions might be involved, so they were focusing in on emotions centers of the brain, and sure enough, they found that as the bubble was forming, there was this excess activation in the reward pathway of the brain. And so the reward pathway was leading to the value of the securities and overshooting their fundamental value. And so you might conclude from this, that okay, we’ve got to take emotion out of investment decisions, emotions trip us up, but it’s not that simple. What the investigators also found is that there were some participants who sensed that the bubble was about to burst and got out before it burst. And they were like the best performing subjects in terms of the amount of money that they made in the experiment. And what led these subjects to get out before the burst was also an emotion. It was activation in emotional center of the brain related to pain, discomfort, even disgust. And if you think about disgust, that’s an emotion that makes you spit out something, reject it, and that is exactly what these participants did. They had this emotion of disgust as an early warning signal that gave them the intuition to get out before the bubble burst.

    Mary-Catherine Lader: So can you test investors for disgust but then give them the courage to act on contrarian views?

    Emily Haisley: If only I had an FMRI wand, yeah, you’d better believe I’d be using it. But alas, the technology is not there yet.

    Mary-Catherine Lader: This is so fascinating, we could keep talking for a long time. But I’m going to end with a rapid fire round. So, I’m going to ask you a couple questions and answer each of them in one sentence or less, ready?

    Emily Haisley: Ready.

    Mary-Catherine Lader:  Okay.  So you’ve consulted companies like Google, McKinsey, obviously BlackRock, banks, and even the U.S. Department of Health and Human Services, in your behavioral science research. What one project across all of those, not just in the realm of behavioral finance, has surprised you?

    Emily Haisley: Well, I’d say rather than one project, it’s been a commonality across all of them that psychological framing of a decision trumps economic incentives.

    Mary-Catherine Lader: What’s a behavior of your own that you’ve tried to change based on your expertise?

    Emily Haisley: Every single aspect of myself. So how much I eat, how much I exercise, how much I procrastinate. I’m constantly trying to nudge myself towards better behavior.

    Mary-Catherine Lader: So what do you do to stop procrastinating?

    Emily Haisley: So actually, Dan Ariely’s work really influenced me there, where he has a paper on the impact of deadlines. And how much better students do if they have intermittent deadlines rather than just one deadline at the end. So I carve out my tasks with intermittent deadlines, and then to avoid procrastination, I just plan enough time to work to meet the deadline with a bit of a safety factor.

    Mary-Catherine Lader: Interesting. What is the secret behind being a smarter investor?

    Emily Haisley: This is a self-serving answer, but know the common mistakes and know your biases.

    Mary-Catherine Lader: Best book recommendation on behavioral science?

    Emily Haisley: Far and away, Michael Lewis’s book, who is the author of The Big Short, The Undoing Project.

    Mary-Catherine Lader: Interesting. And then based on all of your expertise and study of this subject, does money buy happiness?

    Emily Haisley: So savings buys happiness. It’s not that more income is going to make you happy, it’s being able to live within your means and having enough of a saving and investment buffer that lasts a long time if your income were to stop coming in today gives you peace of mind.

    Mary-Catherine Lader: Fascinating, thank you so much for joining us today, Emily.

    Emily Haisley: Thank you very much, Mary-Catherine.

  • Mary-Catherine Lader: What’s something irrational you did today? Hold that thought. Here’s what people said when we asked around.

    Female 1: I spent more money on a flight because I had credit card points that I could use, even though I could have used them on anything, but I just bought a more expensive flight.

    Female 2: The most irrational thing I did today was started a fight over nothing with my husband.

    Female 3: I packed my lunch and I worked really hard to pack it and forced myself to bring it this morning, and then I bought lunch anyway.

    Mary-Catherine Lader: Despite our efforts to make every decision right or to go through a day without making mistakes, it’s pretty much impossible to actually do that. You buy a shirt you don’t need, just because it’s on sale. Or you buy $4 – well, in New York, $5 coffee even when there’s cheaper, equally-good coffee across the street.

    On this episode of The BID, we speak to an expert on irrationality: Dan Ariely. Dan is a renowned behavioral economist and a professor at Duke University. There, he co-founded Common Cents Lab, a nonprofit focused on increasing financial well-being for low-to moderate-income people in the United States. BlackRock is working with Common Cents Lab to help people build emergency savings.

    Dan has published six books, given six TED talks, and co-founded five startups. In fact, he ends his emails with a signature sign-off: “Irrationally yours.”

    Today, we’ll talk about just that: what makes us irrational, particularly when it comes to money, and how behavioral economics can help us tackle big issues like the short-term savings crisis and the retirement crisis.

    I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Dan, thank you so much for joining us today.

    Dan Ariely: It is my pleasure.

    Mary-Catherine Lader: So let’s start by explaining perhaps an often-used term that may not be totally well-understood by all those who throw it around: what exactly is the behavioral economics?

    Dan Ariely: Yes, it’s actually I think not exactly understood even by the people who practice it. So, behavioral economics is really easy to understand in contrast to standard economics. So what is standard economics? In standard economics, we assume that people are rational. That people take all the information into account, that people can think into the future, they don’t have emotions, and so on and so on. And because of that, we think people always, always, always make the right decision. In behavioral economics, we say, not so fast, let’s not make assumptions about people; let’s just put people in different situations and see how they behave. So the first difference is that social science and behavioral economics are experimental in nature, rather than based on assumptions. And when you get people to behave, you see that they’re often irrational. And now comes a really interesting point is if you believe that people are rational, you will build the world in a certain way. You would convince people to stop smoking or stop texting while driving in one way. But if you believe that people are irrational, in systematic and predictable ways, then you would go about improving the world in different ways, right, you wouldn’t necessarily say to people, hey, did you know that texting and driving is dangerous, stop immediately; you would do other things. So the difference is about the assumptions, how we learn about people, and what are the implications for improving society?

    Mary-Catherine Lader: So is there a magic answer about what exactly makes us irrational, and how those solutions designed for irrational humans are different? Or is it different depending on the kind of choice you’re solving for?

    Dan Ariely: Yes. So, there is one way to be rational and there are many ways to be irrational.

    Mary-Catherine Lader: So it’s not so simple.

    Dan Ariely: It’s not so simple. And it depends on the level of granularity that you want to talk about. So, if you’re trying to think about the most general case, you could think about evolution. And you could say, our brain was developed to deal with an evolutionary environment that is very unlike the environment we’re in right now. Just think about the differences of running in the savannah and being afraid from a tiger to being afraid that your stock portfolio is going up or down. And then if you get to more specific levels, and you say, but is there one reason? The answer is no. For example, one reason is emotions, right, emotions get us to be derailed from our long term best interest many times. We have things that have to do with our difficulty in computing things, difficulty in holding multiple hypotheses in mind, difficulty of thinking many steps ahead. So there are many, many things that we do wrongly on this specific level, but they all stem from this fact that we’re basically utilizing brain mechanisms, think about them as tools, in a way that they were not designed for.

    Mary-Catherine Lader: We talk a lot on this podcast about choices people make around money, whether they’re professional investors or individuals. You started Common Cents Lab, essentially a research organization to help focus on better decision making around money. What is specific to irrationality when it comes to how people engage with money?

    Dan Ariely: Yeah. Can I ask you if you thought about your biggest money mistake, what was it?

    Mary-Catherine Lader: It’s not investing enough soon enough; it’s waiting too long to try to make the perfect decision.

    Dan Ariely: Yeah. So one is procrastination, just delaying, and that actually has a few causes to procrastination. And then the second thing is not sacrificing enough now for the future.

    Mary-Catherine Lader: Yeah.

    Dan Ariely: Which is to say, I see a new bicycle now, I really feel like it, it’s really wonderful. If I delay to the future, how exciting is that? Not very exciting. So if you think about the process of de-cumulating wealth, and making the rational decision, it’s really, very, very tough. You need to know how long you’re likely to live, and what will you need in retirement. If I told you, you were going to die at age 50, life is much simpler from computing how much you need to save. But if you don’t know if you live to 60 or 100, now things are very difficult. So the thing about money is both that it’s a wonderful, wonderful invention, it’s at the level of the wheel in terms of its contribution to society. It’s unbelievable what this abstract notion is doing to us as a society in a good way. At the same time, really hard to think about it. And I’ll give you one example, we went to a Toyota dealership a few years ago. And these were people who went to meet the dealer, they knew what the price of the car was, and they had to decide yes or no. And we stopped them, and we said, “Look, if you are going to go ahead and buy this car, what would you not be able to do? What is it coming instead of? What is the opportunity cost?” And people had no answer. Why? Because they never thought about it. So we pushed them and pushed them, and then the most common answer we got was, “If I go ahead and buy this Toyota, I can’t buy a Honda,” which of course is not the answer we were looking for. The answer we were looking for is, this is going to be instead of three weeks’ vacation for the next three years and 700 lattes and 16 books and so on. It turns out that the most beautiful thing about money which is that we can buy lots and lots of things with it, is also what makes it really hard to think about. The abstract notion. So if I gave you now $3 dollars, what exactly did I give you? How exactly do you think about it? Do you think about the marginal value of $3 dollars? No. By the way, it’s a simple representation. We find that we have a much easier time getting people to do something for a cappuccino than for $3 dollars.

    Mary-Catherine Lader: That’s fascinating. Why, they didn’t trust you when you offered the $3 dollars? The value is different to everybody?

    Dan Ariely: It’s the representation. Imagine I was on the street corner, I said, “Hey excuse me, will you fill a survey for $3 dollars?” What exactly is this $3 dollars giving you? It could give you a cappuccino, but it could give you a lot of other things. But at that moment, you’re not thinking about a cappuccino, even something better. But when I say, “Would you fill a survey for ten minutes for a cappuccino?” Now all of a sudden, you represent the value of what you’re getting. And that is part of the challenge with money is we have a hard time representing the value of money. And because of that, we make lots of mistakes in how we spend.

    Mary-Catherine Lader: So what are some practical real world examples of trying to help make people make better decisions about money? Particularly decisions in the moment that have the kind of future implications you’re talking about?

    Dan Ariely: So I’ll tell you about some tricks we found in the lab and there is a digital wallet called Capital that implemented it. There are some things that are bills that are just coming out. But the things we have control over are discretionary spending, restaurants, cabs, coffee, beer, supermarkets.

    Mary-Catherine Lader: Right.

    Dan Ariely: Now if you gave people a monthly budget for these things, we find that people run out very quickly. Let’s say your monthly budget is $2,000, you look at it at the beginning of the month, you say, look at me, I’m so rich, I have $2,000, and two weeks later you’re at zero. So we found out that a month is too long of a timeframe to plan, so we pushed it for a week. And then we found out that a week that starts on Friday is very different than a week that starts on Monday. If the week starts on Friday and I give you $500 in this spending account, people spend way too much on the weekend. If I put it up on Monday, it will savor for the weekend. So this company called Capital took this idea seriously. And they give people a prepaid debit card. And they load up the amount of money that you need for the week every Monday. And they show you how much money you have from your plan. So that’s one trick, and of course you could do it yourself; you don’t have to do it with somebody else, but the idea is the month is too long, get it to be weekly, start the week on Monday.

    Mary-Catherine Lader: Picking the number, the right number is a whole other question I’m sure.

    Dan Ariely: That’s right. It’s not basically pick a number and the dangerous thing to do is to see what have I been spending so far? And just using that number, because that is a recipe for repeating past behavior. What you really want to figure out is what kind of joy am I getting? And that’s another study we did is we asked people to look at their spending and for each spending event, we asked them to what extent they were happy with this and to what extent they regret it. When we buy things, it’s always with an eye to the future: how would I feel if I got this, how would I feel if I did this? We don’t very often go back and reflect on what we’ve done, and say, was this a good decision or a bad decision? And when we get people to do that, there is lots of categories that people say, I did spend way too much money. By the way, the leading category that people regret is eating out. And it’s not because eating out is a bad idea, it’s because they eat out, they eat too much, they drink too much, and they regret all of those the next day. So trick number-one is weekly budget, starts Monday; trick number-two is from time to time, think about what makes you happy. And part of the challenge in the world is that everybody wants something from us, every app, every coffee shop, everybody wants our time, money or attention right now. And because they design the environment, they have a really easy time derailing us from our goal. So let’s say you go to the supermarket, and you have a goal of what you want to get. The supermarket also has a goal, it’s just not the same as yours. And guess what, they decide what is going to wait for you by the cash register, and they decide to put things in there that would ignite your emotions and get your curious and make you likely that you will buy it. They don’t put the tomatoes and cucumbers there. So, another important thing is to try to remember what we’re working towards, what we really want, and not be swayed as much by the environment, and that is also why having discretionary spending is good. For example, I’ll give you my own example, I think I need to change my car in three years. And every time I get a salary, there is a fixed amount of money that goes to a separate account for my future car. And I don’t trust myself if it’s in my checking account, I could just say, here is my balance, minus something. I basically want to see the balance actually reflecting more correctly what I have. And for the goals I want, I try to move the money to those goals automatically, so that it accumulates and I don’t have to worry about it.

    Mary-Catherine Lader: So is this what you call choice architecture?

    Dan Ariely: All of this is part of choice architecture, absolutely. So choice architecture is the idea that the design of the environment really matters, you design the environment one way, you’ll behave one way. If you put the fruits and vegetables in your refrigerator in the bottom drawer, you will not get to it very often, and by the time you do, they’ll rot. If you put them at eye level, you eat more fruits and vegetables, right, if you set up things to move money automatically to some categories, you’ll have money for those categories, if it doesn’t, you’ll find ways to spend it on other things.

    Mary-Catherine Lader: So then how does this apply in the context of professional investors? You could argue the incentive is pretty clear: professional investor or portfolio manager has to make money to earn a return, whereas maybe in our personal lives, as you’ve been talking about, sometimes it’s hard for us to be really honest about our goals or to size them appropriately. What have you learned about choice architecture or controlling for the irrationality in investing in public markets, for example?

    Dan Ariely: Yeah, so this belief that the moment we become professional we become somehow better is really interesting. So you could say, maybe if it’s not your money, you don’t care so much, so you’re not as emotionally invested. But of course we pay financial advisors proportional to how much money they make, so it is their money. You could say maybe getting a lot of training is helpful, like professional chess players, they’re really good, they play, they play, and they’re really good at it. But to develop that, you’ll need a lot of repetition and you’ll need accurate feedback. The stock market of course doesn’t give it to you. So there are cases where a professional could be distant, for example, lots of patients go to their doctor and say, doctor, you’re recommending this procedure, what would you do? Or if it was your son or daughter or mother, what would you do? And Jerry Groopman in one of his books, he’s a very good physician, he analyzed many situations, and said that it’s really good for doctors not to care about their patients.

    Mary-Catherine Lader: That sounds terrible.

    Dan Ariely: Yeah. Yeah. But he said that when they care about their patients, they are biased in their opinion. And when they don’t care, they are more able to give them objective, clean information. So there are cases where professionals are more objective; I’m not sure the stock market is like that. And there are cases where people can get lots of experience by repetition and by doing things differently and seeing how things work, and they also become professionals. Again, I don’t think in the stock market it is the case. So I actually don’t view a lot of professional investors as investors in that, but what I think they can be good at is helping people understand the psychology of money. You get out of college, you get your first job, you have a tendency to want to get an apartment, and a new sofa, and a TV, and maybe a car, and do all these things. A good financial advisor would say, slow down. Right. It’s more of the let me help you figure out how to run your life with this amount of money.

    Mary-Catherine Lader: So those kinds of tradeoffs, visualizing those, understanding those, studying them, is part of what you do at Common Cents Lab. Why did you start Common Cents Lab and why focus on money and particularly lower middle-income Americans?

    Dan Ariely: So first of all, why focus on money? So I think about all the cases in the world where we as human beings don’t live up to our potential. So I think we waste our time, we waste our money, we waste our health, we don’t create the right conditions for motivation in the workplace, we waste the environment and we hate. Mainly those are the big ones—

    Mary-Catherine Lader: So many! Big problems, yeah.

    Dan Ariely: —yes. And I picked a few years to focus on money because I think that the transformation of the cell phone and digital currency gives us tremendous opportunities to do that. So as long as we had physical money, there was not much we could do with it, not much that we could change in how people think and represent it. But now that it’s digital, and we have the phone walking around the world with us, it means we can have a decision aid in real time, helping us do things better. And there is one way to go which is Apple Pay, which is to say let’s make it easy to spend money. Let’s make it frictionless, let’s make it such that people don’t think about spending money, that they tap or swipe or touch and then they get very surprised at the end of the month. Or you could say let’s create a different type of technology and get people to think a little bit deeper and maybe it will be a bit more painful, but make sure that it’s more likely people would spend according to their long term goals in a way that is actually good for them. So that was the first reason for going into the domain of money, and we focus on low-income because the mistakes there are incredibly devastating. Imagine a low-income person that lives hand to mouth, and they have no extra. And one month, something bad happens, they have no extra! What do they do? They borrow, in the current environment, they borrow at a very, very high percent interest rate. And let’s say that there months later, that problem they had is fixed, maybe somebody was sick, the roof was leaking, something like that. Now they are three months behind plus interest.

    Mary-Catherine Lader: Right.

    Dan Ariely: Right. And that spirals down. So for people, I’m a university professor, I have a salary, if there is a negative income shock, I am perfectly able to handle it; but if you don’t, that creates tremendous turmoil and just to give you some statistics, what percentage of Americans do you think don’t have enough money to be able to pay an unexpected bill of $500 dollars?

    Mary-Catherine Lader: I’ll say 60?

    Dan Ariely: It’s a little bit less than 50, but it’s a lot, right. When you think about that statistic, you think about a third world country, you don’t think about the U.S.

    Mary-Catherine Lader: Right, totally.

    Dan Ariely: Imagine you have 100 percent of wealth and you broke Americans into five compartments, the poorest 20 percent, the next 20 percent, the 20 percent in the middle, the richest, and the absolute richest. And you ask the question, “From this 100 percent of wealth, how much does each of those buckets of 20 percent, hold?” And of course we know the top 20 percent own a lot of the wealth, but what people often don’t know is how little the bottom people have. So from a total of 100 percent, the bottom 40 percent of Americans have about 0.3 percent of the wealth.

    Mary-Catherine Lader: Wow.

    Dan Ariely: Basically nothing. And we focus on inequality of the top side but the real terrible thing is it’s the bottom. So if I could get somebody in the middle range of the distribution to save another $1,000 dollars, that’s lovely. But if I can get somebody at the bottom end of the distribution to save $500 dollars, I could protect them from some serious downsides. And you could ask, can they save? And the answer is, yes. We’ve shown it in slums in Africa, we can get people who live on $10 dollars a week to save some money for a rainy day, and we’ve shown that if you just open an account for people and you call it the saving account for their kids, and you put a tiny amount of money in it, people start thinking of their kids differently. All of a sudden, the parents say, oh my goodness, this kid is 2-years-old, but has a college savings account. And they start reading to them more and all kinds of things happen. So money is not just a way to accumulate wealth, it’s also a way for people to think about themselves. And in some of the research, it’s shown that let’s imagine somebody who owes $10,000 dollars in credit card debt, and you could say, what should I do first? Should I get them to pay it first or to build a little savings account? And the rational answer is to get them to put as much as possible towards the debt, because they pay higher interest rate on that than they make from their savings account.

    Mary-Catherine Lader: Right.

    Dan Ariely: But it turns out that having some money in a savings account gives people a lot of hope and confidence and optimism. And that by itself, is an important thing to do. Here is another statistic, what do you think is the turnover rate in places like Pizza Hut, McDonald’s, Burger King, how often do people change their jobs?

    Mary-Catherine Lader: I would say every eight months, and maybe the turnover or the attrition is like 30 or so percent?

    Dan Ariely: The turnover rate is 130 percent.

    Mary-Catherine Lader: Whoa!

    Dan Ariely: So basically what you said, right, people change more than once a year. And when people change jobs, it’s not that there is another job waiting for them.

    Mary-Catherine Lader: Why do they leave?

    Dan Ariely: You know what, it’s a big mystery, but somebody could get in a situation where they can’t make it—their car broke down, and then they feel embarrassed to show up again. It could be that somebody got a shift that didn’t work well for them. So, lots of things happen and there is lots of pain in the lower-income—everywhere in the world, but in the U.S., we should be better.

    Mary-Catherine Lader: Totally, totally. And so you mentioned, you sort of hinted at the connection we make between money and work. You’re doing more research these days what drives people and what motivates people in the workplace. So what have you learned about the extent to which money motivates people to show up to work? Whether they’re working at a Pizza Hut and they need to show up for that one day after they missed a shift, or in a completely different context?

    Dan Ariely: I have data on about hundreds of companies, big companies in the U.S. stock market, and I have data about all kinds of ways how people treat their employees. And I can look at this data, and I can say, if companies treat their employees well, do the companies also do better in the stock market? And it turns out that absolute salary doesn’t matter that much, relative salary matters a lot. Right. So it’s much more about the sense of fairness.

    Mary-Catherine Lader: Relative to people who do similar work to us? Or to the people in our communities?

    Dan Ariely: So it’s relative to the people at your job who are doing similar work. Right, that is the most salient one. And one way to think about it is your absolute level of salary doesn’t come into your mind very often. But when you see injustice in your company, that really bothers you. Another thing that seems to matter a lot is the sense of autonomy. If you think about work, a lot of things about work are the things that allow us to prosper, where you don’t think you’re like a pawn and someone tells you what to do and you’re just executing. But you feel a sense of connection and meaning and so on. And those things really matter, and we find in these large datasets that companies who are better at this – giving their employees a sense of meaning and autonomy – also do better in the stock market.

