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  • Oscar Pulido: Welcome to The Bid, where we break down what’s happening in financial markets and explore the forces changing investing. I’m your host, Oscar Pulido. The COVID-19 pandemic has reshaped the healthcare sector, accelerating trends like digital health, at-home care and new methods of vaccine development. How have the virus and the upcoming U.S. election changed the way we think about investing in healthcare?

    Today, we’ll speak to three healthcare experts: Erin Xie, Lead Portfolio Manager for Health Sciences within Active Equities; Sarah Thomas, Research Analyst for the European Equity team; and Andrew Farris of BlackRock’s Private Equity Partners group.

    To start, Sarah Thomas shares the trends that have emerged since COVID-19 came into focus and how that’s reshaped the healthcare sector both on a global level and with a European focus.

    So curious to hear your views on the trends that have emerged in the healthcare sector since the pandemic began. I know the healthcare sector is quite broad and diverse, but are there actually any areas that we’ve seen fall out of focus?

    Sarah Thomas: So, you’re absolutely right. It’s a huge topic at the moment. In the short term, we’ve seen loads of trends that I hope don’t stick. We’ve seen patient stocking of drugs, we’ve seen pressure on elective procedures, a shrinking oncology market, for example. But luckily, moving through the third quarter, we’ve seen those trends start to reverse, which is really encouraging. I’m hoping to see maybe greater adherence to medication for patients, particularly given the link of comorbidities to COVID. We’re definitely seeing increased use of technology and digital in terms of diagnosing patients, drug marketing and maybe even how they’re running clinical trials. Other trends, perhaps the importance of vaccines might come to the forefront. That sounds relatively simple perhaps to people in the U.S. but regions like China have never really had proper vaccination programs. More on the med tech side, very much an ongoing trend of people moving away from hospitals in some more outpatient settings. This definitely started before, but because of the pressure in the hospital system, it’s absolutely being accelerated. And then perhaps more as we think about the life sciences segment, I think we should have greater confidence in the funding environment for R&D. I think COVID has certainly highlighted the importance of that and I would hope that maybe we start to see greater use of diagnostics as well, being able to diagnose people and treat people better. You asked about trends that might be weakening. The two that I may be keeping an eye on, firstly on the consumer side, will depend on the depth of the recession, but you know how people choose to spend their money. For example, will they go for dental implants? Or buy the latest hearing aid? That’s going to be important. Increased cost generally of doing business is going to be a bit of a negative trend that will impact the margins I would say. Capex spend as well is probably an important one. We were just entering a big capex cycle as hospitals were upgrading fast their imaging equipment, for example. I think going forward, governments aren’t going to have as much money and hospitals are certainly going to be struggling. So, I wonder if we might see either a reduction in capex or perhaps just being more selective, maybe they don’t need that next robot, for example.

    Oscar Pulido: It’s fascinating to hear all the different moving parts. I’d like to go back – you mentioned digital medicine and we’ve heard a lot about telemedicine this year. I’m just curious, do you see this changing that the usage of that as economies begin to restart? I mean, presumably if we go back to normal at some point, you know, people will just start going back to the doctor’s office, won’t they?

    Sarah Thomas: I think it’s going to be a mix really when you talk about digital. Telemedicine, I agree with you. I think people will probably start going back to the doctor a reasonable amount, but it will completely depend on the reason. There are certain things, whether you just need a quick prescription or something that will absolutely still be done digitally, I think. Areas where you need to be examined, where doctors aren’t as comfortable, I think people will come back relatively quickly. In terms of selling drugs, again, I think salespeople prefer face-to-face contact. So again, I think that will probably revert back as quickly as possible. But other areas when I talk about digital, they are starting to develop apps, for example, to help patients track symptoms better, and that links directly into doctor’s office. They’re starting to run clinical trials using digital endpoints. Marketing, they’ve been doing virtual conferences, for example. There are definitely aspects of this that are likely to stick around for the foreseeable future.

    Oscar Pulido: It sounds like a kind of a balance in terms of how people will engage in going back to the doctor and you also mentioned the vaccine. I have to admit, I’m one of those people that still squirms at the thought of getting a vaccine, but I can’t wait until we have one for COVID. I’ll be rushing to the doctor’s office or however it will be administered. So, how has that race towards the vaccine progressed? Where are we in terms of actually having this cure?

    Sarah Thomas: Yeah, so you ask the question just as we’re waiting for the phase 3 data. It’s a bit of a tough one to answer. But what I would say is that so far, I’ve been pleasantly surprised at the speed at which everything has happened up until now. Vaccine development normally takes a decade. We could be at the point of having a product with emergency approval by the end of the year. So, that’s huge. I think if I go back bigger picture first, the early stage data that we’ve seen looks really encouraging. We’re seeing immune responses when we use the vaccine and we’ve also shown separately if we inject antibodies as a drug, which is something that’s being pursued separately, we are seeing that it helps reduce symptoms and reduce viral loads. Now, these are all separate points, but I’m hoping the data from the vaccine will help us join all the dots together. The frontrunners are Pfizer and Moderna who are using this MRNA approach. It’s a bit technical, but basically what you’re doing is injecting the vaccine, the genetic code into our bodies and our bodies will read this code and make the spike protein ourselves. And then we have an immune response to the spike protein. So it’s pretty cool, but it is an unproven technology and it is a little bit more difficult to manufacture and needs to be distributed at between -20 and -70 so it’s a little bit tricky from that perspective, but they’re in the frontrunning position and we should get data within the next month. We have a couple behind from Aster and J&J. These were different mechanism looking at viral vectors, and all I’ll say here is that they’re both on pause at the moment because of safety. I don’t think that’ll end up being a long-term issue here, but it’s interesting that both of the viral vector approaches are struggling at the moment. And then behind that is actually my favorite approach, these are called subunit vaccines and you just make the spike protein in the lab and inject it directly into the body. It’s a proven technology used in many vaccines that we use today, but they are three to six months behind. So, going back to your original question of where we are. I’m kind of cautiously optimistic that we’re in a good place. I think the vaccine studies will likely be positive. But I think it’s more likely to reduce disease rather than stop people transmitting the virus. I’m a bit nervous on data in the elderly. We know they have weaker immune systems and I’m also a bit nervous on how long the vaccine will last. It may well end up being a seasonal vaccine and it’s worth remembering that we don’t really have very effective respiratory vaccines. Flu is a little bit harder because it changes its spots every year if you like. So, we should do better than flu, but it’s still going to be difficult and I imagine we’ll still have plenty of questions even when we start to get their data coming out.

    Oscar Pulido: It sounds like there’s been a lot of progress and human ingenuity never ceases to amaze me. I want to then turn to investment opportunities. You’ve talked a lot about what’s going on at what I’ll say is a more macro level just trends in the industry. But then how do investors take advantage of this if they’re looking at individual companies?

    Sarah Thomas: This absolutely depends on your timeframe and then stock specifics. Today, I do really like the life science and the diagnostic segments. I liked those before COVID as well I would add, but I do still like them today. Not only are earnings underpinned in the near term by the COVID theme if you like, but the underlying trends are really strong. With life sciences, it’s about making drugs and we’re just needing more and more of those and more complex types of drugs as well. And then on the diagnostic side, as I talked about at the beginning, we’re just starting to use diagnostics more and more now to help personalize medicine if you like. The other area is large cap pharmaceuticals to highlight. I’m hesitant on this one because valuations are looking attractive and the fundamentals are good, I think in this phase, it very rarely does well through an election, there’s often a lot of conversation on pricing pressure and what’s going to happen generally with drug pricing. So, while it’s looking attractive, I think it’s a good opportunity today on a multi-year view, but for the next three or four months, I am perhaps a little bit more nervous. And then finally, maybe just mentioning med tech. I think there are all trades to be had here, but we have seen a lot of moves in the last three months or so in the recovery trade. And what’s really hard with the med tech piece is working out what is pent up demand because people missed appointments through the last three to six months, you know, and what is the underlying trend that were seeing. So, the space is very attractive on a long-term view, with reliable mid-single-digit growth at least. But just working out that piece is going to be quite important for finding out what’s attractive over the next few months.

    Oscar Pulido: And then, Sarah, you’re based actually in our London office and as I understand it, London is not quite under lockdown, but I think it’s a little bit more restrictive than here back in the U.S. So, talk to us a little bit about what’s it like being on the ground there? And then, does that have any implications in terms of investment opportunities in Europe in the healthcare sector?

    Sarah Thomas: So, London is actually going into stricter lockdowns. We were doing okay at the beginning of October, and then a couple of weeks ago, we did all get sent home again because the numbers started to spike. And we’re moving into what the UK has introduced the next tiered category which means that you can now only meet to six people outdoors which isn’t particularly attractive as we move into November. So, we’re doing okay, but concerningly, we don’t have the infrastructure in place. Testing has been horrific. Our testing and tracing strategy isn’t particularly working, and getting access to test has just not particularly worked. So, I’m not sure were in the best place, if I’m honest. As I think about how it affects my investments, from a healthcare perspective, I’m not sure it does too much as I think about Europe. I tend to bucket it into four in Europe: the drugs and therapeutics, the life sciences, the med tech and the diagnostics and all of those themes and trends would generally be supportive regardless aside perhaps from, elective procedures if people are locked down. When you think about the globe though, the U.S. has a lot more ways to invest in healthcare. There is a lot more segments, you could own health care insurers for example, that hospitals managed care businesses, even healthcare IT has its own segment on the market. So, I think there’s a broader way that you can play the theme through the U.S. But here in Europe, we still have enough choice to, you know, to make some money for our clients.

    Oscar Pulido: As Sarah mentioned, the healthcare sector in the U.S. is pretty different from Europe – namely, there are more ways to invest. In the U.S., we also have next week’s election top of mind. I spoke to Erin Xie, Lead Portfolio Manager for BlackRock’s healthcare fund, about the potential implications in different election scenarios and which policy areas she thinks will play out no matter what the results end up being.

    Erin, as you know, we have an election that is imminent in the U.S. and anytime we have presidential elections, the health care industry takes center stage. What’s top of mind for you in terms of implications for the industry as we get closer to the election?

    Erin Xie: Monitoring the potential policy changes is definitely a very important focus for us. If we look at the polls, it does look like Democratic sweep is the most likely election scenario. However, Democrats would probably have 51 to 53 seats in the Senate, which lack the 60 votes that are necessary to pass major legislative changes. Therefore, we think any changes will likely be limited in scope. In terms of the specifics, Biden would likely want to expand Obamacare, which could be a net positive for health insurance companies. A public plan could be proposed, although our work suggests that the passage is unlikely. Elsewhere, drug pricing could be a focus. Here, we think the devil will be in the details. While some form of drug pricing reform is likely, we view the drastic scenario as a low probability. In an alternative election scenario of Trump getting re-elected, we think health policy most likely remains status quo. Although Obamacare repeal is a concern, taking healthcare coverage away from 20 million Americans is politically very challenging, especially during COVID. We would expect the ultimate outcome be moderated. So, net net, while we see a lot of rhetoric on healthcare, the actual changes will likely be more muted.

    Oscar Pulido: And so just to kind of maybe dissect that a bit, you mentioned sort of scenarios under a more Democratic administration versus a more Republican administration essentially the incumbents winning. What are the policy areas you expect will be the same regardless of the result?

    Erin Xie: We would expect the policy to continue to favor value-based care. Meaning that the care will become increasingly focused on quality and outcome as opposed to quantity and this will help to manage healthcare cost increases. For example, there will likely be a continued push to lower cost settings such as home care. We also expect regulation around telemedicine to become more robust. Elsewhere, drug pricing is a bipartisan issue. We would expect some changes likely, but unlikely drastic.

    Oscar Pulido: Erin, as you talk about some of these policy areas that you expect to play out regardless of the result of the election, how should investors think about that when they’re investing in the healthcare industry?

    Erin Xie: So, we think companies benefiting from such policy shift should have very strong fundamental momentum and represent attractive investment opportunities. For example, telehealth was still very early in the adoption curve, even though COVID has fast forwarded the telemedicine adoption. We’ve seen a six-fold increase in the use of telemedicine services during the first half of 2020, and we believe this trend is here to stay. But we’re seeing very widespread investments from hospitals, from physicians, investing in telehealth capabilities. And we think consumers have also started to get used to this model. We think there’s still a lot of room for continued adoption. We also believe that business models that provide care away from hospitals such as outpatient surgical centers as well as home care will continue to gain momentum as well. I think the penetration is still relatively low and many kinds of care can be taken care of at home instead of being done at more expensive provider sites such as hospitals.

    Oscar Pulido: You mentioned trends that have been accelerated due to the COVID-19 pandemic like telehealth and wider adoption of at-home care. How has the healthcare industry changed since the pandemic hit the U.S.?

    ERIN XIE: Yeah, Oscar, you’re right. The healthcare industry has definitely been front and center during this pandemic. The industry has put in tremendous effort developing COVID vaccines, drugs, as well as diagnostic tests. We believe ultimately the combination of vaccines and drugs will really take the wall out of the pandemic. And the fast pace of vaccines and drug development speaks to the innovation power of the industry. For example, we’ve seen more than 150 vaccine programs get underway and we expect to see some pivotal vaccine data released before the end of the year. COVID-19 has catalyzed some structural shift in healthcare.

    Oscar Pulido: And it seems like these days, there’s a lot of talk of the second wave, that it’s coming or maybe it’s already here in the U.S. and it’s hit other parts of the world. So, I’m just curious in terms of the path forward, what is that path forward? How do we get out of this? And is the U.S. on a different path than the rest of the world?

    Erin Xie: So, I actually think we’ve been in one wave. The first wave just really never stopped. The ultimate path forward, I would think is really going to depend on the vaccines and drugs. There’s obviously a lot of focus on vaccines, but I actually think drugs will be an important component as well. The elderly and people with underlying diseases tend not to respond to vaccines as well as healthy adults or young people. So, in those populations, I think that the drugs will actually be very important if those people still get sick even when we get a vaccine. And I think that ultimately, the whole world is the same boat and if one country it’s not under control, the whole world is not safe, and the vaccines and drugs will ultimately help get us out of the pandemic.

    Oscar Pulido: Erin and Sarah both discussed how the coronavirus pandemic has reshaped healthcare, particularly in the public stock market. But what about companies that aren’t listed on a stock exchange? We turn to Andrew Farris of BlackRock’s Private Equity Partners to talk about what’s changing in private markets.

    Andrew, your role is in private markets rather than the public stock market. So, can you just take a second to help us understand what that means?

    ANDREW FARRIS: Sure. Private markets include investments in companies that aren’t publicly listed on a stock exchange. This could include venture capital, growth equity and leveraged buyouts. These companies can invest in long-term growth initiatives without the pressure of public quarterly earnings reports.

    Oscar Pulido: So, it sounds like maybe a different set of investment opportunities that you’re looking at relative to what’s just on the stock exchange. So, then with respect to the health care industry, how is that industry different for private versus public companies?

    ANDREW FARRIS: Private healthcare companies are generally smaller and earlier in their development than their public counterparts. On the early stage side, healthcare venture capital investment activity has risen a lot in recent years and that’s most notably happened in biotech, which has been driven by advances and drug research and an improved environment for exiting via IPO or sale to strategic buyers. We’ve also seen increasing activity across the healthcare landscape both in growth equity investments as companies stay private longer and in leveraged buyouts, which are private acquisitions of companies using a significant amount of debt. A key difference versus public markets is that private equity investors typically have a four to five-year investment horizon, which allows them to invest for growth outside of the public eye.

    Oscar Pulido: So, you mentioned things like biotech, is that one of the areas of the healthcare sector that you’re more focused on right now? Or are there other areas as well?

    ANDREW FARRIS: Biotech is one of those areas that we are looking at, but in terms of areas of deeper focus, I’d say we’re mostly looking at companies that are benefiting from certain thematic market growth drivers and they can make the healthcare system more efficient. I’ll just highlight a few themes to illustrate that. The first focus area I’d mention is value-based care, which is experiencing a continued shift from fee-for-service. More providers are assuming risk in a value-based care environment and there’s increasing vertical integration between payers and providers. The second area I’d touch on is digital health which includes areas such as telemedicine, data analytics and remote patient monitoring. These companies can have strong growth potential as they solve pain points in the healthcare system by increasing convenience for physicians and patients or providing cost savings for payers. The third area I’d mention here is pharmaceutical outsourced services such as contract drug development and manufacturing. These are companies that can benefit from the growth trends and pharmaceutical R&D and prescription drug volumes, but they have limited reliance on the success of any single drug. The final area I’d highlight here is Medicare advantage, which for our non-U.S. listeners, are plans for retirees offered by private insurers partnering with the government. The Medicare policy addressable market is growing fast with 10,000 seniors reaching age 65 every day, and they’re increasingly choosing Medicare advantage as it can offer lower premiums and more benefits. Penetration of Medicare advantage is still low at 35%, but that’s forecast to rise to 60% to 70% percent over the next one to two decades.

    Oscar Pulido: Some of the things that you’re mentioning were benefiting from trends that were already in place before COVID-19. For example, an aging population, it’s sort of well-known that there’s a number of parts of the world that are getting older, developed markets in particular. So, how do you see the aging population around the world impacting the healthcare sector?

    ANDREW FARRIS: That’s a great point, Oscar. I’d say that the world is really at a steep point in the aging curve right now. That should continue to propel growth in the healthcare sector over the next few decades. In the U.S., we’ll have the baby boomers aging through their 60s, 70s and 80s. And the over 65 populations in emerging markets such as China and India are expected to triple over the next 30 years. So, these are major demographic trends which should continue to support the demand for healthcare. That’s because spending increases pretty dramatically as people age. If you just look at some data in the U.S., healthcare spending per person is about three times higher for those 65 and older versus working age people. The key reason for that difference is that the elderly have higher incidents of chronic conditions such as heart disease, cancer, diabetes and high blood pressure. These are conditions that require ongoing treatment and monitoring. So, they will continue to support demand for healthcare providers, pharmaceuticals, medical devices and diagnostics.

    Oscar Pulido: Andrew, as we mentioned, you’re looking at companies in the private markets and you’re investing for the long-term. So, I’m just curious, where do you see the industry moving in the next 10 or 20 years?

    ANDREW FARRIS: I’d say we expect to see significant changes across the healthcare landscape and there’s a few areas that I would highlight here. So, the first is that the industry will move more towards an integrated approach to caring for the patient. This would really represent a shift from today’s typical care model where doctors are often focusing on treating a single issue. We could see primary care physicians playing a central role in coordinating patient care across a team of other providers. To support this more holistic care model, electronic health record systems will become more integrated across providers. The second point I would highlight is that where doctors see patients will shift to more convenient and cost-effective locations enabled by advances in technology. We’ve seen the adoption curve for telemedicine pulled forward by several years due to the COVID-19 pandemic and expect that its use will continue to be widespread in the future. There should also be a continued shift of medical procedures from the hospital to outpatient settings. The final point I would make here is that advances in technology will support both preventative care and improve patient outcomes. We’ll see an increased adoption of wearable devices that send health data to providers and allow them to proactively see patients and address potential issues before they become acute. We also expect advances in personalized medicine to allow better customization of therapies for individual patients.

    Oscar Pulido: Sarah, Erin and Andrew all talked about how COVID-19 has changed the landscape for healthcare, accelerating innovation in technology and in methods of providing care. And with the U.S. election just a short time away, we may see more changes in healthcare policy. But they also had a sense of optimism – with these advances come opportunities for vaccines, better access to care, and higher efficiency in the ways we provide care. All of this opens the door for new investment opportunities in the sector.

    That’s it for this episode of The Bid. We’ll see you next time.

  • Catherine Kress: Welcome back to The Bid, where we break down what's happening in markets, and explore the forces shaping investing. I'm your host, Catherine Kress. With the U.S. election just a few weeks away, what are the key issues we should be tracking, and how might the result impact markets? 

    Today, Mike Pyle, BlackRock's Chief Investment Strategist, walks through three different scenarios to plan for. He'll share his views on the implications of these scenarios for macro policy as well as his thinking on how the elections might impact sectors like healthcare, technology, and energy given the potential for regulatory reform. 

    Mike, thanks so much for joining us today.

    Mike Pyle: It's great to be here. Thanks for having me.

    Catherine Kress: You worked for five years in the Obama White House – really at the center of the president's economic team. So needless to say, you've spent a fair share of your career thinking about politics and how policymaking can influence economic and market outcomes. With this in mind, I'd like to get a better understanding of how you're thinking about politics today, and specifically, the upcoming elections in the U.S. The election this year, at least as I see it, looks to be one of the most consequential elections in modern history. Would you agree with that? As a follow up, what would you say makes this year different?

    Mike Pyle: So, I clearly think it's an extraordinarily consequential election. First, the country is facing a pretty historic degree of interlocking crises or challenges at this moment. 2020 has certainly presented all of the crisis and challenge associated with the coronavirus pandemic, the catastrophic human toll that that has placed on the United States and so many Americans. Secondly, the economic crisis that has come as a result of the coronavirus crisis that we've come out of the worst of it, but there's a long way back and a lot of household, small businesses, larger businesses still really grappling with that challenge in pretty profound ways. Third, 2020 has been a year of social unrest, social change, demands for justice in ways that we haven't seen in this country probably in my lifetime. And then lastly, looking out over the longer-term, we see the climate crisis and that that is an accelerating challenge, a challenge that is with every passing day more and more upon us. I'd say the other thing that makes this so consequential, of course, is the really stark divergence in terms of the two party's policy platforms. So, the stakes are high in terms of the issues we face, the stakes are high in terms of the divergent perspectives that the two parties, the two candidates bring to those. The one other thing I would say – you mentioned my background in policy, in politics. I'd say one thing that's different – I was in the White House in 2012 during the reelection campaign. And one of the things that I felt as part of that experience is, in the final months, there comes a moment when you recognize that you've kind of gotten done what you're going to get done in terms of policy. There are no more legislative opportunities, very little by way of things that could be done by executive authority. And you're kind of handing them off to a campaign to go persuade the American people that you've done the right things and done enough of the right things to merit reelection. I think it's a slightly different environment this time where, because of these crises that are unfolding in real time, policy still matters right now. Even if the path is very narrow, we still see live negotiations around additional economic relief. Obviously, the ongoing public health challenge requires countless decisions by governments, including the federal government day in and day out. So, I think just one big thing that's different today versus 2012 is precisely because of the unfolding, interlocking crises that the country faces.

