Celebrated economist Joseph Stiglitz, University Professor at Columbia Business School, says the slowness in developing a comprehensive approach to debt in emerging markets and developing countries will result in a weaker global recovery. He urged for a restructuring of debt in a coordinated approach between the public and private sector.

Speaking at FIS digital in May Joseph Stiglitz, University Professor at Columbia Business School and Nobel Prize winner, began by noting the large difference in various governments’ ability and willingness to act to support the recovery leading to an uneven recovery.

“It will not be a global recovery until the disease is under control and there is equal access to the vaccine,” he said.

He noted the big change in US policy in support of equal access to the vaccine. Commenting how the vaccine waiver on IP would allow many countries to produce the vaccine, he said that drug companies are arguing developed countries don’t have the capacity to produce vaccines.

“If they don’t have the capacity, what is the problem?” he asked.

He noted how the biggest producers of the vaccine in India and South Africa also face a clear shortage of supply. And cited other important measures to increase access to the vaccine like the lifting of US export constraints on critical ingredients to make the vaccine.

“There has to be a transfer of technology to make production accessible,” he said, adding there is no place in the world that is safe until every place is safe.

Stiglitz noted that although the US has taken measures to fuel a strong recovery, emerging markets don’t have the resources to do the same and are spending a fraction of their GDP in contrast. Here, he noted that Biden is now supporting the IMF’s Special Drawing Rights (SDRs) which could see additional funds flow to developing economies, especially if advanced economies, which don’t need the additional funds, follow through on initiatives to recycle them to the more needy.

Stiglitz noted that many emerging market economies were in debt before COVID making their current situation unbearable.

He urged for a restructuring of debt in a coordinated approach between the public and private sector.

“We need policies to encourage private creditors to participate,” he said.

Stiglitz downplayed the threat of US inflation. He argued that the only time the US economy has succeeded in bringing marginalised groups into the labour force and have wages rise has been when the labour market is tight.

“I am hoping we have a tight labour market,” he said, welcoming a slightly heated economy.

He noted that the US is leading the global recovery with China and noted ample supply ahead. Even so, if the market grows too overheated central banks have tools to counter at their disposal.

The Fed could raise interest rates, something he described as a good thing. He said near zero interest rates distort capital markets and allocations.

“Getting out of a zero interest environment would be good for the US and global economy,” he said. Elsewhere he noted the need to raise taxes and end a regressive tax system.

 

Responding to Stiglitz’s remarks, Fiona Reynolds chief executive of the PRI warned that government assistance was removed too early in the wake of the GFC, cutting spending in essential services and leading to economic inequality and warned about falling into old traps.

Regarding the need to build back better after the pandemic she stressed the importance in rectifying underinvestment in health and education, adding that pushing wages down and tax avoidance has eroded the base for essential services. However, she said she was encouraged by trends by activist investors to bring about change at oil majors Exxon and Chevron.

She noted how more investors now understand that having a good ESG strategy is good for business.

“We can see this in the amount of money pouring into ESG funds,” she said. She also urged investors to integrate the SDGs, getting behind them to build back better.

“We can solve most of world’s problems via the SDGs,” she said.

Jaap van Dam, head of strategy at PGGM in the Netherlands also noted the importance of the SDGs in steering investor strategies towards building back better.

“The building blocks are in place and pension funds are motivated to move ahead; they just don’t always know how, and best practice isn’t in place,” he said. Here he drew delegates attention to an SDI Asset Owner Platform developed with APG which combines an SDI taxonomy with AI to assess thousands of potential sustainable development investments.

Like Stiglitz, Sharan Burrow, general secretary of the ITUC in Belgium argued that inflation and rising wages would provide valuable support to the broken labour market currently characterised by insecure and low paid workers.

“We need to look at a different model,” she said urging investors to integrate ESG.

“If we leave people behind mistrust in democracy will grow, moreover a low minimum wage ($15 an hour in the US) is ridiculous in such a rich country.”

She also noted the perils of vaccine nationalism, counselling on the importance of sharing production capacity.