    Mary-Catherine Lader: And so then if money is part of it, autonomy is a big part of it as well, then what creates that sense of meaning in a productive workplace, how can companies do a better job in giving their employees that sense of meaning and autonomy?

    Dan Ariely: So lots of ways. I think the first thing to do is to realize in how many ways we are killing autonomy. And basically, that is what bureaucracy does. Think about what bureaucracy is, it is basically the company saying to the employee, we don’t trust you. Right, and it could be that we don’t trust you that when you go to dinner you’re doing the right thing, so we want to see the receipt, and we want an essay about who you met and we want recording of all the things. So one thing we need to start doing is to realize the cost of bureaucracy, the cost of lack of trust to employees. And then the second thing about giving autonomy is that we need to understand that while giving autonomy, there are pluses and negatives, just the plus outweighs the negatives. I’ll give you an example, if I have a new person in my research lab comes in, the easiest thing for me to do is to meet them on the first day, and say, here is the project you’re on, go. And we’ll help you do it of course, but this is what you are assigned to do. A much more difficult position is to say, tell me a little bit about you. And help me understand what you are curious about, what interesting is for you, what your career goals are, what you want to learn in the few years that you’re going to be here. And then, tailor something to them. And say, why don’t you go and think about these three projects and see which one fits you better. Now if you think about this, it’s something that loses efficiency. I just wasted a meeting with somebody, I learned something about their parents, and their hobbies, and so on. I gave them a task for the next week. They’re not going to execute, they’re just going to think about what fits them better. And you could say, this is a very inefficient use of time. But if you think about people not as robots, think about what will be the sense of meaning and connection and commitment to the project, for somebody in my first story versus the second story, it’s very, very different. We need to understand that if we aim for efficiency, and everything is about efficiency, we’re also going to take away this sense of connection, belonging, autonomy, and these things need investments of time and resources. They just pay very well.

    Mary-Catherine Lader: And do you see companies trying to do that at scale and prioritizing it? And how does it end up paying off for the company to make that initial investment in understanding what gives their employees a sense of meaning, even at an individual level?

    Dan Ariely: So from the datasets I told you about, hundreds of companies, I can tell you that the companies that were doing well on employee motivation in my data, do about 12 percent over the S&P on average. So companies who are good at this, in my dataset, have a 12 percent return a year on their stock value.

    Mary-Catherine Lader: And how do you know if they’re good at it?

    Dan Ariely: In my research, I have measured about 80 different dimensions of employee well-being, satisfaction, all kinds of things. Some of them, as I told you, don’t seem to matter, like absolute salary. Some of them really matter. And I can take the ones that matter, and I can compute how much better the companies that treat their employees well do compared to companies who don’t treat their employees well or compared to the average company. It’s a very large study, it took me a really long time, but I think it is starting to show that the returns are substantial.

    Mary-Catherine Lader: So purpose really matters then for companies?

    Dan Ariely: Yeah. Absolutely. Here is the thing. Think about the minimum you need to do not to lose your job, and the maximum you can do if you’re really excited.

    Mary-Catherine Lader: It’s a really big difference.

    Dan Ariely: This is called good will, how much good will do you have? And as we move to the knowledge economy, good will is bigger and bigger. Because if you had a job like organizing the chairs around the table or something, somebody can see and measure it. When your work is between your ears, it’s happening in your brain, it’s very hard to supervise, very hard to contract on it. So now it’s just a question of how hard do you want to work? You can sit at your desk and ponder life, you can work really hard, you can think, you can read, you can do lots of things. It’s up to you to decide what your motivation is. And the question is, what gets people to be motivated? And meaning, purpose, a sense of connection, teamwork, all of those things really, really matter.

    Mary-Catherine Lader: Well, that’s an inspiring and also challenging note for us to end on. Let me end with a rapid fire round, where I’m going to ask you a couple quick questions that you can answer in one sentence or less. Ready?

    Dan Ariely: Okay.

    Mary-Catherine Lader: So what motivates you?

    Dan Ariely: Reducing misery.

    Mary-Catherine Lader: That’s pretty powerful. And it sounds like you’re doing that in spades. What is the hardest decision that you’ve ever had to make?

    Dan Ariely: It was as medical decision. I will give you more than one sentence, but I was badly burned, over 70 percent of my body was burned, and many years ago I was in the hospital for many years. And there was a real question about amputating my arm or not, and the doctors all recommended it for all kinds of reasons. I decided against it. My hand is not very functional and it’s quite painful. I’m not sure it was a good decision but it was a very, very tough decision.

    Mary-Catherine Lader: That sounds extremely challenging. And what as the easiest?

    Dan Ariely: What was the easiest decision? Okay. I turned 50 two years ago and I decided to celebrate with my best friend. We are friends from 7th grade.

    Mary-Catherine Lader: Wow.

    Dan Ariely: And we decided to take a month — we grew up in Israel — we decided to take a month and hike in Israel. And we hiked from the north to the south for a month, and every day we invited people to join us. Some people we knew; some people we didn’t know. And that decision to take a month off and simply hike and spend time with a friend was one of the best decisions I’ve made.

    Mary-Catherine Lader: It sounds like it, it sounds pretty memorable. And in the spirit of choice architecture, you talked about how we can change our environment to make different decisions. What have you done to change your choice architecture?

    Dan Ariely: I do lots of things, but I do have a standing desk, for example. And every night when I leave the office, I put it in the up position.

    Mary-Catherine Lader: Ah, smart.

    Dan Ariely: And what that guarantees is when I come in the morning, I start by standing. It’s electrical, it’s not that difficult to do.

    Mary-Catherine Lader: Right.

    Dan Ariely: But I found that even if I come in the morning and it’s in the down position, I don’t put it up. So that’s one example. Another thing I’ve done is I have created an accountability rule for myself. I have a cousin who I love dearly, her name is Yael, she lives in New York. And we made an exercise pact. It’s very hard to exercise: I travel a lot. It’s not too complex, but for example, you can have one dessert only on the weekend. And we have to exercise three times a week and if we don’t do it on a weekly basis, we have to report and then we get punished by the other person. And that system of accountability really helped me gain much better control over my health, both eating and exercise, plus I get to talk to my lovely cousin.

    Mary-Catherine Lader: One last question: in your spare time, you’re a chef, you’re actually working on a book about cooking. What is your favorite dish to make?

    Dan Ariely: So, first, this book is like my Moby Dick. One day I will write it. So what is my favorite dish? I think that my favorite thing to do is actually to make homemade pasta.

    Mary-Catherine Lader: Challenging.

    Dan Ariely: I think there’s like a dramatic difference in the quality, and there is also something incredibly — I don’t do it when I’m just by myself, but when I invite people — it has the extra sense of taking care of people that I like as well.

    Mary-Catherine Lader: Well that sounds really compelling. Dan, thank you so much for joining us today, thank you sharing you insights, your research, a little bit about your own choices; it’s been an absolute pleasure having you.

    Dan Ariely: It was lovely, and I’m looking forward to our next meeting.

    Mary-Catherine Lader: BlackRock is partnered with Dan’s Common Cents Lab on our Emergency Savings Initiative. We’re enrolling and encouraging thousands of Americans to save. To learn more about the Emergency Savings Initiative or get involved, visit

  • Jack Aldrich: The world is full of great debates. Like, Coca-Cola or Pepsi? Android or Apple? And which was better: the book or the film?

    At our recent Mid-Year Investment Outlook Forum in London, portfolio managers and strategists held some great debates of their own. Is the next downturn on the horizon, or do we believe this business cycle still has room to run? And what will drive markets over the remainder of 2019: policymakers and central banks? Hard-to-predict but enduring geopolitical dynamics? Or something else entirely that we’re not paying enough attention to?

    On this episode of The BID, we’ll talk about where these debates netted out. Each summer, we release our Midyear Investment Outlook, which talks about the themes we see shaping markets for the rest of the year. In preparation, we sat in on our midyear forum to hear how our strategists are thinking about today’s markets.

    We’ll walk through our views on the remainder of 2019 through conversations with members of the BlackRock Investment Institute, like Jean Boivin, Head of BII; Elga Bartsch, its Head of Macro Research; and Tom Donilon, its Chairman, as well as investors like Rick Rieder, BlackRock’s Chief Investment Officer for Global Fixed Income. I’m your host, Jack Aldrich. We hope you enjoy.

    Over the course of two days, about 100 of our portfolio managers and strategists came together to hash out our mid-year outlook for markets. One critical theme that came up throughout: the prospects for regime change, or a paradigm shift in how markets, the economy and policy work.

    Our view? We are late in the business cycle, and global growth is slowing. We think this cycle is set to play out over a longer time frame, and economic over-heating or a recession are not immediate market risks. But the back-drop is a fragile one – and vulnerable to potential regime change.

    Rupert Harrison, a portfolio manager in Multi-Asset Strategies, spoke with BII’s Elga Bartsch to discuss what’s on the line.

    Rupert Harrison: What do you mean when we talk about regime change?

    Elga Bartsch: Yeah. So regime change can mean one of two things, one is a regular regime switch that would be, let’s say, from a low volatility to a high volatility regime, so basically allows you to go back and forth between two states of the world and you can go back to how things were. But there is also the possibility of more radical regime change which basically changes more fundamentally the underlying system, the characteristics of it, and it means that you’re most likely not going back to how things were.

    Rupert Harrison: We’ve seen that really exacerbated with the shift at the end of last year. We had a big selloff in markets, we had to make a big judgment about was that turning into a recessionary regime. We took the view that no, the global economy was still in a decent place and we’ve seen a big rebound since then. I’d say I guess what is a little bit more difficult is thinking about when can you tell the difference between a regular regime change and a radical regime change? So thinking about some of the different challenges we’re facing from U.S. trade policy for example. Are there any signposts for you that would help us to distinguish what is a regular regime change and whether we’re seeing the beginning of something more radical?

    Elga Bartsch: I think the minute you are starting to see developments that look very much like an escalation, that could be described as non-linear and where you really feel that tectonic plates are shifting. And I do think that what we are at the moment seeing in trade policy could be that, because it could mean that a lot of working assumptions on the global economy, deeper integration, leveraging scale, seamless technology, just in time management and all the benefits of globalization could potentially be on the line now.

    Jack Aldrich: As Rupert and Elga mentioned, we’re facing new and different challenges today. In our view, trade disputes and broader geopolitical frictions are now the key drivers for the global economy and markets, rather than late-cycle recession risks.

    These geopolitical tensions may pivot us from an era of globalization to de-globalization, where countries take a more nationalist rather than cooperative stance in the global arena. But it’s more than that. According to Tom Donilon, BII’s chairman and former U.S. National Security Adviser, we’re moving to a different stage in the world order – and the U.S. is a main driver of geopolitical and economic uncertainty. BlackRock’s Vice Chairman Philipp Hildebrand sat down with Tom to get his perspective on what might be changing from here on out.

    Philipp Hildebrand: From your perspective, what is unique about this juncture, both in terms of the economy but also how politics interacts and plays into the economic outlook?

    Tom Donilon: Yeah. I think a couple things are unique. Number one, we do have an unusually large number of volatile and unstable situations in the world. Now, they won’t all go to worst case scenarios, but there is a large number of them that have to be considered by markets. Second, I think we’re in a different phase in terms of the world order. The post-Cold War period has ended. We’re in a new phase at this point where you have a number of players, including obviously China as a big player right now. Third, I think the relationship between economics, technology, and geopolitics is quite unusual. We see that in the competition that has developed between the United States and China over technology issues, which are really driving a lot of what’s going on between the two countries in terms of their interaction. And of course, we have a trade situation right now, which is one of the principle threats to the economic order.

    Philipp Hildebrand: When we heard initially at the Inauguration, the president articulate the America First Strategy, you couldn’t quite figure out what it meant today. When I look at it from Europe or from Asia when I travel, when you look at it from outside the United Sates, it looks more and more that what this really means is the U.S. is exporting fragmentation, volatility, and these are all things that are very new. If we think of the post-world order, the hegemon so to speak has always been there as a stabilizer, as a guarantor to some extent of the rules. Of course with some enlightened self-interest in mind. Is this really a completely new game that we’re entering here?

    Tom Donilon: It’s a very different approach. I think what we’re seeing right now is the implementation phase of the America First Policy that has been put forth by President Trump. And it is a departure in a lot of ways as to the way the United States has conducted themselves with respect to alliances and trade most directly—international agreements, international institutions. It’s most clear in the trade area, where today, the United States, I think it’s fair to say analytically as a matter of fact, is in trade disputes with most of its major partners around the world simultaneously. And it’s using a number of tools right now to press its case. They’re unusual, especially tariffs, and a number of steps that have been taken that are typically reserved for adversaries, right, during the Cold War. President Trump has undertaken to use these tools to impress the economic case for the United States in an unusual, and in some cases, an unprecedented way. So yes, I think we’re seeing something different. I think we’re seeing the implementation of America First policy. I think it is different from the way the United States has approached a number of key issues over the last 75 years, and it’s been disruptive, there’s no doubt about it.

    Philipp Hildebrand: And of course, the key question will be, how does this impact market pricing? I think we have to assume that there is some sort of risk premium across all of this. Investors are focused on the reelection campaign that is about to get going in earnest in a couple of weeks’ time. There is a Federal Reserve that’s back in play with potential interest rate cuts. So we have essentially countervailing forces that are going to make it very challenging to have a clear sense of how we should think about the implications.

    Tom Donilon: A lot of different vectors, I think, a lot of different vectors. We do have an election coming up in the United States, and I think that the right analytical tool when you look at Washington right now, if you’re trying to determine which way one of the parties is going to go is through the 2020 electoral lens. I think that is what is going on in the United States. And we’ve already had the elections really kick off in the United States with debates. Second, we do have again, an aggressive trade policy which has to be considered by markets. And we’ve seen that the president is engaged in yes, China, and I think the markets thought that would be the principle focus, but he’s also engaged in a number of other places and is willing to use the tariff tool with respect to Mexico, in a non-tariff, non-trade arena, in order to pursue a policy of a political goal: that is unusual for a president of the United States, and I think that is going to continue. I think essentially what’s happened is that President Trump’s approach to foreign policy has come into sharp relief. I think we now have a sense of his style, his approach, his goals, and I think we are going to continue to see that for the remainder of his term, whether that’s through 2020 or thereafter. I think this is the Trump approach to foreign policy and economic policy.

    Philipp Hildebrand: The big risk of course is that this could undermine the fabric of the global economy and really damage growth potential in the long term, potentially having inflationary effects in terms of higher prices as a result of it. So this would be a very unpleasant combination basically of lower potential growth and higher inflation as a result of this fundamental questioning of the economic order. Do you see a risk here tearing at the fabrics of the global economy that could lead to lower potential growth and higher inflation over time?

    Tom Donilon: I do see the risk. There is a risk that in achieving short term narrow goals if you will by the United States—in the trade area for example—that you could be, through the approach, risking the health of the overall system going forward. The United States at this point is not a strong supporter of the WTO system or the international free trading system generally; it’s seeking in many ways to upend that system and to interact in a transactional way with allies and friends around the world. So the risk is yes, achieving some short term goals, but when the United States steps back from leading that system, what happens? The system does start to fray, bad behaviors emerge throughout the system, but most importantly, I think when there is a crisis, if you don’t have a leader in the international system—for example, as we did in 2009–

    Philipp Hildebrand: Yeah, I saw firsthand what happens in the crisis, how important that U.S. leadership was.

    Tom Donilon: And so that is the question: if you don’t have that leadership, if you haven’t built up these habits of cooperation, if you haven’t really kind of worked on the same values and outlooks, in a crisis, you can have grave difficulty which was really important, for example, in 2009, that the United States was in a leadership position and working in a cooperative way with the world to address the crisis. It really made all the difference at the end of the day.

    Jack Aldrich: As Philipp and Tom discussed, we believe geopolitical conflicts have the potential to undermine the global economy.

    One our Forum’s most central debates was how a trend toward de-globalization could affect inflation. One side sees tariffs and supply chain disruptions as a supply shock that could prove inflationary, both in the short run and longer term. They see the possibility for an unfavorable mix of slowing growth and rising inflation pressures over time, as prices rise and productivity falls.

    Another camp believes protectionism could actually be disinflationary, due to the gradual realignment of supply chains and manufacturing capacity. On top of that, technological innovation could also keep a lid on inflationary pressures – think about how companies like Uber have made the ride-sharing market more competitive, and caused lower prices among other ride-sharing companies and taxis.

    Jean Boivin, Head of BII, spoke to Rick Rieder.

    Jean Boivin: One thing we’ve discussed which I think to me is a big deal not only for fixed income but for the other asset classes, is what is going to happen to inflation? One place where we’ve been debating is what trade context is doing to that, and does it change the supply chain picture? Does it lead to bigger adjustments? And at the same time, we’re worried about potentially inflation being too low. So we have now a pretty interesting divergence.

    Rick Rieder: So I have felt for a long time that it’s hard to create, that inflation is in a structural downshift. I believe that because if you look historically, particularly when you have trade wars, you think about what happens when you have a trade war, you can have a near term shock to inflation, you can have a bit more inflation. But what happens is, you increase productive capacity. You saw it in agriculture, you certainly saw it in energy, you think about the development of shale and deep water and oil sales. You create productive capacity. So I think the other thing you do with tariffs particularly, is you’ll dull aggregate demand, you’ll dull growth. So today, I could see a little bit more inflation, certainly wages are accelerating and we think inflation will pick up a bit from where it is today, which has been pretty depressed. But I think there are some headwinds to long term structural inflation, and we talk about it a lot. That entrepreneurialism, innovation today, I’ve never seen anything like this in all my years in investing or even studying history. But that entrepreneurialism and innovation is literally targeted right at price. It’s targeted right at margin. And where the new companies develop, it’s literally where there is margin and price today. So you’ve got a big headwind. I’m not saying you can’t create a bit more inflation, but there is something structural in commerce that is unique to anything I’ve ever seen in studying economies for years.

    Jack Aldrich: Like Rick said, we appear to be breaching new territory here. But there’s a lot to be optimistic about: we do think the cycle, and risk assets like stocks, have room to keep running forward. There’s more space to take risk, we just prefer to do so with some resilience built in.

    Jean sat with some of our portfolio managers to get a sense of how they’re thinking about investing at this point in the year. First, we turn back to Rick for his views on the Fed and the path forward for fixed income.

    Rick Rieder: I think the big deal is this shift the Fed made back in January. For investing, it’s the biggest thing that we think about. You’ve got a Fed now that is not hiking rates, that is not tightening against you. So when you think about managing risk, you think about your portfolio and risk assets, you have a central bank that is sensitive to what happens to growth and inflation. It’s a very big deal.

    Jean Boivin: What is tricky for me as we were debating is that I think it’s a bit different. It’s not only about the data anymore, but it’s about what is happening with tensions and trade and tariffs. And the tricky thing is that it’s not clear that easing will be the solution for any of these predicaments we’re dealing with.

    Jack Aldrich: For now, the Fed has pivoted to an easing stance, and central banks around the world are following suit. Yields on government bonds have plummeted, but we still like them as a way to buffer portfolios against market swings.

    There are sources of resilience and quality in the stock market, too. Tony Despirito, Head of U.S. Active Equity, shared with Jean why he’s still optimistic about certain stocks.

    Jean Boivin: Q4 last year has been a difficult quarter. What lessons have you drawn from that and how does it affect your outlook for the next six to nine months?

    Tony Despirito: Well, one of the lessons is that markets are always more volatile than underlying economic reality. So the market is going to predict more recessions than we actually have. And I think that is what is happened.

    Jean Boivin: Many more.

    Tony Despirito: Many more. And I think also you see policy responses when there are growth weaknesses. We saw the Fed become more dovish, for example, and I think that is to be expected. You know, we are getting later in the economic cycle, and cycles don’t die of old age. But there is less pent up potential and as you get later in the cycle, I think volatility picks up. It’s natural. And so that is something that we need to keep an eye on going forward. The other is I think the market is giving us a free opportunity with respect to balance sheets. The market is not distinguishing much between companies with really strong balance sheets and companies with weak balance sheets. And I view that as a free option to upgrade the portfolio towards stronger balance sheets. Now is a great time for that.

    Jean Boivin: So how much of your constructive view and the valuation story you just said depends on what is going to happen with the Fed? And there is a lot of cut being priced in right now by the market. How important is that to your process?

    Tony Despirito: Well, I don’t think it’s about the Fed, I think it’s about long rates, right, and the market has adjusted regardless of the Fed. So I think in terms of the rates scenario, we’re seeing that in the long bond already. And one of the things that we’re looking for in the U.S. is high quality, stable companies that haven’t yet gotten bid up like bond proxies, and we’re seeing a couple industries like that, like insurance brokers, pipeline companies in the U.S. are examples of that, steady cash flow yet not bid up in stock price. That means you should pay up for growth and you should pay up for high quality, bond proxy-like companies. And so I think that is important. On the margin side, I do worry a little bit that we’re late cycle and therefore, maybe there is some risk to margins, whether that’s wages—we’ve had a rising wages, now that has come off a bit. The global trade that we talked about, the supply chains, that can mean that costs go up and margins go down for companies. So that is one of the things I’m worried about.

    Jack Aldrich: So we’re not necessarily at the peak of stock market potential, but we do see reasons to be cautious going forward.

    Many topics were in debate as we worked through our views for remainder of the year. So where did we net out? Global growth is slowing, and the pivot of global central banks to easy policy has bought investors time to make their portfolios more resilient

    Geopolitical tensions – from the U.S.-China relationship to an ‘America-first’ policy – might wind back decades of globalization. And it’s critical we understand what this de-globalized world might look like, and what it might mean for inflation and central banks against what has been a longstanding backdrop of disinflationary forces.