    Catherine Kress: Mike, that's super insightful. Policy makers are still trying to get so much done, but it's in the midst of an election season, and so that can certainly complicate things and influence decision-making. But we're right now just a few weeks away from November 3rd, so as we think about the range of election outcomes, what would you say are the key scenarios that you're planning for?

    Mike Pyle: So, there are three scenarios that we're really tracking. We're tracking the likelihood of a status quo election where President Trump is reelected. Congress remains in divided hands with Democrats controlling the House, Republicans in the Senate. Secondly, we’re tracking the likelihood for a Biden win with unified government with Democrats in control of both the House and the Senate. And lastly, tracking the likelihood of a Biden win in the presidential race with divided government in Congress, with the Senate remaining in Republican hands. When we look at the polls, we see three things. We see a national race that looks as if it has a material advantage now for Vice President Biden. Secondly, we see a race that’s been extraordinarily stable for the past several months – four, five, six months. And that compares to the significant volatility that we saw in the polling in 2016; it’s much more stable than that. It is striking in light of the interlocking crises that the country is facing in 2020, and it's striking how stable the polling has been even in the face of historic events. But third, President Trump continues to run somewhat stronger in some of the decisive states than the nation as a whole, which continues to put the potential for President Trump to be reelected through a narrow win in the Electoral College even given, a pretty material lead for Vice President Biden in the national polls. 

    Catherine Kress: So that’s for the presidential contest; what about the Senate race?

    Mike Pyle: On the Senate side I think something actually quite consequential has happened over the last week to 10 days. We've seen the polls nationally, which had favored Vice President Biden nationally widen out by an additional couple of points probably, on the heels of the debate in light of President Trump's COVID diagnosis. That has taken the Senate from a setup where, to our eyes, it looked more like a toss up to a place – as a result of those kind of couple of points difference in the national environment – where it leans a little more significantly democratic. The big question over the next week, two weeks is whether we see the overall national environment revert back to the national lead that we'd seen for four, five, six months before this – or whether this larger lead is the new normal. That's going to make a good deal of difference about how we think about the likelihood of the presidential race, how we think about the likelihood of contested election scenarios post the election, and how we think about the environment in the Senate which, as we'll get into I suspect, is going to be extraordinarily consequential for defining the policy pathways post the election, with huge consequences for markets and asset allocation as well.

    Catherine Kress: I found it interesting that you noted just how stable the polls have been, because I know one thing I've been reading a little bit about, too, is just how small the number of undecided voters is this year relative to previous years, which indicates that that polling may indeed remain more stable moving forward. So, as we move on to some of the policy implications of these different scenarios, it's clear given how far apart the parties are in terms of their policy priorities that each of the scenarios that you mentioned could have really different implications for the policy outlook. What are some of the key areas, in your view, where we could see meaningful policy change? Which ones are you paying most attention to?

    Mike Pyle: So, we're tracking five big macro policy areas across each of those three scenarios – macro policy areas that we think have top-down consequences for global economics and global financial markets. Those five are stimulus and ongoing coronavirus relief, public investment, tax, the regulatory environment, and then foreign policy including U.S.-China relations and trade. Some of those will turn based just on the result of the White House, in particular the regulatory environment, the foreign policy environment. Some of those require Congress and the president working together – anything really to do with fiscal policy either on the public investment side or on the tax side. And so how are we thinking about it? First, with respect to the issues really in the hands of the executive branch, in the hands of the president, we think that the regulatory approach under a President Biden would be considerably more stringent than we would expect under a second Trump term, where deregulation has really been the touchstone of the past four years. We think that's going to matter a lot for the energy sector, but I'd like to also sort of point out that we think it could be quite consequential for the tech sector. Renewed energy around things like anti-trust, renewed energy around things like privacy, is really putting the technology sector front and center in the regulatory conversation. And that's particularly important because the handful of, in particular, mega-cap technology names in the U.S. have been such an important part of overall market performance both this year and recent years. And a change in the regulatory environment there could mean a much different operating environment, a much different financial environment for those companies. Secondly, on the foreign policy and trade side, one of the things we've talked about is the ways in which there has been a bipartisan shift on China in a direction more towards strategic competition, towards rivalry. So, our expectations regardless of who wins in November, we're likely to see a much more competitive, significantly more aggressive posture towards China than we've seen in past decades. That said, we think that a Biden administration would be different than a Trump administration both in its emphasis on working with allies, but also in terms of providing greater transparency, greater predictability about the framework that it's bringing to bear on U.S.-China relations on trade, what have you. In some ways, it's been the uncertainty and unpredictability of the Trump approach that has been the biggest source of volatility in markets as a result of this changed direction on China. And so, on balance, we think that a similarly tough but more predictable framework on U.S.-China relations and trade policy is probably a market positive. 

    Catherine Kress: You just discussed regulation and foreign policy – two areas that are largely driven by the executive branch. But it seems that some of the other issues you mentioned – especially in the fiscal space – will require more participation from the legislative branch (Congress).

    Mike Pyle: Yeah, so going to the areas that require legislation, this is where the Senate becomes so consequential. We could see quite substantial changes both in terms of tax policy, but also in terms of the scale of stimulus and public investment that we see. Obviously, in divided government scenarios, perhaps especially under a President Biden, we wouldn’t expect a great deal of movement on the big fiscal policy questions. Maybe some capacity in a Trump reelection scenario for some additional relief, but what we've seen really is just over the past couple of months and the struggles to get a phase four stimulus deal done ahead of the election highlights that, even in a status quo election, it's going to be really hard to get additional fiscal policy over the line. So, what we're really talking about is a Biden unified government scenario just being categorically different than the other two. The additional thing I would say is I think during this summer in particular, there was a lot of focus on the tax pieces of the Biden agenda and what that could mean in a unified government scenario. The likelihood of higher corporate tax rates, the likelihood of higher capital gains tax rates of other transitions in individual taxation. And I don't think investors are wrong to pay attention to that. I do think that that's likely to happen. There are likely to be changes in a Democratic scenario. Taxes are likely to move higher. That is likely to flow through to corporate bottom lines. And in particular, again, given some of the tax changes that are being proposed on the international tax front, you could see particular headwinds to some of the larger tech firms, to some of the pharma firms. But the thing we've been saying again and again is, it's right and fine to sort of focus on those bottom-line impacts, but you shouldn't ignore the top-line impacts of a much more aggressive posture around additional stimulus, a much more aggressive posture around public investment whether it's in infrastructure, or clean energy, or R&D. We think that that kind of scale of fiscal impulse, of public investment impulse, you would see from a unified Biden scenario would have pretty profound implications for the top line for overall economic growth and the economy, for growth in earnings for firms large and small to really accelerating the U.S. back to something like potential output and beyond. That’s a big difference, and we think that when investors take too much of a tax-centric approach, too much of a bottom-line-centric approach, they're missing what could be the big fiscal policy stories – the impact on the top line, on revenue, on growth in the overall economy and in businesses.

    Catherine Kress: Mike, I want to follow up on your fiscal outlook. You mentioned that this is an area where the Senate really matters. It's clear when we think about the Senate outlook, we could have a situation where we have 49 Democratic senators, or we could have 50 Democratic senators or more. How do you think about the impact of that difference in the actual Senate makeup when you think about the overarching fiscal outlook and potential for stimulus moving forward?

    Mike Pyle: That's a great question. The single biggest question is who has control of the Senate, and that is going to create the biggest difference in policy outcomes. The difference between 49 Democratic senators and 50 Democratic senators, plus a tie-breaking vote from a new vice president, is extraordinarily large in terms of the types of policy outcomes that we can expect. I think some of our back of the envelope thinking suggests that that difference alone could amount to a difference on the order of three, four, five percentage points of GDP in additional stimulus and public investment over each of the next two to three years. Just one or two Senate seats can really make a very profound difference in terms of the macroeconomic policy environment we step into post January: around coronavirus relief, around public investment, around just major change on infrastructure or clean energy, R&D, as well as just basic support for households and small businesses, and states and localities.

    Catherine Kress: So, it's clear it's not just a consequential election, but it's likely to be very close, and so we have to track all of these issues closely. But on that note, we've seen so many pieces and so many analysts and experts commenting on the risk of a contested election, and what that might mean for volatility in financial markets. I know the three themes that we've been thinking about along these lines are, one, potential disruption to the mechanics of the election, just given kind of the uncertainty that the COVID pandemic has injected into the elections. The second being a potential delay in the tally and actual announcement of the election results. Election Day could become election week just depending on how quickly the actual votes are counted and the ways in which states manage the election. And then third, the risk of potential disputes just given how close the election could be. So, I want to get a sense from you as to how you're thinking about this risk of a contested election, and what that might mean for volatility in markets?

    Mike Pyle: Well, we've certainly seen volatility markets respond to the likelihood and evolving assessment of risks around the prospect for a contested U.S. election. So that's clearly happening in terms of market pricing. I think we acknowledge that we are, as a country, conducting an election in a historic moment, a moment unlike really any other that we've attempted to conduct a presidential election in, and that is introducing a host of challenges to the set up. I think in our base case, precisely as you said, because of, appropriately, a lot of people transitioning to voting by mail, voting absentee as opposed to voting in person in order to stay safe, we do expect that there are likely to be some delays in counting votes including in some of the key states, places like Pennsylvania. I think our base case is we see resolution of the election, we know who the next president's going to be, but it may not happen on election night. It may take two or three days to get to a place where the results are clear, the results are counted, the major networks and other observers begin to call the election. That's kind of our base case. 

    Catherine Kress: What do you see as the risks to our base case?

    Mike Pyle: We see risks on both sides of that. In terms of getting clarity on election result, there are going to be a lot of eyes on places like Florida, which will count its ballots both mail-in and in-person on election night. We should have a pretty clear sense three or four hours after the polls close who's won Florida. And if it's outside of the automatic recount margin, and if that happens to be Vice President Biden, I think we're going to get a pretty clear sense of which way the election is likely to go, precisely because it's very hard to construct maps where President Trump can win in the absence of having Florida. So that I think is an outcome where you could see a lot more clarity sooner than in our base case. And then of course on the other side, there is the risk that a number of these decisive states, especially in the upper Midwest, decided by narrow margins, decided by margins of mail-in ballots, maybe margins of mail-in ballots that have been excluded for one reason or another. And that's the type of scenario that brings in significant litigation risk, significant risk of state legislatures and state courts getting significantly involved, significant risk of Congress and the Supreme Court ultimately getting involved. I think it's very hard to trace what exactly would transpire in that situation. But all that said, I'll make two final observations. One, this is part of the reason why I think this question that I posed earlier about whether or not this widening out of the polls that we've seen over the last seven to ten days, whether that proves to be durable. Which path we take could be pretty consequential here. Volatility markets have begun to settle a little bit in the past couple of days, looking out into November and December volatility pricing. I think that's partly because, in a world where Vice President Biden's leading by ten points as opposed to seven and a half points, markets I think appropriately are assessing that the risk of a contested election is significantly reduced. It's going to be very important to see over the next little bit of time whether we stay where we are, or we revert back to that prior mean. And the other thing I would say is I do think that we have conviction that ultimately, we're going to see a resolution. There is going to be a president who is sworn in on January 20th. We have conviction that that's going to be a result that's generally accepted and seen as legitimate. And as a result of that, from an investment perspective, we believe that any volatility on the heels of the risk of a contested election, the actuality of a contested election, that by and large is going to be something that may be uncomfortable in the moment, but is going to be best looked through by long-term investors who keep their long-term goals in mind, who if anything, use the volatility to maybe add to high conviction positions. But really something to look through and keep those long-term goals in mind.

    Catherine Kress: Mike, that's very refreshing to hear your view that we will ultimately get to some form of a resolution. So, building on that last point you just made in terms of seeing through some of the noise, seeing through some of the uncertainty, what are the key investment themes that you're thinking about that you think investors should be prepared to move on in the aftermath of the election?

    Mike Pyle: The first would be to look at international equities, perhaps especially places like emerging market equities. We think, especially in a scenario where we see a Biden win or we see unified Democratic government, that should be a pretty favorable environment for global cyclical exposures. We think we could see quite an acceleration of that fiscal impulse, quite an acceleration of global recovery particularly perhaps when paired with a vaccine in 2021. And places like the emerging markets – perhaps especially when paired with a more certain foreign policy and trade environment which, of course, has been such a source of uncertainty and volatility over the past four years – that to us looks like a place that's interesting in the face of a Biden win with unified government. And secondly, we'd say within U.S. equities, a Biden win with unified government is potentially a real cause to see a rotation in leadership in the U.S. stock market. The past few quarters, even the past few years, has really been characterized by this very pronounced tech outperformance, and even within that, this very pronounced outperformance of the handful of megacap names in the technology space. We think that that sort of election and policy scenario could lead to a pretty substantial reordering of leadership within the U.S. equity market as I was talking about for reasons like anti-trust regulation, for reasons like tax policy changes that could pose particular headwinds to the U.S. tech megacaps. We see more by way of headwinds there to ongoing outperformance. On the flip side, I think we see that kind of big push on fiscal, that big push on public investment, leading to a much more kind of bottom-up growth picture in terms of the U.S. restart and recovery, and as a result, more of a bottom-up led U.S. equity markets. So, looking to places like small cap U.S. stocks, looking to places even like an equally weighted S&P 500. Those are exposures to us that look as if they have more significant tailwinds behind them in that kind of scenario. You know, in a world where President Trump is reelected, in a world where we see divided government, in a world where we see less of that big kind of fiscal rotation on the policy side, I think that to us is a little bit more of a what we've seen is what we're likely to continue to see. So, to us, the knife's edge is around leadership in the U.S. equity market and whether we should expect to see more of the same, or a much more profound transformation in what's leading the U.S. equity market. 

    Catherine Kress: So, the first two themes are international equities and leadership in the U.S. equity market. What about the fixed income market?

    Mike Pyle: There, too, the big divergences are between a Biden united government scenario and the others where the big reflationary impulse that we could see on the fiscal policy side and that unified government scenario could be pretty important for causing U.S. yield curves to steepen, causing the long end of the curve to sell off a touch. Break-evens could widen. We think that the kind of big impact would be a pretty significant rally in a place like TIPS. Both because we do think inflation expectations would move somewhat higher on the back of a view that, particularly combined with fiscal stimulus, the Fed would be likely to achieve its objectives of a modest to moderate inflation overshoot in the years ahead. But that in particular, because the Fed is also likely to be pretty aggressive in not letting financial conditions tighten, not allowing the long end of the U.S. yield curve to sell off too aggressively. But a lot of that adjustment is going to come on the real interest rate side, is going to come through TIPS and through TIPS rallying given the real interest rate exposure there. 

    Catherine Kress: Mike, thanks so much for your insights today. I know you mentioned these are unprecedented and uncertain times. So, I'm looking forward to speaking with you in a few weeks to see how all of this plays out.

    Mike Pyle: Absolutely. I can't wait to continue the conversation. Thanks for having me.

  • Mary-Catherine Lader: Welcome to The Bid and to our mini-series, “Sustainability. Our New Standard,” where we explore the ways sustainability and climate change in particular will transform investing. I’m your host, Mary-Catherine Lader.

    Today, we’ll focus on one area of sustainability, impact investing. Impact investments aim to deliver progress on environmental and social goals in addition to financial returns: doing well while doing good. That might sound a lot like ESG, or environmental, social and governance investing. How is it different? You’ll have to listen to find out. Joining us today is Eric Rice, Head of Impact Investing for BlackRock’s Active Equities. We will talk about how impact investing differs from other forms of sustainable investing, the attributes that define an impact company and how businesses have pivoted in the face of a global pandemic and the focus on social and racial inequities.

    Eric, thank you for joining us today.

    Eric Rice: Hey Mary-Catherine. Very nice to be here. Thank you.

    Mary-Catherine Lader: So, throughout our mini-series on sustainability we have talked a lot about ESG or environmental, social and governance investing. Your role and part of your career has been in impact investing. Can you just explain what impact investing is and how it differs from ESG investing?

    Eric Rice: I think the simplest way of thinking about that difference is that ESG is about how companies do what they do, and impact investing is about what they do. So, we are all thinking about how they treat their world, but ESG is about how any company operates. Is it good to its environment? Is it good to its stakeholders? Does it have good governance? And any company could be a great ESG company, but an impact company is a company that makes goods and services that are actively solving the world’s great problems. And of course, if done properly, an impact investing strategy should involve ESG integration. It should also involve the kind of negative screening; no one wants to see a gun maker in an impact strategy. Of course, that would never be a solution to a big world problem, but you know what I mean is that impact investing is like a 2.0 here. It includes other aspects of sustainability and it also includes engagement with the company.

    Mary-Catherine Lader: That is such a helpful way of thinking about it that ESG is about how a company does what they do, and impacts is what they do. And so, I guess from that perspective, what activities then make a company an impact company? What criteria are you looking for to qualify as impact?

    Eric Rice: The starting point is this thematic area: Are they doing something good for the planet or good for our society? On the planet side, it could be cleaning up the environment or doing renewables or making things more efficient. On the people side, it’s quite a range. It’s from access to education, healthcare, it’s digital and financial inclusion, it’s better health, better safety, security, all sorts of things that are the identified big problems of the world. You want companies that are advancing those solutions to problems. Two other criteria are important for us. One is called materiality. Materiality means that it should be most of what the company does. So, we don’t want a company that is dabbling in do good, but at the same time they are just making chairs and steel like every other company might be doing. The second thing is that the company should be additional, and that’s really interesting. That means that the goods and services of that company should have either a new technology or a new business model or be bringing those goods to a new population that hasn’t had them before, so it’s additional in the sense that if it weren’t for that company and what it’s doing, that problem wouldn’t be addressed.

    Mary-Catherine Lader: So with those criteria in mind, what are some of the more exciting opportunities that you’re seeing in the world’s stock markets right now?

    Eric Rice: It sounds like you are asking me if I have a favorite child, do I like financial inclusion or do I like environmental cleanup, and I can’t tell you that, that’s not fair, because we have lots of exciting things going on. But I would tell you, I think more relevant for right now is that we are at a moment on the financial side when some of the most unloved stocks this year that never recovered after the March downturn are starting to look interesting and we are starting to see that they have the prospect of going into 2021 with some recovery and some strength. Like the most terribly beaten down, high efficiency buildings and building systems and materials, they never recovered, most of them. I think what we are learning is that the companies are telling us, the management is telling us that they are starting to see business come back. We have of course online education, those rallied, but we have some in-person education companies in emerging markets; those have done really poorly, but those too are starting to show signs of recovery and signs of M&A activity and that’s encouraging and exciting. And then a lot of healthcare has done well, but some of it hasn’t because elective surgeries have been put off, so many things have been put off just to make room for COVID-19 activity and so now that there is a little bit of breathing space we think that that’s going to be a 2021 opportunity.

    Mary-Catherine Lader: On that note of things being put off to handle COVID-19, how have you seen companies pivot in the wake of this crisis as well as around unrest around racial inequality?

    Eric Rice: I use exactly that word, to “pivot.” I think one of the reasons that some impact strategies did really well this year is because we have companies that were not necessarily producing the goods and services that would naturally be a solution to COVID-19, but they were just because they are problem-solving companies, they did pivot to solve some of these problems, Some examples are in healthcare, we have one medical devices company that never produced a ventilator in its history, but when COVID-19 came along they are very good at tinkering with things, they came up with a substitute that’s used in the U.S. and many countries that is not exactly a ventilator, but it serves the purpose of a ventilator only at 95% less cost. So, they have been pumping out thousands of these and they have been going to hospitals around the world. We also have a mass notification company and what that means is if there is a flood, they notify of a flood to the employees; if it’s a company it’s the client or to the citizens if it’s a country. And now what do they notify? They notify people about COVID hotspots or changes in the rules around shelter-in-place. It’s amazing. And companies that do education, they pivoted to distance learning. On the side of inequality, I think the pivot is really to more awareness, and awareness among companies about getting their E and S more right, that they have to improve in ESG even more urgently than before. And you see companies that are oriented to helping with inequality, financial inclusion companies. We have Brazilian university companies that are solving a problem there, that’s a problem of inequality for working class students. But it’s less a pivot than the fact that a lot of these companies are always oriented to those kind of inequality issues.

    Mary-Catherine Lader: You mentioned 2021 opportunities. As you think about 2021, how does the upcoming U.S. election figure into your thinking as an investor generally, but also in terms of what impact-related opportunities it might present or infringe upon?

    Eric Rice: So we saw an interesting thing in 2016, which was in November 2016 we weren’t investing in “Making America Great Again,” in the sense that we were investing globally and we weren’t invested in coal or petroleum or steel or old industries, we were invested in disruptors and solutions to problems and especially new kinds of technologies and for some weeks after the election that did badly. So, I think that would be true in a Trump victory. And alternatively, I think in an election that resulted in Biden winning, a perception that the Green New Deal will go through, the kind of stocks that we’ll invest in will do well. I think in an environment where there is a perceived respect for science and education, technology that this will be an opportunity for impact investors going out the gate. But our universe that we invest in has done well because it’s a faster growing universe. It’s an inexpensive universe in terms of stocks, because people don’t really understand what it’s going to be. And so, I think year after year, there can be terrific performance, no matter what happens politically.

    Mary-Catherine Lader: So, one of the common views about sustainable investing generally is that it means sacrificing financial returns. You were a traditional investor. You have now been in the impact space for seven years. What’s your perspective in terms of whether this focus on values can sometimes mean a tradeoff in terms of value?

    Eric Rice: I have been asked that often. I think there is a reality to it that there could be a tradeoff, but I think there’s a way to construct an impact investing strategy where there isn’t one. And I will tell you what our early insight was; that we had to separate the identification of what are high-impact companies. So, we built out a universe. We have a universe of nearly 800 companies and that’s $7 or $8 trillion of market cap. So, it’s a vast universe that we could invest in. And because we have identified them and set that high bar for impact among those companies, then what the team can do is just do conventional investing. We are doing the usual kind of stock selection and portfolio construction. If you separate the two out and if your universe is good enough and big enough, why should there be a tradeoff?

    Mary-Catherine Lader: Why isn’t impact investing totally mainstream? Why doesn’t every asset manager have an impact investing fund or team and why isn’t it part of everyone’s portfolio?

