As trade wars between the US and China dominate financial markets, Princeton historian Stephen Kotkin has assured pension funds that the world order that has been in place since World War II remains intact.

“The notion that the US is on the decline is complete bunk,” said Kotkin, speaking at the Fiduciary Investors Symposium at Harvard University this week. “It’s one of the most idiotic things that you hear relentlessly.”

The professor of history and international affairs at Princeton University said that despite the chaos in the White House under US President Donald Trump, there was no other country that came close to matching America’s military, economy, currency or its number of allies. He also said that China’s economy is not the “giant” that everyone thinks it is, despite its growth.

“If you add up the US economy with its allies, its overwhelming,” the academic said. China “knows this fact, they know that the US is still in the driving seat. China is not this insurmountable threat, it is instead something that needs to be dealt with,” he added.

His comments came amid media reports that Trump’s administration is weighing whether to restrict pension fund investment into China. Michael Trotsky, chief investment officer at the $75 billion Boston-based Mass PRIM later told delegates at the Harvard Symposium, that no institutional investor would support a restriction.

Kotkin said that the US institutions designed to keep the government in check were a lot stronger than people think, as evidenced by the launch of the impeachment investigation into Trump last month. He added that there is a loss of confidence among American elites because globalisation had failed to unite the world as they had predicted did not translate to a “systemic crisis” nor “equate to a US decline.”

As for the future of liberalism, Kotkin said the rule of law, separation of powers and open dynamic markets without monopolies still works in practice but it needed to be kept in check and cultivated.

“There is no system which is superior,” the professor said. “It can be corroded from the inside if not properly tended … but the instruments are still available for us to fix things. It’s not about getting rid of Trump, it’s about where did he come from in the first place.”

He also warned that the sentiment amongst voters that installed Trump to the White House and saw Britons vote for Brexit remain in place today, despite the lies that were peddled by politicians on both sides of the Atlantic.

“The politics are fake but the sentiments are real and that is a very important point,” he said. “They are all still there. You can argue that they are deluded, but there were 65 million people who voted for Trump and they are all American citizens.”

So what about climate change which is a constant source of controversy within the Trump administration? Kotkin told delegates that there was no government who will be able to achieve the vision that the people have for them. He said whether a country joins the Paris Accords on greenhouse emissions, or leaves as Trump has done, it will have little impact on the behaviour of companies.

“You can’t solve those problems without the private sector,” he told the pension fund delegates, when asked about ESG investing. “Your capital is invested in private enterprise.”

The solution to slowing global growth lies in a new way of thinking, said Stephanie Kelton, a leading Modern Monetary Theory (MMT) scholar at Stony Brook University and senior economic advisor to presidential candidate, Senator Bernie Sanders. Today’s rock bottom interest rates and further rounds of QE show that Central Banks have run out of stimulus and policy levers, leaving them without ammunition ahead of the next recession. Monetary policy is no longer enough, and a more ambitious approach is needed.

“Let’s change the way we think. MMT asks you to reset your thinking,” she told delegates at the Fiduciary Investors Symposium at Harvard University.

MMT’s central premise is that governments are in control of issuing their currency – and can ultimately issue as much as they need.

“In the US, the Federal government has given unto itself the exclusive right to issue the dollar,” she said.

“This distinction changes everything because the issuer of a currency can’t go broke.”

As sole manufacturer of dollars, the US has a monopoly over issuance and can never run out or be left unable to pay bills, she said. This could manifest with the Federal government directly crediting companies to build infrastructure or aircraft carriers; universities to expand labs and fund research, or directly financing universal medicare and tuition fees.

Moreover, the government doesn’t have to tax or borrow to fund itself in this new expanded policy space. The idea of taxing people to pay for spending “leads down the wrong path.”

Instead, Congress is completely within its rights to write and pass budgets.

“Congress has the power of the purse,” she said. “What we are saying is that there is space available to us that we don’t take advantage of; we don’t run our economies at their full potential. We restrict the use of the fiscal policy lever.”