    For the full read-out of these discussions, head to to read our complete Global Mid-Year Investment Outlook.

    Thank you for joining us on this episode of The BID. We’ll see you next time.

  • Catherine Kress: Markets are sending pretty mixed signals. At the end of 2018, we saw a downturn, yet in the first half of 2019, we've seen the stock market rally against a backdrop of incredible volatility in the international environment.

    This geopolitical whiplash looks set to continue with the 2020 elections in the US in full swing, a Brexit deadline postponed to October, trade disputes ongoing in almost every world region, and tensions building in the Persian Gulf. This wide range of unstable situations leads us to believe that trade tensions and broader geopolitical concerns will be a key driver of the macro and market environment moving forward.

    On this episode of the The BID, we'll be speaking with Eric Van Nostrand, head of Macro Research and Portfolio Strategy in BlackRock's Multi-Asset Strategies Group. Eric is one of the smartest people I've met when it comes to teasing out what big picture issues like geopolitics mean for markets and investing. He's pioneered a variety of approaches for helping to identify the disconnects between macro developments and market movements and seizing on the opportunities that those disconnects create. From the BlackRock Investment Institute, I'm your host, Catherine Kress. We hope you enjoy.

    Eric, thanks very much for joining us today.

    Eric Van Nostrand: Thank so much Catherine, great to be with you.

    Catherine Kress: Let's start off big picture. There's been a lot going on on the geopolitical front. What's top of mind for you right now?

    Eric Van Nostrand: Catherine, the last six months have seen the evolution of a lot of different geopolitical issues that have been festering for a couple years but have really come to the forefront in the past two months. Chief among them is China and its trade relationship with the U.S. The breakdown of the negotiations at the start of May in Washington have, in our view, fundamentally changed the relationship between the U.S. and China in a way that's going to make it more strategically competitive and more economically competitive in the years to come. And that matters a lot for financial markets. At the same time that these U.S. and Chinese tensions are rising, we're seeing persistent geopolitical risk in the Gulf and continued uncertainty coming out of London as the Brexit negotiations continue. All these risks together, coming from different angles, but each mattering a lot for financial markets in their own way, are going to be very important for investors to watch in the near term.

    Catherine Kress: Right and we've specifically highlighted that geopolitical risks can matter more for markets when the economic backdrop is weak, so these will all be pretty important issues to watch I think moving forward.

    Eric Van Nostrand: That's exactly right, slowing global growth makes this all much more important than it otherwise would be. I think it's clear that geopolitics has mattered a lot more to financial markets in the past few years than it it did in the past few decades. But more specifically, geopolitics has mattered a lot more just in the past couple weeks. I think the biggest difference is that in the first week of May, the U.S.'s relationship with China changed meaningfully in a way that is unlikely to improve pretty meaningfully in the near term. That's something that matters a lot to markets in the months to come. BlackRock's own indicators of geopolitical risk, for example, have shown a much higher correlation with overall financial asset moves – with what stocks and bonds have done in the past couple weeks – even more so than they have over other periods of the Trump era where geopolitics has mattered a lot. So it's going to be incomplete to have a financial market conversation in 2019 without really engaging thoughtfully on the geopolitics.

    Catherine Kress: When you say correlations, you mean that geopolitics and markets are moving much closer together, implying some kind of a closer relationship than perhaps we would have seen previously?

    Eric Van Nostrand: That's exactly right. The markets are following the geopolitics. What's happening out there in the world matters a lot for U.S. investors.

    Catherine Kress: We both just highlighted U.S., China. What are some of the key issues or flashpoints that we should be thinking about?

    Eric Van Nostrand: So I think in general, we should take a step back and recognize the following, which is that it's very easy to talk about the various geopolitical issues of the day and say that they might matter for financial markets in general, but unlike most of the things that investors at BlackRock track to forecast financial market moves, geopolitics is very hard to measure. So the particular flashpoints we're going to be looking for are those that really bring into focus geopolitical risks and geopolitical concerns that right now appear to be in the background. There are really two types of flashpoints I think we're going to be watching from a geopolitical perspective as we think about asset allocation and investing in the firm: (i) those that involve short-term tactical positioning – thinking about how the Brexit parliamentary negotiations are going to shake out over the coming weeks; or (ii) more strategic themes, such as how broader trends of deglobalization and the economy are going to evolve over the years to come. Deglobalization in particular is probably the single most important thing for financial market participants who are concerned about geopolitics to be following. Because what that reflects is the reversal of a trend that has really characterized the evolution of the global economy over the past couple decades and that we've become quite used to as a source of ongoing stock and bond market returns. Every piece of trade news that comes out of the Trump administration's negotiation with China, every bit of information about when auto tariffs with Europe might start to materialize, is going to be important for figuring out the extent of that trend and what it matters for the economy.

    Catherine Kress: One thing that I noted was particularly interesting in your comments is you mentioned that geopolitics is pretty difficult to measure. Why is that and how do you grapple with that issue?

    Eric Van Nostrand: Most of the investors at BlackRock, who use macroeconomics to forecast trends in the economy that matter for financial markets, are doing it from a quantitative perspective, or they're doing it with things that can be measured quantitatively. We're trying to figure out what's happening with growth. We're trying to figure out what's happening with inflation. We're trying to figure out what's happening with unemployment. There is a deep academic literature from the economics community and from the market research community on how to measure those impulses and how to understand their likely path forward. Geopolitics is different. Geopolitics is the most purely qualitative input to our investment process that we can imagine. I know that China is a topic today, and I know that China was a topic in May 2018. But it's hard. It's not obvious for me to measure how different, quantitatively, the impact of China is in those two different periods. And that's really the frontier of our research on these issues are trying to attack that hard question and try to start measuring those topics.

    Catherine Kress: Got it. And so, you mentioned deglobalization. That seems like one of the biggest themes that I can imagine that might be one of the more difficult ones to measure. How do you actually, as an investor, define deglobalization and then begin to actually process that and its impact on markets?

    Eric Van Nostrand: Sure, so what the trend of globalization has meant over the past couple years has had a lot of important primary and secondary effects on the way we investors think about the evolution of financial markets. And the reversal of those trends recently are equally important for a number of different reasons. The first is trade flows. When economies are working closer together, when trade lines are open, the obvious first-order impact of that is that countries are going to import and export more with one another. That trade flow is itself an important source of growth. It boosts productivity growth because countries can focus more on their comparative advantage and deploy their labor and capital in more productive ways. That's something that benefits markets but also incomes across the distribution of incomes in all sorts of global economies. As we've seen over the past couple years, as countries have become less inclined to work with one another, and more inclined to put up barriers between trade, a lot of those positive trends for the economy risk getting a lot worse. This is a particularly worrying time for global productivity growth. Since the global financial crisis, productivity growth has slowed meaningfully, and economists don't have a lot of great answers about why, particularly in this period, where we look at the reach of the internet around us and it feels like we're innovating more. But economists say that productivity has been slowing according to the data. This is a big downside risk that could result in much lower productivity growth going forward. And that has implications not just for market returns, but for all participants in the global economy.

    Catherine Kress: What's the timeframe that we're thinking about here? Is this something that we're seeing happening now, over the next couple of months, or do you think it's going to take years or maybe even decades to play out?

    Eric Van Nostrand: That's a great question, Catherine, and that really gets at the crux of the different ways we think about different geopolitical issues. Deglobalization is something we view as a strategic theme that we expect to emerge over the next couple of years. I'm not going to change my clients' investment profile based on my view of how a certain bit of trade negotiation is going to unfold over the next week or so. That's not something that, in investment parlance, I have any edge on. What this trend reflects is the change in the way global trade is perceived over the next couple years, and that's something we're going to be watching closely.

    Catherine Kress: That makes sense, so it's not just about China. There's something much deeper and broader going on here.

    Eric Van Nostrand: China's obviously been the flagship of the deglobalization tension over the past couple months but as we've seen with the Trump administration's relationship with Mexico and the threatened tariffs there and the specter of auto tariffs in Europe as an example, it's clear that this is a tool that within the United States, the Trump administration plans to use on an ongoing basis even beyond China. But even beyond all that, it's not just Trump. Related to broader trends of political populism and what it's meant for attitudes toward global trade, we're starting to see other economies begin to talk about and, in some cases, take some protectionist measures. That means that this is something that's going to outlast Donald Trump. It's going to outlast the current round of U.S.-China trade spat. And it's going to be important to the conversation for years to come in our view.

    Catherine Kress: So shifting gears a little bit, Iran has been front and center in the headlines recently. That and trade seem to be dominating conversations. May marked the one-year anniversary of the U.S. pulling out of the Iranian nuclear deal, and just within the last month or two, we've had a series of attacks on oil tankers in the Persian Gulf and off the coast of Yemen, an Iranian attack on a U.S. drone and retaliatory cyber-attacks by the U.S. on Iran. We also saw a somewhat incredible series of events in which President Trump called off air strikes against Iran at the last minute. Between this, trade talks, one thing that's been very interesting to me is how well riskier assets are performing. I would have expected a much rockier road, frankly, given all these geopolitical tensions, but the U.S. equity market, for example, has returned to all-time highs. What's your view on what's going on here?

    Eric Van Nostrand: That's a really important point because it illustrates something we can't forget as we're having this conversation. We just talked a lot about how geopolitics matters—and it does, and it matters more than it used to. But it's still not the only thing that matters. The past couple weeks of equity market performance in the United States have been principally driven by an increased expectation of central bank action from the Federal Reserve and other global central banks to keep monetary policy easy by keeping interest rates low. That's not unrelated to geopolitics. In fact, it's in large part a reaction to some of these geopolitical tensions that have manifested globally, but it underscores the fact that those easing moves by the central banks, which are having a positive impact on asset prices today, are in the past couple weeks mattering more than the worries about geopolitics themselves. That's if you look over the past two weeks. If you look over the past eight, you see a different picture as geopolitics has been the real driver.

    Catherine Kress: You're an investor who actually has to make decisions about your portfolios with geopolitics in mind. What's your starting point?

    Eric Van Nostrand: As I said before, the principal challenge is that this feature, geopolitical risk, is really hard to quantify relative to conventional macroeconomic variables like growth and inflation. In our broader investment process, we use a lot of modern quantitative techniques like various forms of artificial intelligence and various forms of machine learning to forecast economic data and get a sense on what it means for asset returns. We don't have an artificial intelligence algorithm that's going to predict what Kim Jong Un is going to do in the next six months. That remains well beyond the capabilities of the quantitative investment community. We have developed over the past few years an indicator that we lovingly refer as the BGRI, the BlackRock Geopolitical Risk Indicator. What the BGRI measures is how much attention markets are paying to a given geopolitical risk. When our BGRI is high, that tells us that markets are very focused on geopolitics and that worries about geopolitics are likely in the price already. That means that we don't need to worry as much about a big downside tail event because the market's already on it. Things are already priced. When a BGRI is low, the market's not paying close attention to a particular risk, so if our geopolitical research team thinks that risk is a real one, then we better watch out because the markets are likely not discounting it.

    Catherine Kress: How do you actually build that indicator? What's the process that goes into creating it?

    Eric Van Nostrand: Thank you, Catherine. I love it when people ask me these methodology questions because I get to geek out about our research processes, and I'm pretty proud of this one. This is a great use and one of our flagship uses of what's typically called big data or unstructured data. What does that mean? It means we subscribe to and read in our systems, a tremendous amount of global news articles and financially-oriented publications. We scrape and read a tremendous amount of broker reports published by Wall Street firms and other research outfits that reflect the market topic of the day, and we zoom in on social media, look for accounts on Twitter that tend to discuss finance and look at what they're talking about. We use the same artificial intelligence tools we use to design quantitative signals around macroeconomics to measure how much those market sources are talking about geopolitics. The theory behind that is when they're talking about it a lot, that's an indicator to us that the market probably already knows about it. It's not a secret. When they're talking about it very little, that's when we tend to be a bit more on the defensive.

    Catherine Kress: Are there ever instances where we might interpret a particular geopolitical issue or event as being not so great, but it turns out to be positive for markets? And I guess with that question, how might the BGRI help us identify that disconnect?

    Eric Van Nostrand: Yeah, so that's something that happens a lot in analyzing the interplay of geopolitics and markets. The classic example of that is the 2016 U.S. presidential election. It had been widely forecast leading into November that the election of President Trump, were it to occur, would be a negative for risk assets because of associated uncertainty. As we know, that wasn't the case. The expectation of his tax and infrastructure policies when he was elected, wound up driving markets higher, in combination with the expectation of lower interest rates which are also central to equity prices in general. So sometimes you get market responses like that that are based on a different interpretation of the geopolitical event than you had before. But other times, and this is where the BGRI comes in, you might see a negative event happen that was already priced in before the event were to occur. An example of that might be the first round of U.S.-China tariffs in 2018. It was kind of telegraphed that this was starting to come. The BGRI rose as markets talked about it and then when the tariffs were actually imposed, it wasn't that big a surprise, and markets weren't damaged by that too meaningfully because it was already priced in. And that's really where we focus a lot of this research is understanding when markets price this in and when they don't, because that helps us understand the profile of risks that'll drive our investments overall.

    Catherine Kress: Sure, so if I were sitting on my couch starting season 1 of Game of Thrones, could I use this methodology to forecast who would take the Iron Throne at the end of the series?

    Eric Van Nostrand: I don't think anyone could forecast that, certainly given how things panned out. But I do think what something like the BGRI could tell us if we ran it in Westeros is who the consensus choice was going in, who the broad expectation was would wind up on the throne, if you will. And in the case of the real world or in the case of Westeros, we might think oh, if the market's crowded, if everyone expects it to be Daenerys, then perhaps there's a potential for surprise that we're not appreciating. And that I think would have, avoiding spoilers, that would have paid off in both Game of Thrones and the markets I suppose.

    Catherine Kress: So if we had actually created a dashboard for Game of Thrones, and we qualitatively said that we thought it was going to be someone else that wasn't Daenerys, but market attention on Daenerys was high—that would have been an interesting point to flag where we could have taken advantage of some opportunities.

    Eric Van Nostrand: That's exactly right, Catherine, and that's a great analogy for what we do when we think about geopolitical risks at BlackRock. We're never going to put a lot of risk on things that are inherently uncertain, such as the output of a lot of these geopolitical risks, but we're always going to be exposed to them. And what we need to understand is the way the markets are likely to respond in different scenarios so that we have a balanced allocation of risks, and exactly the process you laid out is just how we might think about that.

    Catherine Kress: Taking it back to the real world outside of the Seven Kingdoms, where does the BGRI sit for the risks we talked about earlier? So I know we have BGRIs for each of our top 10 risks that we track but, for example, global trade, U.S.-China competition, Gulf tensions, what are those indicators telling us?

    Eric Van Nostrand: Perhaps unsurprisingly, Catherine, all the risks we talked about are risks that the market isn't missing. And the BGRIs for each of those three topics are all very high. And they all say that, for example, the market attention to each of those topics is significantly higher than it has been in recent years, and that's not a surprise because we're talking about them, too. Those are the popular topics right now. And let me be clear. I don't mean we shouldn't be paying attention to them. Those are real risks in all three cases, and all three will be very important to markets over the coming years. But we think markets have largely appreciated the fact that these are happening in the background, sometimes not even the background, and are already getting the focus they need. Where we tend to worry is when we have a view that a certain geopolitical risk is on the horizon, but markets aren't paying as much attention to it.

    Catherine Kress: Alright, Eric, I'm going to end with a rapid-fire round. In one sentence or less, I want you to answer the following questions. Are you ready?

    Eric Van Nostrand: Let's do it.

    Catherine Kress: What is the market missing?

    Eric Van Nostrand: One geopolitical risk the market has paid less attention to recently is North Korea, which drove the focus in 2017 and 2018 but has since fallen out of the conversation.

    Catherine Kress: We just spent a lot of time on geopolitics. What about just politics?

    Eric Van Nostrand: One sentence on just politics? I would say domestic politics matter as much for the micro as they do for the macro; watch specific industries for their relationship with the policies proposed as we approach the election next year.

    Catherine Kress: Perfect. What about the macro environment?

    Eric Van Nostrand: Well, I think growth is slowing, but the markets know that, and central bank policy is working hard to offset it.

    Catherine Kress: Final question, a bit of trivia for you. Sansa Stark in Game of Thrones is played by an English actress named Sophie Turner. Who is Sophie Turner married to in real life?

    Eric Van Nostrand: The Jonas brother. I can't name my Jonas, though.

    Catherine Kress: Which one?

    Eric Van Nostrand: Hard pass, hard pass there.

    Catherine Kress: Alright, the answer is Joe Jonas.

    Eric Van Nostrand: I'll keep that in mind.

    Catherine Kress: Eric, thanks so much for joining us today. It was a pleasure having you.

    Eric Van Nostrand: Thank you.

  • Mary-Catherine Lader: Sometimes it feels like all topics lead to technology these days. And it’s not just in dialogue with our friends, our families, our coworkers, it’s also what we ask when we’re alone. Our Google searches of buzzwords like blockchain and 5G are up over 1,000% in the past couple years. Searches for fintech are up 843%. And Google searches for AI have risen 38%, even though AI is a decades old subject. But what tech topics aren’t we talking about? We asked around to find out.

    Man 1: How bad actors are using technology to disrupt our political and financial systems and what we can do to defend ourselves both personally and as society against those actions.

    Woman 1: I don’t want to carry around credit cards anymore because I want to use Apple Pay for everything.

    Woman 2: Corporate governance within ride sharing companies.

    Man 2: Within the next 10-15 years, we’re going to be living in a society where people will be walking around with glasses that will give you directions of where to go, tell you the names of buildings. Keep an eye out for augmented reality, it’s going to take over.

    Mary-Catherine Lader: So what else aren’t we covering? On this episode of The BID, we’ll speak to Kevin Roose, technology columnist for the New York Times and best-selling author. We’ll discuss how technology is influencing our politics and culture, and his own journey as he tried to stop using his phone. I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Thanks, Kevin, for being here.

    Kevin Roose: Thank you for having me. What a pleasure.

    Mary-Catherine Lader: Such a pleasure to have you. You write a technology column for the New York Times called The Shift. Before that you covered Wall Street, you’ve written a couple books. And you’re really familiar with the world of business, politics, and also the underbelly of the internet. What got you into this cross section and what about technology got you to start writing The Shift?

    Kevin Roose: Well, I have always been obsessed with technology. I was a child hacker, prodigy—not prodigy, but I liked to go on weird parts of the internet, I had lots of Geocities webpages. I had a little web design business with my brother. From a pretty early age, I was into not only the internet but the things that the internet made possible. And then I graduated from school, I got into financial journalism because I was writing a book about Wall Street. And then after that, I saw sort of the world moving to tech. A lot of my sources, people I talked to in finance and in consulting, they were moving out to San Francisco to work at startups, they were transitioning into engineering, they were going back to school to learn how to code. It just felt like there was this kind of tectonic shift that was happening that was pushing people that I knew and respected into tech. And I thought, well that is interesting. Maybe I should go spend some time trying to figure that out. And then it just happened that the woman that I was dating at the time, and am now married to, lived out in California for school. So I thought, well maybe I could combine these things and go to California to write about technology, and that’s what happened, and here we are.

    Mary-Catherine Lader: But you came back to New York.

    Kevin Roose: Well, this partner of mine, this spouse, my wife, she is law school here in New York. I just keep following her around basically and adjusting my career accordingly—but no, I like writing about technology from New York, because I think I lived in Silicon Valley for several years and have an understanding of the reality on the ground there. But I think it gives me a useful remove to have some distance. Often I felt in San Francisco, it’s hard to be objective about the tech industry. When your friends work at these companies, you are constantly running into people that you know. And you get a very cloistered worldview at certain times out there.

    Mary-Catherine Lader: And so much of what you write about is what people aren’t talking about, and then they start talking about it, because you have a great ability to spot these sorts of trends and things that we should be talking about. What do you think people aren’t talking about right now? It feels like tech dominates all headlines, all companies are technology companies, so what is there to cover that isn’t being covered?

    Kevin Roose: I do think technology is the story right now. It really feels like we’re transitioning from one economy to another. And we’re part of the way through that, which is why you see every company being a tech company. But I guess they call it the fourth industrial revolution. Which is not a phrase that I love, but I think it’s useful in terms of it positions this as the correct size of transition, I think. And so I don’t think we’re talking enough about AI and labor and the future of work. We talk a lot about it, but I think if we had a better understanding of what was happening, it would be all we were talking about. Do you feel like there are other things we should be talking about?

    Mary-Catherine Lader: No, I think that is a lot of it, AI and the future of work. We think about that all the time in financial services. There are a lot of jobs that will be affected. And it’s funny, because it’s hard to figure out where you start in the conversation about AI and ethics and work. Do you just bemoan the potential loss of jobs in the future?

    Kevin Roose: I had the same question, like I didn’t really know where to start with it. So a couple months ago, I started going back and reading about the first, and second, and third industrial revolution, what was it actually like to be a farmer in the 19th century who suddenly saw these factories springing up and thought, “Oh Man, I’ve got to go to the city now and leave my farm and go get a job in a factory.” What was it like to work in an auto plant in the mid-20th century and see the robots coming in around you, and you think, “Oh, I should probably find something else to do.” And was the actual cumulative impact of the changes on the societies which took place? I’m a little bit of a history nerd, so I love going back and reading contemporaneous, you know, what were the people of 1830s England saying about the factories?

    Mary-Catherine Lader: And have you found a good analysis that gives you hope about the future? For example, I sometimes wonder, has anyone done an economic analysis of the impact of the washing machine? That was positive for most people. Have you found good work that gives you hope about what this could mean in the fourth industrial revolution?