    Eric Rice: Well, that’s a multipart question. I think it’s not in everyone’s interest among investors to do it. Just as investors are moving toward all portfolios being sustainable to some extent, I think you will see some more movement, but this is where we talk about what we do as being a satellite kind of strategy. You might want to have exposure to steel makers and cola makers and whatever, that’s not what’s going to be in this portfolio. So, it’s necessarily a bit niche and it’s necessarily going to deviate a bit from a benchmark-hugging strategy. It just will. And so, this is useful as another building block of one’s allocation of assets, but it’s not going to be a standalone. You are not going to replace everything in global equities with impact. It’s just not like that.

    Mary-Catherine Lader: I am curious, you used to be a diplomat and a World Bank economist, how did you become interested in impact investing?

    Eric Rice: Well, I suppose I might have been interested in it when I was a development economist, but it didn’t exist. I am old enough that I had to grow up in an older paradigm where if you wanted to do something good in the world you would be a diplomat or a development person. And I actually ended up in finance because I took an extended leave of absence, a sabbatical to go check out the financial industry after I had been working in the financial crisis in Mexico and I thought I would go back to the World Bank, but some other things started emerging, like social entrepreneurship and impact investment that I was finding fascinating, but that was all in the private markets. And so, seven, eight years ago I pitched the idea to my then employer that we should be able to do the same thing in the public markets; it shouldn’t be the case that only someone with a million dollars of investable assets can be an impact investor. Everybody wants to be. And so, I was just driven by this idea that you could bring together the public markets and the private sector to the solutions that I was seeing being done at small scale in the private markets.

    Mary-Catherine Lader: And so, given that you have said that you are part of an older paradigm, I am curious then what paradigm you think we are in now and then what you see for the next 10 or 20 years for impact investing.

    Eric Rice: I think there is a recognition when everybody looks at the scale of problems that we have that we are very much in a new paradigm where you say okay, it’s great, the government, NGOs, philanthropy, they all do important things of some size, but it takes everybody to solve these problems and in particular it takes the kind of technologies and market approaches that are in the private sector and that impact investors can bring to bear. So, there is no going back at this point. I think that that’s going to be a very exciting thing over this period. I think also that public markets’ impact investing is here to stay and will become bigger. I think also we will have regulatory changes so that retail investors and pension holders will be more permitted to invest with a view toward impact just in the way that ESG is still in question in some places. And so, I think that we will be moving to a world where everyone recognizes that sustainable investment is just investment and impact investment is also alpha-oriented investment.

    Mary-Catherine Lader: When you say we’ll move to a world where sustainable investment is just investment, and impact is just another way to generate alpha in portfolios, it makes me wonder if then you think we will have some standardization, or just a shared understanding of how one measures impact? In ESG investing, for example, we constantly hear that we don’t have standards and that makes it hard to compare products with one another. In impact investing, do you see us moving towards some kind of agreed upon approach to measuring performance or do you think that doesn’t matter so much?

    Eric Rice: It absolutely does matter. There was a handful of things that stand in the way of that transformation. There has been a lack of democratization, bringing it to the public markets. And so that if I have a hundred dollars, I can invest in impact. There has been a lack of information and education, what is impact. I mean even after all these years people mean different things when people ask me that question. And then as you might have been alluding to, there is the lack of impact standards. When we started there weren’t UN Sustainable Development Goals to tell us some of the ways of thinking about what the big problems of the world are. That came later, and that’s helpful, but it’s not really a standard, and I would tell you that inadvertently it facilitates greenwashing and impact washing. What’s better is that on top of this, we have the Impact Management Project and what’s called the IFC Operating Principles for impact investing and there is a taxonomy for impact goals, which is called IRIS+. All these things are setting up some standards so it won’t be that you’ll see funds that say that they are impact funds, but they invest in fizzy drinks or ice cream makers or that they invest in your local water utility that’s just been delivering water to your wealthy door the same way for the last many decades, but that it requires that these be companies behind which there is some theory of change and that these are actually companies that are not just aligning with the UN SDGs but advancing the solutions to the problems.

    Mary-Catherine Lader: You mentioned the United Nations Sustainable Development Goals and I am curious if you could just share your view as to why it is that investors and their clients have become interested in mapping their portfolios to those Sustainable Development Goals. They are essentially a set of objectives that the United Nations put forth to improve the state of the world, everything from ending poverty to ending hunger and so they are ambitious and lofty, and you might not think of them as immediately tied to financial markets. So why is it that that’s become a framework for thinking about impact?

    Eric Rice: The UN SDGs have been very useful, I would say, for catalyzing and mobilizing around the problems and what it would take to solve those problems. When we started there weren’t UN SDGs, and we came up with a set of social and environmental problems and lo and behold a few years later when the UN did probably similar research they came up with a quite similar set of problems. The thing is, though, it’s not actually aligned with investors or in line with what companies do. For instance, they don’t talk about financial inclusion or digital inclusion or personal safety and security. Those are things that companies do. And so, it’s great, but it’s a little bit misaligned. And so, what we do is we look not to the 17 UN SDGs, the goals, but to the SDG targets, of which there are 169, and those tell you what the problems really are. And when you look at those, you can see why for a development agency or for a philanthropy it really homes in on what needs to be fixed and a lot of that translates to investment, but some of that we have to go beyond; we call it a little bit cheekily SDG+. If we are dealing with factory security or cybersecurity, that’s not in the UN SDGs, so that’s for us an SDG+, things that companies can bring a solution to and that we and our clients care about solving.

    Mary-Catherine Lader: We end each episode of our sustainability mini-series with the same question to each of our guests, Eric. What’s the one moment that changed the way you thought about sustainability?

    Eric Rice: It’s funny, I can tell you exactly when that was and it was me a couple of years ago standing in the old neighborhood I lived in 30+ years ago in Kigali, Rwanda. That’s where I was a diplomat and I was reminded of how people solve problems before. That in my neighborhood there were local folks and they live in the city, and if you live in the city, there is always someone back in the village who is sick. And so, they would typically come to me to ask to borrow some money or give them some money for medicine and then they would buy some medicine and they would take a jitney for days, some of them would walk to go bring the medicine to whoever is ill in their village, and it’s very cumbersome and inefficient. What struck me that day was how much has changed, because what I saw on my walk through Kigali that day was a microlender that we are invested in, that meant that if someone is sick in the village, they will have called you on your cellphone, you can go to the microlender to get a $10 loan to buy the medicines you need. You don’t have to go travel for a week to bring the medicine, you tap your phone at the mobile money kiosk and it gets transferred to your family back in the village. And then if you are lucky enough to be in Rwanda, that’s where they have had the trials of drone ports. And so, a drone will bring the medicine to your village from a city and it’s just all solved seamlessly, and I realized that sustainability, and for me it means impact investing, that these companies can actually solve problems so much better than in the old paradigm. It was just a lack of imagination, a lack of experimentation that has taken us so far in the last decade.

    Mary-Catherine Lader: That’s a compelling anecdote. I spent time myself working in Nairobi in mobile money and I think that the way that that empowers economic growth and change was really stunning. So that resonates with me. Eric, it’s been an absolute pleasure having you today. Thank you so much for joining us.

    Eric Rice: Thank you very much for having me.

  • Oscar Pulido: Welcome back to The Bid, where we break down what’s happening in the markets and explore the forces shaping investing. I’m your host, Oscar Pulido. Seventy-four percent of Chief Financial Officers expect some portion of their workforce to remain virtual forever. Stay at home orders have led to a 60 percent increase in content consumption on video and audio streaming platforms, and there’s been a 35 percent surge in video game sales over the past few months.

    These are just a few of the ways the world has changed since the coronavirus pandemic first started. And they can all be encompassed by megatrends: the long-term forces shaping society. Today, Jeff Spiegel, U.S. Head of Megatrends and International ETFs, will walk us through a few of the themes he’s thinking about, including virtual work, the future of innovation, technology and healthcare.

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

    Jeff Spiegel: Thanks for having me back, Oscar.

    Oscar Pulido: And in fact, you are coming back. We had you back on in April to talk about the coronavirus and how it has accelerated the five megatrends that we’ve been watching. And just as a reminder, those five megatrends are technological breakthrough, demographics and social change, rapid urbanization, climate change and emerging global wealth. Now I guess my question is, are we continuing to see these trends accelerate over the past few months?

    Jeff Spiegel: In some ways, April feels like a lifetime ago. Yet in others, and this certainly applies to megatrends, 2020 has actually propelled the future to come at us faster than ever. So, more directly to your question, I’ll quickly click through those five megatrends you listed and give you a sense of some of those acceleration highlights. In technological breakthroughs, greater connectivity is really leading to huge investments in big data, in networks, and cyber-security; while at the same time, deglobalization driven by the pandemic is driving greater focus in areas like robotics and automation. In demographics, genomics and immunology were major focuses of our last discussion and how they’re enabling us to fight back against COVID, because they’re the disciplines at the forefront of the vaccines and the therapeutics that are providing us hope. Rapid urbanization and climate change I’ll put together here. We’re seeing hundreds of billions and actually expect trillions of dollars of investments in these two areas in the near term. In traditional infrastructure and clean energy, as governments use stimulus specifically in these spaces to get people back to work. Then in emerging global wealth, we’re already seeing countries like China post-rebounding spending and manufacturing at a far faster rate than the rest of the world, propelled by the rise of the middle-class consumer in that and similar countries. But finally, the most powerful themes actually coexist at the intersection of multiple megatrends. And so, at the intersection of tech and demographics, we’re experiencing this amazingly rapid expansion of virtualization that’s fundamentally changing the way we work and the way we live.

    Oscar Pulido: So, you’ve touched on this a little bit, but as you think about these broader megatrends, what are some more of these specific themes within that that you’re focused on in light of all of these societal shifts that you’ve started to mention?

    Jeff Spiegel: Yeah. So, I’ll go further on that tech demographic intersection that is driving towards more virtual work and virtual living. A rise in connectivity was already a fast-moving megatrend long before the pandemic. In fact, there were about 30 billion internet connected devices at the start of this year, and that was set to rise to 75 billion by 2025. Then, the pandemic forced an even more rapid acceleration. Countless activities done in person every day by hundreds of millions if not billions of people had to be replaced in short order by virtual solutions. So, in considering that, we really think about it as two distinct categories that have taken off: virtual work and virtual life. What really has to be emphasized, though, is that this virtualization was well underway within the tech and demographics megatrends before the pandemic; it just managed to leapfrog much of the earlier adoption phase given our sudden need to go virtual in the crisis.

    Oscar Pulido: It’s very true – you said something before about the future kind of coming at us. I don’t know about you, I used to work from home maybe once or twice a month and obviously now it’s a daily occurrence for me. So, speaking of that, we’ve heard that companies are letting their employees work from home through the end of the year and in some cases, actually even into next summer. So how do you see the nature of work changing on a go-forward basis?

    Jeff Spiegel: So, we think different companies are going to take different approaches to bring workers back. That’s primarily because there’s no real playbook or even any consensus regarding the course of the virus and it differs profession to profession, geography to geography how safe it is to come back. We do know that workers will eventually be able to return to offices safely, whether that’s in six months, twelve months, eighteen months. The big question is what happens then? And to that point, 74 percent of CFOs expect to offer more virtual work forever, long after the pandemic. Many of them because they see ways to maintain productivity, reduce costs and meet employee demand. That’s been one of the important lessons of this work from home experiment forced by the crisis. At the same time, a similar number, 72 percent of workers, actually want the flexibility to work two or more days from home long term, in that case so they can avoid a grueling commute, so they can have more flexibility in where they live, and so they can have a greater ability to manage more personal needs like childcare. Now companies ranging from tech firms like Twitter to insurance providers like Nationwide have actually announced that they are going 100 percent fully virtual for the long term. As a counterpoint, Reed Hastings, the CEO of Netflix, has been really vocal in saying there is no way he’ll offer his teams more remote work once return is safe, because he worries that at Netflix, he would be stifling creativity. Now those are the extremes, but most of us will not be 100 percent virtual or 100 percent in person going forward. And you know, BlackRock actually surveyed us and asked what percentage of the time we’d all like to work from home, post-pandemic. I have to admit, in contrast to my prediction a moment ago, I personally said I’d like to work from home 100 percent of the time. Oscar, I know you’re the one asking the questions today but I’m curious if you could share where you cast your vote?

    Oscar Pulido: I don’t remember exactly how I answered it, but I will tell you, I did not answer 100 percent of time that I want to work from home. I like variety; I don’t mind a commute. Perhaps mine is a little less grueling than folks who might live out deep in the suburbs. I live pretty close to New York City. But I tend to think that there are some benefits to being in the office and being around your colleagues. So obviously work from home is one of these things that has changed in the course of our lives over the last few months, but there’s a lot of other things that have been brought into our home. It seems like exercise classes have been brought into living rooms and people are watching friends get married over virtual wedding ceremonies. What are some of the other areas besides just working from home we’re you’ve seen technology really break through?

    Jeff Spiegel: So, in virtual life, we’re seeing the end game for some megatrends that have been running for a while. And we’re also seeing a massive leap forward for those that had just started emerging. And just like you and I were talking about, right, with different views on how frequently we want to go to work, different CEOs have different perspectives on this, there isn’t a one-size-fits-all solution going forward. So, to some of those end game examples, those hold-outs, we all know some of them who never had an Amazon Prime account or never had a Netflix account. Well, the vast majority of them during this pandemic have finally signed up. Amazingly, Disney+ achieved 50 million users only months after launch. It took Facebook years to accomplish a number like that. At the same time, video game sales saw that 35 percent surge and 20 percent of romantic couples are now meeting online. Including, by the way, and as an aside, yours truly and the love of my life. Actually, to be precise, she and I met in nursery school, went our separate ways at the age of six, and then actually found each other again 30 years later on Hinge. But we’ll save the details of that story maybe for another Bid, Oscar. To be fair, most of us had experienced e-commerce, streaming, video games. I had certainly experienced online dating changing my life. And many of us had embraced these areas pre-crisis. Newer areas of virtualization, though, are really leaping forward from those early innings. Areas like tele-education and tele-medicine that most of us really hadn’t tried previously. Now yes, our kids will go back to school. That is a boon for the many of us out there tired of having every other Zoom call abruptly interrupted by our little guys and gals. But tele-education will nonetheless live on. In fact, global ed-tech spending is expected to grow 18 times through 2025. Why? Because recorded lectures allow students to learn at their own pace. Because a limited number can fit in a room to hear from the world’s preeminent professor of nuclear physics. But an infinite number can hear from her online. At the lows of pandemic life, I actually took a free Yale University course on happiness, and it had an amazing impact on me. Another game-changer was the speed with which health insurance companies abruptly changed policies to allow for tele-medicine in the face of the pandemic, which is, by the way, impressive in that industry’s speed to respond. And yes, many types of doctors’ visits will continue to require in person examinations, but many won’t. Again, I’ll share a personal anecdote and I hope that the aforementioned love of my life doesn’t mind that I keep referencing her today. But Kim is a psychiatrist at New York Presbyterian Hospital. At the height of the pandemic, she was still going in every day to take care of the in-patient unit she manages. But her private patients obviously weren’t going to come in and see her live at the hospital, so they moved to tele-psych. Nine months later, not one of them wants to go back to in person sessions.  And as a clinician, she’s actually been shocked to find that she is just as effective in that virtual environment.

    Oscar Pulido: Jeff, I actually think that it’s not just another podcast – we might have a feature film that we need to make about you and Kim and the 30 years that it took for you to reunite.

    Jeff Spiegel: Let me know when we’re filming the movie. I’m all in. I’ll check with Kim to see if she is down.

    Oscar Pulido: Certainly, a lot of the things you mentioned resonate with me in terms of yes, I signed up for a Disney+ account, my nine-year-old daughter now is reciting lines from Hamilton. We were definitely experiencing the education at home through Zoom, so I have to imagine a lot of people are relating to this.

    Jeff Spiegel: And I also have to note, Hamilton has been stuck in my heat for months since Disney+ put it online, which is certainly a good thing, although I have to resist singing or humming it while I’m on calls with clients.

    Oscar Pulido: And then you touched on healthcare and the advancements we’re seeing there. There’s obviously a race towards a vaccine, that continues. What other areas of development are we seeing in the healthcare space?

    Jeff Spiegel: So that’s going to come back to genomics and immunology again, and we discussed it at length back in April, the extent to which RNA vaccines, the domain of genomics and anti-body replication therapies, the domain of immunology early at the forefront of fighting back against this virus. And I actually think the bigger point here is the long-term impact of the tremendous amounts of research and development that are being marshalled against COVID-19. We’re talking about a Manhattan Project-level of focus and resources. RNA vaccines and antibody replication therapies have never actually been applied to any disease before. They’re massive new breakthroughs. So while it’s hard to say exactly which vaccine or therapeutic will be approved first, or just how effective each one will be or which company is going to get there first, we can say with a pretty good level of confidence that our understanding of game-changing treatments has expanded rapidly. And when COVID is thankfully behind us, we’ll turn our research and development to using these new war-time advances in genomics and immunology to fight countless diseases that have vexed us in the past, or that we may come to face in the future.

    Oscar Pulido: Jeff, earlier you asked me about my intention about working from home, and I mentioned that I live close to New York, my commute is not so bad. So, going back to the office doesn’t seem so scary. But there has been a lot of discussion around this trend of rapid urbanization and whether COVID-19 will reverse it given people have the fear of the ongoing pandemic and the longer-term increases and the ability to remote work. Have we updated our rapid urbanization expectations as a result?

    Jeff Spiegel: Oscar, I get this question more than almost any other lately. So, recall, rapid urbanization is about the rise of cities in emerging markets and the revitalization of urban infrastructure in developed markets, a pairing that we see together driving $100 trillion dollars in infrastructure spending over the next 20 years. So yes, many have lamented the death of rapid urbanization, but the first rebuttal to this concern is that 70 percent of that $100 trillion dollars of incoming infrastructure spending will be sourced in emerging markets. Think about why people move to cities in emerging market countries? They make the rural to urban shift in search of basic education, basic healthcare, non-remote work and even clean water. And often, to cities where disease is already a longstanding concern. So, we see that 70 percent preponderance of this really important megatrend, rapid urbanization, largely unaffected. But clearly, the source of this potential reversal is more focused on the other 30 percent, the developed markets component. In our earlier discussion of remote work, we landed on the view that most office jobs will require less time in the office, but not no time in the office, and different employees are going to have different views as you and I do of how much we want to be there. And that is why in major metro areas like San Francisco or New York, we’ve seen a huge run-up in suburban property markets and an accompanying decline in city rents. But San Franciscans and New Yorkers aren’t, by and large, moving out of their metro areas. Because they will still need some proximity to offices and certainly to friends and family and culture, and the other longstanding draws of cities. So, the urbanization trend and the need to revitalize urban infrastructure in developed markets, doesn’t decline at the metropolitan area level. The burden and therefore the investment, just ends up redistributed away from downtown centers to broader metropolitan areas that we expect to continue to grow.

    Oscar Pulido: And it’s a good point, when we talk about rapid urbanization, it’s not just a U.S. phenomenon, it’s a global phenomenon. So, it’s important to distinguish between how this trend is developing in the emerging markets versus the more developed markets. A lot of the themes we talked about today get into pretty specific areas, such as innovation in healthcare or working from home. So, how does an investor go about taking advantage of investing in these megatrends?

    Jeff Spiegel: Well, the key with these themes across today’s discussions, and really all megatrend investing, is to focus on the long term and to focus on diversification. This acceleration of a number of the megatrends hasn’t changed that. But at the end of the day, we still see too many investors seeking to access megatrends by just picking a single stock winner or trying to make a quick trade. The problem there is, if you get it right, you can certainly achieve returns that knock it out of the park, but if you get it wrong, you could lose it all. We posit three mega-rules that we use to build diversified portfolios for accessing megatrends. Now the first is to weight for tomorrow, not w-a-i-t, but w-e-i-g-h-t. You know, only one of the five largest companies in the S&P 500 from back in 2000 is actually still in the top five today. The others were replaced by firms like Facebook, Amazon and Apple, that rode megatrend themes over the last 20 years, like social media, e-commerce and smartphones, to become the mega-cap leaders of today. We have to think about weighting toward small and mid-cap players who have the potential to ride a new set of megatrends, the next 20 years of megatrends, to become the mega-cap leaders of tomorrow. The second is to connect the value chain. Think about a trend like virtualization, which we spent a good bit of time on today. That’s an entire eco-system of opportunities. It’s not just one company, it’s not even one type of company. Firms set to benefit range from those that build the digital infrastructure, the physical infrastructure that keeps us connected to those building the software that we connect through, the cyber-security that keeps our network safe, and the services, be they online dating, tele-medicine, streaming or video games that we want to connect to. So that second rule, connect the value chain. And the third is to think beyond borders. Yes, the U.S. is the world’s largest economy and is the number-one innovator and we don’t expect either of those facts to change any time soon. But that doesn’t mean that megatrend investing should be U.S.-only. In fact, many opportunities, and connectivity is a great example, show more promise beyond our borders. India has more than two times the number of people online as the U.S. today; 300 million versus about 600 million. But more startling is that while we only have about 30 million people here who have yet to access the internet, India has over 600 million people still offline. Talk about untapped virtualization potential. So, we see these rules applying to all the exciting themes we discussed today from virtual work and life to big data to robotics and cyber-security, to global infrastructure and to clean energy.

    Oscar Pulido: I think when we spoke in April, I might have said this to you as well, but you are a treasure trove of fun facts. Any final thoughts for today, Jeff?

    Jeff Spiegel: Well thank you, I very much appreciate that. In closing, the world will be different after COVID-19. As investors seek to rebalance, rebuild, and reimagine investment allocations for that future, megatrends have a huge role to play in delivering on that future to our portfolios.

    Oscar Pulido: Well, it’s a positive message, we need more of that in 2020. Jeff, thank you so much for joining us today. It was a pleasure having you.

    Jeff Spiegel: Pleasure as always Oscar. I hope you’ll invite me back for a third go in 2021, and also on the hopeful note, that by then, we and our listeners will find ourselves in a happier and a healthier world.

  • Oscar Pulido: Welcome back to The Bid, where we break down what’s happening in the markets and explore the forces shaping investing. I’m your host, Oscar Pulido. We’ve talked recently about how corporations have changed their behaviors in light of the COVID-19 pandemic. But it’s not just COVID-19. Racial injustice and inequity have also come into increased focus, and individuals and corporations alike are taking notice. How are companies changing in light of conversations on race?

