Conversations with Institutional Investors

In this episode of the [i3] Podcast, Conversations with Institutional Investors, we speak with Con Michalakis, Chief Investment Officer of Funds SA, which is a $50 billion investment manager for South Australian public sector superannuation funds and other approved state authorities. Con is well-known in the Australian investment industry, not in the least, for his outspoken views on a variety of investment topics, including gold, crypto and asset allocation, much of which has historically been disseminated through his notorious Twitter or X feed. We trace back to Con's roots as a quant and value investor, and discuss how this continues to shape his current investment philosophy, despite the fact that he calls himself now an ex-quant. We discuss the changes in governance and the implementation of a TPA lite framework at Funds SA, while we also touch upon the turmoil in private credit. Finally, Con admits that he was wrong about innovation and disruption being the most dangerous words in investing, while he stands firm on his dislike for crypto and dynamic asset allocation. Enjoy the show! Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of Podcast with Con Michalakis, CIO of Funds SA 03:00 I'm more of an ex-quant these days 05:00 In my heart, I'm still a value person and a contrarian; I like to invest in areas that are unloved or where capital is scarce 09:30 When I joined Statewide, the GFC hit. It was the worst I'd ever seen and Statewide was in trouble 12:00 By the time we merged with Hostplus, we were one of the top performing funds in the country, but that first six to nine month period was hell 13:30 Covid was short in terms of the market bounce back. What was hard was early access to super 14:30 Governance changes at Funds SA; "There were a lot of meetings here at Funds SA" 16:00 Having a risk management lens and no more siloes is a key part (of the new governance structure) 16:30 You used to have a photo of Trump on your desk to remind you of risk. Do you still have that? "No, I see enough of him!" 18:30 Making changes to the investment committee 21:30 We cut our tracking error budgets for Australian and global shares down by half to almost two-thirds. We've introduced passive, we've introduced quant systematic, and we have an active sleeve. You can't be full one or the other. 23:30 The world has changed: there is faster money, there is pod shops (fund managers that distribute capital across numerous semi-autonomous teams (pods) led by individual PMs) and there is instant reaction 24:00 You have to embrace dispersion across styles and managers 27:00 Implementing "TPA Lite". 27:30 "The idea that you are going to do dynamic tilting, or that you are some sort of macro guru, I call that a Comic Con of Asset Allocation. Everyone dresses up in their favourite character." 30:00 There is a slight survivor bias in the group of TPA proponents that the added value is based on 35:00 You said previously that innovation and disruption are the two most dangerous words in the industry? "I was wrong". 39:00 There was a shoe company in the US that was going bankrupt and pivoted to AI and the stock price went up 5x. Clearly, there is some nonsense going on. 43:00 Crypto; if you want to have it as a digital Ponzi scheme, go for it. 45:00 At Funds SA, we have zero Australian private credit 46:00 Some sort of global small/midcap manager, who has never done private credit in their life, is saying it is going to die. What do they know? 52:30 My worst investment? Probably, single strategy hedge funds. 55:00 Con's Twitter/X presence Full Transcript of Episode 135 Wouter Klijn 02:56 Con. Welcome to the show. Con Michalakis 02:57 Good to be here. Thank you for inviting me. Wouter Klijn 03:00 No worries. So I want to take you back all the way to the beginning to get sort of a sense of your thinking on investments. And I believe you studied mathematical science in Adelaide, then went on to do a Master's in financial economics in London, and ended up at the Oxford Said business school. So there's sort of a combination of, you know, purely mathematical thinking, but also strategic thinking. How has that shaped, sort of, your outlook on investments? Con Michalakis 03:28 Yeah, sure, so I would say I'm more of an ex quant now. I mean, it's a long time ago since I did option pricing and was a quant So, but still, you know, numbers guy in terms of how I think about it, and to be, to be honest, you know, the younger people that I've worked with, whether it was at Statewide, Hostplus, at Funds SA, to say they're brighter, they're more technical, they're more up to speed, so they've way taken over. So I would, I would call myself ex-quant. I still think in terms of numbers, still, you know, pretty Stemmy. And there's a bias across all three firms that I've worked for for sort of STEM type thinking, you know, science, technology, engineering, maths, the but you can't just all have one I have