Speed limits

There are limits to this expanded policy space, however. They are not financial but are held in the real economy. Every internal economy has its own speed limit and can only go so fast, and produce so much, before inflation kicks-in. Currency issuers must therefore recognise how much fiscal space they have and not push too far, she said.

“The relevant constraint is inflation, not solvency. Governments should recognise the limits are real and respect them.”

Next, she expanded on the other central pillar to MMT thinking whereby governments don’t tax to spend. She told delegates that taxes should be used not to fund the government, but to take money out of the economy to reduce inflationary pressure and reduce the income available to spend.

“It is about subtracting spending power because too much spending will lead to inflation. Taxes are a release valve.”

For example, in 2008 when the wheels came off the global economy, the US government had capacity to spend much more.

“Everyone understood there was enough slack in the economy to absorb more spending without the need to put up taxes,” she said.

In contrast, today there is more of a debate about how much slack there is in the economy, and if spending would trigger inflation and merit tax increases.

“Would some portion of that spending need to be off-set by raising taxes to mitigate inflation risk? The debate changes as an economy moves from slack to less slack,” she said, adding that this was not new thinking. Back in the 1940s policy makers said taxing for revenue was “obsolete.”

Deficit shame

There is no irresponsibility to running a budget deficit. “My deficit is your surplus,” she said, explaining that the surplus is there because of the “government’s generosity in running a fiscal deficit.” As government deficits increase, and the negative number grows, so the private sector’s balance sheet gets bigger. For example, the government deficit exploded after the financial crisis, producing a surplus that allowed the financial sector to repair its balance sheet. “The recovery took longer where this didn’t happen,” she said.

Deficits require borrowing that adds to the national debt over time, but under MMT thinking if governments are in charge of their currency issuance – and are issuing in their own currency – it is not a problem.

“National debt is nothing more than a historical record of what governments have spent and taxed away,” she said.

Today, political discourse around the concept of national debt scares people, and it would be easier to swallow if it wasn’t labelled debt. “I want people to see a headline that national debt is at an all-time high but take a breath and know that it is ok,” she said, warning that the process should never be referred to as printing money.

Balanced Economy

The goal under MMT thinking is a balanced economy, not a balanced budget. “MMT says focus on the proper outcome,” she says. If inflation creeps higher, governments will know they have spent too much.

“If the economy can handle [additional spending] without inflation, what is the problem?” If a government spends more than it collects, that does not make it fiscally irresponsible.

In another seam of thought, MMT sees trade in real resource terms. “If you get cars in exchange for wheat you are not getting killed,” she said, in reference to President Trump’s lambasting of Japan for its unfair trade with the US. According to MMT thinking, this is infact a good deal. The idea is to send abroad what we can’t use, and the gain is what we import, she explained. “It is favourable when you gain more by sending out less,” she said. “We are taking more of their stuff than what they are taking of ours.”

Referencing pension deficits, she said the government was in a position to ensure “cheques were always mailed out” and that in accordance with MTT thinking any deficit was “not the issue.” More important is how you build an economy that assures that real assets are created so that pensioners can keep spending.

“Our demographics are changing and that is leaving behind a smaller population of people producing.”

Now the onus should be on creating a system that ensures enough real assets to allow continued spending without causing an inflationary spike.

“If you want to make university tuition free, if you want to spend on infrastructure and universal medicare, it is a question of whether you have the real resource capacity to handle that new spending with contractors, access to steel, architects and professors. This is what matters. These are our real resources.”

 

See also: The dangers of MMT: a counter argument

 

I chat with John, the founder of Quantopian, on how he got started in quantitative finance, where he sees the industry evolving and how he created a global community of intrinsically motivated coders to create unique solutions to the greatest intellectual game on earth.

Nothing on this podcast is to be considered investment advice or a recommendation. No investment decision or activity should be undertaken without first seeking qualified and professional advice.

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Nothing on this podcast is to be considered investment advice or a recommendation. No investment decision or activity should be undertaken without first seeking qualified and professional advice.