“If we don’t share production capacity how can we meet demand for vaccine shots,” she asked. She said that vaccine cooperation reflects countries’ ability to cooperate in the green transition or if it will still be a winner takes all approach that threatens to kill people’s belief in the future and put democracy at risk. Elsewhere, she said tax reform should be front and centre.

Stiglitz concluded with notes that if governments had spent a bit more on vaccines the disease would have been over, quicker.

“For sure the cost of the pandemic has reached trillions, but if we’d spend a few more we would have reduced that cost.”

He said that investors should interpret their fiduciary response broadly.

“I hope those who are investment managers think about the consequences of how they invest,” he said. “We entrust much power to the people who makes these decisions.”

Panellists discuss the possible impact of corporate failures on European banks coming out of the pandemic, and note central banks juggling act around digital currencies; unable to halt their arrival but still having to marshal progress and ensure the technology doesn’t weaken financial stability. The session examined the structural trends in the financial sector that have been entire amplified or altered by the COVID crisis.

The pandemic has triggered a re-leveraging event amongst governments, firms and households with important consequences for two-way risk, said Jeremy Lawson, chief economist, Aberdeen Standard Investments. Speaking at FIS Digital 2021 he said current leverage levels are a gateway to higher inflation or an entrenched lower for longer interest rate regime. He also described the current financial backdrop as unstable with fatter tails around inflation.

“It complicates how we think about the environment,” he said.

Lawson highlighted the importance of monetary and fiscal coordination, stressing the importance of fiscal policy now rotating from support to long-term stimulus. Outside the US where large public investment plans are underway, he said he was sceptical if this rotation would occur. He added it wasn’t clear if policy mistakes of the past wouldn’t be repeated.

Lawson told delegates to expect a structurally subdued inflation environment going forward, with European economies, Japan, Australia, Korea and China struggling to meet long-term inflation targets. He argued that the current factors pushing up inflation like supply bottlenecks in goods will ease when demand moderates and supply catches up, but he noted the challenge for investors dis-entangling the cyclical and structural forces impacting inflation.

Stefan Dunatov, executive vice president strategy and risk at British Columbia Investment Management Corporation suggested service sector inflation might be capped by long term trends in technology disrupting global services. In response, Lawson noted that although remote working in the services sector could push down prices, the pandemic has also pushed up pay levels amongst low skilled workers.

Fellow panellist Professor Thorsten Beck, Professor of Banking and Finance at Cass Business School and a research fellow at the Centre for Economic Policy Research flagged the likelihood of divergence between different regions. He said he expects interest rates to remain lower for longer in Europe, but sees inflation risk in the US and UK. However, he qualified that both these inflation shocks could be transient. Beck said today’s corporate over indebtedness is linked to optimism around the vaccine and recovery.

Beck flagged key risks around banks’ ability to weather corporate failures. People are confident in the banking sector, he said but warned of potential storms ahead. While some firms can handle their debt levels, others may have to restructure, and others may not make it at all.

Corporate insolvency laws vary across Europe with different levels of efficiency regarding restructuring. It means corporate debt could end up on bank balance sheets. He said this combination of corporate and bank fragility could be confined to certain geographies and will depend on the regulatory and policy response. There is a lot of space for mistakes he said, but added that policy makers in Europe have a new level of coordination following the GFC, and said that decisions will ultimately be taken at the political level.

Cryptocurrency

David Veal, chief investment officer of the City of Austin Employees Retirement System asked panellists if they expected structural changes in the financial system, and if central banks will introduce new policy tools to navigate the new environment. It turned the conversation to cryptocurrency, where panellists responded that although central banks have opened the door to changes in the payment systems, they are reluctant to cede control or decentralise finance because of concerns around financial stability. Central banks are looking closely at digital assets and involved in their evolution to ward off disruption from the emergence of private digital currencies.

Any transition from a heavily banked system or signal of a changing dynamic will see investors re-evaluate how they value the banking sector. Any transition amounts to a highly complex exercise for central banks which can’t halt the arrival of new technology, but have to marshal its progress and ensure it doesn’t weaken financial stability.