    Today, we’ll hear from two leaders who are spearheading conversation and action around race, bias and inequity: Dr. Laura Morgan Roberts, Professor of Practice at the University of Virginia’s Darden School of Business, and Wes Moore, CEO of the Robin Hood Foundation, a nonprofit focused on fighting poverty.

    BlackRock’s Lyenda Delp recently sat down with these leaders at the BlackRock Future Forum, a virtual event for thousands of our clients covering topics ranging from technology and the future of investing, to healthcare and post-COVID governance. First,

    Dr. Roberts shares her views on how corporations can tackle issues of systemic racism.

    Lyenda Delp: So, last September you and two professors from Harvard Business School published an important book called Race, Work, and Leadership. Is systemic racism truly commonplace? And I'm very curious to know why you think it persists.

    Laura Roberts: So, with your first important question about systemic racism, is it truly commonplace, is it endemic to the ways that our organizations function today? And, unfortunately, I have to answer based on the data that, yes, systemic racism is still widespread, and it’s deeply baked into many of the structures and practices in corporate America. You know, it shows up at various levels of the process when we think about entry, we think about advancement, when we think about engagement, and when we think about leadership impact, all central important questions around talent management. We see the longstanding and current impact of racism on those processes. So, at the entry level, we see racial disparities in terms of who gets hired and the ways in which racial bias enters into that process just from the point of screening a resume and looking at a person’s name to code or decode whether or not that person might be white or whether they might be a person of color. And numerous field studies have shown that those kinds of split-second decisions will weed somebody out of the hiring process just that quickly. But, let’s assume you get into the door. We see that there are racial disparities in terms of the kinds of developmental experiences that people are afforded, the types of mentoring and sponsorship that they get along the way, and those translate into whether or not they’re tapped for these high potential opportunities that allow them to advance beyond entry levels in organizations. And then, the last piece is around the leadership impact question. So, let’s say you advance, and you make it to the level of managing director or similar senior leadership roles within your organizations. We find that even at those levels, people of color and black people in particular still face the day-to-day stressors of racial microaggressions, of people questioning or doubting their authority, of being mistaken for lower level or lower wage workers in the organization or perhaps an administrative assistant or someone who’s on the custodial team, rather than someone who’s responsible for initiating and executing important decisions. So, all throughout the journey of one’s career, racism still plays a role. It persists because systemic racism is capturing the idea that racism operates as a system and by system we mean the reinforcing system of beliefs, decisions, practices that create self-fulfilling prophecies around who has power and advantage and opportunities within our organizations and who has to struggle harder to get access to those opportunities, if they get them at all.

    Lyenda Delp: Clearly now there’s a bright light being shone on corporations and leadership across America.

    Laura Roberts: I think, Lyenda, the first step is to do what we’re doing today, which is to invite more open engagement and learning conversations around race. For so long, race has been unspeakable. I have certainly seen a difference in the past months and the floodgate of opportunities that are opening for organizations to start to advance anti-racist work because people have started listening. And when leaders signal that they’re listening, then members of the organization and other critical stakeholders will begin to speak more freely about their experiences and people can learn together how to create or co-create the best path forward. But what corporations are doing now is looking internally, so also having to create cultural audits to say, hmm, let me look at my engagement practices, let me look at my hiring practices, let me look at the rate of advancement and the level of credentialing for members of different racial and gender groups within the organization to see is there a different path that certain individuals have to follow within my organization versus others. So everybody has to get that internal data and then from there invest in the necessary infrastructure to promote sustainable diversity, equity, and inclusion initiatives. 

    Lyenda Delp: So, what do you think are further catalysts that corporations need to act and go beyond the talk to demonstrate their real commitment? What would be the drivers?

    Laura Roberts: I think it’s important for us to acknowledge that a lot of the urgency of change right now is coming from those external catalysts and drivers of success. It’s been a public global outcry around racial injustice and that is much of the same horror that drove change during the 20th century civil rights movement and the anti-apartheid movements. Now, internally, what happens here in driving the change is to have those courageous voices who can partner with their colleagues in the organizations to help engage this new call to consciousness. But there are others for whom race represents a collective shame or guilt or just a lack of empowerment, a frustration about what to do with this big challenge and how to fix it. So, therefore, I'm afraid to talk about it and acknowledge it. And then there’s a third group who have actively resisted a lot of the DEI initiatives. So, for those who say they feel that their organizations haven’t done enough, there are others who have been reflected in these that say white men are being overlooked and excluded by DEI initiatives. And so, the DEI initiatives then have fallen out of favor, especially when people feel that they are focusing too much on race or racial and ethnic minorities. So, leaders, in order to move through change are going to have to contend in some way with that conflict, the internal conflict within the organization about how much attention and how many resources, to be quite frank, this kind of work should be getting. COVID is still having a disproportionate impact in a shocking and brutal way on black and brown communities. And we are still not of common mind or common voice about what it takes to protect the lives and livelihoods of our planet, much less those who are most vulnerable. And so, those remain deep-seated concerns for me. I'm encouraged by the fact that many corporate leaders have expressed their unequivocal support. I'm also mindful and observing the fact that there is still a wide continuum where some corporate leaders are all-in and other corporate leaders sort of dipped their toe in the water and now they’re realizing it’s a little hotter than they expected that it would be and they’re starting to pull back a little bit. So, you know, bottom line am I hopeful? Yes, I'm hopeful. 

    Oscar Pulido: That was BlackRock’s Lyenda Delp with Dr. Laura Morgan Roberts, Professor of Practice at the University of Virginia’s Darden School of Business. Next, we’ll hear Lyenda’s conversation with Wes Moore, CEO of the Robin Hood Foundation, on the role race plays in the fight against poverty and how the Robin Hood Foundation has transformed over the past few months.

    Lyenda Delp: Wes, you are the CEO of Robin Hood, one of the most important organizations in the effort to address poverty in our nation. You are a combat veteran, a bestselling author, a social entrepreneur. What were some of the challenges and the key influences that enabled you to become the man you are today?

    Wes Moore: I am the grandson of someone who was the first one on my mom’s family actually born in the United States. But, it was actually the Ku Klux Klan, that actually ran my family, my grandfather and my great-grandfather, out of the country, because my great-grandfather was a minister who was very vocal and verbal threats eventually turned into physical threats, to the point that he decided that he had to pick up his family and leave the country. And most of my family made a pledge never to come back to the United States. But, my grandfather did, and my grandfather always said that this was the country that he was born into he felt that he had just as much ownership as anybody else. He came back here. My father died in front of me when I was young and my mother was having a really difficult time with that transition, then decided to move us, myself, my older sister, and my younger sister, to go live with my grandparents, who lived up in the South Bronx. And they had a house that was barely big enough for them, but they figured out a way to make it big enough for all of us. I think in many ways the fact that my family has always gone through this idea of being tested, the fact that the neighborhood that, frankly, I grew up in was one that was chronically neglected, and we knew it. We continue to feel this need of being able to feel a self of justification for belonging. And I think that feeling, that push, and frankly the fact that I had a lot of people, to include my family, but eventually leading to this amazing string of people who entered into my life and showed me and believed in me in a way that I wasn’t even prepared to believe in myself at the time, that they really helped to guide me and direct me into not just the person that I am, but also into the things that I want to focus on and the impact that I'm hoping to make.

    Lyenda Delp: Would you say there were any differences in the type of racism and bias that you may have observed either at different times or at different places? 

    Wes Moore: Some of the most predictable life outcomes are completely highlighted by race, right, and that includes life expectancy. It includes academic achievement. It includes income and wealth, physical and mental health, maternal mortality. That's just the data. But it’s also highlighting how those different mechanisms continue to have generational impact. The fact that I was the first in my family to go on to places that my family didn’t even imagine even existed. Going to school in England and all this kind of stuff and doing everything, again, that was being asked. But here’s also the reality is that a black person with a college degree has the same wealth as a white person who is a high school dropout. And that’s a true fact right now in this country, that a black woman who has breast cancer has a 42% higher chance of dying than a white woman with breast cancer. If it was just about, well, you lived in an impoverished community and, therefore, this is what it is, that’s one thing. But, the thing that the data continues to show us is that even if you transcend from there, that racism still continues to show itself, because it is one of these things that has permeated every system that we have within our society, from housing, transportation, education, criminal justice, everything. 

    Lyenda Delp: Can you explain for us the cost of child poverty? Can you break that down just a little bit further?

    Wes Moore: Absolutely. So, if we’re looking at the cost of child poverty, the numbers actually come from an OECD study. And so, we’re talking about a study that’s looking at the impact in the levels of deep poverty and what deep poverty has actually meant and done to our measures of society. So, you consider the fact that three decades ago the poorest families in America received, most of the transfers going to families with private aid comes below 200% of the federal poverty threshold. But if you look at kind of where that is right now in recent years, those families receive less than one-third of all of the transfers. We have fundamentally made the challenge of child poverty more and more difficult. And so, when you’re looking at things like the OECD study, when you're looking at things like the National Academy of Sciences, who are talking about the $800 billion to the $1.1 trillion a year, they’re looking at it in lost adult productivity, so increased costs related to crime, increased health expenditures. And as staggering as that number is, it also fails to capture that level of untapped genius and unrealized potential of the nearly 10 million children, 10 million children in this country who are trapped in poverty.

    Lyenda Delp: How has the work of your organization changed in any way since the murder of George Floyd in particular? 

    Wes Moore: 2020 has been a year that none of us could’ve predicted and all of us wish we did not have to have these twin crises that arrived at our doorstep, right. It’s twin crises of the introduction of a virus that has had absolutely catastrophic health and economic implications on society and also, the very unneeded reminder of how policing is not equitable in every neighborhood. But the interesting thing that I think it also has shown that while COVID-19 impacts everybody, it did not impact everybody equally. And while policing reform is necessary in every neighborhood, we watched how George Floyd’s name was added to a long litany of people to include names like Michael Brown and Philando Castile and Freddie Gray and Walter Scott and Sean Bell and Eric Garner and Sandra Bland and Breonna Taylor and Laquan McDonald and Tamir Rice and Ahmaud Arbery and Travon Martin and the list goes on. But you watch how these twin crises really exposed a singular truth. And that singular truth is the role that race plays in our society. And if you look at our work, it’s absolutely undeniable to understand the role that race plays in the poverty fight that we have going on right now. And so, organizationally we have really pushed in and doubled down on our commitment, not just to keep our north star of moving families out of poverty measurably and sustainably, but also double down on being able to attack these things that we’re seeing not just at the effects but also at the cause, being able to address this issue of racial inequity in a very real and a sustainable way. And we’ve made a few movements in that space that I'm very, very proud of. One is how we’re thinking about it from an organizational perspective about how we really move to attacking it internally and externally in every way that we see it, but also in the creation of something called the Power Fund. So, the Power Fund is a new initiative to fund and elevate nonprofit leaders of color who share in Robin Hood’s mission of increasing economic mobility from poverty, and it allows us to address this issue of poverty through the lens of that interplay between racial injustice and economic injustice. Robin Hood, in addition, is putting $10 million of our own capital into this, but also being work with other partners to be able to target something that we know is not just an issue now, but address it on a long-term basis as well by supporting the leaders of today and also the leaders of tomorrow.

    Lyenda Delp: Thank you for all you’re doing at Robin Hood to help those less fortunate, to help make things better for others. The common themes implore us to learn, reflect and act decisively and with empathy for the betterment of others, perhaps, but also for the larger society and therefore our own selves and our own organizations. Many thanks to our guests and to all involved in making this important discussion possible.

  • Brian Chesky: Today, companies aren’t just entities that make things. Today, companies are entities that stand for things. And when you buy something, you not only buy what they do, you buy why they do it. So, I honestly think a purpose-driven company is the very best thing for society.

    Catherine Kress: Welcome back to The Bid, where we break down what’s happening in the markets and explore the forces shaping investing. I’m your host, Catherine Kress. The overarching view for decades, if not centuries, was that a company’s mission is to create profits and drive value for its shareholders. But in recent years, that view has changed. Companies need to do more than just generate profits – they need to have a purpose. Employees are demanding it; more customers are expecting it; and more communities are requiring it. In the wake of the COVID-19 pandemic, the expectations for companies to lead with purpose has only intensified.

    BlackRock Chief Marketing Officer Frank Cooper and Airbnb CEO Brian Chesky recently sat down at the BlackRock Future Forum, a virtual event for thousands of Blackrock clients covering topics ranging from technology and the future of investing to healthcare and post-COVID governance. Today, we’re sharing their conversation on why company purpose is more important than ever in times of crisis. We hope you enjoy.

    Frank Cooper: We’re at a critical moment in our society overall, but we’re also at a critical moment in business where purpose during this crisis, I believe, will become one of the most critical factors in determining who emerges from the crisis more strongly. But the fundamental question we hear virtually every day from leaders who are grappling with purpose is how do you make it real, and how do you actually make it real in periods of a social crisis? I want to start by digging into how purpose is discovered or revealed. You know, my view is that purpose is not invented. It’s revealed or discovered. But specifically, how Airbnb found its purpose, its why. It’s 2007-2008. You're living in San Francisco. It’s the beginning of the global financial crisis. Millions of people are losing their jobs and there’s a critical election coming up. In the midst of all of this – this chaos, this anxiety, and this uncertainty – you decide to launch Airbnb. In the beginning, at that moment, was your focus on purpose? Was it purpose-driven action or was it something else? And if not, if it wasn’t started with that, how did Airbnb find its way to being a purpose-driven company?

    Brian Chesky: That first weekend, my purpose was to make rent so I had a place to live. I mean the way it started, I had just turned 26-years-old. I was a designer by background. I'm living in San Francisco with my roommate, Joe, and we don’t even have enough money to pay our rent. And it turns out that weekend, an international design conference was coming to San Francisco. All the hotels were sold out and we had an idea. We said, what if we just turned our house into a bed and breakfast for the design conference. I didn’t have any beds, but Joe had three airbeds. We pulled the airbeds out of the closet. We called it We ended up hosting three people that weekend, Michael, Kat, and Amol. Well, we were able to make rent. That was pretty important. But something more special than that happened. You know, these three designers like ended up living with us. We brought them into our homes. We introduced them to our friends. We took them to this conference. We kind of shared our hopes and dreams and what we wanted to do in our lives. And that’s I think when we realized like there is something deeper here. And we thought wow, we can get paid to meet cool people. And I asked Joe, who’s the best engineer you know? He said my old roommate Nate is. And we set out to build Airbnb. But to answer your question, it wasn’t ‘til years later when we actually put words to what we did. Airbnb back then was the power of human connection, the idea that you could have a meaningful connection with somebody else. And so, years later, we kind of put words to it and we basically said our purpose is really this idea that you can belong anywhere. And I think that a mission is the reason people actually come to work every day. It’s the reason people actually buy your products. It’s the reason that people actually want you to exist.

    Frank Cooper: I imagine some CEOs and leaders are thinking, okay, Brian, that sounds great. You know, you’re from Silicon Valley. You guys have the high-minded ideas and ideals and you guys are always pushing the envelope. My company, we’ve been around for 50, 75, or 100 years. Is this purpose thing, is it just for newer companies, for the kind of leading-edge companies that are starting out? If you were advising a CEO at a company that’s been around for 50 to 100 years, what would you say to that CEO about purpose-driven leadership within their company?

    Brian Chesky: I would repeat back something you said, and I’ll just add to it. You said companies don’t invent their purpose, they discover it. If that’s true, and a company’s been around for 80 years, then they already have a purpose. They already have ways of doing things. They already are distinct. I love that when somebody once said, imagine your company is on the brink of disappearing and/or it does disappear, and your customers and your employees and your partners have to go to your eulogy for your company. What would they say? Whatever they’d say at the eulogy, that’s why you actually exist. And I never really thought I'd have to ever have done that exercise in my head until four months ago when a global pandemic shuts down all of travel and suddenly our business flashes before our eyes.

    Frank Cooper: You know what’s fascinating is that if you rewind back a couple of years and you looked at book titles, there are a bunch of books with the word purpose in the title. And a bunch of CEOs and leaders were saying, hey, I'm purpose-driven and the economy was doing fairly well. People were feeling good. Stock price was strong. We’re now in the midst of a deep crisis and some of the skeptics will say, you know what? That purpose thing was fascinating. I want to hold onto it, but I'm going to put it on hold right now, because I'm in the crisis and I'm fighting for my survival. What’s your perspective? How do you manage Airbnb through this tumultuous time where we are trying to survive but we also want to emerge stronger? How do you put purpose in perspective in a time of crisis?

    Brian Chesky: Well, honestly, I can’t think of a better time to put purpose into the center of the company than a time of crisis. In other words, a way a company could discover its purpose is to look at prior crisis and see how they handled it and what emerged and what was unique. I just want to back up and say the following. I came back from the holidays, like many people who are fortunate enough to go somewhere for vacation. And I came back this January feeling pretty good about myself and pretty good about the company. We had a pretty good run over 10 or 12 years, and we were planning to go public. And then suddenly within six weeks, we lost 80% of our business, 80% of what we had built more than a decade creating. And in that moment, I saw our business flash before our eyes. It felt like I was staring into a travel abyss. There were reporters writing headlines like, “Will Airbnb exist, and will they survive the coronavirus?” And in the midst of the crisis, suddenly when your business drops by 80%, everything breaks at once. I’ll give you an example. We had more than one billion dollars of reservations that customers, guests, had booked on Airbnb. It wasn’t our money. It wasn’t the hosts’ money. It was money we were holding on behalf of the hosts and then you pay the hosts when the guest checks in. Suddenly, more than a billion dollars of cancellations come in. What do you do when a billion dollars’ worth of customers want their money back but the people that depend on the money, hosts, are telling you they need this money to pay their rent or their mortgage? That was the first test in how do you manage multiple stakeholders? We were going to have to make a series of defining decisions during this crisis and that these decisions were going to be leaving indelible marks over the course of a decade. And I decided at that moment as a team that we were not going to make, quote, business decisions. We were going to make, quote, principle decisions. A business decision is a decision you make when you try to optimize for the outcome and the outcome usually benefits the corporation. A principle decision says you know what? Things are so bad, they’re so crazy, I don’t know how they’re going to end. How do I want to be remembered? So, we decided to refund the guests, because we didn’t want them feeling like they were in a moral hazard traveling in the midst of a pandemic. We ended up giving $250 million of our own money to hosts. We didn’t ask for the money back. That was a big deal. And then we had to do a series of other decisions. And in that crisis, I started getting emails and calls and text messages from early employees, early community members reading these articles saying, we do want Airbnb to exist. And I started asking myself, why do they want us to exist? It’s the idea that at the end of the day what we’re really just trying to do is help bring people together in communities all over the world and that is a pretty special thing. And it’s actually even more special now during a pandemic, because there’s also another pandemic or epidemic happening in this world. It’s an epidemic of loneliness, an epidemic of division, epidemic of disconnection, isolation, race. They’re all things that are basically obstacles to people like connecting and coexisting together. As we get more digitally connected, it doesn’t seem like it’s totally getting better. You know, your purpose is likely how you survive the crisis, not something you put on the shelf to revisit after the end of the crisis.

    Frank Cooper: What’s fascinating about that, you mentioned earlier that purpose requires courage and commitment and consistency. What you just explained certainly demonstrates that. The other interesting thing about a deep social crisis is it reveals the pain points and the tensions that exist beneath the surface of everyday life in society. And the coronavirus pandemic has, among other things, brought to the surface of mainstream culture issues of racial injustice and racial inequity, as well as the related topic of diversity and inclusion. As Airbnb seeks to create a community and connection through hosts and guests, how do you think about mitigating the inevitable challenge of bias?

    Brian Chesky: Yeah. It is a big challenge and I have to admit my cofounders, Joe, Nate, and I, three white guys that were about 25-26 years old starting Airbnb, we hadn't experienced what others in our community experienced. In 2016, there was a hashtag on Twitter that was trending, and the hashtag was #AirbnbWhileBlack. And that was basically a bunch of black guests, primarily African American in the United States, although it was really a global phenomenon but it was mostly most of the attention was in the United States, were describing discrimination and bias that they were experiencing when they tried to book an Airbnb because in Airbnb you often would see the photo of the guest. The whole point was to connect. Well, when there’s an opportunity to connect, there’s also an opportunity for discrimination and bias. And this became an existential crisis for us, right. If our whole purpose is to help bring people together, discrimination and bias is a major obstacle to that purpose. We declared it an emergency and I think one of the things is, a lot of times I think there’s an instinct of leaders when there’s a crisis to not jump on it right away. We always wanted to feel like we made a bigger deal about a crisis than the public did. So, if the public is an eight out of ten on outrage about the crisis, we’re going to be a 20 out of 10. Because either we get dragged into the future kicking and screaming or we could lead our way into the future. And always the goal was we must do more than the world expects. Because if you do what the world expects of you, you get zero credit. You always end up falling short. So, we said we have to skate into the future of where the world is going and choose to be a mirror of society where it wants to be. But that gets really hard, because now you have to start admitting stuff, like you’re not where you need to be. So, we did a whole bunch of work and over the last four years it’s culminated in a partnership with the largest online civil rights group in America, Color of Change. They have never done a partnership with a tech company before. And we partnered with them to work on a project called Project Lighthouse, which essentially is a huge commitment to try to end discrimination on our platform by measuring it. No internet company has tried to measure the amount of bias and discrimination on their platform in a systematic way And while working with privacy groups, we are going to now measure the amount of discrimination and bias that we can see on the platform so we can better design the platform to hopefully reduce it in the years ahead, because if our purpose is to do something, and we’ve got to be honest, this is an obstacle to it, then this has to be a priority to address. So, that’s a journey we were on.

    Frank Cooper: And I'm sure people recognize, and they commend you and Airbnb for embracing purpose and ESG and diversity and inclusion and that’s all great. But, is it profitable? Do you see purpose and profit being at odds?