    Kevin Roose: I think that the default story is one of hope, right, because we all used to have terrible jobs, like farming is not a fun job and it’s back-breaking, and it’s unsafe. And it’s good that only two percent of us need to be farmers now to feed the other 98 percent, it’s good that our productivity has resulted in better jobs. But there is some pain involved in the transition. It’s not like we just snap our fingers and all the farmers become factory workers and all the auto engineers learn to do other skilled labor. It takes a while for society to catch up with the technology, and that is happening faster this time. It took a long time for technology to proliferate in these earlier shifts, and now it’s happening every day.

    Mary-Catherine Lader: And where do you think the dialogue among technology leaders, founders, people you interview about this is like right now?

    Kevin Roose: Well, there is kind of a public dialogue and a private dialogue. So, I’ve heard both because I’m a journalist, so when people talk to me, they usually have their public face on. In that case, the public discussion is, we’ll get through this essentially. We have made every transition before in our history work, automation is going to create new categories of jobs we don’t even know what they are yet, and people will find new opportunities. There is not a fixed pie. The private conversation was often a little bit bleaker than that, I find. Because these companies feel enormous pressure to automate. They feel if they don’t do it in the next quarter, their competitor is going to do it. And their margins are going to get fatter, their shareholders are going to reward them for that and the people who don’t automate, are going to be left behind. So I think there is an incredible amount of pressure felt by corporate leadership to do this as quickly as possible. And frankly, maybe too quickly. Maybe it should take a little longer for this to be implemented in the company, knowing that people are going to be affected by this.

    Mary-Catherine Lader: Do you see anyone trying to do anything about that? I think about the minimum basic income advocacy and some attention to solutions. Is that about headlines and PR? Are you seeing anything tangible?

    Kevin Roose: No, I don’t think that is about headlines and PR. I think people understand that every transition has some elements of good things and some elements of pain. And if we can ease the pain for people, that’s good. We should do that. And I’m actually optimistic. I think that part of what we see in periods of technological transformation is that actually huMan skills become more important. A lot of people for a lot of years, their jobs were basically robotic, they were taking things from one place and putting them in another place, or they were changing cells on a spreadsheet. And it’s good if we don’t have to do that anymore, we get to do more creative things. We just need a system that supports that transition and the people who can’t make the jump or can’t make the jump as easily.

    Mary-Catherine Lader: Part of what we’re doing at BlackRock through Aladdin Wealth is basically building technology software algorithms that help our clients, banks and wealth Management firms transition to using technology to make a financial advisor’s life more about their connection with the client. And what is funny is that a lot of those startups who a couple years ago were like, “We don’t need people, we don’t need huMan advisors. It’s going to be all the algorithm.” They’re now adding huMan advisors. So there is this equilibrium of huMan plus technology that we’re reaching at least in wealth Management. What kind of trends have you followed in financial services or fintech, given that you started your career on Wall Street, and how have things played out maybe any differently than you would have expected?

    Kevin Roose: I’m fascinated by the venture market right now. I know it’s not exactly financial services but the VC economy is really interesting to me. I know Uber filed to go public. And that is a fascinating example of a company that got enormously large, raised more money than probably any private company in the history of private companies. And it’s just a different model. We’ve never seen a company go public this large with this much venture money in it. I’m fascinated by the growth and explosion of the venture capital backed ecosystem and all those services that we all depend on every day that may not have gotten off the ground were it not for these resources of private capital.

    Mary-Catherine Lader: And do you think in the wake of these IPOs, that people are raising just as much money? It seems like nothing has really changed. It’s not daunting the hopes of today’s entrepreneurs or the expectations of today’s venture capitalists doing those early stage deals.

    Kevin Roose: No, I think there is a natural skepticism of loss-making companies, but I think people generally understand that you lose a lot of money for a little while, and hopefully you get market share, and then you can have pricing power. The bad example of this is MoviePass, which I wrote about last year, which had explosive growth because they were basically losing on every transaction, they had negative margins on every new customer. So that is not the best model, but there are models I think that work. We saw Amazon be unprofitable for Many years, and I think they’re doing okay now.

    Mary-Catherine Lader: But that premise of get so big so that you have pricing power, there is something about that that is a little complicated in terms of its relationship to the consumer, right. And it’s amazing to see all these brands be so beloved by all of us, because they’re convenient. But ultimately if the business model is to have pricing power, it’s a little anticompetitive. Do you think we’re catching on to that? Do people talk about that when you are covering them, or no?

    Kevin Roose: It’s great for consumers. They get all this cheap stuff, right. We get movies for free and we get rides to the airport for probably 20 or 30 percent less than their natural price would be in an unsubsidized market. So for consumers, it’s great. I think if you’re the investor, how long are you willing to subside growth? I think those are questions above my pay grade. For consumers, I think we’re living in a golden age of cheap stuff. And I used to joke, I had a friend who was a venture capitalist out in San Francisco and every time I would use one of these services that he funded, I would say thank you for the three dollars, really appreciated the discount on that ride. And he didn’t think it was funny.

    Mary-Catherine Lader: But he should have thanked you for being a user. So what other kinds of things are you writing about these days?

    Kevin Roose: Right now I’m really interested in social media and the reckoning around privacy and data use, and extreme content. I’ve been doing a lot of reporting on Facebook and YouTube, and I think we’re sort of at a moment now where we’re collectively reckoning with the fact that a lot of our lives are connected to these platforms that may or may not have our best interests at heart.

    Mary-Catherine Lader: And what do you think will change as a result of the increased public attention around behavior or policy?

    Kevin Roose: I think there will be some regulation. I think everyone at this point expects regulation of at least privacy and maybe some content stuff. I think people are starting to view these services differently. I’m not sure what the average user of these services feels, but I know at least amongst the people that I know, they’re having different conversations about it than they would a couple of years ago, I don’t know, what do you think?

    Mary-Catherine Lader: I think the piece about the fact the devices in your home may have a huMan listening, maybe attached to a huMan that is transcribing your words, when that becomes real, that is pretty powerful. Whether it changes your behavior, I don’t know. I haven’t changed any of my behavior. I check Facebook a little bit less.

    Kevin Roose: But you’re still on it.

    Mary-Catherine Lader: I’m still on it.

    Kevin Roose: So am I.

    Mary-Catherine Lader: I still love the device in my home. And I‘m curious what lessons from the financial crisis and regulation in the wake of that there are for social medial platforms and whatever may transpire here. The content is so different, the nature of the issues are so different, there may not be any whatsoever. But it will be kind of interesting to see how that gets shaped and written and then how it gets digested by these companies, particularly because it’s not really an area where those writing the rules have a lot of depth of expertise or even use it themselves.

    Kevin Roose: Yeah. I’ve sat in enough hearings to know that Congress is not logging into Instagram all that often for the most part. I think there are some useful lessons from the financial crisis and one thing that we saw with a lot of the post-crisis regulation is that it really did entrench the big financial institutions. It became prohibitively expensive and hard to start to form a new bank. There are basically zero new banks since the financial crisis. And I think the big banks are probably safer and less levered and have better capital controls than they did before the crisis. So in that sense, I think the financial system is better for more people. But, if the goal was to break up the banks, they certainly didn’t do that.

    Mary-Catherine Lader: So bridging your two worlds that you’ve covered the most, financial services and technology, and now that we’re in this fourth industrial revolution, what ways do you see financial services ripe for disruption and change?

    Kevin Roose: Well, I think some of this is happening around the margins, we’re seeing little things like the lending models are changing for personal finance, we’re seeing robo-advisors. There is a lot of startup activity that is being used as a pilot vehicle for the rest of the industry, like oh, we can do that we can do robo-advisors, let’s do that, or acquire one ourselves. My sense is that the financial service is actually ahead of a lot of industries in terms of technological adoption. So high frequency trading has been a thing for decades, and there’s been lots of automation throughout these firms. I still think there is room for improvement on a lot of these. I think a lot of things like underwriting, there is still a lot of opportunity for automation there. I think you have to be careful with things like underwriting because if you have biased data, you’re going to have biased results for things like home mortgages. But trying to get through one interview without mentioning the Blockchain world, it’s very hard these days. But I do think there are probably some useful applications there.

    Mary-Catherine Lader: As you’re covering these tech companies and everything they’re going through in Washington and with consumers now, any lessons for financial services?

    Kevin Roose: I think one thing that has really stood out to me and that has surprised me actually is how responsive these tech companies have been to their own workers. We’ve seen in the past year, engineers at Google and Amazon and Microsoft and other large tech companies, push for real change within those companies, and be listened to. I think that because the talent pool is so tight there, because these are such valuable employees, they’ve found out that they have a lot more leverage than they thought. And if their firms aren’t doing things that they feel proud of, they can band together and change that. And it doesn’t take very Many of them. It doesn’t take very long. So I think that in financial services and every industry, some social responsibility can be led from the top and the hope is always that the top is leading, and in the cases where it’s not, the workers actually have a pretty substantive impact in the right situations.

    Mary-Catherine Lader: That makes a lot of sense, especially since millennials are now the majority of a lot of these firms –

    Kevin Roose: Really?

    Mary-Catherine Lader: Yeah. Yeah. The average age at BlackRock is 34, which is a millennial actually. Well, also millennials not so young anymore.

    Kevin Roose: Right.

    Mary-Catherine Lader: So a lot of what you spend time on is gloomy and negative, but you also--

    Kevin Roose: What are you talking about?

    Mary-Catherine Lader: I guess the dark underbelly of the internet. But you also give out good tech awards. So who got good tech awards this year and why?

    Kevin Roose: This is my favorite column of the year, because you’re right, I do spend 51 weeks a year in the muck of the internet. But then at the end of the year, I like to actually look at some of the people and companies who are doing great things for the world. So this year, let’s see, I had a company called Zipline that does blood delivery by drone. So they have remote places in Sub-Saharan Africa or other places that need medical supplies for hospitals and remote clinics. And they actually now have drones that they can plop the bag of blood onto and shoot it out, and get it to the place where maybe you couldn’t get an ambulance. So that is really cool. There was also a great project run by Code for America which is a non-profit that does civic coding projects. In San Francisco they had a law passed where you could expunge your criminal record if you had a marijuana-related conviction. But it involved a lot of paperwork, it was kind of cumbersome. And so a lot of people just didn’t know how to do it who were eligible for it. So Code for America teamed up with some organizations and built an automated system where you could just automatically expunge these convictions, which was a great example of automation in practice, creating more justice and equity for people. So things like that, I like to save up through the year. I have a little folder in my inbox that is good stuff, and every time I feel a little bit down in the dumps, I just look at that and remind myself that not everything is horrible.

    Mary-Catherine Lader: Right, exactly. So I’m going to end with a rapid fire round of a couple questions for you. Okay, are you ready?

    Kevin Roose: Yes.

    Mary-Catherine Lader: Okay. So you were on Times’ list of 140 best Twitter feeds.

    Kevin Roose: Oh my god.

    Mary-Catherine Lader: What is your social media of choice, Twitter, YouTube, Instagram, other?

    Kevin Roose: Other. I’m really into TikTok right now, which is a Chinese lip-syncing app—

    Mary-Catherine Lader: Why?

    Kevin Roose: It’s amazing, it’s so good. I wrote a whole column about it, you can go check it out. But it’s very happy. It’s just people being silly on the internet, like it used to be. And it’s delightful. You will feel very old if you are over 25 and you open TikTok. Like I felt like I was chaperoning a school dance or something. But it’s delightful.

    Mary-Catherine Lader: So you had a 30 day breakup with your phone. What is the consensus?

    Kevin Roose: Phone, but less phone. I did this detox because I was on my phone for five and a half hours a day on average. And it was getting in the way of my marriage and my work and life, and I just thought, this sucks, I don’t want to do this anymore. So I got a phone coach, who helps me--

    Mary-Catherine Lader: That exists?

    Kevin Roose: She’s amazing, she’s my phone coach, and she helped me get down from five and a half hours a day to one and a half hours a day. No phone is not the answer. No one can have no phone in 2019 unless you’re like Amish. No shade on the Amish, they’ve got it figure out. But I do think we can be more intentional about how we use our phones and not just use it to kill time.

    Mary-Catherine Lader: So in that period, you picked up pottery?

    Kevin Roose: I did.

    Mary-Catherine Lader: Are you sticking with it?

    Kevin Roose: I hope so, it’s really fun. It’s fun to do something with your hands that doesn’t involve a screen. It gets your hands really dirty, you can’t really check your phone while you’re doing pottery, and it’s very meditative. I made some very crappy bowls—if anyone is in the market for some mediocre bowls, I’ve got a cupboard full of them.

    Mary-Catherine Lader: Who has been your most memorable interview?

    Kevin Roose: I did a show at an anime convention once, you meet a lot of characters at an anime convention. So let’s see, I interviewed a vocaloid, who is a hologram pop singer. So it doesn’t actually exist, but I did a story about these imaginary pop singers who have thousands and thousands of fans that come to their “concerts.” So that was pretty weird.

    Mary-Catherine Lader: So all more memorable than Mark Zuckerberg?

    Kevin Roose: Mark Zuckerberg is fine. He’s no hologram.

    Mary-Catherine Lader: And what book do you want to write next?

    Kevin Roose: Oh Man, well I am writing a book now but I can’t talk about it yet. It’s loosely on this issue of AI and the future. So 2020, get your Amazon carts ready.

    Mary-Catherine Lader: Okay. So stay tuned.

    Kevin Roose: Yes, stay tuned.

    Mary-Catherine Lader: Thank you so much for joining us, Kevin.

    Kevin Roose: Thank you for having me.

  • Oscar Pulido: It’s no secret that there is a race for technology dominance. The speed of adoption in digital technologies in China has caught the world by surprise. From superpowers like Alibaba and Tencent to artificial intelligence, to the development of 5G technology, China has become one of the most vibrant hubs for technology in the world.

    Surprisingly, it’s all pretty recent. In 2010, a little over one-third of China’s population was using the internet. And most of that was desktop based. In the U.S., it was 71 percent. So how did China become this superpower, and how will the race move forward from here?

    On this episode of The BID, we’ll speak to Rui Zhao, Portfolio Manager for Chinese equities within BlackRock’s Systematic Active Equity Group. We’ll talk about how China grew into the superpower it is today, what makes Chinese technology different and where she sees opportunities for investors. I’m your host, Oscar Pulido. We hope you enjoy.

    Rui, thank you so much for joining us today on The BID.

    Rui Zhao: Thank you so much for having me here.

    Oscar Pulido: Let’s start at the beginning: where was China five or ten years ago in terms of technology and how did it become the superpower it is today?

    Rui Zhao: China has completely evolved to a very different country as of today. And ten years ago, we don’t have much big data or machine learning going on in China, but fast forward to today, those are very widely available and very prominent in China. I would say the transition really started in 2003 after China added itself into the WTO. The whole stock market only started in 1993 and in that year, it only was six companies. And the whole purpose for the stock market is not anywhere for people to invest, it’s more about helping the SOEs, State-Owned Enterprise, to divest their shares. And the stock market really becomes investible to normal people after China entered WTO. So the number of private companies in China, growing rapidly, and also the size of those companies, also grow rapidly. A lot of the GDP growth which is generating wealth and cash flow are not cash flow generated by the publicly listed companies, rather they were generated by private companies or companies owned by the government. That’s why they can direct the usage of the cash flow generated to long term investment. The government has been directing all those cash flows to invest in future infrastructure projects, or in technology upgrade. And also in venture capital companies that help to fund a lot of the initiatives in the technology development. I think that is also part of the reason we have seen such a fast growth in China’s technology sector. But also I have been thinking about this question myself a lot as well, so I think in China, the education component really played a key role in this fast catch-up process. Back for myself when I go through my school process, we were always told math, physics, and chemistry are the key things we need to learn and I think for my generation everyone has learned a lot of hard science but very little of the liberal arts. So it’s pretty narrow knowledge but it’s really helping us to take advantage of the engineer component.

    Oscar Pulido: The government plays a role in this as well. My understanding is that President Xi’s Made in China 2025 Initiative seeks to transform China into a leader in new technologies. So how does this support actually play out?

    Rui Zhao: Yes. You’re absolutely right. The government has been a key component in driving the technology upgrade in China. The Chinese government usually set a five year plan and revisit it every year so they have expressed a key focus on the technology upgrade and recently, called five years ago, the big data usage in the whole economy. I think in the long run, the government really recognized that big data and technology can increase the speed of catching up and can increase speed of economic growth as well as stability in the society. The Made in China 2025 has been widely quoted among the media and it’s caught a lot of peoples’ focus, this time I think it’s part of the trigger for the U.S./China tension so that is why it has become a very widely quoted concept. But really when you look back in China’s history, they always have a five year plan going on, and they also have a couple times this 30 year discussion. But for 2025, the government wants to upgrade the technology platform in China, not only on the AI and machine learning, and they really want to apply technology in normal peoples’ daily lives to increase the whole productivity of the society.

    Oscar Pulido: Rui, what are some of the advantages that the leaders in China have when helping with this investment in technology that perhaps leaders in the U.S. and Europe don’t have, in your opinion?

    Rui Zhao: I think in China we all recognize it’s a one party dominated system, so I think there is nothing wrong to say that out loud. That is really give the country or the government advantage to implement. So when they committed to anything or when they decide any change they want to make, they can really implement it quite efficiently. The downside is usually lacking very thoughtful discussion and deep understanding about the impact on the environment and society. But in terms of getting things done, they do have the advantage of that. And also I think the party system have a very detailed focus that is on stability. So I think the whole government agreed on the main agenda is to focus on stability, and to deliver stability, they need to deliver growth so that the public can enjoy some of the growth and improvement in daily life, and also at the same time, the employment has been a key focus of the government. So I think China has been enjoying high growth historically but the most of that agenda is really to deliver or maintain stability over the long run.

    Oscar Pulido: Let’s talk about the consumer base in China. For example, in the U.S. when I think about technology, there is a hesitancy to share personal information with tech platforms or there is worries about privacy, but in China it seems like the opposite. I just heard that at major airports in China for example, you can walk up to a kiosk that scans your face and gives you all of your boarding information: is that true?

    Rui Zhao: Yeah. I also heard about that, but I haven’t tried it myself, but I will not be surprised this is happening in China or is going to be widely available in China in the near future. I think you are right, maybe part of the culture or maybe part of the past experience of history, Chinese people are less concerned about their privacy. They are really more concerned about the growth for their wealth. So that is why they are willing to share their information in order to maybe grab a better opportunity or at least try to grab a better opportunity or try something new. But I think the next generation things might change. I already seen some dramatic difference over the current generation and the young generation, the millennials. So I think things can evolve, but it just happens to be in the past few generations people focus more on the growth and wealth perspective rather than other parts.

    Oscar Pulido: That’s interesting, people are less worried about privacy and it sounds like they’re more focused on economic advancement. And that makes me wonder, the idea of a super-app where you can do everything all in one experience — it’s not something that you typically see in the U.S. but for example, WeChat is a good example of this where you can message a friend saying you‘re on the way to dinner, you can order a car, you can play a game on your ride to the restaurant, you can order your food before you get to the restaurant; there are a number of things you can do all within a single app. Do you see this being replicated outside of China, and what do you think are some of the advantages and disadvantages of any app like this?

    Rui Zhao: Yes, I think it really helps people to manage their daily life in a higher efficient way. And I personally enjoyed it a little bit when I was traveling in China. You can use WeChat to handle everything. I think in China it’s probably the first place, this type of super-app started, especially WeChat. But I think slowly we have seen some major companies in the U.S. starting to try out and expand out of their normal business lines, and to give user a better experience to try to do things together. For example Amazon started as an online company and now they are consolidating online and offline with Whole Foods; and Apple expanded into ApplePay which is an online transaction system. So I think in the U.S., we are seeing some of the new apps or new companies being tested out but in China there was an advantage that a lot of the companies started with the same idea and each of them can go out and find a lot of the users because of the huge population. That’s usually what happens in China, it’s not just a one company coming to play. And also there are pretty decent amount of the venture capital funding available in China, either backed by the government or by large existing companies, and they have helped to fund all those trials. So that is why we have been seeing in China a lot of new ideas being tested, and on the other side, as we mentioned earlier, in China the consumers are less concerned about their privacy. They are quite excited to try out some new apps either to have a better experience or just to increase their day to day efficiency. So they are very open-minded to try those things which also help those super-apps to grow.

    Oscar Pulido: Do you think that Tencent which owns WeChat and Alibaba and perhaps others, would they have been as successful if they weren’t trying to launch their businesses in China? Or do you think they’ll have equal success abroad?

    Rui Zhao: That’s a great question. Honestly, I think Tencent can only exist in China. And also, I think they take advantage of China being semi closed on the economy and market. One big advantage that they had was Google was not available in China. So I think if it’s in the U.S., Google will probably become a dominant player in the whole market, however, while they are not in a hurry to enter the other fields, like banking, like investing, or for food delivery, for example. So they are really taking it slowly and more carefully plan their business trajectory, versus in China, a lot of things are moving super-fast.

    Oscar Pulido: So it’s interesting now you’re comparing and contrasting Chinese companies versus non-Chinese companies and what each other do well. So in what way do you see China learning from some of these other global players—you mentioned Google for example—and what way do you see China setting the bar for some of these global companies?

    Rui Zhao: I think in China, it’s only been 15 years in this decent high growth regime, so they have a lot to learn. The U.S. is a very mature market and developed market, and there are a lot of the cutting-edge technique available here. But I think on the other side, China is really good at executing. So when they have the idea, when they see the opportunity, they tend to move very fast and also because of the competition in the industry, usually there will be multiple companies to start, so they tend to have really push to move faster compared to the U.S. peers. And also the government did help the companies by supporting this technology upgrade, and also big data availability agenda. So the data has really become more available in China compared to the U.S. For example, in the U.S., I think a lot of companies who try to use data will be varied about the legal consequence, versus in China, consumers are less concerned about the privacy. So those type of data tend to be more easily available.