Beck also noted how the growth of corporate funding by non-banks can make monetary policy less effective. Linking back to earlier points on bank fragility, he said it was important to create cross border banks rather than silos. Regarding digital currencies, he said central banks are reacting with a defensive regulatory response that allows fintechs to have a role in the payments system, but also protects traditional finance. Noting how China has gone further in limiting the size of big tech companies, he said the regulatory response (in the west) will be careful and cautious: expect a change but not a revolution, he concluded.

Bridgewater’s co-CIO Bob Prince explains the perils of MP3 and suggests investors need to think differently, shaping strategies around cash-flow yields – connecting equity cash flows to stable sources of spending in the economy.

Today’s MP3 world where monetary and fiscal policy work hand-in-hand has resulted in important secular shifts. Speaking at FIS Digital 2021 Bob Prince, co-CIO at Bridgewater told delegates that MP3 has changed the way investors should think about bonds, stocks and portfolio construction. This against the backdrop of zero interest rates, a political and cultural pendulum shift from right to left, growing divergence between China and the US and increasing ESG integration.

Prince explained that the way monetary policy is implemented has changed compared to recent decades.

“Under MP1, interest rates were the driver, used to change levels of borrowing and lending to alter spending habits – you used to see 300-500bps interest rate changes to move an economy,” he told delegates.

“Under MP2 which kicked-in a decade ago, QE became the main tool whereby governments printed money to drive up asset prices. Now under MP3, monetary and fiscal policy is used hand in hand.”

Under MP3 the Fed borrows and directs money into the economy wherever it wants, supplementing incomes and raising spending.

“Now governments are trying to supress interest rates so as not to offset the stimulation from the fiscal side,” he explained. “It means that the goal has become supressing and holding interest rates stable so as not to conflict with the person on the accelerator.”

This shift in linkages has big implications, he warned.

For example, it has led to the transfer of wealth from asset holders to debtors since pushing interest rates down provides long term debt relief. Yet one person’s debt is another person’s asset.

“We are the asset holders and we are on the wrong side,” he told delegates, citing the wealth destruction across cash and bonds over recent years. “Holders of cash have lost their purchasing power and seen a reduction in the value of their money and the same process is also happening in bonds. Cash and bonds are no longer a saving vehicle.”

Prince explained that fiscal stimulus raises nominal incomes and enables governments to target their spending. Governments can send cheques wherever they want, he said. Indeed, fiscal policy gives real freedom. Yet although MP3 has the ability to raise productivity in the long run and can resolve wealth inequality, success also depends on the quality of decision makers.

Here he flagged central banks now only playing a support role to governments. He said governments are now heavily involved in markets, adding we would not have negative bond yields if it was a function of the market. Negative bond yields are a policy directive of governments he said, adding that the distribution of liquidity by fiscal authorities simularly distorts asset prices.


Time to think differently

Next Prince explained that raising nominal incomes raises cash flows throughout the system with implications for assets in the real economy like equity and real estate. Cue his argument for investors to think differently and get returns through cash flow yield. He suggested investors connect equity cash flows to stable sources of spending in the economy, explaining that it is possible to create a tracking portfolio of stable sources of spending in the economy. Stable cash flow streams still get price volatility, but it is possible to hedge this. He added that value managers typically offer stable cash flows that are less vulnerable to economic cycles.

Later, in conversation with Stephen Gilmore, chief investment officer of New Zealand Super Fund and Tom Tull, chief investment officer of the Employees Retirement System of Texas, Prince explained that historically interest rate policy impacted a whole country. Now, since governments are directing cash flows into specific parts of the economy, investors can target what assets will benefit from a higher or lower income.

And rather than look at the market through a public or private lens, Prince suggested investors just think of investments in terms of cash flow.

“Just think, what is the cash flow of the asset and what are its characteristics,” he said, adding that public and private assets are on the same plane. He said this amounted to another degree of freedom and that investors should think of just diversifying their cash flow streams.