Low for ever, a risen China and climate change, are just some of the 10 changes set to sweep through the investment industry in the next 10 years, said Cyrus Taraporevala, president and chief executive of State Street Global Advisors. In his opening speech to 85 asset owners from 20 countries responsible for a combined $9 trillion assets under management at the Fiduciary Investors Symposium at Harvard University, Taraporevala described a brave new world where only the fittest survive.

Deflationary pressure will stretch into the future with low for long becoming low for ever – or at least in the lifetime of conference participants. “Deflation, not inflation is the biggest challenge,” he said. Despite historical economic expansion in the US, wage growth and productivity remains low. Low rates of unemployment in developed markets hide a continued decline in labour force participation, especially in the US. Despite continued monetary stimulus, Central Banks are struggling to meet inflation targets resulting in a poor macro backdrop for asset prices in the years ahead. Around a quarter of global government debt currently trades at negative interest rates.

“What if this grew to 50 per cent by 2029?” he asked. It leaves investors needing to take on more risk and complexity in their portfolios to meet savers’ objectives, resulting in a keen focus on fees where every basis point matters.

Technology will transform every corner of the investment industry, impacting how investors research, trade and build their portfolios, creating industry winners and losers. The quest for data and technology is the new industry arms race, determining who comes out on top, he said. This will result in even more pressure on fees, highlighting how much of a return is genuine, skills-based manager alpha. Data and technology will also drive a move away from fundamental stock picking strategies to data driven systematic strategies, he predicted. However, Taraporevala does not believe machines will replace humans just yet. Instead the industry will focus on recruiting data scientists and software engineers to ensure survival into the future, resulting in fierce competition for talent with the tech sector.

By 2029 the largest asset manager in the world will be Chinese, Taraporevala predicted. Although US asset managers today are much bigger, Chinese asset managers are growing at break-neck speed. Assets under management in China will see an annual growth rate of 17 per cent over the next 5 years.

Factors driving this growth include more funds flowing from China’s shadow banking sector into mutual funds and digital disruption, as fintech firms leapfrog western competitors and move into the heart of asset management. Chinese asset managers could also buy foreign groups as the country moves into the global capital markets, marking the biggest regional shift in history of asset management.

As DC continues to replace DB, so the onus on individuals to save for their retirement will grow. Moreover, as people live for longer, retirement periods could double. This will demand change in the decumulation phase to ensure people “don’t run out of money,” in turn triggering different retirement income solutions. These could include LDI-based strategies in individual nest eggs, dynamic drawdown strategies and income annuities to manage longevity tail risk, as well as governments stepping in with new securities to hedge tail risk, the use of behaviour economies and new technologies to personalise solutions for individual investors.

Come 2029 the balance of assets in index funds and ETFs compared to active allocations will have flipped in favour of passive in a trend that spreads beyond equity to fixed income. It will be driven by the ability to analyse true sources of alpha.

“In 10 years time these skills will be razor sharp,” he said. “Active managers will be disrupted out of existence.” Benchmark huggers, who still account for a large portion of the industry revenue pool, won’t be able to hide anymore. He said this will improve the quality of active management and prioritise the importance of asset allocation, making this the “new alpha.”

Over the next decade ESG will no longer be a standalone. “A company’s ESG rating will be as important as its credit rating.” Taraporevala also predicts investors will increasingly focus on the long-term with the emergence of a “patience premium” whereby investors reward companies that take a long term focus and penalise those that don’t. Compensation will focus on the long term, and asset managers will offer investors enhanced commercial terms for long-term strategies.

He also predicts that retail investors will be able to invest more in private markets, which they currently struggle to access. While DB funds have found rich returns in private assets, DC funds have struggled. The decline in the number of companies going public is locking out DC savers from an important seam of wealth in a “de-democratisation of investment.”

Regulation will adjust so retail investors can access private market opportunities, he predicted. In the future investors will be able to choose from a wider investment choice to create personalised portfolios based on their own preferences.

Taraporevala’s final prediction focuses on climate change “the biggest challenge for our industry and human life. Here he forecasts that only those investors able to “take seriously” the value destruction potential of climate change will survive.