    Brian Chesky: Today, companies aren’t just entities that make things. Today, companies are entities that stand for things. And when you buy something, you not only buy what they do, you buy why they do it. That is how billions of young consumers are going to think. Businesses are becoming so big, I think the best thing for shareholders is that society wants you to exist. So, I honestly think a purpose-driven company is the very best thing for society. In the midst of the crisis, our business drops by 80% and we don’t know how long the recovery is. And we made a series of decisions that we thought were the right things, not knowing what the outcome would look like. And something kind of remarkable started happening. Our business started coming back. I can’t prove to you all the reasons why that is and there’s probably a whole bunch of kind of systemic, kind of industry-oriented winds to our back that afforded that and it might be pent up demand, but I will say I do think that there was some benefit to some of the decisions we did make that I think drew people back to Airbnb. I do think people pay attention. And as the problems of the world get bigger, almost every problem in the world is a global problem. There are very few problems that are limited to a single geography. And I think if there was ever an example of that, this pandemic’s a reminder that problems are global, and they can’t just be governments rising to the occasion. There are going to be companies and that citizens are watching, because citizens are also consumers. And so, honestly, I think the very best thing for business and for shareholders of these companies, for people to want these companies to exist and I think here’s a way forward, something that Larry Fink talks about, just following your purpose.

    Frank Cooper: I love that. Brian, I think we have time for one last question. What I’ve found is that in the work I’ve done around purpose is that when the employees, the workforce, they have a personal connection to the true purpose of the company, it flourishes. How do you get it into the hearts and minds of the workforce?

    Brian Chesky: Yeah. It’s a really good question. A lot of crazy things we did. I interviewed the first 400 employees and around the first like 100 or so, I tried to convince them to join. And after that, my final interview, I try to convince you not to join, because I realized I'd rather make sure you really, really want to be here rather than trying to sell you to be here.So, we tried to really make sure that everyone came for the right reasons. We created these things called core values interviews, where we trained people that weren’t in the direct line of reporting of the person interviewing to be able to interview the people just for culture, just to make sure they will be successful here. And they had a veto that the hiring manager couldn’t override. It can only get escalated to me. That was actually really, really important. I also think employees notice every defining action you make. Your culture are your most defining actions. It’s the rituals, the rhythms, the things that happen when you're not in the room. But, it's also the things that are most defining. Whatever those most defining things are, are the things that represent your purpose, because everything you do ideally ladders up to that.

    Frank Cooper: Brian, thank you so much, that was a fascinating conversation. I want to thank you so much for taking time out of your schedule to spend time with us at the BlackRock Future Forum. I personally am encouraged and energized by the thoughts and actions that you shared with us about purpose-driven leadership. We wish you and the entire Airbnb community well.

  • Jack Aldrich: Welcome back to The Bid, where we break down what’s happening in the markets and explore the forces shaping investing. I’m your host, Jack Aldrich. At the start of each year, the BlackRock Investment Institute sets three themes for the year ahead. When we created this year’s themes, though, we never could have anticipated the coronavirus shock and the impact it would have on markets. With just a few months left in the year, how has the coronavirus changed our market views?

    In short: The future is running at us. The trends we saw as market drivers in the long term – namely, inequality, globalization, macroeconomic policy, and sustainability – need to also be considered today.

    Today, we’ll hear from Elga Bartsch, Mike Pyle and Vivek Paul on why that is and how our views have changed in light of this year’s coronavirus crisis and market volatility.

    To start, let’s assess where the economy is today. When the pandemic hit, global economic activity was put on pause, and the initial shock was sudden and very deep. But now that we’re a few months in, we asked Elga Bartsch, Head of Macro Research for the BlackRock Investment Institute, for her take on what we’ve seen since.

    Elga, now that we’ve seen some of the impact of the current downturn, how would you say this macro shock compares to that of the global financial crisis or other prior downturns?

    Elga Bartsch: So, the shock itself is certainly bigger than the global financial crisis; most likely bigger than anything that we have seen since the Second World War or the Great Depression, but what matters for financial markets is the cumulative loss in economic activity, and that is determined by the extent to which the original shock is propagating through the system. And given the very material and swift policy response that we are seeing which is helping to build a bridge across disrupted income and cash flow streams, we expect the propagation of the original shock to be much more contained this time around than it was during the global financial crisis. And we can already see that the restart of the economy is getting underway. It might take some time before we make a full recovery back to the level of activity that we saw before the outbreak of the pandemic and indeed even longer to make it back to the trend level of activity that we were on before the virus outbreak. But for the moment, the restart looks encouraging and if anything, we see only some temporary local setbacks in terms of pickup and infections and we potentially also see some headwinds caused by the uncertainty about the continuation of the policy responses in some countries.

    Jack Aldrich: You mentioned that global economic activity has begun to restart and that, that’s encouraging in part. What risks are we watching out for that might derail that or threaten the trajectory of that?

    Elga Bartsch: Yes, so, as you said, there is a robust rebound in the making, especially in the early months after the social distancing measures were eased again, but there are some indication that that initial rebound is starting to lose a little bit of momentum in recent weeks, and I think there are two main reasons around it. One is the fact that infections have picked up again as activity restarted, so that could mean that consumers are more cautious again in terms of going out, visiting restaurants, visiting retail outlets. And secondly, there is still some uncertainty in a number of countries about the continuation of the policy support which could mean that households as well as companies for the moment rather sort of preferred to build up some precautionary cash buffers, precautionary savings rather than go out and spend the money on discretionary items or decisions.

    Jack Aldrich: So, with those risks in mind, what signposts are we tracking to determine the health of the economy? 

    Elga Bartsch: Once we have assessed the size of the shock, we want to know about the restart of the activity for which we can track the interaction between virus infections, mobility and then high-frequency indicators of economic activity, and what is key is the ability of countries to restart activity without seeing a material and broad-based increase in virus infections. That’s the first signpost. The second signpost is regarding the policy stimulus, which is important to bridge across the shock period during which income and cash flow streams were disrupted. So, it’s important that the policy stimulus is sufficient in size but also that it reaches households and firms. And then thirdly, we are looking for any signs that despite the policy response, there are indications of a buildup of financial vulnerabilities or any other forms of scarring that might dent productive capacities more permanently than we are currently factoring in.

    Jack Aldrich: So, lastly, what do you see as the potential long-term consequences of the coronavirus shock?

    Elga Bartsch: I would stress two. One is the much closer coordination between monetary and fiscal policy, which we think amounts to a true policy revolution. That could mean that going forward, central banks will leave interest rates low for much longer than they have done in previous recoveries, that they will continue with their asset purchase programs and that they might even embrace, explicitly or implicitly, a strategy of yield curve control. And then the second important economic trend is that of deglobalization. That means that we see an unwinding of some of the international division of labor, notably in the area of global supply chains. This could mean that we move away from the most cost-efficient global supply chains to global supply chains arrangements that are more resilient and hence, longer term, sort of the more sensible choice. But what this also means is that the costs of production are likely to increase and together with very easy monetary policy, this all could boil down to a material upside risk to inflation long-term.

    Jack Aldrich: Elga made the point that while the initial economic shock was deep, it’s the cumulative impact, or how global growth shakes out over time, that’s most worth watching. As economies start to reopen, there’s a lot of uncertainty, from the rate of reinfection to how long policy support will last.

    The world has changed, and that’s led us to a new framework for our views on the markets. So how have our three themes changed since the start of the year? We asked Mike Pyle, BlackRock’s Global Chief Investment Strategist.

    Mike, at the beginning of each year we create three themes as part of our investment outlook. How have the themes changed since the start of this year?

    Mike Pyle: Well, they have changed a tremendous amount. When we started this year, we talked about growth steadily ticking higher, we talked about policy basically on pause, and we talked about the need to redefine resilience in light of late cycle conditions. Well, of course, the world has been transformed since then and our themes are similarly transformed versus what they were just a handful of months ago.

    Jack Aldrich: What are our three themes for the rest of 2020?

    Mike Pyle: So the three themes are first, activity restart. On the back of the historic standstill on economic activity as a result of the coronavirus shock, activity is restarting around the globe but at different speeds and different regions and in different parts of the economy. This multi-speed restart is the first of our three themes. The second is policy revolution. In the face of the shock, monetary and fiscal policy have responded with an unprecedented speed and scale, but beyond that, we’re seeing monetary and fiscal policymakers coordinating the policy effort together in historic, indeed revolutionary ways. And third, the theme that we’re also focused on is what we call real resilience, and this is the idea that the coronavirus shock has accelerated a set of tectonic trends in the real economy and these transformations around sustainability, around deglobalization. They’re really going to define the investing landscape for the coming period of years, even a decade or more, and investors need to be making decisions that are built to stand the test of those trends today and in real time, to build portfolios that are resilient in the face of these real economy shocks. Those are our three themes.

    Jack Aldrich: I want to walk through each one of those themes individually and talk a little bit more about what it means for investors. Maybe we can start with activity restart, the first theme.

    Mike Pyle: Absolutely. So that theme itself is really meant to highlight that activity is restarting after the standstill from the coronavirus but it’s restarting at different speeds in different parts of the world – East Asia and the robust public health response they’ve had there perhaps leading the way, Europe maybe a step or two back from that, emerging markets outside of Asia having some more significant difficulties around the public health dimensions of the coronavirus shock, more challenges restarting those economies, and the United States itself facing significant headwinds restarting. I think coming into the period of the crisis where the contraction in economic activity was most acute, we had really one strong view reflected across the book, and that was to be up in quality and to be underweight cyclicality and value. And now that we’ve gotten past that, now that we’re getting into the phase of the shock that involves the restarting of economies, we don't want to be as cautious on cyclicality, but we also want to calibrate them to the parts of the global economy that are seeing the speediest and smoothest restarts. So as a result of this, we have done things like close our underweight in value, close our overweight in min-vol, but in particular we’ve zeroed in on Europe as a cyclical exposure, both by virtue of the strong restart in activity they’re getting on the back of their robust public health response as well as the significant uptick they’re getting from the policy framework that both monetary and fiscal policymakers have increasingly put in place in the past period of weeks.

    Jack Aldrich: Let’s shift gears and talk a little bit about the second theme, policy revolution. Walk us through that in a bit more detail.

    Mike Pyle: In some ways, this has been consistent since the coronavirus shock first manifested itself and the policy response was taking shape, and the idea here was investors should be seeking out strong policy backstops. That's true in a very direct sense. The Fed, the ECB have announced historic programs that back credit markets and seeking out assets that have those strong policy backstops is going to continue to be an important theme and an important way of generating protective downside but we think some ongoing upside in the period of time ahead. We think that the policy framework that has now been put in place in Europe is a particularly strong backstop to be seeking out while in the U.S., we’re a little more cautious. The U.S. for the early stages of the crisis delivered the most comprehensive and forceful fiscal and monetary response; looking ahead, especially into the uncertainty of the election, we see some risks around the U.S. policy response, especially on the fiscal side, and that, along with the greater challenges the U.S. is having on the public health side, has caused us to pull back our optimism around U.S. equity exposures to something more like neutral, and that's not a negative call on U.S. equities. We think they’re going to perform in line with the rest of the world but the belief that they were going to outperform, as they have through much of the year, we’re more cautious on that from the midyear forward.

    Jack Aldrich: Our third theme is real resilience. What do we mean by that?

    Mike Pyle: What we mean by that is in a moment where rates have been driven to even deeper historic lows, when the policy revolution looks to be holding rates at historic lows deep into the future, and when inflation risks can potentially be ticking up over the next handful of years, nominal government bonds, those traditional diversifiers in portfolios, are less central to solving the portfolio challenge perhaps now than they have been. In some ways the most high conviction view we have in the portfolio is to be overweight high-quality assets, and that's particularly true in the case of the equity quality factor. These are companies that have really strong business models, that have really strong financial metrics, strong balance sheets, strong cash flows, oftentimes in a commanding position within their sectors, and really have both seen secular tailwinds at their back – in technology, in pharmaceuticals, in consumer discretionary – but have also seen very strong resilience in their performance through the period of the coronavirus shock to date. I think the core of the real resilience theme, though, is looking out over longer horizons and looking at the total portfolio. This is the idea that resilience at the total portfolio level has traditionally been a financial concept, pairing risk assets with a duration asset like nominal government bonds that cushion the portfolio in the face of shocks. But in this moment, when the value of nominal government bonds in portfolios over periods measured over years is perhaps less than it’s ever been, resilience needs to be rethought and in particular needs to be rethought along the lines of the profound transformations happening in the real economy globally, as we talked about, things like deglobalization, things like sustainability. And what that means is what we thought were going to be slow-moving longer-term investment decisions that investors and assets owners had to make are really decisions that they’re going to have to be making in the here and now. To take just one example, this concept around deglobalization, around the reversal of a lot of the trends towards the stronger integration of goods markets, of financial markets over the past number of decades. Over the decade ahead we continue to see the U.S. and East Asia rooted in China as really the two big engines of global growth. Having a balanced set of exposures to those two key engines of global growth and doing so in thoughtful and intentional way is going to be an important way that investors build resilience into portfolios but is going to be a different way than they have traditionally built resilience over the past number of decades.

    Jack Aldrich: To sum it up, Mike mentioned three new themes for the year: Activity restart, policy revolution and real resilience. Mike walked us through how these themes play out in the near term. But he also mentioned why we believe that long term trends are becoming more important today.

    Structural trends are being accelerated by the coronavirus. We turn to Vivek Paul, Senior Portfolio Strategist for the BlackRock Investment Institute, to talk about how we’re rethinking our views. 


    So, earlier we spoke with Mike Pyle about our shorter-term investment views. Among other things, Vivek, you focus on our strategic views, or views which span a five-year time horizon and longer. How do the themes Mike talked about apply to that time period?

    Vivek Paul: One of the critical aspects of our outlook is this idea of the future running at us. In a strategic horizon, trends have been supercharged. So, this central idea around the views has just never been more relevant to building portfolios with a strategic horizon. And if we think about some of those key themes, you know, the idea of the policy revolution. The extraordinary measures we’re seeing in monetary policy and in fiscal policy, this fundamentally shapes our strategic views. The path of government bond deals shifting lower, the idea that we might be approaching levels where they can’t get any lower still, this has material impacts for the role of government bonds. We would hold less government bonds all else equal than we would have done before, by materially so. And also, the monetary and fiscal interlink is part of that policy revolution. It paints a picture for us of an environment where we could see higher inflation in the future, and that’s why we like inflation-linked bonds. And the idea of this need for real resilience, which is another one of our key themes, that underpins and drives our belief on a strategic horizon. The Chinese assets, private markets assets for their diversification potential, and at a more fundamental level sustainable assets as well are critical to strategic horizon portfolios.

    Jack Aldrich: We also spoke with both Elga and Mike about the emerging restart in economic activity. How does that shape our long-term views?

    Vivek Paul: The economic restart I think is crucial of course, but I think the thing we’ve got to bear in mind for strategic portfolios is it’s the cumulative impact rather than the very near-term impact. So, what I mean by that is, the fact that the economy gets up and running now versus next month, all else equal, actually has less of an impact on a strategic horizon. The only reason why that might not be true is if that additional month delay causes some structural long-term issues or debilitating issues for the economy. But if we see that that wasn’t the case, we’ve got to remember it’s the cumulative that matters. And let’s think about this in the context of equities. Very simply, equities are just effectively a stream of cash flows going out into the future and we’re placing a price on those cash flows today, and the point there is the plural. It’s not just a cash flow. We don’t just care about the next year. We care about the year after that, the year after that, the year after that. And critical to our view here is this idea that the cumulative impact is just materially less, it’s a different order of magnitude than, for instance that we saw in the global financial crisis. And that underpins our view around equity, our view around credit that these risk on assets and still play a role in the portfolio despite the fact that we’ve seen this lockdown and this extreme market move.

    Jack Aldrich: That’s really helpful. And I want to touch on some of the things you’ve already brought up, Vivek. Perhaps starting with the role of government bonds. Historically bonds have been a complement to stocks in portfolios as a way of providing diversification, but this policy revolution you’ve mentioned has pushed bond yields to record lows; and this has been magnified by central banks globally cutting rates in response to the coronavirus shock. How has the role of bonds changed and how are you thinking about that?

    Vivek Paul: So, the role of government bonds has materially shifted for us, and there’s a couple of things to say here. This is much more than just returns being lower. The fact that those yields have fallen means government bonds are more expensive. It means the forward-looking return might be lower. But the key point here is it’s much deeper than that, and the reason is, as you pointed out in your question, Jack, I mean, part of the appeal for holding government bonds in the first place is this kind of risk-off behavior, what they might do when equity markets also sell off. And that is the thing that actually we really have to start to question now because of where yields are. Because if you were to believe that there’s a chance that yields are not that far away from the lowest that they can go for nominal yields, for instance, the idea that yields can’t get below zero in the U.S., then the critical point here is that there’s a whole host of potential future outcomes where yields aren’t falling when equities might be falling. That means the government bonds are not giving you that return that they previously did when equities are falling. And so, it’s a combination of those two things. It’s the fact that the returns are lower but also that kind of protection you’re getting is just naturally going to be impinged by the fact that yields are so low, because yields can’t fall that much further, has a huge impact on the amount of government bonds being held. 

    Jack Aldrich: And so, with that said and with bonds no longer playing as much of that diversifying role, where should investors be looking for diversification today?

    Vivek Paul: It’s a great question and the sad answer, the short answer is there’s actually almost no asset that is direct like-for-like. You know, if you think about the last 20 years, you look at the role of nominal government bonds like a consistently materially negative correlation or relationship to equities or risk-on assets, and there’s just nothing out there that plays the same role in the same way. And so, the answer to your question is there’s no one asset that does this, and we’ve got to think more holistically about the overall portfolio. For instance, the role that Chinese assets can play. Chinese assets increasingly in a world where we’re kind of moving towards a sort of bifurcated state of affairs; the idea that there’s a U.S.-centric hub, there is a Chinese-centric hub and more than ever before they’re a little bit disparate. That means that buying Chinese exposure is getting you genuinely diversified sets of cash flows, sets of returns and much more diversified arguably in the future than it was in the past, when globalization was at its peak and effectively there was just one homogenous single market. Another asset that could help is inflation-linked bonds. I think linked to this idea of the policy revolution, we believe that there could be a case where inflation is greater in the future than the markets are currently pricing. That would mean, all else equal, inflation-linked bonds are part of the solution in replacing some of that lost resilience benefit that you’re getting from a nominal government bonds, and private markets as well. Private markets give you the ability to shape deals and exposures. And the way to think about this, maybe, is you know, if you were to go into a supermarket and just buy something off the shelf, that’s like a public market. But if you were to go in and be able to kind of shape precisely what type of pasta you got or whatever it might be, you know, that’s more like the private markets. You have the additional ability to shape those exposures which means you have an additional ability to shape the amount of resiliency in your portfolio. But the final point I’ll say here, Jack, just to kind of reemphasize this point, there is no one-for-one asset. It’s more at a whole portfolio level, and this really gets to this idea about the real resilience, because this acts at a more granular level than just broad asset classes. Think about the post-Covid world. We might have material sectoral impacts. Thematic impacts that you can’t just summarize in one-line item called U.S. equity or European equity or whatever it might be. Sustainability is a good example of this, right? So, sustainability can act in different ways, in different sectors, in different regions and we’d be silly to try and think that the way in which we position a portfolio is just to buy more or less of an overall group bucketed asset class because of these factors. We’ve got to go below the hood, and that’s what we mean by real resilience.

    Jack Aldrich: I’m glad you just mentioned sustainability because my next question for you is actually on that topic. We talk a lot about sustainability as a firm and Mike mentioned how it ties into our theme around building real resilience in portfolios. How do we see this sustainability trend playing out in the long term?

    Vivek Paul: For us this is crucial because what we’ve seen over the last few months has just been the tip of the iceberg in our view. This is investment risk, first and foremost. And the thing to say here is that we are very firmly of the view that sustainability is a return enhancer. It’s not one of those things where it’s not going to harm your return so you might as well do it to be good to the world. It’s more than that. If you kind of think about the flows into sustainable assets and products over the course of this last year, even though we’ve had an extreme sell-off in markets, that flow continues. That’s just evidence here we think that this is really a structural sort of societal shift towards sustainability. And the crucial point is if it’s not yet in the price as is our thesis, well, the return you’re going to get is going to be enhanced by everybody else getting onto this bandwagon. Everyone else seeing the light. Everyone else getting involved with sustainable assets. The fact this is topical like never before means that arguably this is actually going to play out maybe not over decades but maybe over a single decade, for instance, and the time horizon’s been brought forward.

    Jack Aldrich: Vivek, this has all been really helpful, and just to wrap it up, I wanted to ask, bringing it all together, what’s one thing investors really need to know when thinking about markets in the longer term?

    Vivek Paul: I think the one thing I’d say is that right here and right now, the most important single decision an investor needs to make is to reconsider the strategic asset allocation that they have. It’s the number one thing. Typically, strategic horizon decisions, portfolio construction, because it’s like slow-moving, because it’s long run, it’s not as newsworthy. And people might think well, look, that’ll take care of itself. I’m going to care about the near-term stuff. Now more than ever, you know, it’s, this is the newsworthy thing, because all of the things we’ve talked about today, you know, the idea of the policy revolution. The idea of sustainability, the idea of deglobalization and the role of China in the world, these are structural issues. These are things that have basically been supercharged and it’s shifting the investment landscape. If you think about our personal lives, for many of us, buying a house is the most important strategic decision we ever make, right? Imagine you were someone with a long-term plan to upscale your apartment. You want to do it at some point in the future, but that day will come. You’re not really worrying about it; it’s going to happen in the future. And suddenly you and your partner discover that you’re pregnant with triplets. You’re not going to be able to kind of resolve this by just buying some wet wipes, right. You need to supercharge your plan as to where you’re going to live. And this is really the same with Covid-19 and the impact of this shock. This is not something that you can do by tweaking around the edges. The whole thing needs to be reevaluated, and it needs to be reevaluated now.

    Jack Aldrich: The coronavirus crisis has caused us to reevaluate our market views. The pandemic has exacerbated inequality across income levels, race and countries. It’s exposed the vulnerabilities in global supply chains, adding more fuel to the fire of geopolitical fragmentation. As central banks and governments alike have stepped up to respond, we’ve seen the lines of monetary and fiscal policy start to blur. And lastly, it’s emphasized the importance of sustainability, particularly around the role of corporations.

    As a result, we have three new themes for the rest of 2020. We are moderately pro risk in our investment views, and we like credit over stocks. In the longer term, we see Chinese assets, private markets and sustainability all playing a greater role.

    That’s it for this episode of The Bid. We’ll see you next time.