As to whether investors should similarly lose any distinction between emerging markets and developed markets, he described this approach as challenging. Emerging markets don’t have zero interest rates, moreover zero interest rates, deficits and printing money, doesn’t exist in Asia. It makes investment in Asia another source of diversification and he urged investors to move between east and west. China has an independent monetary system that is driving the whole region.

“There is risk there, but it is a different risk,” he concluded.

Investors need to ensure they are accessing the new economy if they are to benefit from the growth story that drives emerging markets returns. Investors at the Fiduciary Investors Symposium talk about how they allocate to emerging markets.

Just under half of the companies in emerging market indexes are low growth old companies that typically miss out on the key growth trends that have been unleashed by digitisation and the smart phone according to Sara Moreno, managing director at US investment manager Jennison.

Moreno explained that the digital transformation at ground level in emerging markets is driving opportunities. It is also behind financial inclusion across populations excluded by the traditional banking sector. She said China led the revolution, using e-commerce to increase inclusion and allowing companies to market directly to consumersMark Walker, chief investment officer at Coal Pension Trustees, a £21 billion pension fund for employees in the United Kingdom’s former coal sector, said his focus is on trying to avoid distinctions between emerging and developed markets.

Walker views allocations through a regional lens and has a growing allocation to Asia where he described China as the driver.

“We are less focused on market cap and more focused on our split between regions,” he explained. “If you only look at equity market cap as a signpost to future growth opportunities, you are likely to be disappointed.”

The pension fund’s investment in China began in the private equity and venture space with 10 per cent of the fund’s private equity allocation now allocated to China. The portfolio has also shifted away from accessing China via Hong Kong since establishing an A Shares portfolio in 2019. The challenge is ESG integration, explained Walker.

“If you look at the data, carbon emission intensity in emerging markets comes particularly from China; China is bigger than other markets.”

Regarding ESG, Jennison’s Moreno advised not painting China with one brush since underneath there are many companies integrating ESG.

Healthcare

One of the most important secular growth trends in China is in healthcare, where the aging population is also wealthier with money to spend. Moreno said that the pharmaceutical industry is being led by innovation and Chinese talent in the sector is increasingly returning from abroad. Lots of scientists are graduating out of China too, she said.

Areas of focus include developing drugs to fight cancer where China has particularly high levels of the disease, and telemedicine. She noted a cross pollination between Chinese healthcare companies and multinationals too.

Coal Pension Trustees, which counts its two biggest exposures in China to healthcare and technology sectors, said geopolitical tensions also pose a risk.

“The last thing we want is to put our money in and not be able to get it out, ” said Walker, noting a recent spike in risk from authorities questioning sending money outside China during a recent Chinese private equity fund distribution.

“You have to think what might change from a political policy perspective,” he said describing the biggest risk as permanent loss of capital.

“We can’t know the minds of politicians” he said, so his focus is on individual investments at a micro level.

Elsewhere in emerging markets investors see exciting opportunities in India despite the impact of COVID.

“The market is very forward looking; although emerging economies lag the recovery growth will accelerate,” predicted Moreno.

In India, strategy is also focused on bottom-up stock picking and she noted India’s high level of savings, good demographics plus a reform agenda and interesting infrastructure cycle all offering opportunities.

“India has taken a step back, but longer term the fundamentals haven’t altered,” she said.

Walker said investment opportunities in emerging markets depended on – and highlighted the importance of – a global vaccination program.

“There has to be a global solution; we need to work on getting everyone vaccinated,” he said.

In another observation, Moreno said that emerging economies are no longer export led.

“For sure, Chinese growth has fuelled commodity, export-led demand in many emerging economies but now emerging markets need to focus on local growth.”

Here she said, some economies are more successful than others.

“It involves leveraging their demographic and education systems to digitise at a faster pace.”

One of the silver linings of the pandemic has been that location is not a restraint on investment when it comes to investing in venture capital with investors seeing venture opportunities springing up in all corners of the world.