The industry is still viewing climate change in the context of customer preference, not thinking about it through investment values, he said. Ten years from now the value of investors’ holdings will be depleted because of the ravages of climate change. We as investors have a genuine opportunity to deploy capital in a way to support climate solutions and embrace opportunities, he concluded.

“We take the S in ESG very seriously,” said John Adler, mayor’s trustee and advisor to the other mayoral appointees at New York City’s $200 billion five retirement systems. Speaking at the Fiduciary Investors Symposium at Harvard University, Adler highlighted the critical role investors play in protecting workers’ rights and ensuring a just transition as the global economy adapts to the implications of climate change.

One area this is visible in strategy at NYC Retirement Systems is a responsible contractor policy within its real estate allocation, and broader real asset portfolio. For example, the system insists building and cleaning contractors pay their workers well and don’t “union-bust,” said Adler. These policies are long-standing; more recently the funds are working to update them and apply them more widely. This includes more due diligence on how its asset manager cohort (the fund outsources all asset management) are integrating social and labour issues.

“Our goal is to create sustainable value, and we can’t do this with managers who exploit workers,” he said.

Now due diligence at the fund involves scrutinising asset managers for any ongoing or historical disputes with workers in the assets they manage.

“Managers will be asked tough questions by our trustees,” he warned, adding that they would get questioned “closely” on issues in their portfolio that involved anti-worker behaviour. Now the retirement system is also pressing its managers on unfree labour and labour rights in supply chains, he said.

Carol Gray, board member at IFM Investors, illustrated how the Australian-headquartered asset manager is working to protect labour rights and ensure the S in ESG in its portfolio.

“It is only possible to ensure superior returns when we look at workers and their rights,” she said. When the manager bought the Indiana Toll Road in 2015 it embarked on an aggressive $200 million investment to right a poor safety record and end road accidents. This included hiring a new CEO, aligning renumeration with safety, and retraining employees in a process that involved prolonged negotiation with the labour force. Indiana Toll Road was recently voted the safest road in Indiana.

Just Transition

Integrating the S in ESG will increasingly focus on ensuring a just transition, whereby the risk to labour and jobs is justly navigated as the world moves to a low carbon economy. It is particularly important since green jobs don’t “float every boat,” warned chair of the session David Wood, adjunct lecturer in public policy and the director of the Initiative for Responsible Investment (IRI) at the Hauser Center for Nonprofit Organizations.

There is a tendency to forget the implications of the transition to a low carbon economy on workers in the carbon sector, added Damon Silvers, director of policy and special counsel for the AFL-CIO, outlining the importance of the task ahead. Wealthy people, who “don’t dig coal for a living,” forget that the lights are still kept on by coal in many parts of the US, he said.

He also flagged that in the US, the pension funds for these workers are often underfunded. Today’s deflationary economy, where workers’ wages are kept “soft” is another key factor impinging on the rights of labour and fostering future instability.

“We need to build a high wage economy. There is always someone saying we can do it cheaper, but minimum wage jobs don’t work, he said.

Vonda Brunsting, program manager for  the IRI’s Just Transition Project added that a policy response to counter climate change will put even more pressure on the need for a Just Transition.

At NYC Retirement Systems, managing climate change within the context of a just transition is coming centre stage in its recent pledge to increase investment in climate solutions. For example, recent strategy to ensure buildings in its portfolio are energy efficient by 2030 must include protecting jobs and workers’ rights. Elsewhere, forthcoming investments in offshore wind will focus on how construction of the platforms will ensure “good, permanent jobs,” said Alder.

IFM’s purchase of Australian utility Ausgrid encapsulates the challenges of climate change impacting workers, explained Gray.

IFM bought the utility from the Australian government in 2017 in an investment that led to 800 jobs going. IFM set about consulting and engaging with the work force in a “fair and transparent” way that set out the challenges, and provided mechanisms and tools for employees.

These included mental health counselling and financial and career advice a year before any redundancies. For remaining workers, IFM introduced new roles linked to performance that allowed employees to boost their income. “It does take time, start now,” she concluded.