  • Mary-Catherine Lader: Welcome back to The Bid and to our mini-series, “Sustainability. Our new standard.” I’m your host, Mary-Catherine Lader. The coronavirus crisis has accelerated sustainability. It’s brought to light issues around the environment and our climate, as well as social issues like how companies engage their employees, their communities and their customers. And so investors are turning to sustainable investing more and more to build resilient portfolios. Now as economies around the world begin to aim for recovery, or at least adjust to a new normal, can sustainability accelerate that recovery?

    Recently, at BlackRock’s first annual Global Summit, I had a conversation with leaders in this field about how sustainability can help us build back better. Today, we’re sharing that conversation. We’ll hear from Mindy Lubber, CEO and President of Ceres, Fiona Reynolds, CEO of the Principles for Responsible Investment, Marisa Drew, CEO of Impact Advisory and Finance for Credit Suisse, and Peter Bakker, President and CEO of the World Business Counsel for Sustainable Development. Let’s get to it.

    Mary-Catherine Lader: So to start, the overall theme is can sustainability accelerate recovery? Fiona, much of your role at PRI is helping to advocate for policies with both public sector and private sector leaders. What are you doing to capture the opportunities of this crisis?

    Fiona Reynolds: Anyone who has been in doubt about sustainability issues I now think understands the interconnectedness of issues, so I keep saying that people really can now see through Covid-19 that if you don't have healthy people and you don't have a healthy planet, you can't possibly have a healthy economy. Those three things go together. And, at the beginning of this pandemic, I had so many people particularly in media and other people who said to me, well, surely sustainability is going to fall off the agenda. That hasn't been the case. I think sustainability has been very much at the fore, but what we need to do making sure going forward and just mentioning about build back better is that with stimulus packages that are going to total somewhere between $10 to 20 trillion, really we have to think about that what we do today and tomorrow, over the next couple of years is really going to shape the future of our economy but also our society for the next decade. And the private sector business and investors really need to play a significant part of that solution, because governments alone are not going to be able to fund the transformation that we need, and I think that we’ve got such a great opportunity from the sustainability community to make sure that we're part of ensuring that the new normal is the world that we want to be in, that we have an economy fit for the 21st century and that really has environmental and social aims at the heart, and that we can create the jobs for the future and the skills that we also need for the future. So, as they say, never waste a good crisis, and I think from our perspective from the investment community, that's what we're very much trying to do. How do we push sustainability forward.

    Mary-Catherine Lader: And, Peter, on that note, you wrote an article recently saying that CEO leadership would be absolutely critical in pushing sustainability forward and trying to not waste this crisis and create some systemic change, so what specific actions do you think in 2020 you would hope to see from leaders who care about really using this to accelerate sustainability?

    Peter Bakker: I think for every CEO and every leader in business, the perspective of risk will be completely changed. Most supply chains in the world found themselves ill-prepared for the shock that COVID brought. We all realized that climate change has the potential to bring even bigger shocks to our systems, so how do we get prepared? So the first step that companies need to do is integrate sustainability truly into their governance, into their risk assessment, into their position making, eventually in their disclosures to capital markets, their investors or financiers. The second thing we really need to do is we need to, as this system transformation gets underway, understand that to implement sustainability well, you're really building the competitive position of your company. And then, thirdly, as you disclose transparently the process that your company is making, really find new ways to engage the investors in the capital markets. Now, we need to move to a system where the cost of capital of a company is determined by its sustainability performance as well as its financial performance. 

    Mary-Catherine Lader: Mindy, the work that Peter's talking about is certainly your work every day as well. I'm curious how optimistic you are that we'll see real change in the next 12 months and what exactly you'd be asking CEOs to do differently as they think about incorporating ESG issues into their decision making and strategies.

    Mindy Lubber: Well, let me just pull the lens back a tiny bit in response to a few of my colleagues and then go right into that question. Right now, I think Fiona mentioned it, there will be about $12 trillion moving into our economy to remedy and to help build us out of the Covid economic crisis. That's the global number, and that's stimulus packages and infrastructure packages, certainly $2-4 trillion in the United States. Not all of that is in the marketplace yet, but some of it is, and it's moving out quickly. That money could be spent in one of two ways. It could move us back to a business as usual, highly fossil-fuel-driven economy, or it could be around a clean energy, clean transportation start evolving us as it relates to the chemicals we use and the cement we use and the steel we use and the way we build bridges and schools and the infrastructure of electric vehicles. So to come back to what we ask of the companies we work with, we do expect integration of sustainability or ESG from the board room to the supply chain. We might train corporate boards, help them set goals, so we get to a Paris-aligned future that we know where we need to get, and we can't start in 2045. We need to start today, so set audacious goals for the next 20, 30 years starting today, apply those goals and standards to their supply chain. If they have climate and human rights and other standards in the states, make sure we're applying that equity and fairness around the world. And to start changing what they do, what they buy, what kind of products, and it will help them with their employees, with their consumers, with their profitability, and we work with hundreds of investors, that's what they want to see from their companies, integration of climate risk and opportunity, of sustainability risk and opportunity into everything they do, and this is not about changing trading off values for value. This is about making money, creating a long -erm sustainable future, doing so in a way that's good for the company but also good for the planet, and the final point is those very same companies that Peter and I are referencing or Fiona as it relates to investors need to join us and stand up and support policy and support those stimulus packages to move us to a sustainable future.

    Mary-Catherine Lader: Marisa, I would love a reality check from you. When we say that it's not about trading off value for values, look, I talk with all kinds of investors all over the world in off-the-record settings every day, as you do, too. Is that a debate that you think is really settled, or how much of your time is still trying to make that case, trying to illustrate that the data's there such that sustainable investing does not have to mean a trade off in return?

    Marisa Drew: I think it depends on who my audience is. So I think the institutional community for sure now is seeing just through the crisis alone we see the performance. When I speak to people as individuals though, I think there's an education to be had. I do often have a conversation about whether this is trading off return if people are aligning values with their investing habits, so the more cases that we can demonstrate that we do generate good returns, the better off we are able to drive that further bucket, if you will, of the private investment, which then of course is giving asset managers capital and then demanding of them certain things, so there's sort of a holistic value chain effect. When we also think about the smartest investors who have had tremendous success over decades, increasingly one by one, they're joining our party too and waving the flag and saying this is an enormous investment opportunity. Jeff Ubben at ValueAct, who is relinquishing part of his old fund, jumped in, and he said when you address something like climate change, which is the single most important thing that we need to be investing in for global prosperity, I'm paraphrasing his words, but he says when you're addressing climate change with a business solution, in his words, he says that's a 10 times your money deal, and that kind of mantra I think is what we need to continue to reinforce in whatever way we can, but good data and good case studies I think is key to that. 

    Mary-Catherine Lader: So to help quantify the 10 times your money deal, we still have some gaps, right? There's growing data about the potential risks of not having more sustainable strategies and investments, but still kind of quantifying even specifically climate risk is a little bit challenging and still an evolving space. Fiona, what do you see as near-term needs to help make climate risk in particular sort of more tangible and actionable?

    Fiona Reynolds: In many parts of the world, and certainly in a lot of our signatory base, rather than just thinking about ESG from the fact of how do ESG issues come in and affect my portfolio from a risk/return point of view, more of our signatories are starting to think about how do ESG factors in my portfolio affect the real world, and we have to have that discussion as well. But as the reality of climate change becomes increasingly apparent, it's not when governments will act or it's not if, it's when, and the longer we leave it, the more that we are going to see that more drastic and urgent policy issues are going to need to be brought in. So we're seeing across the world that there's many countries, including the EU that's now got a green new deal and that's leading the way. The UK's got a net zero target, as have countries such as Canada, Norway, Denmark, and the list goes on. But also achieving net zero doesn't just magically happen. The only way governments can actually achieve them is by changing the policy sense. I think that the message that we certainly try to give to investors is you need to act now, or you're going to pay the price later, because this is happening, and it's a reality. 

    Mary-Catherine Lader: In that spirit of acting now, I'm curious, who are we looking to as leaders? Who are we looking to to really step out, whether I think of a specific government or a specific company? We had the Bank of England, for example, like took the lead in identifying what climate stress tests might look like, but that's been put on hold to some extent, understandably given the challenges of the current crisis. So for the next six months what names should we be looking out for?

    Mindy Lubber: Well, first of all we need to look at all categories. Let's start with companies, and I could give you 100 examples. But Jeff Bezos stepping up with a 2040 net zero pledge, so that's 10 years sooner than most. It's obviously a company of inordinate power and magnitude. Some of our largest asset owners, people who manage $300 billion, whether it's the California public pensions fund or the California teacher's fund or the New York state fund, we are working with them to come out with a plan for Paris-aligned portfolios. A few others, we have to have policy. There are tens of thousands of companies below the Russell 1000 who aren't doing anything. We need policies so there's a level playing field. And our Federal Reserve Bank needs to follow the lead of the Bank of England. We are working with them every day and with leaders in every one of the federal offices to make climate a systemic risk, meaning the risk is to all of our economy, and they need to be part of the discussion and regulation, not just congress or not just the securities and exchange commission. And finally I would ask the SEC to mandate the disclosure of climate risk, because you can't act until you understand the risk. If we can move on all of those fronts, we would make a good deal of progress. 

    Mary-Catherine Lader: Indeed. Peter, I see you nodding. Would you add a few to that list?

    Peter Bakker: I would give a generic answer and then name a few names, so I think generically what you need to do is make a list of which are the companies that have signed up to science-based targets, because that's where the climate change journey starts for a company. Set yourself a target to get to 1 ½ degrees or net zero carbon by no later than 2050 and have a realistic plan to half the emissions in the next decade. Any company who does that will probably qualify. The second element, which are the companies that have signed up to TCFD to bring this stuff in their governance and be transparent towards capital markets. If you look at it like Mindy says, you probably want to go sector by sector, you know. I thought some of the companies that stood out in the last few months were probably BP, that as the first major oil and gas company came out with a net zero target, swiftly followed by Shell. In the food and fast-moving consumer space, Danone is really pushing hard for regenerative agriculture. Unilever broadened their ambitions with a holistic plan that captured not only climate change but also biodiversity loss and some of the social aspects, so there's the big brand names out there, but I think the generic; is there a framework science-based targets companies adhere to and then start through their disclosures measuring what they actually do and not just talk.

    Mary-Catherine Lader: Absolutely. Moving onto another dimension of sustainability, so the social responsibilities and opportunities or risks in the investment landscape, there's been a lot of talk that in the wake of Covid-19 there's more focus on S, and that I think is a false construct, because we need to be thinking about all of these simultaneously. That's the point of sustainability, but to the extent that this is an opportunity to refine our understanding of what data we need to be collecting, what companies need to be doing to think about social risks, that this is a welcome opportunity to do that, whether it's about resilience in the wake of great challenges and exogenous shocks like Covid or a pandemic or whether it's about what drives employee loyalty, retention and even how we think about elements of social equality and how they refract inside a corporation or an investment opportunity, so, Fiona, I'm curious, from PRI's perspective, what are you doing in the wake of that kind of conversation right now when there's a discussion that there's, quote, more focus on S, what are you going doing about that to take advantage of that opportunity?

    Fiona Reynolds: I completely agree with you that you need to look holistically at the issues, but for some reason, people don't. And I think that Covid-19 has really just exacerbated the systemic social issues across the globe, from inequality and inclusion, decent work, social protections, and I think it's really unveiled a lot of the shortfalls in our economic system. The ITC have estimated that up to 300 million jobs can be lost, and this is going to cause some people to slip back in poverty. There's sort of two types of people in this crisis. So there's the people who are getting paid, who are working at home, and we can homeschool our kids, and, yeah, sure, we've got a bit of inconvenience in our life, but, if we're healthy, that's all we have. But we also see lots of other people who are in jobs where they're on the front line or they have no sick pay, they have no social protections, they are feeling even if they're sick, which isn't helping anyone, that they have to go to work. So we need to really not just be looking at the climate issues, we need to be looking at the social protection issues. A lot of the disruption that's happening at the moment and a lot of the social divisions that are happening, a lot of it stems from inequality. We're talking about the fact that we need to build back better, we're talking about that it's between $10, 20 trillion that's going to be spent on the recovery, that recovery needs to focus on creating jobs, but they need to be jobs that are focused on the skills that we need for the future, but we also need to make sure that they are good jobs and that we have good social protections in place. If we look at some of the reasons that countries in the world that don't want to make this transition to a low carbon economy, it's because they've got lots of people in jobs in the fossil fuel sector, and that can't hold us back, but we can't leave those people on the scrap heap either. We need to make sure that there is a just transition to a net zero world and that we factor in work forces and we factor in communities, or we're not going to get anywhere.

    Mary-Catherine Lader: Marisa, what do you make of this increased focus on social factors and sustainability?

    Marisa Drew: I think there was a recognition through the crisis that the E and the S are inextricably interlinked. If you don't have a healthy planet, we are going to have more sickness, we are going to have more pandemics and so on. The companies I think that have demonstrated they've taken all of the ESG into consideration to me are the ones that have outperformed to the crisis. Why? Because they've been more aware of the total factors, they've demonstrated more resiliency, they've probably by the virtue of better governance had better scenario planning, and then I would point to the companies that handled, even when they were going through, say, a furlough process, the companies who handled that well versus those who didn't, just think of the headline risk of the ones who didn't. So, as we come out of the crisis, then those are the companies that are going to create I think customer affinity over the longer term. They're going to be the companies who will be the employers of choice, so the business case I think is becoming very clear.

    Mary-Catherine Lader: So just as you said the E and the S are linked, so are the E and the S linked to the context in which a company operates, right, so whether that's the social lens through which you look at a company's operations as affected by the social construct and the social contract of the companies in which their operations are most concentrated, or the environmental effects of where their operations are. How do each of you think about how we adjust these themes we've been talking about, frankly, at a global level for local realities? 

    Fiona Reynolds: So I would just say of course there's regional differences and of course economies are different, but I think the baseline of what people should expect has to be the same around the world. People should expect to be able to make a living wage. Now, that wage will be different in different countries. They should be able to go to work and have safety and be protected and not be put in situations where they're working in a way that there's huge numbers of accidents. Such should be the same for everybody. 

    Marisa Drew: The only thing I would say is that we do have to be sensitive to the developing world who face many different challenges, so if I'm going to pick one sector, say that pulls at peoples' heart strings, something like animal conservation. We're facing a moment now say in Africa where we have come a very long way to retrain poachers not to go after animals because you have tourism, and that's created sustainable livelihood for those people who would otherwise seek a different outcome. Now, during the shutdown in Covid, those people cannot feed their families. The tourism has dried up, and we're seeing an increase in poaching. So, when we talk about build back better, sometimes we put our western lens on things, and, you know, you don't have those social systems or plan Bs, if you will. So I 100% agree that everybody needs that basic human right to a good livelihood and good opportunity, but, if you're making a choice between killing an animal and putting food on your table or being a conservationist, those are really tough choices, so I think over time what's incumbent upon us as we do think about building back better is to try to demonstrate to them that if we can help in whatever way to maintain and preserve the ecosystems that will be sustainable in the long term and show the benefit of making those investments for the long term and how they will then come back and create a return for those communities, that's got to be a part of the equation, but it's a sensitive topic in some of those areas today.

    Peter Bakker: I would probably put a bit of a health warning on it all. I mean, I am in complete agreement that the S will gain a lot of momentum as a result of Covid, and everybody is now talking about it, but the reality is the data quality, the tools to measure and to manage the science-based targets are simply not there in many of the areas, not the way that they have been developed on the environmental issues. So I think we need to translate this conversation quite quickly, and what are the material issues that on the social side we wish to focus on. Now, obviously human rights and supply chains is one. I would argue living wages throughout supply chains could be another one. And so let's quickly organize a global conversation about what are the 10 big indicators that we all want to start measuring, what are the tools we do not yet have or the standards we need to make those measurements happen on a comparable basis, and then step by step drive this in, because otherwise we're going to continue to talk about feel good stuff but fundamentally don't make the change that we need.

    Fiona Reynolds: Just on the developing countries, I think that one of the things that we also need to be very cognizant of during Covid-19 and in the recovery and coming back to jobs being available in those communities system, last year I chaired a financial services commission on modern slavery and human trafficking through the UN, and there's 40 million people in some form of modern slavery and human trafficking today. It's 1 in 185 people, it's a $150 billion annual business for traffickers. It's important to the finance sector, because you have to launder your money somehow, and you do it through the finance sector in cases. For investors, a lot of issues in supply chains. So this is more people within slavery than in any time in the history of the world. But one of the sad things about Covid-19 is that traffickers peak on the vulnerable, and we're going to see far more vulnerable people, and I think that we'll see an increase rather than a decrease in this issue, and it's the other reason why we in the developed world have to be very conscious of things about supply chains, making sure that suppliers are paid so workers down the chain get paid within this issue when we are thinking about this from all economies, not just from the developed economy side of things, because I really do think on that side we're going to see more human tragedy happening if we're not careful.

    Mary-Catherine Lader: Mindy?

    Mindy Lubber: I want to be sure that we don't overly separate E and S issues. They are so interconnected as to sometimes be inseparable from my perspective, and, if we just take climate change and how it exacerbates problems, particularly in the developing world, but everywhere else, climate change will cause less water availability. We already know that. We will have about 30% less water than we need as a world community in 2026 or 2027. That comes out of the World Economic Forum, not an environmental piece, and no company could survive without enough water to run manufacturing. It will decrease their share value, but the humanity of it, right now women who are already in the developing world spending hours trying to get enough water for their families, that will double, that will triple. The issues of climate, of people have traditionally thought it's an E issue, the environment. It impacts those who have been most affected by other tragedies of the economy more so than any other issue, and we've got to be mindful as we take on climate, it's not about the planet, it is about the people in the planet and whether my kids and your kids will have a future. 

    Mary-Catherine Lader: I want to ask each of you, we’ve touched on a number of different things, whether it's the importance of regulation and policy and standards or lack of excuses in that category. We talked about the integration and links between these different issues, what's one question that each of you thinks is really critical to ask to raise the credibility of what it means to do sustainable investing and to create progress in this area that we may not have touched on yet?

    Fiona Reynolds: I'll start. So, if I was talking to a company and wanting to drive sustainability forward, and I'm coming from the investment point of view, I would really want to understand how do they manage sustainability and manage profit? So how are they managing profit, people, and planet? Tell me about it all in an integrated way. You know, how does their work contribute both positively and negatively to sustainable outcomes in the world? I think it would tell me what was a really good long-term company that I want to invest in.

    Mary-Catherine Lader: Mindy?

    Mindy Lubber: So I would ask major financial enterprises, including BlackRock, if in fact the data is clear that we're seeing, no compromise in investments, if we factor in social and environmental issues, how do we move a company who's literally a trendsetter in everything? You are trendsetters and appropriately so, from a fifth or whatever number of sustainable investing products to 50%, to 70%? And how does that happen much more quickly than it might otherwise? You all have extraordinary power, I'm not putting you on the spot now, but those are the kind of questions I'm asking colleagues and at all the large financial institutions.

    Mary-Catherine Lader: I think it's an important and fair question. We've certainly set a target of a trillion dollars in 10 years, but seeing just the flows in the first quarter of this year—we have more data basically to base those goals and those targets on rather than just aspirations and hope, and I think we welcome observations and input from each of you in your organizations as you see how we and others can be doing that. Peter?

    Peter Bakker: I would say Covid has proven to all of us that we can radically change if the circumstances are there, so I would expect every business leader to come up with a very clear picture on what is the end state? What does build back better mean for your sector for your company? And then, as an investor, I would really focus my questions on how are you going to manage the transition, because I think the winners and the losers are not going to be determined by figuring out that we need to electrify transport. The winners and losers will be determined by who gets there first in a responsible way, and that's really where the focus now needs to shift.

    Marisa Drew: I would ask for our companies to be more consistent and to provide more disclosure and really, as they start to think about their transition plans and as they start to think about integrating E, S and G into their operations, to really try to identify and isolate those material factors that are helping to drive their business. Because what investors are calling for is the ability to have that information so they can make informed decisions, so to me it's a lot about the data and the disclosure. And then we add on technology, machine learning, AI. I really think we're on the cusp of being able to provide enough information so you can really pick and choose those winners.

    Mary-Catherine Lader: Well, thank you to each of you for sharing your perspective, for raising those questions, and I at least am hopeful that if we were to reconvene in six months, much less a year from now, hopefully we'll have slightly new things to talk about as opposed to saying the same things. It feels like we are at a turning point in terms of progress, and that much broader recognition of the importance of sustainable investing, so thank you.

  • Oscar Pulido: Welcome back to The Bid, where we break down what’s happening in financial markets and explore the forces shaping investing. I’m your host, Oscar Pulido. Globalism is at a crossroads. Coronavirus has caused a dramatic pullback in the once-seamless transfer of technology and people across countries. And as a result, companies more and more have to adapt with societies and their needs, or else get left behind.

    BlackRock CEO Larry Fink and Microsoft CEO Satya Nadella recently sat down at the BlackRock Future Forum, a virtual event for thousands of our clients where they discussed topics that are informing the future of investing, from technology to post-COVID governing to healthcare. Today, we’re sharing their conversation with Becky Quick, co-anchor of CNBC’s Squawk Box. Larry and Satya talked about how changes in geopolitics are shaping the global business environment, the fortunes of different economies and the path for corporations in the long term. Let’s get to it.

    Becky Quick: Larry, I’ve been thinking about globalism, and just a few years ago it seemed like things were going so global. You had borders coming down. You had people and technology and companies moving across countries seamlessly, but that seems to have been part of the big reason that the coronavirus has replicated so quickly, too, and we’ve definitely seen a pullback since that time. When you’re on the ground, what do you hear in terms of what governments and companies are thinking these days, and what do you think about the future of globalism?

    Larry Fink: The future of globalism is intact, but it’s evolving. It’s going to be adapting with societies and societies’ needs. But let’s be clear: Globalization has helped more people in society than any other economic forum. And yet globalization has left some segments of society behind, and so that’s why I said globalization has to change and evolve. And technology is going to accelerate globalization in many ways and inhibit globalization. Right now, we’re seeing the impact, and also because of COVID, as you framed the question. The supply chains are being redefined because of technology, and we were seeing the trend of more onshoring of some manufacturing products. We’re seeing moving supply chains closer to demand, so that evolution has already occurred. It may be accelerating now, but let’s be clear. I think even now the sharing of science related to COVID is a good example of how globalization can accelerate humanity. If we don’t focus on globalization and the positive impacts of globalization, we are going to leave billions of people in society and different countries behind. And so if we are still humanists, and I think we all are, we all need to be working together to build a more holistic world. And I know that’s not fashionable at the moment, and we’re all focusing on nationalism and make America first. I believe we still can make America first, using that phrase, but in the context of globalization as a positive force.