Leading an expert panel discussing venture capital investment at FIS Digital 2021, Todd Ruppert who’s current roles include chair of INSEAD endowment following a 27-year tenure at T. Rowe Price, said investors should tap the asset class since many companies are staying private for longer. Moreover, investors who have backed start-up innovation have played a significant role in helping find solutions in healthcare and technology through the pandemic.

Magnus Grimeland, chief executive at Antler described the VC firm’s mission as helping grow companies that will help build a better future. Antler finds founders, and backs individuals, to build companies from scratch and deliver strong investor returns. He said trends in the VC space show really high returns from the top decile funds but enduring volatility. He also described a tremendous amount of deal flow, investors with dry powder at the ready and fierce competition to invest in the best companies.

He also noted how regulatory changes mean more capital is flowing into the asset class. At Antler strategy is focused on the very early stage, finding entrepreneurial founders in research teams at institutions or tech companies seeking to build new companies from scratch.

“We find people who otherwise wouldn’t be an entrepreneur,” he said, noting that this approach also skews away from the California and China bias to finding companies coming out of new ecosystems.

Fellow panellist Mitchell Hammer, investment associate at Princeton University Investment Company, told delegates that the endowment began investing in venture capital in 1981, and that venture is now a meaningful part of the overall asset allocation. The fund has a 30 per cent allocation to private equity comprising pre-seed and venture to buyouts, currently overweight at around 40 per cent.

“In many ways, venture is the perfect asset class for endowments,” he said citing the fund’s ability to allocate long term.

Similarly, Todd Cohen, director, investment office at New York Presbyterian Hospital described the fund’s positive view on venture in a relatively new program. Several years ago, the allocation was just a small corner of the portfolio, now it is increasingly central within private equity and the fund is increasingly taking the allocation out of buyouts and putting more into venture. Venture will be the risk generation for the portfolio going forward, leading out-performance.

“We are long term bullish; some valuations give us reason to pause, but we will continue to allocate into the foreseeable future,” Cohen said.

Panellists reflected on how venture opportunities are springing around the world. Although San Francisco and China will continue to produce great companies for years to come, more cities across the US are developing hubs for fast growing companies like Boston, Miami and Seattle. Outside the US, panellists listed Stockholm, Berlin and Singapore as venture hubs alongside Vietnam, Japan and Korea.

Grimeland also expressed excitement in Africa, noting great companies coming up, just a few years behind Southeast Asia. Adding to the list, Cohen noted opportunities in Israel while Hammer said that one impact of the pandemic (and travel ban) has been to make geography less of an issue when backing founders.

“We increasingly see managers outside their typical locations; location is not a restraint on investment,” he said.

Panellists also noted the broad similarities between selecting entrepreneurs and selecting managers. Antler seeks to fund entrepreneurs and founders with drive to solve a problem and grit to press on when they hit barriers, citing Tesla and AirBNB’s founders as entrepreneurs with this flavour of true grit. The ability to execute is another sought-after characteristic.

“We look for a history of execution,” said Grimeland, noting that often founders have great ideas but can’t execute.

Panellists agreed that VC can be a hard way to make money but that it should have a place in a diversified portfolio. Moreover, they also cautioned on the volatility between high and low venture fund performance. As a stand-alone allocation it is buyer-beware, but as part of a diverse portfolio venture adds a lot of value.

Next the conversation turned to start-ups listing via SPACS, or Special Purpose Acquisition Companies, one of the hottest trends in investment circles. Grimeland described the trend as holding positives and negatives for start-ups.

On one hand, it provides these companies with a new source of capital. On the other, and less positively, it has resulted in some companies going public too soon and put under pressure from management teams in the SPAC. It can lead to founders worrying more about shifts in the stock price than building a great business, he said.

Echoing these sentiments, Hammer suggested founders ensure incentives are aligned and described the SPAC craze as a symptom of equity market exuberance that could lead to founders and investors making poor choices.

As for VC manager selection, panellists counselled on the importance of diversity across geographies, ideas and advisory networks for a different perspective.