    Oscar Pulido: You mentioned the competition going on between companies in the U.S. and China. I want to talk more about the race for technology dominance between these two countries. We’ve heard so much about this in the headlines: what started the race and where do we stand today?

    Rui Zhao: When China stared to upgrade into the higher tech of industry on the sector of the economy, some of the competition naturally happened. And the way I think about China 20 years ago is mainly being labeled as a big industry of manufacturer and assembly. Versus today, they are entering this higher value added sub-industry sector of the market, of the economy. Some areas have been traditionally dominated by the U.S. players, so some of the competition happened naturally, but at the same time, because China moved so fast in the past 15 years, a lot of those things are not really done very carefully. For example, regulation set up for a potential data breach risk or even the consumer privacy. Even though people don’t care about it today, that doesn’t mean they won’t care about it in the future. So a lot of regulations haven’t been really thought about very carefully. Versus the U.S., things tend to be moving in the more careful fashion. So the conflict will naturally start. I think this is a good opportunity for China and also for the U.S.—the U.S. has been helping China in terms of the past fast growth, but in China’s case, I think it is a good time to take a pause and think about what is the best way to set up regulation for the long term growth.

    Oscar Pulido: It seems to me like there are a couple of areas in particular where this race in technology is most prevalent: 5G comes to mind, as does artificial intelligence. And I want to start with artificial intelligence since that seems like the basis for a lot of the most recent and rapid advancements in Chinese technology. How competitive are the U.S. and China when it comes to artificial intelligence?

    Rui Zhao: I think for artificial intelligence, it’s a very broad topic and it can be applied to anywhere. But in the end of the day, if you want to teach the machine anything or you want the machine to learn anything out of itself, you have to have the data. And that is one of the advantage of China because data availability is huge and is really lack of constraint. So a lot of the AI can be trained and applied to this vast amount of data. Versus in the U.S., I think regulations already followed up quite quickly, so some of the data becomes not easy to access. So that might make the speed of the development different.

    Oscar Pulido: What about 5G: it seems like there is the U.S. versus China when it comes to this topic that this is where there’s another tension between the two countries and their advancement in this technology. Does there have to be a winner and loser when it comes to 5G?

    Rui Zhao: I hope the answer is no, because I do think there will be a big benefit for both countries to collaborate in this area. As I mentioned, the U.S. really has the thought leadership and the cutting-edge innovation, and in China, it’s pretty good at executing the ideas or has been executing ideas. And also because of the amount of data, you can see whether it’s successful or failure idea, quite quickly. So I think if we can really combine the two country’s strengths, that could benefit everybody in the world. But I think going forward, there could be different focus between the U.S. and China in terms of the 5G technology and AI.

    Oscar Pulido: So let’s talk about some of the investment implications, I want to take advantage of your background as a portfolio manager looking at markets. What does all of this mean for investing in technology? We had heard from Kate Moore on a recent episode that in her opinion, it felt like you needed to invest in U.S. and Chinese tech independently just given the difference in the two ecosystems. I’d be curious to hear your view as to the investment opportunities based on everything you’ve mentioned.

    Rui Zhao: I totally agree with her view. I think she has a good point that as an investor, you might want to own both U.S. and China in terms of technology development because they might be going so different paths. This competition might become long term, and the advantage of the two countries are also quite different. China is good at implementing testing and finding data for the test, and the U.S. has cutting-edge innovation. And also I think in China, the technology or the use of internet, use of the mobile app has rooted deeply into peoples’ daily lives. From consumer day-to-day life, to investing, you can also buy mutual funds with the Tencent WeChat app, or to healthcare, you can see doctor on your phone either through a VC or through just a text chat or through picture. So a lot of the development in China are focused on the usage perspective which helps to improve humans’ daily lives, versus the U.S., it could be more focused on a different aspect. So I think owning both sides of the company can probably provide investors a more comprehensive view of the technology upgrade or growth.

    Oscar Pulido: Another one of the differences you mentioned between these two countries is the willingness of individuals to give up data about their social media usage. So how do you use this when you’re making investment decisions?

    Rui Zhao: Yeah. That’s a great question. So I’ll focus on China first, so we can get a lot of information from internet, including social media, but also including a lot of these disclosures that companies are required to broadcast to everybody. So we combine data from different data sources together to give us a more comprehensive view about a company. One example I will use is back 30 years ago, even in the U.S., an investor can only get information by reading through the financial statement the company put up, or talking to the management team through one-on-one meeting, But fast forward to today, we can get a lot of information about a company though their online activity because we know how many people click their website every day, or we know how many people opened up their app and look at the company how long they spent lingering around in the app. We can read through social media and see which brand people like and which brand people complain. So just overall by leveraging the data, it answers a lot of the questions we always wanted to answer before, but we couldn’t. And today with the data and technology, it’s just helps our human being to answer this question. 

    Oscar Pulido: Well, it’s apparent we’re going to be talking more about China particularly in the context of our portfolios based on everything you’ve just shared. Rui, I want to end with a rapid fire round where we’re going to predict the future a bit, or at least we’re going to try. I’d like you to tell me whether you see the following things happening in five, ten, thirty years, or never. Are you ready?

    Rui Zhao: Yes.

    Oscar Pulido: Okay. Household robots.

    Rui Zhao: Within five.

    Oscar Pulido: A cure for cancer.

    Rui Zhao: Five years.

    Oscar Pulido: I sure hope you’re right on that one—there are a lot of people rooting for you on that answer. Personal jetpacks.

    Rui Zhao: Ten years.

    Oscar Pulido: That’ll be a good way to get to work I suppose if that works out. One world currency.

    Rui Zhao: I would say somewhere between 30 years and never.

    Oscar Pulido: Commercial space travel.

    Rui Zhao: Ten to thirty years, and I’m actually looking forward to this. I’ve already been talking to my kids that someday I’m going to take them to the moon. But they didn’t show any interest so far.

    Oscar Pulido: It’ll be a great way to earn accelerated airline miles for sure. Rui, thank you so much for joining us today. It was a pleasure having you on The BID.

    Rui Zhao: Thank you so much for your time and thank you for having me here.

  • Oscar Pulido: In 1987, China’s gross domestic product, or GDP, was just shy of $273 billion dollars. Sounds like a lot, right? Fast forward 30 years to 2017. GDP was over $12.2 trillion dollars. That’s over a 4,000 percent increase. In the same timeframe, the U.S. experienced about a 300 percent increase.

    China has had huge economic success in the last 30 years. While it was once considered a mainly poor and rural country, it’s become a global manufacturing power, and a quickly growing middle income economy. But until now, investors haven’t been able to take part in its success. Chinese authorities have kept financial markets closed and prevented them from being integrated with the rest of the world. Now, this is starting to change. The Chinese market is opening gradually, creating more and more opportunities for investors to take part.

    On this episode of The BID, we’ll speak to Jeff Shen, Co-Head of BlackRock’s Systematic Active Equities Group, who believes the market opportunity in China is too big to ignore. I’m your host, Oscar Pulido. We hope you enjoy.

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

    Jeff Shen: Thanks very much, it’s great to be here.

    Oscar Pulido: And I should say welcome back, because this is now your second time on the podcast, so I think you know how this works.

    Jeff Shen: I hope it’s a good sign.

    Oscar Pulido: Let’s talk about China’s growth. It’s actually really impressive when you think about what they’ve been able to accomplish over the last 30 years. What’s been the catalyst of that?

    Jeff Shen: I think number one is China really started to reform starting in 1979. And whenever we think about China, I always tell people that are three things that are actually most important. It is government, government, and also government. That certainly has been a major catalyst for the country to move from essentially a country that was quite a bit below poverty, think about 90 percent of the population lived below poverty back in 1979. Earning less than $1.19 a day. Fast forward to 2019, there is only less than one percent in this kind of extreme poverty. So I think the policy has certainly been the first most important driver. I think the second one is China joined the WTO in 2001, and that certainly allows China to open up to the rest of the world. And I think it’s certainly gone from a country in the 60s and 70s that was actually quite isolated to the rest of the world, to essentially having China come on to the world stage, whether it’s trade, whether it’s investment. That desire to interact with the rest of the world certainly allows a country to progress quite well since joining the WTO. And so these are the two things that I think we’ve certainly seen this extraordinary economic growth that we haven’t really seen in any other countries or at this type of scale in the human history. So it certainly has been pretty phenomenal.

    Oscar Pulido: And you mentioned government. So back in 2015, China’s president Xi Jinping unveiled the Made in China 2025 plan. What exactly are the details of that plan and is this also one of the reasons why we continue to see this extraordinary growth?

    Jeff Shen: Made in 2025 is certainly a way to think about to the next phase of economic growth for China. And I think, if you will, this mindset in China that what got you here won’t get you there. So for the next every five or ten years, you’ve got to do something that is fundamentally different. And Made in China 2025 is certainly emphasized from a growth perspective the country’s got to go from the quantity of the growth into the quality of the growth. And to go for quality, essentially you need to have a lot of technology to enable you to swim up on the value added curve and there is quite a bit of discussion around electric cars, AI, robotics, big data. So there is certainly quite a bit of emphasis on using technology to drive the economic growth going forward in this. And I think the one last thing I want to say that is I don’t want people to get the impression that it’s a new thing. In the sense that China is actually pretty regimented about coming up with these five five-year plan, ten-year plan, 20-year plan. And the technology certainly has been in a bit of DNA in the country, certainly produces one of the largest science and engineering graduates in the world. I think it’s important to think how this is actually not that much different from what the country has been doing for the last 30, 40 years.

    Oscar Pulido: Is China unique in its ability to think more strategically about its economic plan? It feels like sometimes maybe we just hear a lot of the short-term news about quarterly growth in an economy, maybe a new piece of legislation. But what you’re describing suggests that China thinks with a much longer time horizon than maybe other countries, other governments.

    Jeff Shen: Yeah. I do think that this is maybe because of the civilization has been around for a long time, there is a certainly a long horizon planning, long horizon thinking, which I think sometimes is good, sometimes it’s bad. But I think it certainly helps for a country of 1.5 billion people to think in a longer horizon, because otherwise, things tend to go much slower. In 2015, we talked about Made in China 2025; that was also the time the government decided on artificial intelligence alone, there is going to be hundreds of billions of dollars that’s going to be spent on these types of initiatives, over the next five to ten years. So this certainly longer horizon allows the government to be much more decisive in driving some of these key initiatives.

    Oscar Pulido: And you mentioned artificial intelligence, and I think you mentioned robotics. China is becoming a bigger player in technology, so as they transition from being more about quantity of production to quality, it’s certainty a benefit for China, but is that a benefit to the rest of the world, or is it a threat to the rest of the world?

    Jeff Shen: I think there are two elements here. One is I do think that China is about 1/6, 1/7 of the world’s population, so from that perspective, if we can use technology, whether it’s AI or big data or robotics, to make life for 1.4 billion people better, I think that in itself is certainly a good thing for the human race. And I think as to the impact to the rest of the world, this is not necessarily a zero sum game, in the sense that the technology discovery will certainly benefit countries, not in a singular sense, but really in a plural sense across the globe. And I think that certainly has been the case in scientific community, if there is a major breakthrough discovery, that type of discovery certainly tends to be beneficial to the overall community. At the same time, I do think that this is not going to the park to have a picnic either. I do think there is some element of competitiveness in there, in the sense that it does drive a bit of a competitive edge for different companies or governments. You can also think a little bit along the lines of military. So I think that part is certainly I think also part of the reason why that’s introduced in some geopolitical tension, because for the rest of the world, China does present different economic growth model that is quite different from how we traditionally think about capitalism, that it should be. So I think that alternative model as it gets stronger, as it gets infused with more AI and robotics, it does worry the rest of the world a bit.

    Oscar Pulido: So you said “geopolitical tensions,” and it feels like the headlines that we read about China have those words in them all the time, and we lose sight of the longer term perspective of what’s been going on from a growth perspective. What’s your opinion on the trade war, what is its impact on the Chinese economy, and how should we think about it in terms of investing in China?

    Jeff Shen: I think the trade war can really be thought about as a bit of a tip of the iceberg. The trade deficit between the China and the U.S. has certainly been around and persists. And I think that is an issue that is quite a focal point. At the same time, I think underneath the surface, we can certainly mark 2018 as a year that the U.S./China relationship has gone from historically, certainly has been a model of cooperation to the new phase of a model of competition. And I think given just the sheer size of the Chinese economy, even though on a per capita basis, it’s still a below middle income developing country, but given the population size, and also the transformation it’s gone through, that certainly has created a bit of a tension. It’s actually not only with the U.S. — it’s actually also with the rest of the world. Think about state ownership, the political system that is very different from a typical Western growth model. So I think it’s not only the economic interest, but also what is the ideal way of growing that is presented to the reset of the world, that is at stake here. So I think we are entering the phase of competition—that being said, that may not always be bad. A bit of a competition can potentially drive a bit of a growth and innovation that we have seen before. So I don’t think it’s all bad, but I do think, at the same time, that we need to recognize we’re going into a new era.

    Oscar Pulido: Does China think more about prioritizing growth and less so about managing some of these geopolitical relationships? That is what it sounds like listening to you talk, and that is what it sounds like will be the case at least in the foreseeable future. But at some point, does China start to really think about the importance of maintaining more stability in some of these geopolitical relationships? Or will it always just be about growth?

    Jeff Shen: I think the rising tide certainly can lift up a lot of boats from a domestic perspective. I think the growth can certainly lead to domestic stability, which if you think about the growth that’s been happening in China over the last 40 years, that certainly allows the Communist Party to be much stronger and also extraordinarily well-liked in the country. So I think domestically growth has actually been a recipe for success. It is the case that the economy is large enough, the global implication is certainly one that is sometimes outside the Communist Party’s direct control. If you think about the populism that we see around the developed countries, a lot of the jobs actually have gone away in the developed countries either because of globalization or maybe, actually, importantly, because of technology. But nevertheless, you just need to go to some of the manufacturing centers in some of the developing countries to realize that the China story rising up on the horizon certainly has global implications. And that is something that I think China has to think about it—I think they’ve been forced to think about it, so this is actually giving us additional context to think about not only just growth in its full form, but also what are the collateral damage, what are the opportunity costs, of that growth? Whether it’s the environment, whether it’s the global implication, these are the things that are additional problems as China rise up on the stage, that it needs to think about.

    Oscar Pulido: There is no question that the economic growth story in China is very impressive, it sounds like government plays a big role in that, it’s having effects around the world on other economies. But then let’s talk about the investment opportunity, because many times we hear about economies that are doing well, but that doesn’t necessarily mean the stock market of that economy is doing well. When you think about the investment opportunity then in China, actually buying companies in China, is there a compelling case there the way you’ve made a compelling case around the economy?

    Jeff Shen: I think the relationship between growth and the investment returns is certainly a complicated one. And especially when it comes to China, I think it is even more complicated. Higher growth doesn’t always necessarily mean if you just buy and hold a bunch of companies, you’re going to make a lot of money. So I think in China the exciting thing that happened in 2018 certainly has to do with the MSCI inclusion of the Chinese A-shares market into the global equity market. And this is certainly a market that historically, international investors have had very little access to it, most of the holdings have been through the domestic institutions, and importantly, domestic retail investors. So that market essentially has stocks that are traded in Shanghai and Shenzhen, that is opening up to the rest of the world through Stock Connect mostly. And so that is a big deal in my mind that this is a give or take, around $8 trillion dollars in market cap, and that’s a big market, that is actual opening up to the rest of the world. There are 2,000 plus stocks listed in there and the market trades $40 to $50 billion dollars a day. There is a large deep market. And I think for investors who want to tap into the growth story of China, I think it certainly presents a pretty rich opportunity set.

    Oscar Pulido: Talk a little bit more about when you say the markets are opening up, because I think for many investors, at least the way I think about it is that investing has become very democratized. It’s a lot easier to invest in markets around the world. So it sounds like it wasn’t easy to invest in China maybe not so long ago, but what does opening up mean practically?

    Jeff Shen: Yeah. Before, as international investors, certainly you can invest in Chinese A-share market, stocks listed in Shanghai and Shenzhen. But it was a pretty complicated process to do that. You needed to go through what people typically call a Q fee, quota license to be able to invest in that. And it’s a lengthy a bit cumbersome process to go through that. It took us also a while to get a license to invest in that. We got it about seven years ago from the BlackRock as a firm perspective. Sometimes people joke that my second PhD in anthropology always takes a little bit longer to get than the actual license. But I think fast forward to today when we say opening up, is that if an international investor can invest in stocks in Hong Kong, now they can essentially invest in stocks in Chinese domestic A-shares market. So I think it’s very exciting for the international investors, the process is getting to be much more robust and open. So you just need to pick the right ones.

    Oscar Pulido: If I look at the S&P 500, I look at an index that’s very diversified, companies of different sizes, the sector representation is pretty diverse. You have banks, you have tech companies, you have healthcare and the list goes on. If I were to look at the A-shares market in China, what is the composition of that market look like from a sector perspective? And talk a little bit about the corporate governance of the companies in China: should we have the same level of confidence in corporate governance that we would maybe with a U.S. or European company?

    Jeff Shen: Yeah. I think the sectorial composition is also quite diversified. So whether it’s MSCI indices of Chinese A-shares market, or locally they also have a CSI 300 Index, when you look at any of these sectorial compositions, they are actually quite similar to the rest of the world. They are quite diversified, it’s a large economy that has not only got a state-owned enterprise, but has also got a large representation of the privately owned companies, some are exporters, some are also very much domestic oriented. And I think the interesting thing of the Chinese A-share market is that we can also gain access to some of these domestic consumption stories that you probably historically haven’t really been able to get that exposure to through international equity market. Now the corporate governance element of it, the typical perception is that for emerging market countries, sometimes these corporate governances may be a little bit below the international standard. The Chinese governance structure is actually quite strong. The stock exchange actually requires quite a bit of documentation, compliance and information for any companies to be listed and there is even quite a bit of requirement on the company to make profit for three years before they can even be considered as listed, especially in the main stock exchange, in Shanghai. So, I think the governance and also transparency and information and data, surprisingly, is actually quite abundantly available. The Chinese economy is actually transforming very quickly into a digital economy. So from a data availability, transparency, information, you actually find a lot of that in China that is actually often times to peoples’ surprise.

    Oscar Pulido: And transparency, the Chinese consumer, or the individual, is a big user of technology and social media, and that leaves a pretty rich digital footprint. In your role, being able to access that data I believe is an important part of how you can analyze the investment opportunity set. How is it that you use that big data to understand where are the better opportunities in China?

    Jeff Shen: Absolutely. I think China certainly is a great playing ground for using big data, using artificial intelligence to gain a bit of investment insight. For example, for fundamental information, you can actually use satellite image information to get a sense of the metallic content on the ground, essentially to get a sense whether it’s industrial manufacturer or the real estate companies where the metal frames of the buildings are coming up, to essentially get a sense of how industrial production is coming along, or whether there are trucks moving around port, or whether the building site is actually progressing at normal pace. So you can measure fundamentals using these kind of alternative data source like satellite image to give you additional sources of information to validate some of your prediction. Same thing, through social media, you can certainly get a sense of some of the retail flow sentiment, just to get a sense of the 130 million retail investors. Are they loving the stock market? Are they worried? What their mood is. This information certainly historically was never available because people never really blog or Tweet about what they like. But today in aggregated form, you can get a sense of overall market sentiment. So I think we can certainly use some of this new informative alternative data to essentially enrich your understanding of the market, but I think a lot of it is also about asking the right question, making sure that with the new set of data, you can ask some interesting and relevant investment questions, and hopefully we can use new data and tools to gain a bit of an edge.

    Oscar Pulido: And what is the data not telling you? I imagine there is still a role for going to China, spending time there, talking to people, that supplements maybe some of the analysis that you mentioned.

    Jeff Shen: I think we use a lot of tools, a lot of models, and sometimes people think we are just a bunch of machines. But in reality, humans play an enormously important role in driving an investment result. If you really want to understand what is going on with the government, we talk about how important that is, certainly very important to gain a bit of insight from the policymakers, what’s on their mind, clearly you can supplement that with a bit of data science to look at some of the trends people actually use to gain a bit of a sense of what is on the policymaker’s mind. But at the same time, I do think that a model at the end of the day, or data, the insights you gain, is essentially a simplification of the world. And the world is pretty complicated. So I think the human’s job is certainly around asking interesting questions, but it’s also asking, “What is the model missing?” The model has never seen a trade war in its life, but it’s certainly going to be important going forward to think about what the new era is going to really mean for investment. So I think this is probably also why we love what we do, because nothing will work forever and you’ve got to keep innovating.

    Oscar Pulido: And with a market as big and complicated as China, I’m sure having all those tools is something that helps a lot. We’re going to end with a bit of a rapid fire round, where I’ll ask you a series of more personal questions, I hope you’re ready?

    Jeff Shen: Absolutely.

    Oscar Pulido: I know you live in San Francisco: so I have to ask, electric scooters or electric cars?

    Jeff Shen: I think electric scooters with helmet, so take risk but with a bit of risk management.

    Oscar Pulido: And this is your mode of transportation to work in the morning or is that just on the weekends?

    Jeff Shen: Weekends, I walk to work.

    Oscar Pulido: Now I’ve heard your daughter watches Shark Tank, which shark do you prefer? Mark Cuban or Mr. Wonderful?

    Jeff Shen: I think Mr. Wonderful is a little bit scary for my kids, and Barbara Corcoran is actually the family’s favorite.