    Becky Quick: Hey, Satya, let’s just talk a little bit about what you’ve seen and how this really accelerated how humanity uses technology. What have you all seen at Microsoft?

    Satya Nadella: So I think of it as in three phases, Becky. They’re all happening in parallel. There was the response phase. There is the recovery phase. There is the re-imagine phase, and in all of these phases, technology is creating both the conditions for business continuity. I mean during the response phase, if you think about it, the biggest challenge was how do we continue to work, but most importantly, the critical parts of our economy, the first responders. So, we became the digital first responders to the first responders out there whether it’s in healthcare, whether it’s in public sector. And so, the idea that technology can help the continuity of business, that’s been the most important thing. Now, as we start thinking about hybrid work in the recovery, in the re-imagine, we start seeing some of the structural change. Take even what’s happening in retail. Omnichannel retail was there before. Guess what? Omnichannel retail will take new shape now. What’s happening online? How does it get consummated in some contactless drop-off, and so on? So, the idea that we will now start seeing bi-business process, in other areas, telemedicine. Telemedicine has been something we’ve been talking about for 20 years, 30 years. Guess what? Telemedicine now is mainstream. Basically when every hospital shut down for COVID, all of their outpatient activity, in fact, moved to telemedicine, and it’s not going back to normal. In fact, an AI triage tool to a telemedicine consult then showing up in the hospital is going to become a norm, and so these are good changes. These are going to be helpful even in terms of us taming the healthcare costs.

    Becky Quick: So Satya, Larry just said that he doesn’t think globalization is dead, that it’s going to continue. It’ll evolve. But do you think technology is going to be a huge part of the reason why and just the means for how that happens? Do you agree with what he said?

    Satya Nadella: I liked Larry’s even overall framing. You see, in fact, I think perhaps one of the biggest mistakes we made whenever the Berlin Wall fell was to talk about it as if it was end of history. If anything, it should have been just, hey, the continuation of history, and globalization has been there. It didn’t start in ’89. It has been there all throughout human history. The question is how do we adjust even for some of the unintended consequences of globalization? If anything, I think we all are as “multinational companies” have to be grounded on what happened in that phase of globalization. A lot of businesses got created. A lot of the middle class in Asia was able to make progress or recreate it. But at the same time, communities in the United States were also devastated because of jobs going away and those communities not having the ability to move up the social ladder and the economic ladder. So now in this next phase, as a multinational company grounded in that fact, so I believe my license to operate whether it’s in the US or in the UK or in India or what have you, comes because something else that Larry has been talking about because we are creating local surplus. Companies can’t be just out there. They have to be where they are living and working and contribute, and so that to me is what I take away. So, therefore, I think globalization will continue, but we also and especially in business, also need to talk about the real issues that got created in, say, the last phase of globalization and how we’re going to address them.

    Becky Quick: Let’s talk about one of those issues, and that might be something that we’ve traded around the globe as well: the fiscal and monetary policy to deal with some of the problems, huge economic fallout that has come from this and that what we saw happen last time with the Federal Reserve and other central bankers when we saw this back in 2008, 2009 step in to try and do these things. One of the unintended consequences that was that it made wealthy people eve wealthier by trying to preserve assets and hold things up. And so I kind of wonder what happens this time around. Larry, you talk to a lot of these central bankers all the time. What do you think the potential unintended consequences could be?

    Larry Fink: And we’re engaged with five different central banks right now in helping them with their policy formation. So there’s no question. Monetary policy has been the dominant tool for stabilization of the world, and monetary policy monetizes financial assets. And financial assets have done better than any form of assets. In post-2008, it’s certainly what we witnessed since the Federal Reserve and other central banks began their policies. And so there’s no question the wealthy people who own financial assets are huge beneficiaries. Now that’s the first line. The reality though, monetary policy stabilized so many great American companies, so it’s not invisible. And in the third week of March, the Federal Reserve announced their intended programs. We announced a trillion-and-a-half-dollar fiscal stimulus with more to come. Other countries did the same. And so, the very difference between today’s monetary policy function and 2008 was the monetary policy, as the fiscal policy, is all about preservation of jobs, and in every conversation I’ve had with every central banker and policymaker, how do we preserve jobs? How do we create stability? And through that obviously you see this big impact in the valuation of equities, but the job stability was enormous from the very low point in March. And I think those are the things we’re not emphasizing enough. The positive actions, the aggressive actions of the central banks, and our Treasury was enough to stabilize our economies. It was able to stabilize hundreds and hundreds of companies, thousands of small businesses. And I’m not saying we’re over it, and we still have a lot of structural problems today, but the actions were fantastic. Now, the unintended consequences are going to be generally when you have deep recessions, we generally benefit from companies that fail because we have the resurgence of new companies. We’re not going to see that. We are creating some structural imbalances in the long run, but we shouldn’t care about the long run because if the policies work and we create new economic growth and we have a vital economy going forward, much of the unintended problems will not be as significant. Unquestionably we’re going to have trillions and trillions of dollars added to our deficits, and ultimately that will be a big issue one day, and it will be a bigger issue if we don’t create growth in between that. We have to look at it in the whole totality of what was done, and I would applaud our policymakers.

    Becky Quick: I would applaud them too, but I wonder how lasting some of these issues will be when you hear companies like United say that they may have to lay off half of their employees come the fall if things don’t turn around. 

    Larry Fink: There are going to be a lot of companies that are going to be impacted by the disease curve, and right now we’re seeing a resurgence of the disease curve. We’re seeing some rollback. And so let’s be clear. In some industries, we do have systematic problems that will still persist, but for many, many other companies, they feel a lot better today. Their prospects in the future are far better than they were in March.

    Becky Quick: Hey Satya, let me ask you about tensions between the United States and China. It’s certainly not new, but the rhetoric has dialed up recently, and I think that’s in large part because of what’s happening with the pandemic and the scare that has kicked off things. How has that changed how you handle the supply chain, how you handle your customers, and how do you just deal with your own company, dealing with a global company?

    Satya Nadella: I think one of the issues coming out of this is definitely the relationship between the U.S. and China but quite frankly the U.S. and European Union and what is happening between India and China. There’s a lot going on in the world today whether it’s nationalism, whether it is about national security, whether they’re legitimate interests each country has in terms of their own trade and what’s in their interest. So, the way I look at it, I go back, Becky, to say, okay, what does it mean for us to serve our customers where they are with the sort of types of networks and businesses that they have. For example, let’s take a European multinational customer who is on our clock. What they care about is Microsoft doing the job to help them operate both in China with the Chinese framework and the laws as well as in European Union and in the United States. So we need to be where our customers expect us to be. That’s sort of why I’m being practical about where the world is being reshaped and where are our customers expecting us to show up, and with what type of data sovereignty, what type of locality that people expect from us whether it’s employment locally, whether it’s data center operations locally. In some sense you could say tech was one of those industries that didn’t face regulation. Larry and everyone else in the financial sector has always faced a lot of barriers and a lot of sort of local regulations, whereas tech had unfettered access to markets. Those days are gone, and the idea that tech will now need to make sure that they have local operations, local jurisdictional relevance I think is going to be the case for us.

    Becky Quick: Gentlemen, you both talk an awful lot about corporate responsibility and what your companies need to do to step up in this world. I think people have turned more and more to corporations in recent days and especially in the last several months, and I just wonder if you can address the idea of what it is that you think corporations should be doing and maybe talk about one or two things that you are doing to make sure that you’re involved with this. Larry, why don’t we start with you?

    Larry Fink: I write these letters. I’m already working on the ‘21 letter. Stakeholder capitalism is becoming more and more important. Satya talked about a license to operate. This whole trend of de-globalization we have to prove in every part of the world. We earn that license to operate every day. COVID is an existential risk of health. I wrote about climate change. It’s an existential risk to health and so much larger, and I think the role of corporations are going to be even larger and larger. Society is frustrated with government. I wrote about that in the last two years, and I think society is looking for large corporations like Microsoft and BlackRock to play a bigger role. And, more importantly, our clients want us to play that role, and most importantly, if you don’t show a strong purpose, you’re not going to get the best and brightest young people joining your firm. And so, I do believe over the next 12 months we, as corporations, are going to have to be even more vigilant in terms of our role in society. In the United States, we are going to have to show a great deal of what we are going to do about the social issues in our country. We’re going to have to talk about how we are keeping our employees safe as we ask them to come back to the office. The majority of your employees in the United States are still frightened to be coming back to the office. As much as they want to get out, they are worried about public transportation. They’re worried about going up and down elevators. They’re very worried. I believe one of the good positives out of this will also mean, though, we will never have 100% of the people back in our offices. We’re going to rotate. We’re going to be working there. That’s going to be a good thing. We’re going to actually improve the environment. We’re going to have less city congestion. Can you imagine New York and Seattle with less congestion?

    Becky Quick: Less traffic.

    Larry Fink: But anyway, the most important thing that I think we have to think about as leaders in companies more than ever, we have to show a little more emotionalism. We also have to prove our actions with courage. That is something that I’m saying loudly right now that we are going to have to be more courageous as a company, and those companies that are being identified, that are making these changes, that are really focusing on stakeholder capitalism, they’re going to be the huge winners in the future. And the reluctant, non-courageous leaders at companies, they’re going to fall. They’re not going to get the best and brightest young people. Their clients are going to be pulling away from them. The thing about long-termism and long-term capital is going to accelerate more than ever, and we all are going to have to be a little more courageous.

    Becky Quick: Hey Satya, I know one of the issues that all corporations are kind of looking at right now is diversity and trying to make sure that their employee base represents their customer base and the rest of the world beyond that. I had read recently that you were going to make sure that Microsoft is reaching out to some of the historically black colleges and making sure you have better connections there, and I thought, wow, that’s the perfect sort of scientific logical way about going about doing this. 

    Satya Nadella: I think this is the time for every one of us to have that sense of purpose not just in words but at the core of the business model. And one of the things I describe it as Microsoft will do well if the world around us does well, and that has to be true. That means what we do in the core, whether the products we produce, the business model we have leads to that broad success. And diversity and inclusion is the same piece, Becky. We have to represent the world if we want to serve the world internally. So one of the things that we did, given the moment we’re living through when it comes to black and African-American experience in the country, let’s start with our own company. One of the things that has been, quite frankly, a massive learning moment I think for all of us, for sure for me, was just the limited experience of people who are black and African American in Microsoft, in Seattle, in the communities we live in and saying, okay, what are we going to do about, first, representation at all levels, inclusion at all levels? And so that’s sort of the commitment we made, which is to say let us think about our own culture, our ecosystem. So, for example, we spend a lot of money. We have supplier programs that, for example, now have sustainability metrics. Let’s even have representation metrics, so we are now expanding our supplier programs, our programs with customers, partners so that our ecosystem also takes this as a priority just like how we are taking climate change as a priority. And the same thing goes with even the communities we live in so using data perhaps to create more transparency around the criminal justice reform that is much needed. So Microsoft needs to start within our own house first and live our own culture but then reach out whether it’s to the historically black colleges to make sure that they have the STEM education, but really it’s more like when I look at the intern class – I was just looking at the demographics of the intern class at Microsoft, which by the way is all virtual. I’m sure it’s the same at BlackRock. It’s pretty stunning. It’s one of the most diverse, gender, ethnic. It’s sort of fantastic to see. One of the things that I do worry is when they look up, when they look around them, is it inviting? Is it giving them that, okay, this is a place where I can succeed? And that’s, I think, the job ahead of us, and so that’s what we committed to doing.

    Becky Quick: And finally, I’d just like to ask you each, when you look at what’s happening, the crises that we’re all dealing with in the world with the pandemic and everything associated with that with the economic fallout, do you think it puts some of these issues on the back burner? And I ask that because there was a study that took a look at the words “climate change” and how often they came up in conference calls. In the first quarter, it was down 50% from where it was in the fourth quarter. Is this a temporary thing, or is this a bigger hurdle to try and jump over? 

    Larry Fink: We’ve had record flows into sustainable funds. We’re seeing an acceleration of more and more people interested in sustainable funds. As I said, COVID is an existential risk of health. Climate change is an existential risk too. It actually accelerates it, and let me just be clear. The young people who are starting BlackRock this month, they’re doing it virtually. These are the same young people who were teenagers during the great financial recession. They were born or a few years old during 9/11. They have a totally different experience than we did. I personally had the most idyllic childhood. I was happy and dumb. It was perfect. It’s not that way anymore unfortunately. And these young people are demanding change for their future. COVID is an accelerant for more focus on climate change.

    Becky Quick: Satya, a quick last word?

    Satya Nadella: I would first of all agree with that, which is in some sense the way we think about systemic issues is to really make sure that we have a systemic response. So inside even at Microsoft when I look at what we are doing whether it’s climate change or racial inequity or dealing with healthcare coming out of this, all of these things will require us to re-imagine how to make the systems better. So, I think that we as a society can keep multiple priorities prioritized as opposed to trading one against the other. But I do think that we need institutional strength all around.

    Becky Quick: Satya and Larry, I want to thank you both very much for your time today and for the conversation.

  • Sandy Boss: A company that has its relationship with its employees, its relationship with its customers, very clearly connected to its purpose, that company then will be much more able to deliver in a very uncertain world like the one that we are facing right now.

    Mary-Catherine Lader: Welcome to The Bid and to our mini-series, “Sustainability. Our new standard,” where we explore the ways of sustainability – and climate change in particular – will transform investing. Earlier this year, we announced at BlackRock a series of changes regarding sustainability. We’re launching new products to increase access to sustainable investing. We’re delivering data to help others build sustainable portfolios themselves and we’re increasing transparency in our Investment Stewardship activities.

    Today, we’ll speak to Sandy Boss, Global Head of Investment Stewardship. Investment Stewardship is how shareholders hold companies accountable. In short, it involves engagement with public companies to promote positive behaviors and We’ll talk about how COVID-19 has impacted company behavior, why companies are now accountable to stakeholders beyond their shareholders and what actions, we, at BlackRock have taken to increase transparency. I’m your host, Mary-Catherine Lader. We hope you enjoy.

    Sandy, thanks so much for joining us today.

    Sandy Boss: I’m very happy to be here. Thanks for having me.

    Mary-Catherine Lader: So, you’re the Head of Investment Stewardship at BlackRock, and that sounds like it could mean a lot of different things, but it really means something specific. So, can you just start by sharing what Investment Stewardship means?

    Sandy Boss: In a very simple way, we are looking after our client’s interest in the companies that they invest in. So, if you were an individual shareholder, you would invest in a company, you would watch how it was performing, you would vote on the shares, you would take that personal interest. And what we do in Stewardship is do that on behalf of our clients with a lot of companies. So we go and speak with the companies, we meet with the directors, with the CEO, with the chairman and we understand how they’re running the companies, we focus in on the big issues, the key things that are really going to drive value. And on behalf of our clients, we then take votes and help them ultimately achieve better returns for their retirement and for whatever reason that they might be investing with us.

    Mary-Catherine Lader: How do you decide what you engage them on, what issues are you talking to them about and who are you talking to?

    Sandy Boss: We’re talking to the people who are calling the shots at the company so it will be the chair, the director, the CEO, sometimes investor relations. And what we do is we’re focusing on the things that make the most difference to value. So, if it’s climate, we might be talking to a company that has a really big carbon footprint about what are they doing to manage climate risk and possibly get some opportunities from managing the transition that we’re going through to a lower carbon economy. We talk to them about board quality, so in that, we’re thinking about, are the directors independent, are they skilled, are they diverse and are they representing a wide range of perspectives that are ultimately going to make that company more valuable on behalf of our clients. We might talk to them about human capital management. Human capital management is essentially looking out for primarily the employees, but the other stakeholders in an enterprise and how are the practices in a company enabling that company to be more successful, because there’s a lot of research that says if the employees are engaged, they like the company, they’re staying, they’re doing better work, they’re more productive and that then leads to better profits for the company. So those are just a couple of examples of the kinds of things that we would talk to companies about. But always, it’s anchored on what are the issues that are really important to the companies and that are ultimately going to drive value.

    Mary-Catherine Lader: And some of those questions have quantifiable answers, but in other areas of your discussions with companies and some of these other topics, for example, S part of ESG, social issues like human capital management as you mentioned, there aren’t as quantifiable answers. So, what are the issues you are talking to companies about in those social issue categories and how do you get clear answers there?

    Sandy Boss: Well, first of all, you are definitely right that some of these social or S issues are much harder to quantify, but it’s become obvious in the context of the COVID crisis if it was not before that managing that social and economic contract between the company and its customers, its suppliers, the community that it sits in, its employees perhaps first and most foremost. That set of relationships, that’s absolutely integral to companies’ social license to operate. So what we are finding is that – and there has actually been research in the context of the crisis – the companies that have really sustainable practices across E, S and G, with S being quite prominent right now, those companies have actually been a lot more resilient in how they have managed the financial side of this crisis. And so, when we think about the connection between these factors and investment returns, we see a clear correlation. So when we meet with companies, what we’re doing is we’re trying to understand how are they embedding these types of issues into the way that they face their day-to-day business. Yes, we’re interested in how they are immediately responding to the crisis, but more importantly what we’re really looking for is how are they embedding these kinds of social considerations into the way that they intend to emerge from the crisis. And this comes back to, a company that has its relationship with its employees, its relationship with its customers, very clearly connected to its purpose, that company then will be much more able to deliver in a very uncertain world like the one that we are facing right now.


    Mary-Catherine Lader: So you mentioned climate and that’s been a particularly important topic for investment firms and particularly at BlackRock recently. And you mentioned one reason is a company’s carbon footprint, for example, is something that management teams have control over. But can you just explain a little more like as an investor, why do we care so much about companies’ climate preparedness and why should our investors in turn, then care?

    Sandy Boss: Well, I think the simplest way to put it is that climate risk is an investment risk for the companies that we’re invested in. So, we don’t see this in terms of the broader social good, that is important, but as an investment company, our job is to really focus on the returns to our shareholders. And we can see that there will be a really substantial change in the way that capital is allocated as people start to anticipate a lower carbon economy, the companies that move quickly and manage these risks will be more valuable. The companies that don’t, that then presents a real risk to our clients. We’ve actually done research that shows that the companies that are thinking about sustainability and climate in particular, they’re managing these risks better and they’re already beginning to show better risk-adjusted returns which is what we’re looking for as managers. We ask companies to use a couple of disclosures, a couple of ways of demonstrating how they are managing these risks, so that we as investors can understand better, one of them is the Task Force on Climate-Related Financial Disclosure, the other is the Sustainable Accounting Standards Board or SASB standards. But we ask for that information so that we can look at how the company is handling the strategic situation that they’re facing, what are the decisions they’re making, what are the targets they’re setting. And then as investors, we can make decisions about whether that satisfies our expectations and whether that is ultimately going to move that company to a better position from a long-term value creation perspective than if they were not managing this risk. And our belief is that indeed, by managing these risks, that will generate value.

    Mary-Catherine Lader: And so once we have that point of view, what do we ask of them and what do we do about it, what are the leverages we use?

    Sandy Boss: The two things that we do in working with companies: one is engaging, which is meeting with companies to tell them what we’re expecting and the other is using our vote. So we’ve set aside companies that we think really should be managing climate risk for example, and we’ve met with them to share with them, these are the concerns that we have, these are the expectations that we have, and then what we do is we evaluate how management responds. The board, the management, they’re responsible for ultimately the decisions to take as a company, many of them have responded to requests from ourselves, from other investors and are now disclosing how they govern risk, what their strategy is around climate, how they’re actually changing their capital investment plans, what targets they’re setting for reducing their carbon intensity, and when we see that, we’re satisfied because that’s what we’re looking for as investors. However, if we don’t see that, then we might take a couple of actions. One is voting action, so just as an individual would, owning a share, we have opportunities to vote on directors and specific proposals that are on the ballot. We’ve taken several votes this year against people who are responsible for climate risk or sustainability risk or sometimes, it’s members of the board who are in a senior position. But we’ll take a voting action in order to demonstrate that we’re not satisfied with the way that we’re handling these risks. The other thing that we might do is vote in behalf of the shareholder proposal. So, if a proposal has been put forward that we think is immediately addressing the issue that we’re concerned about, then we might support a proposal.

    Mary-Catherine Lader: So just to dig a little deeper on what exactly we mean about these climate discussions, maybe take an energy company for example. What are you asking them about, and how is that different from, or how far does the disclosure get you?

    Sandy Boss: That’s a great question. Let’s take a big oil company, for example. The primary climate question for a big oil company is how are they managing the transition to a low-carbon economy? And really what we are looking for is to what extent is that company then aligning its business to a Paris-aligned scenario. What a really good TCFD disclosure actually gets us quite a bit. It tells us how the company is governing that transition risk. It tells us what is the strategy that the company has set, it tells us what are the targets that the company has and how they are managing toward sustainable business model that is prepared for this transition and you know we can see then the connection between the targets that the company is setting, say several companies have now set net zero by 2050 targets. We can see the connection between those targets and then the decisions that the company is taking around, how they’re investing in new capital expenditures, for example, are they making green investments, starting to shift to different kinds of technology or less carbon intensive production methods as opposed to companies who are saying that they’ve got really good targets, but at the same time making investments that looked very much like they’re continuing into a very carbon intensive future, making very long-term expectations around how you know say, deep sea oil will contribute to their business model. So really with this disclosure and the dialogue that we have with it, we really get to understand that the approach of the company is taking and how that then will connect to the valuation of the company and we’ve seen in this year alone, you know enormous swings in valuation in oil companies for example, part of them having to do with the obvious pandemic that we’re all facing and with the very low oil price that we have experienced particularly the beginning of the crisis, but also part of it is that the choices those companies are making around their transition to a lower carbon economy.

    Mary-Catherine Lader: And so it sounds like our thesis, the evidence supporting it, our whole method of engagement is really well supported, but it really does depend in some cases on this voluntary engagement and voluntary responses from companies. So if they don’t respond, if a company fails to disclose, what happens then?

    Sandy Boss: Well, that’s a good question. The tool that we have is our vote. If we don’t see companies providing that kind of disclosure that we need, then we will begin to vote against them in the 2021 year. And so, we see a direct connection between our expectations and then how we use our vote.