“It is difficult to get into our program,” said Hammer. That said, he noted that the endowment doesn’t look at track record that much, and invests in first time funds based on their team strength.

Panellists also touched on the importance of diversity in the founder pool, and the dangers of missing talent.

The interruptions to work and the revolution of technological tools in 2020 have changed thee way investors assess funds managers. A discussion around due diligence in a lockdown environment finds  that allocators have tended to stick with existing relationships through the pandemic making it difficult for managers approaching investors for the first time to form relationships and win mandates.

Technology will play an increasingly important role in manager due diligence, said Rick di Mascio, chief executive, Inalytics, speaking at FIS Digital 2021.

Lockdown has made building manager relationships and trust more challenging; pension funds struggling to carry out due diligence on managers without the ability to look them in the eye can use technology to provide a valuable new lens.  Inalytics uses technology to verify what managers say, providing the ability to get behind what pension fund teams are being told. Data plays a role by allowing investors to see from an evidence base where a mangers key strengths and weaknesses lie, he said.

Quant analysis can add value to investment decisions and enables better monitoring of managers, agreed fellow panellist Dev Jadeja, head of investment due diligence at the Local Pensions Partnership Investments where he is responsible for researching and picking managers.

However, he said it was important to step back and ensure the right filters are applied and that human judgement calls have an equal weight in the investment process. A qualitative overlay is important because quant analysis only gets so far, he said. Moreover, he said that most data is available in public markets making the use of quant analysis in private markets trickier.

Luba Nikulina, global head of research at Willis Towers Watson argued that new working practices wrought by the pandemic have bought positives and negatives to manager selection. On one hand, asset managers availability has increased because travel has ended, increasing productivity.

It is easier to set up meetings, she said. Adding that although meeting remotely makes it difficult to assess culture and other soft factors that shape investment decisions, screen-based meetings can also provide valuable insight into a manager’s home life.

Nor does she believe the flow of ideas has slowed. She added that WTW puts qualitative due diligence ahead of quantitative analysis but said investors that failed to take advantage of the availability of data would be making a mistake. She noted however that due diligence on hard assets has been much more challenging over the last year.


Two sides of the same coin

Di Mascio said drawing on data helps addresses personal bias and urged delegates to view quantitative and qualitative analysis as two sides of the same coin, acting in support of each other. Data creates the environment to ask the right questions.

For example, the insight it provides on emerging market managers’ performance ensures investors start with a strong cohort from which to base their selections, speeding up the process and avoiding any hoodwinking on track records.

Data has the impression of being hard edged and in conflict with qualitative analysis, but he said it is particularly valuable in a selection process where there is no relationship or monitoring. You can get behind the numbers and ask real questions, he said.

Looking to the future, Jadeja predicted that travel in person will halve. Positively, he reflected how remote meetings have removed many of the challenges of face-to-face meeting; constant travel to onsite meetings comes with pressure and logistical issues around getting everyone in the room.

In contrast, remote meetings allow investors to target who they speak to. That said, he acknowledged the challenges of getting to know someone personally remotely. You are not just investing in a product he said, you need to know the other side and they need to know you, and this is difficult via video.

The conversation turned to how the pandemic has stalled hiring of new managers.

Jason Morrow, deputy, chief investment officer at Utah Retirement Systems in the US said the fund has allocated mainly to incumbents over the last year.

It is easy to allocate to long relationships in a downturn, he said going on to reference how the Fed backstop repriced assets triggering a surprisingly quick reversion. Allocating remotely bought challenges around getting comfortable, but the fund was doing everything it could from a due diligence perspective.

“We can get face time with everyone we need to and focus on site where we need to,” he said.

Indeed, panellists agreed that small, start-up managers have struggled to get over the line during the pandemic. Many investors have stuck with existing managers because it has been more difficult to get comfortable with new teams.

For example, Jadeja said LPP would not have invested with a new manager if it felt key-man dependent and had never met them.

Where the fund has deployed to a new manager, that decision was based on having monitored them for a long time.