    Oscar Pulido: Yeah, Mr. Wonderful is pretty honest, that’s for sure. Which idea would you bring to Shark Tank?

    Jeff Shen: I think I love artificial intelligence and I also certainly am a big fan of China. So I think maybe a Chinese restaurant with AI driven robots as servers will be my idea.

    Oscar Pulido: Okay. That’s interesting. Now you teach a course on international investment at NYU. I happen to know, because I was a student there. And I didn’t have time to take your class unfortunately, but what is the one word students would use to describe your teaching style?

    Jeff Shen: I think “engaging” may be the word. I do teach an intensive class there that involves 6 hours a day, so that is a lot of coffee and a lot of Q&A, so it’s a lot of fun.

    Oscar Pulido: And then the last question: will China’s stock market capitalization ever exceed that of the U.S.?

    Jeff Shen: I think it’s possible, but I think I’m also a big believer of the U.S. market and U.S. system. Again, I think in this case, there is probably a lot of China versus U.S., but it’s China and U.S. both can be quite good.

    Oscar Pulido: Jeff, thank you so much for sharing your insights today and joining us on The BID.

    Jeff Shen: Thank you very much, it’s great to be here.

  • Oscar Pulido: Electricity is a little bit like the air you breathe: You don't really think about it until it’s missing. When you switch on a light, charge your phone or cook your food, you’re using electricity. But do you ever wonder where it comes from? How it was generated or how it got to your home?

    Increasingly, that power is coming from renewable sources like wind and solar power. We’re moving away from coal and fossil fuels to cleaner energy sources. And as we focus more on society’s impact on the environment and our climate, renewable energy is becoming harder and harder to ignore.

    On this episode of The BID, we’ll speak to David Giordano, Global Head of Renewable Power and the Chairman of the Board of Directors for the American Council on Renewable Energy. We’ll discuss what’s going on in the renewables market today and what it means for us as members of society and as investors. I’m your host, Oscar Pulido, we hope you enjoy.

    David, thank you so much for joining us today.

    David Giordano: Thank you so much for having me, Oscar, it’s great to be here.

    Oscar Pulido: So David, let’s start with the basics. When we say renewable energy, what exactly do we mean by that?

    David Giordano: It’s a great question, and when we’re talking about renewable energy, what we’re really talking about is harvesting the wind, harvesting the solar insulation, the power from the sun, and then transforming that from that raw resource into electricity. We can also do this with hydro plants, do this with geothermal, but the most common technologies out there, are wind and solar.

    Oscar Pulido: And how has the renewable market grown over time?

    David Giordano: As you think about power generation in the developed world and the United States specifically, two-thirds of our power generation comes from the fossil fuel technologies, coal being included in those technologies. This is shifting over the next thirty years to renewable power, but the real sort of inflection point where we industrialized renewable power happened kind of in the early 2000s. I think that's when you really saw that revolution from kind of a niche generation technology into something that was on the track that gets us to where we are today, where renewable power is a mainstream source of power generation. As I think about the technology disruption in electricity generation, I think a great example of that is if you look at telecommunications and the telephone. If you go back to sort of the original Alexander Graham Bell telephone and you think about what an iPhone looks like today, they’re almost unrecognizable. It’s a completely different form of technology. And you see what’s happened in the developing world where many countries and many regions essentially skipped the landline and went right to mobile technology. Well, now take us to electricity and imagine Thomas Edison walking around New York City. He might look up at a transformer hanging downtown in Manhattan and think that it was one that he hung. If you took somebody to a coal-fired power plant, yes, it will have new emissions controls and new systems around it, but it’s essentially the same basic technology. We hadn’t had that kind of disruption in the power generation world until we really began to see the industrialization of renewables.

    Oscar Pulido: So it’s interesting because everywhere around us, it seems like industries are being – you used the word “disrupted” – but you’re saying it really hasn’t come to the power generation market yet, and why is that? Is it because of cost? What is it that has prevented the power generation market from experiencing the type of disruption that has hit other industries?

    David Giordano: I think it’s really two-fold. I think on the one hand, it’s a very high barrier to entry from a capital standpoint to transform that infrastructure, and it’s a very difficult part of the infrastructure equation to do piecemeal. So say unlike telecom, which is a highly regionalized opportunity, with electricity you’ve got to make some major changes. Power plants are one of the essential physical infrastructures that creates this centralized input of electricity into a very old transmission and distribution system, and it’s really kind of the first 1.0 if you will of the power generation infrastructure, transmission, and distribution. The wind blows in places that you wouldn't put a coal-fired power plant, so that changes the need for transmission and distribution.

    Oscar Pulido: So that is an interesting point. When you talk about renewable energy and wind and solar – and this might sound like a silly question – but what happens if the wind doesn't blow or the sun doesn't shine? Do we not have power? How does that get accounted for in a transition to renewable energy?

    David Giordano: Yeah, it’s a key aspect to this energy transition, and the intermittency is the primary criticism and challenge of the transformation. First and foremost, natural gas is going to be a huge part of the transition to how power is generated here in the United States and I think across the developed world. You know, the biggest enemy to coal-fired generation is really not renewables. It’s natural gas. Natural gas is cheap, it’s efficient, it’s low emission. So that's one piece to it. The other piece is the continued growth and proliferation of storage, and right now we’re seeing lithium ion battery storage as the primary technology to be able to have dispatchable power as needed, 24 hours a day, 7 days a week. You draw upon the battery to use electricity when you’re not getting enough power from your renewable source, whether it be wind or solar, and so that's the way that you kind of balance out the supply and demand. The next leg of that stool I really think about is just being smarter about how we consume power. And so right now there’s very few places where an end user is actually encouraged to modify behavior around an efficient use of power being generated, whether it be from renewable sources or any other source.

    Oscar Pulido: You talked about natural gas, you made mention of lithium ion batteries, so just take a step back again and help us understand. There’s the traditional coal-fired power plant, and I’m picturing that as a piece of infrastructure, and help us understand what that infrastructure looks like as we shift to a world where there’s more renewable energy.

    David Giordano: One of the things to think about is you think about centralized power generation that requires a feedstock fuel. Let’s just sort of stay generic with it, right? First and foremost, you’ve got to be located at a place that is centralized for the delivery of that feedstock fuel, so you’ll see a lot of coal-fired power plants along rivers, right, so barges bring coal in. For a natural gas-fired power plant, you’ve got to be on the gas pipeline, the interstate gas pipeline system. Piece two of it, which is an important one as well, is access to water. The most efficient power plants are water cooled, not air cooled. You can air cool some gas-fired power plants, but the water cooling makes for a much more efficient power plant, but it requires a healthy access to water. And then you’ve got the transmission system, which those are the big lines that you see that are carrying massive amounts of electricity over longer distances, and then you get into the distribution which that's really more about the load centers and the end users. So now switch your thinking to what renewable power projects look like. Now, you’re on higher elevations where you can harvest the wind, where you’re going to have more consistent wind, so that's putting you in a very different part of the country than you would, say, for traditional fossil-fired generation. And then that means you need a different transmission infrastructure to support that centralized power generation. And then you go to the distribution level where you start to see power generated on site by a solar array let’s say. Now you’ve got a very different need on the distribution system. It needs to be two-way, so that when you’re generating more power than you’re using on site, you have a way to get that out into the grid to users that need the electrons.

    Oscar Pulido: And you touched on, it’s different parts of the country –

    David Giordano: That’s right.

    Oscar Pulido: – where the infrastructure might live just because of the elements that you need around you for it to succeed.

    David Giordano: Yeah. What state in the U.S. do you think generates the most renewable power?

    Oscar Pulido: I’m picturing wind turbines somewhere in the Midwest, so I’m going to say Nebraska.

    David Giordano: It’s actually Texas, so from sort of a political perspective, I think it’s interesting to think about, you know, Iowa gets 33% of its power from wind. It’s parts of the country that frankly in the past didn't see that kind of economic development and now are really at the forefront of the energy transition, and it’s bringing not just electricity and not just cheap electricity but it’s also bringing jobs along with it as well.

    Oscar Pulido: So if Texas generates the highest amount of energy from renewables, I’m picturing obviously there’s a lot of land there, open land where they can put wind turbines for example, but could you do that in a part of the country that's more densely populated like the Northeast for example?

    David Giordano: So the first opportunity is really just continued developments in technology. There are technologies out there already that are being worked on like thin film over windows of skyscrapers that are essentially solar panels, roof tiles that are also capturing solar energy. One of my favorite gadgets that I use when the power goes out are some light bulbs that have little solar panels on them and that store it up in a small battery and make light. And then the other place is offshore, especially here on the East Coast and especially here in New York. Long Island is perfectly situated for offshore wind. The water depth is right, the wind resource is right, and you’re offsetting some of the most expensive retail electricity prices we have anywhere in the country.

    Oscar Pulido: And so if I think about an economy that's moving to renewable energy, I start to think about something like electrical vehicles, but what else, what other technologies are out there that we will start to see and that will start to impact our lives as an economy transitions to renewable energy?

    David Giordano: You’ve touched on the biggest one, right, which is going to be electric vehicles, and that's going to be a huge driver also in lowering the cost of battery storage because the technology used in electric vehicle batteries is the same that’s used for large centralized battery storage. The next place is just what they’re calling kind of the electrification of things, and so just more things that we do day-to-day with other sources of energy we’re going to start to do with electricity because a) it has zero emissions and so that's a positive, but also b) the economics that drive it. It is the cheapest source of new energy, it’s the fastest-growing source of new energy, and so we’re going to see more things that we do transition to being driven by electricity.

    Oscar Pulido: So if the industry is at a tipping point, what will be the driver that will ultimately turn it on its head?

    David Giordano: The main driver will be the economics. The cost of solar power has come down 80% over the past 10 years. The cost of wind has come down about 46% over that same period of time. In many countries today, wind and solar are actually the cheapest form of new power to go into the grid, United States included by the way. And the other thing to remember in that transformation is the average age of a coal-fired power plant is over fifty years. The average age of a nuclear plant is over thirty years. Just the simple cost of operating a piece of equipment that old means it needs to be replaced, and it’s going to be replaced with the cheapest option available. The other driver is just the demand for power coming from end users. You see individuals looking to add solar in particular but solar and storage, either in their community or directly on their own properties, and so these are big, big drivers of that transformation as well. And then finally, it’s just at the policy level. You’re going to continue to see policies that facilitate the energy transformation. I think they very well will transition to be technology-agnostic, and that takes us back to the beginning of this conversation which is the economics.

    Oscar Pulido: With everything you mentioned, why aren’t we all using renewable energy at this point?

    David Giordano: There’s two big barriers to the transition. First and foremost, it’s just the supporting infrastructure, but secondly it’s just the high upfront cost. There’s no cost for fuel when it comes to a wind project or a solar project, but the counterbalance to that is a higher upfront capital cost. The challenge becomes then folks that can’t afford that kind of generation end up bearing a disproportionate amount of the cost of the existing grid, and so as we think about that transition, we’ve got to also think about a way in which that happens where not only the folks that can afford it end up with renewable power. 

    Oscar Pulido: And what role does government play in this? How could federal policies in the U.S. affect the growth of renewable energy?

    David Giordano: It doesn't have a direct impact. I think an important thing to remember in the United States in particular is that there really isn’t a federal energy policy that then gets granular down at the actual implementation level. It’s much more of bottoms-up industry. So for something like off-shore wind, the federal government will play a more direct role because they are going to control the permitting of off-shore wind projects, so if you have an administration that is not excited about more off-shore wind, you could see that maybe not having the same velocity as it would under other administrations. But really the bigger drivers are going to be state level policies around it. We have over thirty states in the United States that have targets for renewable energy. And you do see some waxing and waning at the local levels around renewables, and renewables don't come at sort of zero societal cost. I mean they change viewscapes, they have a different impact on wildlife depending on where they’re located. And so as we see that transition, it’s going to be really important I think as an industry that we stay very focused on the social and governments component to the ESG just because the environmental piece is so compelling when it comes to renewables.

    Oscar Pulido: And are there countries outside the U.S. where you see the federal government playing a bigger role in enforcing the growth of renewable energy?

    David Giordano: Absolutely. In Europe for example, the EU has hard targets with real teeth behind countries missing their targets, and so that's a place where you see that kind of centralized approach to facilitating renewable power investment as being one of the main drivers, and that's why I think you see a much more mature renewable energy infrastructure and industry in Europe. China is another place where again we’re seeing on an absolute basis the largest amount of growth that's happening there, and that's because it’s being mandated down from the federal government. So under a different construct, the federal government plays a huge role, but here in the United States it plays a much lesser role.

    Oscar Pulido: So you’ve given us a good background of this transition to a renewable energy economy, some of the impediments that we might have along the way, but ultimately some of the benefits that we could feel, so let’s transition to thinking about from an investor’s perspective. You’re the Global Head of Renewable Power at BlackRock, and how do you think about investing in renewable energy?

    David Giordano: I think about it all day every day.

    Oscar Pulido: I’m sure.

    David Giordano: I think what was attractive about this strategy back in 2011 when we launched it here at BlackRock was that it’s a space that has a lot of growth potential, as you think about 9 trillion dollars of infrastructure investment around the energy transformation to renewable power. I think the other thing about renewable power investing is that it requires very specific skillsets just in terms of underwriting investment opportunities, you know, the technological issues are specific to the industry, also the measurement of resource and really understanding how that resource is going to behave over time and how that then translates into an investable opportunity if you will. I think the other thing about this space is that it’s evolving, and that there’s going to be changes that are fundamental, that are disruptive, to go back to a word we used earlier in our discussion, and that is where we see real opportunities for attractive risk-adjusted returns for our partners in the space.

    Oscar Pulido: I picture an investor who is used to opening up the financial statements of a company and thinking about an investment in that sense, and there are certainly companies that are involved in renewable energy that trade as stocks and which you could pursue the analysis in that way, but there’s also I’m picturing people who have to do a completely different type of due diligence when they’re looking at a renewable energy project, which is maybe visiting a piece of land and understanding, I don't know, how fast the wind is blowing for example. Is that the right way to think about it?

    David Giordano: Yeah, it really is the right way to think about it. I mean early on in the industry, you used to go around and look for where the trees grew bent because the wind blew so hard. We’ve gotten a lot more sophisticated with the science in terms of measuring the wind and then forecasting what that's going to look like over the life of the asset, which is thirty years plus or minus. And so it becomes a very specific and self-learning model around measuring the resource, measuring the way in which the equipment is going to transform that resource into electricity, and then the efficiency with which that electricity is going to get delivered to the end user, and really thinking about that kind of holistically is the big driver in evaluating the risk associated with one of these investments. Because at the end of the day, the way that this investment is not going to go well is going to be primarily because you didn't produce the number of kilowatt hours that you expected when you made the investment.

    Oscar Pulido: So if fossil fuels were Electricity 1.0 and what you’ve discussed with renewables is Electricity 2.0, what does the future look like? What does 3.0 look like?

    David Giordano: I think it comes down to kind of three main factors. The first I’d say is flexible supply, so again it’s that movement from just a fully centralized power generation strategy to transmitting the power from the renewable sources, but also locating the power generation closer to the demand centers. I think the second piece of it is flexible demand, and so getting smarter about how we use electricity on a day-to-day basis. If it’s cheaper to use wind power at night, we shift operations, whether it be at the home or whether it be in the commercial and industrial world, to that time of day to where we can get the cheapest, most reliable power. And then finally, it’s the decentralization of the grid in general and going more to micro grids so that we’re able to really take advantage of the inherent benefits of a localized power supply and end user of electricity.

    Oscar Pulido: So while maybe this industry hasn’t been disrupted as much as others in the past, it certainly sounds like we’re on the precipice of something, and I’m going to be looking out for trees that are slightly bent as a potential site of a good investment in renewables. That was one of my key takeaways from listening to your comments here.

    David Giordano: You would have made a great wind power analyst in the nineties.

    Oscar Pulido: Alright. What we usually do here at the end, David, is we end with a rapid-fire round, and we’ve been talking about the shift happening in energy so I wanted to ask you about the shift that's happening in other industries. I’m going to ask you whether you think the following statements will happen in five, ten, thirty years, or never. Are you ready?

    David Giordano: I’m ready.

    Oscar Pulido: Okay. Brick and mortar is replaced with 100% online shopping.

    David Giordano: I might come across a little old-school here but I’m going to say never. I am going to say that we’re going to shift more to experiential shopping, but I think the idea of being in a store, interacting with the staff there, I don't think that's ever going away so I’m voting never.

    Oscar Pulido: I tend to agree with you on that one. Corporations shift to a four-day work week.

    David Giordano: That's a tough one. I think that's it’s not ever going to be officially a four-day work week, but I do think the flexible hours is going to not just be something that we talk about, it’s going to be something that we do, and it really plays into our whole conversation today, right? It might just make more sense to have all these computers going at night, and we know we all have plenty of friends that are night-owls. You know, I’ve watched my son play Call of Duty all night plenty of nights as he’s grown up, so I’m sure he could be a candidate for a night shift computer job. 

    Oscar Pulido: So I know you’re from Philly: when will they win the Super Bowl again? Again five, ten, thirty years, or never?

    David Giordano: That's a hard one because up until two years ago, the answer was never, and I think that there’s a lot of people that would still vote for never, but I like where Carson Wentz and Doug Pederson are, so I’m going to say that's within the next three years.

    Oscar Pulido: Okay. As of the 2016 census in the U.S., over 76% of Americans drive alone to work every day. Only 5% take public transit. When will we see a day where more Americans use public transportation instead of cars going to work?

    David Giordano: I don't know that we’re going to go that direction. I think that we’re going to get to a place, though, where those numbers turn on their heads in terms of ownership of vehicles. I think that we’re going to see less and less people actually just owning their own car, and I think that's where that big shift is going to happen. 

    Oscar Pulido: Do you own your own car?

    David Giordano: I am about to go carless, so I am trying an experiment. Beginning at the end of this month, I will be car-free for the first time since I was 16 years old.

    Oscar Pulido: Alright, I’m sure you’ll survive. David, thank you so much for joining us today on The Bid.

    David Giordano: Thank you so much for having me, Oscar, it was a pleasure.

  • Mary-Catherine Lader: Poker may seem like a vice, but perhaps it teaches us less about how to win money and more about how we make decisions. Like investing, for example, poker requires us to make decisions, gauge risk and trust our choices, all with incomplete information. And we’re not as good at making decisions as we may think we are. So how do we overcome uncertainty, our biases, and do our best to get it right? 

    On this episode of The BID, we’re doing something a little different. We’re bringing you a live recording from our Latin America Investment Forum in Miami, where we spoke with Maria Konnikova. Maria is a psychologist who specializes in risk and decision making. She’s a New York Times bestselling author, and a world champion poker player.

    Maria talks to us about how she got into poker, even though she detests gambling, why sometimes the smartest people in the room can often make the worst decisions, and why the only certainty in poker, as in life is – yeah, you guessed it – uncertainty. I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Thanks so much for joining us today.

    Maria Konnikova: Thanks for having me.

    Mary-Catherine Lader: I’m going to ask the obvious question first, how and why did you get into poker?

    Maria Konnikova: So, I initially got into poker for a book, which is going to be my next book, called The Biggest Bluff, about the role of chance in our lives. And I had no interest in poker, I didn’t know anything about it. I hate casinos, I hate Las Vegas, I hate gambling, I hate everything that has to do with that world. And I came across poker actually from game theory. So someone recommended that if I’m interested in chance, I should read John Von Neumann. And it ends up that John Von Neumann created game theory because of poker; he was an avid poker player. He was a horrible poker player. But he had this insight — he also played chess, he played Go, knew a lot about the gaming world – that if you wanted an analog for life, if you wanted an analog for true strategic decision making, poker was the game for you. It wasn’t chess, because chess he found incredibly boring because it was a game of complete information. There is always a right answer; there is no uncertainty because everyone knows everything and theoretically, you can solve chess. Poker, like life, is a game of incomplete information. There are things that we know in common, but there are things that only I know and there are things that only you know. And we need to play each other and we need to portray ourselves in certain ways, and we bluff and we do things that always convey information. He said that is human decision making. If I can solve that, I can solve the world. And so that is how I initially got into the game. And it was so funny, because I ended up becoming good, leaving The New Yorker, where I’d been for a number of years, to play poker full time. And people would say, oh my god, you became a professional gambler? And I would say, absolutely not. Because if you think that poker is gambling, you don’t understand poker. Gambling is when you can’t control things, and poker is a game of skill. So over the long term, the most skilled poker players, the most skilled investors are going to come out on top. And the key is approaching it the right way, and using it correctly to approach your decision making process. And if you do that, then it becomes something very, very different from gambling; it becomes a strategic endeavor that can I think unlock some of the greatest things about human decision making and help you think about risk, help you think about uncertainty in a much smarter way. When I was getting my PhD in psychology, I studied decision making and decision making under conditions of risk and uncertainty. And over and over, what you come up with is that we’re really bad at it, that the human brain is really bad at probability, that we have all of these biases. And what I realized was that poker is actually a solution, because the human brain learns from experience. It doesn’t learn very well from descriptions. So I can tell you about probabilities and you’re not going to actually be able to internalize it in a way that’s going to translate into your actual decision making process. Poker forces you to make these decisions and to sample probabilities correctly and becomes the tool that can help you un-bias your decision making in very powerful ways.

    Mary-Catherine Lader: That was very convincing. I’ve never played a very successful hand of poker, so next time I see you, I’ll ask for a personal tutorial because it sounds like it’s a very useful approach and framework for life. So taking us out of that specific game and sort of what you learned about decision making, what are some of the attributes that you’ve observed in your research of good decisions made under conditions of uncertainty versus bad decisions?