    Mary-Catherine Lader: So, Larry Fink, our CEO often refers to this concept of stakeholder capitalism or the responsibility of companies to stakeholders like their employees and the society in which they operate, their clients and others beyond and in addition to their shareholders. So, what responsibility do you believe companies have to these stakeholders and how has that changed over time?

    Sandy Boss: I think that is self-evident now as we’ve seen how companies are handling what is one of the most turbulent situations any of us have lived through. We really think that that strong sense of purpose and commitment, that is absolutely vital to a company being able to manage this uncertainty, stay close to its customers and emerge in a successful place. This is very much in the interest of the companies themselves because our observation is that increasingly the companies that are handling these issues well, those companies are able to attract longer term capital, more patient capital, achieve lower cost of capital as a result. What we’re also seeing is the companies that are tone-deaf on these issues, they’re starting to see increasing skepticism in the market, so we’re beginning to recognize that companies who aren’t managing their stakeholder set well, who are disconnected from their stakeholders set are ultimately having a higher cost of capital.

    Mary-Catherine Lader: And so, are you suggesting there’s a link between stakeholder engagement and returns? Or maybe if that’s hard to kind of put our finger on today, is it even possible that these more sustainable behaviors more broadly can mitigate the impact of future downturns?

    Sandy Boss: Well, we’ve definitely seen a connection in research that BlackRock has done between sustainable business practices, and that’s across E, S and G. In stewardship, that’s our conviction. And so, that’s why we put the energy that we do into taking on issues which some are very quantifiable, some are less quantifiable, but there’s clear alignment between these issues and the value generation for our clients.

    Mary-Catherine Lader: And so, to what extent are we trying to then drive those more sustainable behaviors? I mean, you’ve talked about the voting mechanism, we have leverage to do that, but how persistent are we? Are there some examples you can share maybe about where we’ve really made a difference?

    Sandy Boss: I think one of the best examples of this is in Europe and particularly in the UK looking at executive compensation and the role that the pension plays in executive compensation. For a long time in the UK, it was quite typical that the executives would get a very high percent of their salary in pension, much higher than the workforce. What we saw is a disconnect between how executives were compensated and how their workforce was compensated when it came to pensions. And we pushed this issue along in our engagements with companies. We were able to get support from other investors on the issue and we’ve seen absolutely dramatic changes particularly in the last 12 months or so, where we’ve seen many, many companies now have moved to the practices that we think are more appropriate, bringing in new executives at the same level of pension as a percent of salary that they would do with the rest of their employees, and similarly, even seeing a sitting executives take cuts in their pension in order to have a much more aligned compensation structure.

    Mary-Catherine Lader: We are committed to transparency in Investment Stewardship and so, what, as part of your job and your team’s work are you doing to deliver on that commitment? How are we making these kinds of conversations available and transparent to the investors on whose behalf you’re having them?

    Sandy Boss: Well, we’ve actually done quite a bit to be more transparent, particularly since January of this year. First of all, our entire voting record is public and now, we’re disclosing every vote that we take quarterly. Also, in our quarterly report, we started doing something new, which is every quarter, we now publish a list of the companies that we’ve engaged with and we’re also publishing the subjects. So, what are the themes and issues that we’re raising with those companies. So, it really helps give much more texture around what it is that we’re doing when we engage with companies that might be less visible outside that voting record. Finally, we have vote bulletins that we’re putting out on high profile votes when we know there’s interest in the subject and we’re really trying to give that transparency to both our clients and other people who are interested. How did we vote, why did we vote that way, what are we expecting from the company going forward and we’ve gotten good feedback that that’s been quite helpful to people who are interested in what we’re doing as a stewardship group.

    Mary-Catherine Lader: So, all of this work clearly takes expertise in corporate governance, a deep understanding of how companies actually function, probably understanding regulation, a global perspective. Before you came to BlackRock to do this job, you worked at the Bank of England as a member of the Prudential Risk committee and before that, you were a senior partner at McKinsey, so you’ve done different size of those issues and developed the expertise over time, but how did your work in the public sector, in particular, shape your views about this kind of work that you’re now doing back in the private sector?


    Sandy Boss: So, working in the public sector, I think there are some differences and similarities. So, if I think about what our objective was on the Prudential Regulation Committee at the Bank of England, the objective was to oversee the activities of individual companies with a higher aim of ensuring that the UK had financial stability. We had a lot of tools at our disposal, so we were able to be quite influential with companies, but the responsibility for ensuring that the individual companies were themselves safe and sound and then, the system was safe and sound, the ultimate responsibility was with the boards and the management of those companies. So, when I now look at what I’m doing in the private sector, I’ve taken with me that absolute understanding that our expectation of companies, that their expectations and their important expectations, but ultimately, it’s a responsibility of the boards and the management of companies to actually ensure that their company is being led in the right way. Our objective function is different than what we had at the Bank of England. But looking for long-term value for our clients, it’s a broad goal, so it’s very similar to what we were seeking to do in the UK.

    Mary-Catherine Lader: So, we end each episode of our sustainability miniseries with the same question to each of our guests and I had to answer it myself a few weeks ago and it’s actually not as easy as it may sound, but what was the moment that changed the way you thought about sustainability?

    Sandy Boss: For me, this is actually an easy question. I was sitting in a meeting at the Bank of England with the Prudential Regulation Committee and we were considering the first ever climate risk policy put up by a central bank in the world. And the interesting observation that we made in that room and obviously, Mark Carney is a real advocate for thinking about the role of climate risk, was that none of the traditional ways that risk management was done in financial institutions were bringing this very, very long-term risk into the decision making of the here and now. So, a bank would look at I’m about to take out a loan and it’s a three-and-a-half- year loan. Will it pay back in three and a half years? But no one was asking, but what about the cliff edge? What about the viability of that loan, 3 years, 5 years, 10 years from now as we start moving into a transition to a lower carbon economy? And I suddenly realized that if we, at the bank, didn’t move our thinking about what’s the right time horizon, how do we bring what some people might call a non-financial risk into the way that we were doing financial risk management, that we wouldn’t be doing the right thing in our role. And I think that’s the same kind of thing that we’re doing now. When I switched hats and think about my role at Stewardship at BlackRock, these long-term, today’s non-financial risks are increasingly becoming the financial risks of the future. They will show up in the financial statement of tomorrow or two years from now, or three years from now, and that’s something that it’s our responsibility to be thinking about.

    Mary-Catherine Lader: That’s a really remarkable example because it was that series of realizations and those discussions that did exactly what you just suggested in helping make this sort of intangible, far-out risk feel more tangible and of course, help set the standards that next year will probably going to effect for stress testing. So, thank you, Sandy. It’s been an absolute pleasure talking to you and hopefully, we’ll do it again.

    Sandy Boss: MC, thank you very much. Again, a pleasure to be here.

  • Mary-Catherine Lader: When 2020 started, we thought it would be more of the same. No one could have predicted that a global pandemic would come just a couple of months later. Since then, market volatility has been at all-time highs, unemployment has surged and there’s no question that we’re in a downturn. But one prediction we made has held true: Our view was that when the next downturn hit, it would require policy coordination between central banks and governments to help the economy stay afloat.

    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, Jean Boivin, Head of the BlackRock Investment Institute, joins us to talk about how monetary and fiscal policymakers have come together in response to the coronavirus crisis. We spoke with Jean back in January about why he believed a coordinated effort would be necessary when dealing with the next downturn. Today, we’ll explore what’s happened since.

    Jean, thank you so much for joining us today.

    Jean Boivin: Thank you for having me.

    Mary-Catherine Lader: So, you and I spoke in January, and you at that time were talking about a paper you had written that predicted that during the next economic downturn, central banks and governments would have to coordinate in an unprecedented and usual way. And at that time, we talked about how an economic downturn was not anticipated. And so, this is somewhat prescient it turns out. Now that that’s actually happened, are you surprised that the policies you wrote about have become a reality so soon?

    Jean Boivin: Well, we were talking about what would happen in the next downturn and we had obviously no idea than a pandemic would be happening a few months after. So we’ve been certainly surprised that the events precipitated the need for a very aggressive response. We thought that the direction of travel was inevitable so in that sense, maybe not surprised. But certainly, very surprising how quickly that has materialized. Just to give you an example, we tried to write an op-ed as things were unfolding trying to link what was happening to what we had been discussing last August and by the time we were finishing the op-ed for publication in a newspaper, a lot of what we were describing could be happening next had already happened.

    Mary-Catherine Lader: Can you just remind us what the thesis was behind that original paper?

    Jean Boivin: Traditional tools of central banks were reaching very significant limits. So, central banks ultimately with the toolkit that they had were attempting to stimulate the economy, spending or investment, by lowering rates, either short-term or long-term rates. And with rates as low as they were, even last August or before the pandemic, there was not in our view a lot of space to get much more stimulus through this. So that was the first observation. And given that, it led to the question of what could be next. And any aspect of stimulus you can think of that does not work through lower interest rates required central banks or policy to more directly attempt to stimulate demand. Or put stimulus in the hands of the entities that could use it. And so, any policies of that form ultimately requires some specific coordination between central banks and governments, which is exactly the revolution we’ve been going through over a few weeks in February and March.

    Mary-Catherine Lader: And so, you mentioned a little bit about what happened in February and March, but can you just give us a little bit of a recap of how central banks and governments came together in a coordinated way? Those of us in the U.S. watched closely what happened in the United States, but it certainly wasn’t just here.

    Jean Boivin: No, it was literally everywhere. This shock, this pandemic was a global phenomenon. I think it created a necessity to respond very quickly. But to explain/unpack why we talked about a policy revolution, this revolution has I think three or a couple of key elements. So, over the course of a few weeks, between February and March, we first saw an increase in central bank balance sheets, and in particular of the Fed, that was greater than the increase in the balance sheet of the Fed in the entire post-Global Financial Crisis in 2008 period. So, in five weeks, we saw the deployment of central bank policies of a magnitude that was greater than what had been accomplished in five years after the Global Financial Crisis. And then it’s also the nature of these policies that was innovative where we’ve seen central banks, and I’m going to speak to the Fed more directly here, but it occurs elsewhere. Basically, deployed facilities that are aimed at lending more directly to the private sector or to entities rather than going through the traditional banking sector transmission. So less through bank, more directly through some even mainstream entities, even states. So that determinant of the revolution which we had been labeling as going direct as a short end. But it’s really about more directly trying to put liquidity in the hands of the entities that are cash constrained. So three elements: speed, size and then this very significant innovation of going direct.

    Mary-Catherine Lader: And you had talked in January about this innovation of going direct and your anticipation that it would be needed. Do you think this has worked?

    Jean Boivin: Well, the jury is still out. I think it has definitely worked in terms of creating the impression of a very decisive response where central banks and governments are ready to do whatever it takes. It has certainly in an impressive fashion calmed the market. When you think about it, markets were down as much and as quickly as we had seen in 2008 during the Global Financial Crisis when we were in February and March, and now we’ve rebounded very significantly from these lows. So, we had a 35 percent decline, now over the second quarter of this year, we have an 18 percent rebound in global equity indices. So, in that sense, it has worked. But the jury is still out because it’s one thing to announce big plans, it’s one thing to start to try to deploy them, but we need to ensure that the actual liquidity could find its way to the entities that need it. So, we have for instance, programs to support unemployed in the U.S. Not everybody is able to reach through the program, that’s true in Canada, that’s true in other places as well. And before we see the full execution, I think we need to reserve a judgment of whether it has worked. But I think in terms of building confidence, certainly it has worked and I think we are seeing money flowing already in some key places, so signs that it’s working. But we need to keep an eye on execution.

    Mary-Catherine Lader: There’s no question that money is flowing as you suggested, but there’s been a lot of criticism as to whether it’s flowing to the right recipients, especially in the U.S. perhaps; whether the recipients of PPP funds or even the fact that corporations largely receive these funds was the right response. What do you make of that?

    Jean Boivin: One observation I would make is the speed is unprecedented. Over the course of a few weeks, big decisions and facilities have been put in place. It is, I think, unrealistic to expect that money as a result has been targeted exactly where it’s needed. I think the approach here has been more about let’s be decisive, let’s make sure that we go in as meaningful direction as productively as possible. And I think the question going forward will be, what kind of recalibration was needed to ensure we don’t have excess support in places that it could lead to a misallocation of resources, and at the same time, ensure that we don’t see the appearance of very significant cash constraints and balance sheet pressures in other places that could build up into something more systemic. So that is another version of my execution is key now. Execution is about not only making the money flow, but making it flow to the right place to the point of your question.

    Mary-Catherine Lader: Now that we’ve deployed all this capital, what do you see as some of the risks of the approach that we’ve lived through?

    Jean Boivin: I think the first thing is, risk or not, the first thing to do is to provide a bridge to the economy that is facing a very significant health crisis, the solution of which is to stop the economy. And that is creating a big economic hole that needs to be bridged. So, I guess the first point I want to make clear is that yes, there will be risk and outcomes, but those risks are questions for tomorrow or next week or next year. But once we get to tomorrow, next week, or next year, given the speed at which these measures have been deployed, I think there are important governance questions around how central banks and governments interact that have not been fully resolved or even addressed. So, in the heat of the urgency of trying to deal with the situation, the importance of responding quickly was the dominant objective, and for good reasons. But we will need to reconcile, at some point, what interaction and governance issues this raises with central banks and government’s interaction. And there’s a lot to unpack here, but to make that more concrete, a lot of the measures that have been taken have a feature of being a combination of monetary policy, which is the policy of the central banks, and budgetary or fiscal policy, which is the tool of the government. But coordination means joint decision making, and without a clear framework on how these decisions will be made jointly, it leaves unclear who is going to have the final say on which part of these policy tools. And where this could become a problem is in a scenario where again, this is not for today, it’s not for next week, and it might not be for next year – but at some point, the economy will recover and if we’re in a world where inflation starts to reappear, and with all of the stimulus that has been put in place and big deficit, it is a scenario that we need to entertain seriously. And inflation at some point could reappear. And at that point, central banks would be facing a tougher decision/choice between reducing the stimulus that has been put in place in order to contain inflation, but at the same time, removing a spending tool for the government which is very attractive for governments. It is always easier to spend than to stop spending. And that decision would now even be more difficult because it’s going to be related explicitly to the inflation outlook. So, we have a more complex tension trade-off. And before the crisis, there was a clear framework where central banks, when inflation was under threat, central banks had the independence to remove the stimulus in place – that independence now is less clear. Another related risk is the strength of institutions. We’ve been building for 40 years strong central bank frameworks that were anchored in an ability to target inflation, in an independent way, and now by adding these coordinated policies, it raises a question that maybe central banks will become more politicized, or the political side of things will play a bigger role in determining interest rate and central bank decisions. So, inflation is a risk and the more institutional framework is also at risk of weakening without some way of addressing this.

    Mary-Catherine Lader: To what extent are you also worried about the deficits accumulating as a result of this approach? That’s been the case ever since the Global Financial Crisis in the U.S. and in several other markets. Do you think that we have enough to deal with now and that’s a problem for the future, or should fiscal policymakers be addressing it today?

    Jean Boivin: So again, I’m in sort of the same place, because it’s important. The risks are kind of irrelevant to deal with the current situation. We need to deal with this first, and in fact, the best way to minimize the risk I’m concerned about is to make sure the economy recovers as quickly as possible. But yeah, those deficits are meaningful. We haven’t seen deficit spending like this in peacetime, it’s not comparable to the Global Financial Crisis fiscal stimulus and spending we’ve seen. So, the increase in debt is very significant, and left to its own devices, at some point, it could create some tensions. Right after the Global Financial Crisis, very significant government spending was put in place and it didn’t take very long. In 2010, only two years after, government became very nervous about the increased debt that they were facing. And we saw a very significant move globally towards austerity. The narrative has changed: now we have an even bigger, large deficit and debt increase. Nobody is currently worried about what the debt will mean, and nobody is talking about the austerity any time soon. But at some point, that could come back on the table. And so, the couple other risks you can see as a result. One is we move back to austerity too quickly and undermine the stimulus we’ve put in place. I don’t think this is a big risk, but 2010 was a mistake in that sense, we went too quickly back to austerity. If we wait too long to deal with the debt, we might see pressure on interest rates to go up. Because investors at some point will start to question whether it makes sense turning to government for nothing or even to be paid dealing with governments with negative rates when the debt is so high. And to prevent that, I think central banks as a result will need to be more actively trying to prevent rates to go up. But if they do that, that goes back to the inflation risk that I was worried about. And I would say the last risk I would flag, and one that I’m more concerned about is, now that we’ve put on the table the new tools where it looks like you can – and it’s not true but it looks like – you can basically spend an unprecedented amount, and then try to use central bank liquidity or money to finance it. Which is the impression some people have. It opens the door for people to say, well, why don’t we do that also in normal times? And then the big deal question here is once this genie is out of the bottle, how do you put that back in? And we are seeing a lot more people making those kinds of arguments, so that is one of the risks in the absence of guardrails that hopefully we will put in place at some point.

    Mary-Catherine Lader: And what might those guardrails look like? What action or indicators do you think can be put in place?

    Jean Boivin: We need to set some rules that define when this usual policy evolution tool can be used and when should we exit from them? So that’s really what we mean by putting guardrails; it’s like the rules of the game, rule of engagement, so we know now we can use them. If we get in a world where people believe we can use that anytime and all the time, that cannot be true; there’s no free lunch. We cannot just print money out of spending. So, the question is going to be, how do we put a limit to this and an exit? Right now, those have not been defined. All we have is that central banks still have inflation targets, but we haven’t specified exactly how that’s going to play or inform their decision how to remove those new tools, and we haven’t also defined how the government will allow central banks to remove these tools, given there is an element of government policy that is involved in it. So what will be needed to clarify this is a joint agreement between central banks and government, to say for instance that these tools can be used as long as inflation is under control, and not expected to go above targets systematically. And that once we see inflation start to increase, or expected to be running above target, in those instances, the central bank will have the ability by itself to start removing or exit from these tools. So that would be an example of a framework that specifies under what circumstances we would be starting to exit from these unusual tools and who is charge of making that decision. And again, I want to reiterate, this is not the issue of the moment, and the best thing we can do right now is to make sure we recover as quickly as possible in terms of economic activity. That’s why governments and central banks have been focusing on this first ask. Once this is under control, I think it will be welcomed to clarify these guardrails.

    Mary-Catherine Lader: So, what’s your current thinking about how long this downturn will last? And what indicators are you looking at as to whether we’re moving out of it? The stock market and equity markets have recovered at least for now, but so much of the impact of the last several months is still with us. So, what are you looking to and how long do you think it’s going to last?

    Jean Boivin: I’ve realized over the last few weeks that as soon as you say we're going to come out of this and you put a date, no matter the date you put in, you look like you’re optimistic about the situation. So I’m just prefacing that because I think our view, or if you just look at the range of forecasts out there on the most bearish side of things, we’re talking about going back to the level of activity we were before the shock by the end of 2021. This is a shock that it means it is going to take two years to get out of it. It’s not only a couple of quarters. That said, I want to make clear as well even though this is a big shock, it’s very concentrated in time. So, our view is that the worst of it is behind us, it was April, and so while it’s going to take until the end of 2021 to get back to where we were, we’re already on that upward trajectory from this point onward in our view. Of course, there is risk, we could get reinfection, that could slow this down. But we are already starting to be on the recovery path. And the third point to our view is that even though it’s a big shock, unprecedented, April will be left seen as the biggest contraction in peacetime, or even since the Great Depression. We will at the end of it see a cumulative impact or shortfall economic cause of this shock that will be still a fraction of what the Global Financial Crisis cost was. The Global Financial Crisis was a shock that basically led to a downgrade of growth or activity for a decade after. This led to the slowest recovery since the Great Depression. This time around, it’s still going to be about a third to a half of what the cost of the Global Financial Crisis was. So the three points just to reiterate, it’s going to take about a couple of years to really work through this shock, uncertainty around that is important but I think that is a good benchmark. Point number two is that this is a very significant shock in the near term, very profound and cannot be underestimated, but we are already recovering from it. And the third point is that, despite all of this, it still is not comparable yet to what the Global Financial Crisis was and helps to gauge what kind of price reaction you should expect to see overall as a result of this.

    Mary-Catherine Lader: So then what does all this mean from an investor point of view?

    Jean Boivin: Well, that is a big question, but let’s break that down into a couple of key themes. Let’s first talk about the strategic, more longer-term horizon. The fact that this shock is not of the magnitude of the Global Financial Crisis I think gives us an anchor for people with a more strategic horizon to see opportunities in the repricing we’ve seen after the shock. So we should expect a Global Financial Crisis kind of price move for risk assets. As a result of this, in February and March when we saw a very significant move, we thought there was strategic opportunities to go overweight equities or risk assets more broadly. Now we’ve rebounded from this, so there is a bit less opportunity than there was because of a significant rebound, but broadly speaking, I think that leaves us to be pro-risk on a strategic basis in portfolios and looking to maintain this stance as a general statement. Another implication for investments is that the policy revolution is leading to an even lower rate environment, in fact, rates being closer to the lower bound across the entire yield curve and in many countries. And I think that starts to reduce or question more fundamentally the role of government bonds in portfolios. We don’t expect them to play as important of a ballast role as they have historically. The inflation risk that I’ve talked about, we’ve touched on, I think also leads to think carefully about getting inflation protection on a strategic basis in portfolios. I think it leads to other key implications as well around how we think about the long-term impact of the shocks. It’s not only about dealing with the health crisis, but this is changing behavior. This is accelerating some trends that we’ve been already seeing play out before the shock. We are going to see an acceleration maybe of digitalization going forward, air, the way we travel, the way we work, there is a lot of themes that are emanating from this which are not pure, simple, asset allocation themes, but I think will be important for investors to think hard about and trace going forward. If I may bring that on to more tactical horizon, I think that led us to a few things. The very significant policy revolution in the near term is to our mind very positive for credit. And so, we’ve been overweight credit for a few months. Don’t fight central banks I think is a powerful tagline for this.

    Mary-Catherine Lader: So in short, there is a lot to consider, and it’s still an evolving story; thank you so much for sharing your insights with us today, Jean.

    Jean Boivin: Well, thank you very much, it was a pleasure.

  • 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?

    Mary-Catherine Lader: Right.

    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.

    Mary-Catherine Lader: Right.

    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.

  • 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, competition, 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