    Maria Konnikova: Yeah. So one of the key things that I‘ve learned is that we need up being pretty bad at figuring out what we can and can’t control. When you put us in a stochastic environment, and environment where there is a lot of uncertainty, especially an environment that is noisy where there’s not necessarily direct feedback between what you do and what happens—like the stock market for instance. There are so many things going on and you can’t account for all of the factors. We tend to assume a little bit too much agency, so we tend to assume a little bit too much control over outcomes if those outcomes are good. If something goes the right way, we say I am the best, I am so smart, look at me, look at how well I decided that. And then if a decision goes against us, there is so much in the environment you can blame. You can say, you know what, I actually thought of everything but this one thing happened, it’s not my fault. I can’t control it.

    Mary-Catherine Lader: Sounds like that is familiar—laughter in the audience.

    Maria Konnikova: So the beauty of poker is it’s a game, it’s a circumscribed environment, that is why it’s easy to learn because there are only so many variables. In the investment world, the variables are infinite, life is messy and there is so much noise. When I did my thesis work, which involved stock market games, we actually had actual investors play stock market games. And I found that people who were incredibly smart and very good at what they did, ended up falling prey to something known as the illusion of control which is thinking that you’re in control when you’re actually not. So they had to pick stocks and bonds and get feedback based on their decisions, on how much money they were making, and then they could have a strategy and then they could change that strategy. And what ended up happening was when the environment shifted, the people who were very smart didn’t shift as quickly as the people who were less successful, because they said, oh, no no, my strategy is good it’s just there are all these other things wrong. So I’m just going to keep doing what I’m doing because I know what I’m doing. And then other people would actually listen to negative feedback and say, well I don’t know what I’m doing and so I guess maybe I should do something different and they ended up making a lot more money. And so, that’s one of the key variables that I’m trying to get people to stop doing; stop falling for this illusion of control because it’s very powerful and it impedes learning. You’re not going to become a better investor, you’re not going to start making better decisions, if you constantly blame other things for your mistakes and you constantly take credit, even when maybe your decision was actually absolutely wrong and you just got incredibly lucky.

    Mary-Catherine Lader: That’s really powerful and compelling, but it’s very hard to put into practice, right? So what does that mean, trust yourself less is the right answer? How does one do that every day, how do you do that successfully and still have the sort of confidence to make decisions?

    Maria Konnikova: Yeah. I think that it’s a very fine balance: you can’t constantly question yourself because then you’d be paralyzed if you wanted infinite information, because ultimately we are making decisions under conditions of uncertainty. And we’re not going to be able to know everything. But I’m a big believer in having as objective of a framework as you possibly can. When you’re playing poker, it’s very easy to make a bad decision then get lucky when the one card you needed comes your way, and then you kind of forget that your decision was bad because you’re outcome-oriented. You look at the outcome and you say, my decision was good. And on the other hand, if you made the correct decision, but then you ended up losing, sometimes you start questioning yourself. And so it’s incredibly important to actually divorce yourself from the outcome. So when I talk to my coach – and I think everyone needs coaches no matter what you do — you need to have someone with whom you can talk through things. I think this is incredibly true in the investing world. So when I talk to my coach, he actually doesn’t care if I won or lost. He doesn’t care what the outcome was — all he wants to know is to go through my decision making process. At every single step, why did I do what I did? What was I thinking was going to happen? Did I think several steps ahead, did I think how people would react to my decision? So because I know I’m going to be explaining this, I actually have to think through it rather than just reflexibly acting. So I think this is something that we can implement in everyday life in all of our decisions. At every step of the way, actually keep a record of what you’re thinking, what variables you’re considering, what things you think will look like, so that you don’t fall prey to something known as hindsight bias which is where you take the data that you have right now and retroactively apply it to back then. I call it a decision diary and I think these can be incredibly useful to help you get back in the moment.

    Mary-Catherine Lader: This is the right moment to mention your husband is a portfolio manager and you regularly dispense this advice to him. So let’s switch gears a little bit, taking about risk, decision making to talking to about trust. Everyone in this room relies on trust for success, in our relationships, in our word, trust in the brands and organizations that we support. And we’re also living in a time of great diminishment in trust, particularly in large institutions. So what is going on, what do you make of that, what is the research on why we trust today?

    Maria Konnikova: Yeah. I think the first thing, which is a really wonderful thing, is that trust is usually really good, and we’ve evolved to trust. So when I first started researching the psychology of trust, I didn’t know if it was good to trust or bad to trust. Because you can see that both arguments would kind of make sense, right? That maybe it’s better to not trust anyone, because you’re safer. But it ends up over time that we seem to have evolved to trust and that trust is actually the default human condition. And if you stop to think about it, it makes a lot of sense, because who is going to survive in the wild, right? Is it the lone wolf or is it members of the pack? You actually see throughout time and over history and throughout different societies that societies that have higher levels of something called generalized trust, which is trust in your fellow human beings, they tend to thrive. They tend to do better economically, they tend to have stronger social institutions. And on an individual level, individuals who score higher on a measure of generalized trust, they tend to do better academically, they sometimes have higher IQ in certain areas, they tend to be healthier, they tend to be happier, they tend to live longer. So it actually ends up that –

    Mary-Catherine Lader: Trust is good.

    Maria Konnikova: Yes, trust is good, and trust is associated with all sorts of really positive outcomes. And like I said, trust is the default. So when you run studies where you actually don’t give people any instructions and you have them play different games where they’re playing with other people, they start off trusting usually and they end up doing much better. And if you give them specific instructions like hey, that guy over there might not be so trustworthy, you might want to look out for them — then all of a sudden, that dynamic falls out the window and they end up doing much worse and getting worse results as a group. But to me, it’s actually inspiring that if you don’t tell them anything, they start off with good intentions. Now that said, right now we are living at a time where we do see levels of trust at an all-time low. So in a lot of surveys around the world, you see that people are trusting governments less, they’re trusting institutions less, they’re trusting journalism less. We have the fake news hashtag, right? That seems to be permeating everything. But I also think that we can overcome it because I do believe in the power of trust ultimately. And I think that people understand that too.

    Mary-Catherine Lader: So you mentioned two things that were particularly current and interesting: one is that you believe we can recapture trust, and the second that, on an individual level, it’s very powerful. And it’s interesting to think about how even as we have this diminishment of trust in large institutions, we have these large technology platforms that mean that more and more of us are getting in an Uber with a stranger and trusting them to drive us somewhere. We’re trusting a stranger to host us in their home because of AirBnB. And it’s intermediated by technology, and somehow that app or that technology platform creates trust. Why does that work, why does that happen? And what is the takeaway that you see in that for how we can build and recapture trust in pretty short order?

    Maria Konnikova: Well, I think it’s interesting and it goes back to something that I talked about earlier on about how the mind learns, and the fact that we learn from experience. Experiences are much more vivid than any description, than anything you read, than anything you hear. And as these technological platforms become ubiquitous and they’re everywhere, what is your experience usually? It works out, right?

    Mary-Catherine Lader: It works out, and if it doesn’t, you complain and give them two stars, and you get a free ride.

    Maria Konnikova: But normally it doesn’t work out in horrible ways. Normally everything is fine, and if it doesn’t work out, it’s because your driver was on his phone or your driver was annoying, or the AirBnB had a broken shower. These are small problems and we trust that they’ll get taken care of and normally they do. And so we actually have had a lot of positive experiences that will then make us more likely to trust this. Now, if anyone here ever had a really, really nasty experience, with AirBnB, with Lyft, with Uber, with anything, where you have this sharing economy, all of a sudden, that is going to go out the window. Because experience is going to trump everything else. So even if everyone says, you can use this, you can say, well I had this one crazy driver who got into an accident and then I had to go to the hospital. I’m never using ride sharing again. And then you end up in the middle of nowhere with no car and ride sharing, and what do you do? The one thing that can fight through negative experience is convenience. Because we’re also pretty lazy. And so you can go on a moral crusade about how you’re never going to use Facebook because of their privacy violations, but then it’s just really convenient so you just keep your account on the side. I think that is one of the reasons that these technologies have been successful and that we do trust in them. And I think the underlying nature of this is that – my last book was about deception and people who deceive us – and it ends up that most people aren’t out to get you. Humans are pretty decent for the most part. And so normally it’s just fine to trust, and the bottom-line of that book was that yes, you might be deceived and you probably will, but that is okay because that’s a side effect of being human. And you don’t want to live in a world where you couldn’t be deceived because that’s also a world where trust is dead.

    Mary-Catherine Lader: It’s interesting. Much of what you just said really applies to fintech actually. But when you have a bad experience with your money, it’s pretty painful. It may feel more painful to some than getting stranded in ride sharing. And so what we’re going through now is seeing many of these fintech start-ups trying to add in the necessary process, the necessary procedures, and even really user design, to ensure that they comply with regulations, to ensure they can protect against those bad outcomes. And much of the challenge is that tension between wanting to create convenience and wanting to preserve against a bad outcome. What do you think then is the solution and is an answer for some of these tech companies to build that trust? Is it this sort of quick feedback loop that you mentioned, or sort of big solutions like some of the government actions that have been described?

    Maria Konnikova: Yeah. I think feedback is incredibly important. I think transparency is very important, being transparent with what you are doing and aren’t doing, and what you can’t yet do, even though you wish you could. By the way, this is a slight tangent, but I think that this is one of the reasons why people have trouble sometimes with AI technologies, because there isn’t transparency there and you want to know what goes into those decision making algorithms so that you can make a decision for yourself. What are the factors, and can I trust them? Because an AI is only as good as the people who built it. And if we don’t know what goes into that black box, that’s scary. And that goes back to what we were talking about at the very beginning: uncertainty. The human brain hates uncertainty and hates ambiguity, and doesn’t function well in those types of environments. We want to resolve it. And the people who are going to come out ahead are the people who not only tell the best stories, but tell stories that check out.

    Mary-Catherine Lader: So going back to that theme of uncertainty, it’s exactly right in that it has a sort of negative dynamic. What is the psychology behind that? Why does uncertainty necessarily imply that we have to somehow exercise caution and prepare for the worst?

    Maria Konnikova: I think it’s just the way that the human brain is wired: all of the data we have about the way that humans think makes it very clear that we want things to be neat. That’s why we just jump to say, A causes B; we jump to put people in categories, to put labels on things, to make the world explainable. Otherwise, if everything is uncertain, then what world are you living in? Is this room here, am I here? You get into these metaphysical/existential debates right away. And it actually ends up that the way that we are wired, so to speak, to see the world, it’s a two-step process that was first described by a psychologist named Daniel Gilbert, at Harvard University. And what Gilbert found is that there’s two stages to any sort of perception, any interaction, basically anything that happens. The first one is belief. So first we need to believe that things are true. Because that is the only way our brain can process it. Even if it’s just for a millisecond. I call this the Pink Elephant Effect. So the moment I say “pink elephant,” to understand what I just said, just for a second, you need to picture a pink elephant. And then the second stage if verification: is this true or is this false? And you can right away think, oh, pink elephant, pink elephants don’t exist, false. But what ends up happening is that the second step isn’t automatic, unlike the first step. So the first step always happens. But the second step doesn’t always happen. It can be disrupted. We can be busy, we can be stressed, we can be emotional, we can get distracted. And so we just have this belief, this underlying belief that stays in our mind and becomes an incorrect memory. But that is also one of the reasons why we have false certainty about certain things we’re so much more confident in than we should be given the information that we have, because we have this memory of, oh, it’s definitely true. But just imagine how many pink elephants you encounter every single day and they don’t have a big waving flag that says hey I’m a pink elephant. You have to figure out whether or not I actually exist. You just say, yup, pink elephant, come into my head and stay there. And so I think this false sense of certainty is one of the ways that we deal with uncertainty and one of the reasons we become so overconfident, especially in areas where we have some sort of expertise. Because the more you know, often times the more you think you know. And some of the studies on overconfidence that scare me the most are that the greatest experts in certain areas are most prone to overconfidence because they have so much experience that they can’t entertain the notion that they might not know a specific thing.

    Mary-Catherine Lader: So we’re back where we started, the uncertainty of uncertainty as the only certainty. And pink elephants is a very memorable visual of that. I’m going to end with a rapid fire round of questions, which we do on every episode.

    Maria Konnikova: All right.

    Mary-Catherine Lader: Okay. You ready? So you have to answer in one sentence or less.

    Maria Konnikova: Okay.

    Mary-Catherine Lader: Fake news: fad, or here to stay?

    Maria Konnikova: I think if I had to choose one of the two, it would be fad because I believe in the human mind’s ability to get through fake news.

    Mary-Catherine Lader: You’re an optimist in this.

    Maria Konnikova: I’m an optimist.

    Mary-Catherine Lader: In poker, Five Card Draw or Texas Hold ‘Em?

    Maria Konnikova: Texas Hold ‘Em.

    Mary-Catherine Lader: Why?

    Maria Konnikova: Because if you’re looking for a model of human information, it’s the perfect mix of knowns to unknowns. In Five Card Draw, it’s too much chance, there’s too little information that is in common.

    Mary-Catherine Lader: Davos, where you gave a keynote this year, or Miami?

    Maria Konnikova: I have to say Miami, right?

    Mary-Catherine Lader: There was a correct answer to that question. Which brand do you trust the most?

    Maria Konnikova: Wow. Which brand do I trust the most. So I don’t buy a lot of clothes, I hate shopping, so I’m going to say one of the brands that I actually trust is a clothing brand, Everlane. And it goes back to some of the things that we were talking about with trust and transparency. So they tell you exactly where they’re sourcing every single thing that they use and they break down their price, they show you exactly why you’re paying what you’re paying. And they pay their workers really well.

    Mary-Catherine Lader: And what about the least?

    Maria Konnikova: Facebook.

    Mary-Catherine Lader: Popular answer these days. Thank you so much for joining us, Maria.

    Maria Konnikova: And I still have a Facebook account.

    Mary-Catherine Lader: And so do I. Thank you so much for joining us, it’s been a lot of fun.

    Maria Konnikova: Thank you so much.

  • Oscar Pulido: Let’s take stock of the stock market. After a bumpy ride in 2018, U.S. markets and investors alike started to fear that the next recession was around the corner. This year? We’re seeing a different story play out. Stocks have rallied. The question is, what’s behind the rally and can it last?

    On this episode of The BID, we’ll answer these questions with Chief Equity Strategist Kate Moore. We’ll talk about why Kate still likes taking risk in stocks, why we shouldn’t bet against China, and how the tech sector has influenced nearly every sector of the economy. I’m your host, Oscar Pulido, we hope you enjoy.

    Kate, thank you so much for joining us today.

    Kate Moore: Yeah. I’m really excited to join The BID today.

    Oscar Pulido: So Kate, last year, I think everybody knows was a tough year for the stock market, particularly the last couple months of the year — I think it made the holiday season tough to enjoy if you were looking at the stock market. But this year, global stocks are up 12 percent, the S&P is up over 15 percent: were stocks supposed to do this well, this soon?

    Kate Moore: Well, it depends on who you talk to. The fourth quarter of last year was really surprising for all of us. The fundamentals hadn’t significantly deteriorated; we were actually still in a very supportive policy environment. There was some good growth data, and sure we knew that the comparisons in 2019 and things were going to be a little bit tougher. The magnitude of the underperformance was really outsized. And in particular, I was watching what happened to equity valuations, which dropped precipitously. And at the start of this year, we said, some of that has to reverse because over the course of 2018, we saw the worst multiple contraction or derating of the equity market, the third worst over the last 30 years. Most years after that happens, you see a snapback. But at the start of this year, not only did valuations rise and enthusiasm for equities return as people realized the Fed and other central banks were going to be supportive. But actually, the market kept running even while people became skeptical about the sustainability. So that was a long way of saying probably not that much; it shouldn’t have run as far as it has. But it’s interesting to note that we have a lot of good things happening in the equity market that I think are under recognized.

    Oscar Pulido: And so do you think that momentum can continue throughout the rest of the year? Or is it unrealistic to think we’ll just repeat this performance quarter after quarter?

    Kate Moore: If we have a mid-teens quarter for four quarters in a row, I’ll be retiring, truthfully. That will be a pretty good story for my personal account, and actually I think for a lot of the funds here. So no, I think that is unlikely that we’re going to have that magnitude of run. That said, it’s possible the markets run a little further, because one of the things that really drove the equity market in the first quarter was the tone from the Fed and other global central banks, namely that they are going to continue to be super-accommodative that we’re not going to get big rate increases, and that really has reopened I think the possibility for multiples to stay at higher levels and for the earnings environment to be supported. Valuations in equities are really dependent on where interest rates are frankly. And with interest rates staying very low, there’s possibility for equity multiples to go a little bit higher from here; not a lot, but a little bit higher.

    Oscar Pulido: When we started on the year on rates, the belief was that the Fed was going to raise rates, albeit maybe very limited type of increases. But now, as I understand it, there is a belief that maybe the Fed would cut rates by the end of the year; I’m not saying that’s your view but that seems to be the market’s interpretation.

    Kate Moore: Yeah. So we had some great debates at the November BlackRock Investment Institute Forum about what the Fed might do over the course of not just the next quarter but of the next four to six quarters. And I’ll tell you, those debates raged on into the beginning of the year when the Fed really changed its tone. But the market pricing of Fed expectations has been what’s moved the most I think that is what you’re referring to, where the market was expecting two hikes throughout the course of 2019, moved to a cut in January, bounced back up to no move, and is back down to a cut again, and perhaps two cuts over the course of the next twelve months. It’s been a little schizophrenic. We think the bar for the Fed to move either way – to raise rates or to cut rates – is extremely high, and so we’re expecting more of the same: no significant change in policy over the coming quarters.

    Oscar Pulido: Last year was a great year for earnings, and some of that was helped by some fiscal stimulus, in the U.S., the tax cut. But this year it seems like earnings growth is slowing. So how does a slower growing economy, slower earnings growth, translate into still more equity returns ahead? It seems like those things don’t go hand in hand.

    Kate Moore: Yeah. So let’s go back to 2018 and also 2017, because we actually had two exceptional years of global earnings growth. 2017 I always like to highlight. It’s a year where every major equity region posted higher than ten percent earnings growth. That was the first time that had happened since 2006, so it was a really exceptional year. And then last year, as you pointed out, super-charged by the tax cuts and fiscal stimulus, and led by the U.S., we had another really strong earnings year. Not every region growing ten percent or more, but many. And this year, we know the comparisons are going to be hard, and without a significant amount of fiscal stimulus or a change in policy, we’re just not going to get to those numbers. But I would be cautious in general about comparing GDP growth and earnings growth too closely. Actually, over any period of time, the relationship between those two things is very loose, sometimes non-existent. It’s because companies have a lot more levers to use and to pull when they’re working on their earnings. It’s not just a question of how fast the economy is growing. What do they do with costs? What are their labor pressures, what is the competitive environment? What is the interest rate environment, what is the tax regime? There are many other things that go into earnings. We have to be careful about being too reliant on history, because corporate balance sheets and behavior is different today than it has been in the past. Excellent quality balance sheets and companies that are behaving much more conservatively than they have in previous cycles, I think that leads to a longer duration earning cycle than we’ve ever seen. A slower growth environment is something we have to watch for. But it doesn’t always necessarily dictate the course of the earnings growth.

    Oscar Pulido: When we think about the economy, I think about the bond market, which we talked about stocks, but this has been also a reasonably good year for the bond market, which some might interpret as not a good sign, the fact that bond prices have gone up, interest rates have come down, that that’s still telling us something about the outlook that maybe the recession is getting closer. Do you think that is what the bond market is telling us, or does this go back to central banks are going to be patient and therefore people are putting money to work across different asset classes?

    Kate Moore: So I think there are two things to say on this one. The first is, both the equity market and the bond market have celebrated a much more dovish tone from central banks. It has been a rally in equities, a rally in bonds, it was one of those years where if you were just invested at all, you’re feeling pretty good as we start the second quarter. I think the fact that we’re going to continue to have low rates and actually supportive fiscal policy like government spending in a number of major regions, is going to be good for stabilizing economic growth, albeit at a lower level. But there is a second part of this too which is people are skeptical about the duration of this cycle. Even though we don’t have a lot of weak data points yet, at ten years into a bull market and ten years into an expansion, we’ve seen investors put a lot of money into bond funds in 2019 and take money out of equities. I would actually argue that that positioning means that equities can grind higher, because they haven’t been buying into the rally. I do worry that there is too much enthusiasm for bonds, especially just based on the duration of the cycle.

    Oscar Pulido: Right, I was going to ask you about complacency and whether you were seeing complacency from investors given the rally, but what you’re saying is investors are actually taking money out of equity funds.

    Kate Moore: Yeah. There is not as much complacency as you would expect. There are some areas of complacency that we’re monitoring around certain geopolitical risks, where maybe the best case scenario for U.S. and China trade or European politics are getting priced into the market. But when it comes to overall equity enthusiasm, both the external fund flows data that we monitor as well as our internal analysis, it’s all kind of showing that people have been fading this move over the last three months. And that means I think the pain trade is higher.

    Oscar Pulido: So let’s talk a little bit more specifically. As you think about regions, maybe that is a good place to start: are there specific regions of the world that you think the stock markets are better positioned to do going forward?

    Kate Moore: We are actually holding our regional recommendations steady, the ones that we had at the start of 2019, and really for the bulk of 2018, which is our preference for the U.S., given quality, strong fundamentals, the great geographic and global reach of a lot of companies, combined with some strong growth momentum we’re seeing in the emerging world. Now emerging market stocks did—I’m trying to think of a really polite and kind way to say this, but really badly at the end of last year, and it felt completely unjustified. Yes, there were some policy and regulatory headwinds around China for example, but it wasn’t the end of the world, and actually we see great longer term demand and actually even near term demand coming out of some of these markets. And the Chinese government has been stimulating, the consumer, giving incentives to purchase autos or white goods, which are like basically appliances, targeted credit expansion. And all of that stuff should help really stabilize the Chinese economy and demand. So, we see a lot of opportunity for emerging market companies and for equity markets that are geared towards the Chinese story.

    Oscar Pulido: And that is interesting, because most of the China headlines are around trade and trade tensions, and that would lead people to believe emerging markets are an area to avoid. But you just touched on actually the positive headlines which maybe don’t get enough coverage, which is the Chinese economy stimulating. And that helps global growth and that helps maybe the performance of some of these markets.

    Kate Moore: Absolutely. I think it’s a very poor trade to bet against Chinese political will too. Policymakers from all different parts of the Chinese government are very, very committed to stabilizing and expanding growth. They are committed to the consumer, particularly in targeted policies that encourage spending, whether it’s on autos or appliances, on credit to companies and industries that they want to see grow, and they are showing a huge amount of support for the technology sector, also communications and internet companies, that really are the next round of leadership for the Chinese economy. I think it’s important to watch what they’re doing where they are spending their time and attention, and not just on this conflict or perceived conflict between the US and China on trade.

    Oscar Pulido: So let’s talk about the technology sector, which has been a phenomenal sector to be invested in over the course of this ten year bull market. You can’t go far without hearing the terms 5G, artificial intelligence. Are there any other areas outside of those that you think are worth touching on? Or maybe you could touch on the 5G and AI themes.

    Kate Moore: Yeah. So there are limitless themes it feels like in technology, and some of our technology investors here at BlackRock had actually sketched out for me at one time why we didn’t need to invest in any other sector, because within technology and now as part of communications as well, you were touching on all different parts of the economy. I think that is true. You have technology companies that operate in the healthcare space, technology companies that operate on the consumer side, technology companies that are replacing financial services. This is a broad and cross-sectoral theme, and there are great opportunities to invest in the disruptors and the winners across the entire market. I think really important – and this ties back to the China theme, though – as we think about 5G and AI and some of the most innovative and perhaps disruptive parts of technology, the Chinese are leading in many parts of the world. They have great partnerships with countries outside of the U.S. We would expect actually that some of this trade tension, even if we have an agreement in the near term will lead to a decoupling of the global tech sector and actually perhaps two separate tech protocols will be developed on a go-forward basis. If you really want to invest in technology, I think you have to own both U.S. and Chinese tech.

    Oscar Pulido: You made a compelling case for the technology sector, but is there any other sector that we should be thinking about?

    Kate Moore: Yeah. So we still really like healthcare. Healthcare has a couple different elements to it. It has a quality side to it where we have companies that have solid balance sheets that have the potential to continue to grow their earnings even in a slower part of the cycle. It actually has a technology and innovation aspect to it as well, which is quite exciting especially when you look industry by industry within the sector. And then you have a third element which is a demographics element, so a really long cycle where we’re seeing more and more consumption of healthcare products and services, and an aging developed market population that will be spending more and consuming more on the products and services in that sector. So we see a lot of reason to own it for the long term, and also at this point in the cycle.

    Oscar Pulido: Kate, you’ve given us a lot of really good things to think about here, more tactically, but let’s just take a step back for a second, when you think about investing in the stock market for the long term, what are some basic things that you think we should be keeping in mind as we approach the stock market.

    Kate Moore: Well, a few things that come to mind are that no one is so brilliant that they can time the market perfectly. Stick with high quality and growth themes in your portfolio for the long term, and don’t panic too much if the news flow turns the other way. I think it’s also really important to understand your own risk tolerance. I like to invest in emerging markets; I feel really comfortable owning EM for the long term. I understand that it’s going to be volatile, I understand that we can see swings in policy, whether it’s around trade or specific domestic policies that affect the prospects. But for me, compounding returns in emerging markets is extremely exciting. Understand your risk. I have a belly for risk so I can do it. And then I think the third thing is to recognize that taking a diversified approach is super important, because it’s not just good enough to know who is winning right now, but because every sector and every industry is being disrupted, you need to take a broad approach both on a geography as well as sector basis to your equity allocation.

    Oscar Pulido: Great advice. We usually do something here at the end of our segment where we ask some rapid fire questions that touch a little bit on your personal life, so I hope you’re ready for these. These are meant to be-

    Kate Moore: I’m strapped in, ready to go.

    Oscar Pulido: --quick responses. We talked about tech, what is the disruptive piece of technology that you’re most excited to use in your daily life?

    Kate Moore: So I’m not sure how disruptive it is, but the technology that has most changed my life are my Sonos speakers. I’m obsessed with music, and being able to fine tune my music all over the apartment and at other homes, is super important.

    Oscar Pulido: All from your mobile device I’m sure.

    Kate Moore: All from my mobile device, streaming my Sirius and Spotify and having all of my playlists imported, it’s changed my life.

    Oscar Pulido: I heard you’re an avid skier. Where do you like to hit the slopes?

    Kate Moore: I will skill anywhere, but I spend most of my time at Jackson Hole which is my favorite place on earth. I am trying to convince the BlackRock Leadership Team to let me open an office in Jackson, just a hint-hint.

    Oscar Pulido: I will join you if that is in fact the case, and I have to admit having gotten my three-year-old on skis this year was a big challenge, so maybe one day he’ll go to Jackson Hole as well. I’ve also heard you love to read. What book would you recommend right now?

    Kate Moore: So I’m really into science fiction and fantasy, I read the entire Game of Thrones series before there was even a rumor it would become a television program, that’s how nerdy I am. One of the best books I read recently is called The Three Body Problem. It is a science fiction story that was translated from the Chinese. A bunch of our colleagues in San Francisco suggested I read it. I thought it was a fascinating take on both the impact of the Cultural Revolution on decision making as well as some real nerdy science/outer space type of stuff.

    Oscar Pulido: And the last question, what is your favorite place to go in New York?

    Kate Moore: Central Park. I have a golden retriever, and we spend a ton of time in the park, especially during off-leash hours, I’d say before 9 a.m. on Saturdays and Sundays, with a cup of tea and throwing the ball and watching my dog run around is one of my favorite things to do in New York City.

    Oscar Pulido: And now we’re in spring so you hopefully have a little bit more time to be able to do that.

    Kate Moore: Absolutely.

    Oscar Pulido: Thank you Kate for joining us on The BID.

    Kate Moore: Thanks for having me.

  • Jack Aldrich: If you’ve been following the news over the last few years, chances are you’ve been tracking the latest drama concerning Brexit, the United Kingdom’s June 2016 decision to leave the European Union. But Brexit is just one part of the European story, and at times, it’s overshadowed other key developments playing out across the continent.

    On this episode of The BID, we’ll take a Euro trip with Chief Multi-Asset Strategist, Isabelle Mateos Y Lago. We’ll try to make sense of what is happening now, what is bubbling beneath the surface and what we should be watching for beyond Brexit. From the BlackRock Investment Institute, I’m your host Jack Aldrich. We hope you enjoy.

    Isabelle, thank you so much for joining us today.

    Isabelle Mateos Y Lago: My pleasure.

    Jack Aldrich: So much going on, particularly with Brexit, so I’d love to start there. March 29th was supposed to be the day that the UK left the European Union. Yet that hasn’t happened. Why? Every day, we’re hearing of some new political upheaval. What’s going on?

    Isabelle Mateos Y Lago: Yes, good question, everybody’s trying to answer it here in London as well. So look, what’s happened is that Theresa May, the prime minister, hasn’t managed to get the UK Parliament to approve the withdrawal package that she negotiated and agreed with the European Union. And as a result, it’s been necessary to request an extension of that deadline for exiting the EU in order to prevent the chaos of a so-called “no deal Brexit.” So there are now basically two scenarios. One scenario is that Theresa May at long last manages to get a Parliamentary majority for her deal. That is still looking somewhat unlikely, but a number of members of Parliament have been revisiting their position recently, so it’s not completely ruled out. If that happens, the UK will leave the European Union on May 22nd. If, however, there is no such majority in support of Theresa May’s deal, then other options will need to be explored. Something that the Parliament is going to begin to do very shortly with so-called “indicative votes.” But in almost all of these other scenarios, more time will be needed, and that will mean that by April 12th, the UK will then need to notify the European Union that it needs a longer extension, and therefore also will need to take part in the European elections. So the situation is still very fluid, full of uncertainty. I would say the one element of clarity that we do have at this stage though, and that’s a very important one, is that the prospect of a no-deal Brexit, which would have been extremely disruptive in economic and market terms, is pretty much off the table. And that is because Theresa May has said formally that she will not allow a no-deal Brexit unless there is a majority in Parliament for it, and we know there is a large majority against it. So we avoid that acute short term risk, but in the near term, the uncertainty remains very deep.

    Jack Aldrich: So it’s not quite all settled.

    Isabelle Mateos Y Lago: No, it’s not all settled at all. Whatever the scenario, we’re going to see a protracted period of uncertainty, and that’s likely to weigh on UK assets for the foreseeable future.

    Jack Aldrich: I’d love to circle back to the European Parliamentary elections. Could you explain what those are and what they mean?

    Isabelle Mateos Y Lago: So these are the elections for the European Parliament. This is the only body in the European governance structure that is directly elected by European citizens in the context of national constituencies. So it’s a pretty big deal, and the European Parliament is co-legislator together with the European Council, which is comprised of EU heads of state and government, so it has substantial powers particularly with regard to well pretty much all the legislative framework as well as trade relations.

    Jack Aldrich: The results of these elections influence who are Europe’s political leaders, correct?

    Isabelle Mateos Y Lago: Yes, that is absolutely right. In fact, there is an expectation that the leader of the party that has the largest grouping in the European Parliament becomes the head of the European Commission, which is the European executive if you will. In fact, one thing that is almost for sure this time around is it will not happen, because a substantial number of heads of state are against the system. So there is going to be some kind of negotiation to determine which country, which party gets to lead the European Commission. And then of course whoever gets picked as president of the European Commission will have an impact as well on who will replace Mario Draghi as President of the European Central Bank when his mandates expires in October. Because there is always an expectation that different countries get the different jobs; so for example, if you were to have a German to run the European Commission, then it would be very difficult to have a German run the European Central Bank. But vice versa, if you don’t get a German to lead the European Commission, then that opens the door to potentially having a German run the European Central Bank, which has never happened before. And so this is an important fallback effect from the European elections.

    Jack Aldrich: Got it. So these are a big deal.

    Isabelle Mateos Y Lago: It’s a pretty big deal, yeah.

    Jack Aldrich: And I know that one of the sticking points in Brexit is that if the United Kingdom is leaving the European Union, it would be a little odd to participate in upcoming European elections. Is that the right way to understand it?

    Isabelle Mateos Y Lago: Yeah. That is exactly right. As Theresa May, the British Prime Minister, said in her television address recently, it’s been almost three years since the UK voted to leave the European Union and the population probably wouldn’t take it very well, it wouldn’t understand it, if they were asked to participate in elections to the European Parliament. On the other hand – and that is the way the European Union sees it – if the UK is going to remain a member for a while longer, and we don’t know if it’s a short or long while, or forever, then it would be violation of the treaties if it did not elect representatives to the European Parliament. Now obviously it is an involved process and one can see why the main parties in particular are not excited, neither of them, at the idea of running European elections. On the other hand, it’s probably less absurd to do that than to stockpile food and medicine to prepare for no deal. So that is the state of the discussions today.

    Jack Aldrich: After the UK voted to leave the EU, it was widely feared it would start a domino effect of multiple countries doing the same. I recall the potential monikers circulating: Frexit, Grexit, even Ita-leave. Where do these fears stand today?

    Isabelle Mateos Y Lago: No, I think those fears are very much diminished in part because of or thanks to the chaos that the Brexit debates both within the UK and between the UK and the European Union have caused. I think the whole rest of Europe is watching this and thinking, oh my goodness, what a mess they’ve made. And don’t want to have it at home. When you look at peoples’ support for membership in the euro or membership in the European Union across the different countries, it is now as high as it has ever been, it’s over 75 percent of the European population who thinks that membership of their country in the EU is a good thing. So how much of that is linked to Brexit versus simply improvement in the economy, or other reasons, is obviously hard to say. And the main parties that previously had campaigned on an openly anti-EU platform. like the Front National in France or even the League in Italy and others, have had to tone down very significantly their anti-EU rhetoric. But that being said, there is an open acknowledgement now even by mainstream parties, the French president and the head of the government party in Germany, that this status quo is not acceptable. There is a lot of things that need to be improved and fixed in the way the European Union works and that is going to be at the center of the campaign for the European Parliament elections which are getting under way now.

    Jack Aldrich: I know polls predict a small showing for as you mentioned a lot of the populist parties that are either in power today or very much waiting in the wings, and have been laving this period of time to ferment local support. Is that right, does that matter?

    Isabelle Mateos Y Lago: So that is definitely right that opinion polls are projecting a significant increase in the representation of populist parties both on the right and left of the spectrum; that being said, they’re starting from a very low level and so the baseline scenario is still that the mainstream parties between them will remain comfortably within the majority position. I think the key question is, could all the populist parties together reach one-third of the seats, in which case they would have substantial blocking power? But having said that, we shouldn’t forget that these different populist parties don’t agree on most things. They might agree on not liking the way the EU functions today, but in concrete terms, some of them want much more respect for the fiscal rules, others want to throw them out of the window. They have very different visions in terms of foreign affairs for example, how to deal with Russia, with China. So what I think is fair to expect is probably more complicated, more convoluted decision-making going forward after the new parliament is in place but not necessarily a strong shift in one direction or the other in terms of policy making.

    Jack Aldrich: What I think is so interesting Isabelle is this notion of populist parties competing with each other is true both across Europe, but also within the different countries, right? So you have in Italy and France for example, populist parties on both the left and right competing for people’s hearts and minds.

    Isabelle Mateos Y Lago: Yeah. That is absolutely right. And there is a broad agenda of protecting people but frankly, even Emmanuel Macron in France is campaigning on a slogan of Europe that protects its citizens better. So there are issues on which there will be substantial agreement, for example, better protection of EU borders; for example, overhauling the asylum seekers and refugees policy. But then there are other issues like what stands to take on free trade or what do we want to have in the trade agreement that the EU is going to sign with third parties. There will be very significant differences of views there.

    Jack Aldrich: When you think about all that is going on in Europe, there seems to be no shortage of risks. What else is keeping you up at night? Spain’s upcoming elections I know are in April, there are ongoing budgetary tensions between Italy and the European Union. What is on your list?

    Isabelle Mateos Y Lago: So really my biggest concern is how is Europe going to cope with the next recession? If you look at the U.S., and you think what will the U.S. do when the next recession approaches, you can pretty sure that the Federal Reserve will take decisive steps, cut interest rates for example to try and support growth and quite possibly you would get Congress to approve some fiscal stimulus. In Europe, you can pretty much rule out both of these. In terms of the central bank, there’s no space to cut interest rates and we now know the ECB has promised to keep rates at negative point four until at least the end of the year. It’s very politically constrained to restart its quantitative easing program, its asset purchase program. So there is very little room to maneuver on the monetary policy side. And then on the fiscal side, different member states have very different vies as to what needs to be done, and generally speaking, the countries that do have fiscal space like Germany and the Netherlands, don’t want to use it. Whereas those who most want and need to use it like Italy and other periphery countries don’t have the space and wouldn’t be allowed most likely by existing rules to use it. So that would be the conundrum, and at that point, it’s quite possible that markets, again, would really worry about the sustainability of the debt of a number of the periphery countries and you would see a bit of a viscous cycle between market conditions and growth conditions getting worse and worse and worse until you get some kind of a policy response, but that may come pretty late in the game. So in the medium term, that is my main worry. In the short term, there is of course the issue of the threat of tariffs, EU car exports to the United States, which keeps coming up every now and then in the U.S. president’s Twitter feed. That would deal a big blow in terms of economic confidence in the EU and we would almost immediately seen a retaliation from Europe, which would cause a lot of collateral damage as well.

    Jack Aldrich: Got it. So it really looks like you’re looking ahead to the next downturn and fearing how that might turn out. Do you think the trigger for that would have to be economic, or could it be political?

    Isabelle Mateos Y Lago: No, I don’t see political events. I mean, apart from that, it would have to be an economic driver to see a recession in Europe. And frankly, I don’t see this as being around the corner. If anything, now the base case is more a stabilization or reacceleration in the wake of the same thing happening in China. But if you look at the next 18 months to two years, where the risk of a recession striking in the U.S. increases, it’s hard to see a Europe that would decouple from that. So I see this as an economic risk that would get magnified by the lack of an adequate policy reaction than an inherently political risk.

    Jack Aldrich: On the subject of tariffs, it’s interesting because so many of the headlines recently have been around the United States and China. It seems like this is a big deal for Europe through: are we paying enough attention?

    Isabelle Mateos Y Lago: Yeah. So in our view actually it is quite clear that market attention to global trade tensions has been almost entirely driven by developments in the U.S./China relationship. And so in the indicators we use to track market sentiment and market concern around this topic, what we see is a sharp decline in concern since basically last fall. And that is probably justified when it comes to U.S./China, although we don’t expect a permanent truce; we do expect some kind of agreement to be found there. But more importantly, there are other trade issues out there that are largely unresolved, and one of them is the new NAFTA that looks difficult for it to get through Congress. People have forgotten about that. And the other one is these trade talks between the U.S. and Europe, which were supposed to get under way last July after the meeting between President Trump and President Juncker. And these are not going particularly well, in fact, both sides can’t even agree what to talk about. The U.S. wants to talk about agriculture, Europe is saying absolutely not, we will only talk about industrial goods. And President Trump has spoken on many occasions of what he perceives as being a very tough stance from Europe. He’s accused Europe of being even tougher than China. And clearly, from his standpoint, using the threat of tariffs as you go into a negotiation strengthens your hand. Certainly that would suggest to be the experience from the trade talks between the U.S. and China. And so the president now has in his hands a report on the so-called Section 232 which would allow him to declare EU car imports a threat to national security—now one may agree or disagree with that judgment, but it would give him a legal basis to impose tariffs of as much as 25 percent on European car imports, and that is a very significant chunk of the European economy, particularly for Germany, but also through supply chain effects frankly for the entire European economy. So that is something that really markets should be more worried about, and that has been very much out of the headlines and is for us a meaningful downside risk.

    Jack Aldrich: And I think another thing that’s been out of the headlines, and we’ve talked about being one of the under the surface issues between the U.S., China and Europe has been this issue of technology. Can you talk a little bit about that?

    Isabelle Mateos Y Lago: Yeah. So that is another complication. Well beyond trade, the tensions between the U.S. and China are now focusing on technological rivalry for things like 5G networks, artificial intelligence. Europe frankly is at risk of being left behind and having to choose sides in terms of providers between the U.S. and China. And right now a number of European countries are looking at their options and feeling very uncomfortable towing the line that the U.S. would like them to, which is to ban Chinese equipment providers. So that is another source of irritation or tension if you will between the U.S. and a number of European countries who have said, well I don’t really care what the U.S. says, I’m going to allow Chinese companies to provide some of our advanced telecoms equipment.

    Jack Aldrich: And this doesn’t seem like an issue that will be resolving itself any time soon.

    Isabelle Mateos Y Lago: No, indeed.

    Jack Aldrich: So with all of this said Isabelle, should investors steer clear or Europe for the moment or are you seeing opportunities?

    Isabelle Mateos Y Lago: Well, there is always opportunities. There is a bunch of very good companies in Europe that are internationally oriented, and that benefit from a relatively weak euro right now, and we do not expect the euro to strengthen significantly any time soon. Having said that, when you look at the return expectations that you can hope for from European markets compared to the risks – and these are primarily downside risks at this stage – Europe doesn’t look very attractive compared to, in particular, regions like the United States or emerging markets. So this doesn’t mean to say remove any European assets from your portfolios, but we definitely advocate an underweight stance to European equities. We do see opportunities in European credit, where the very dovish posture of the central bank combined with an okay-ish growth outlook means there are opportunities.

    Jack Aldrich: Isabelle, we always end our episodes with a rapid fire round of questions that are a bit more personal.

    Isabelle Mateos Y Lago: Okay.

    Jack Aldrich: The first is, we talked a little bit about technology and I know you’re a tech-watcher: 5G, artificial intelligence, the internet of things, which of these buzzwords are you most excited about?

    Isabelle Mateos Y Lago: Look, I think the exciting part is the combination of all of them. Frankly, AI combined with 5G and you get the internet of things, you get autonomous vehicles, you get all sorts of really exciting as well as frightening developments. Because I think all of us human beings are going to be able to focus on more value-adding activities and maybe have a lot more free time to spend on listening to podcasts.

    Jack Aldrich: And Isabelle, I know you’re on the road quite a lot: do you have a favorite tech device that you can’t live without?

    Isabelle Mateos Y Lago: My phone and my AirPods but we don’t want to do advertising here.

    Jack Aldrich: Switching gears, you, before working at BlackRock, spent 15 years at the International Monetary Fund, which I think is very cool. What is one of your best memories of that experience?

    Isabelle Mateos Y Lago: Well, in 2007, after a couple of years of intense and very difficult negotiations, we managed to overhaul a decision that had been in place since 1977, so a 30-year-old decision on how the International Monetary Fund should enforce surveillance of exchange rate policies over its members, in other words, how it would prevent countries form manipulating their exchange rates. So we accomplished this modernization. It was very hard because the different member countries had very, very different views on what to do. And it was a great moment of happiness once we