now believe that you can't just be one grade. I still think you can take stem people and teach them finance. It's hard to take finance people and teach them stem but you need, you need all sorts. And some of the best thinkers are not necessarily the way they think and critical thinking. They're not always just stem types. I've learned to embrace more diversity in that and interesting some of the managers that we've invested in, you know they come from interesting historians. So you got a critical thinking is more important. But, yeah, definitely bit of a buy. As the stem. Wouter Klijn 05:01 Yeah. So how would you describe your investment style now? Then, because, of course, you mentioned three firms you you worked at Pezna for a while, which is a value shop, a deep value shop. Do you still have some of that thinking as part of your DNA, or are you looking more as sort of a contrarian investor. Con Michalakis 05:22 I think in my heart, in my heart, I'm still a value person and a contrarian like to invest at the margin in areas that are either unloved or where capital is scarce, because highly likely the risk is that hasn't been priced in, and therefore there's a trade off. But definitely call it the maturity cycle, diversification, the ability to invest long term and make sure you have investments across a broad, strange range of strategies and asset classes, and not being sort of, you know, across the cycle, not having one dominating I think, is very important. I've learned that lesson, and it's a lesson that I know, but in my heart of hearts, if it's contrarian in value, it's probably my kryptonite. Wouter Klijn 06:19 Yeah. So, so you learned those lessons. Can you give an example of some of the things, some of the trades? Maybe that taught you those lessons? Con Michalakis 06:28 Yeah, probably bond allocation, fixed income, you know, like, if you look at the Japanese bond market, you know, it was the widow maker, you know, you didn't like it at four. Didn't like it at 3,2,1,or 0, it's come back now. So, you know, maybe the mean reversion took 30 years, but it's coming back. You could just got to be a bit you got to be a bit more smarter than naive mean reversion. Value Investing. There's been a value, statistical value, risk premium over 100 years, but you know, arguably, it's been very chopping. Hasn't worked since the GFC or prior to the GFC. If your portfolio, if you're running a diversified, multi strategy, strategy, multi asset portfolio, and you've let one style dominate your over a cycle, you're going to outperform or underperform because you're too biassed to that at the margin, though, you know, at the margins, I remember you're running a world diversified fund. Occasionally you get thrown these strategies and ideas where either the market has unloved it or there's an opportunity to extract return. That's pretty good. So, you know, we were a bit late to that at state. Well, I definitely noticed. Plus, when we did the sort of insurance link strategies with quota shares, we did that last year here too, at funds SA, and that's that's done really well, you know, in the small and mid cap, you know, where managers can probably do a little bit better. Venture capital, when that was unloved 15 years ago, we were late to that at Statewide, but Hostplus was very good. So you want to, you want to be diversified, but you want to go to early areas and adopt that if you can. Wouter Klijn 08:11 So looking back on that, what does that mean for portfolio? This, is there still a place for value, or are you more style neutral guy? Con Michalakis 08:20 There's a place for value and be conscious. If you're going to use a combination of passive, quant, systematic and traditional fundamental, you want to be conscious of what your and how your managers managing that. Some are core. Some identify as value. Some are kind of fighters, quality or growth. You want to be conscious of what you're carrying into that portfolio, except particularly in this incredible market movements that we've had, probably since Covid, for lack of a better word, that you're going to have dispersion. And that gets down to beliefs. Can you ride the cycle. Do you have the ability to, if you have good relationships and you trust your managers to reinvest when there's…, their style or, you know, there's always a style that they've had an issue with a couple of stocks, do you have the backbone to just stay in the game with them and reinvest? Wouter Klijn 09:18 Yeah, you just mentioned that Covid period. Do you have any sort of lessons from that? Did you change anything in the portfolio to deal with sort of that volatility? Con Michalakis 09:28 You know, when I joined statewide, it was a GFC, so, so I left Pzena, it was, you know, a couple of weeks off, and joined Statewide the first week, my first week that weekend, Fannie and Freddie was nationalised at the end of the week, Wouter Klijn 09:44 yeah. Con Michalakis 09:45 The week later, Lehman went under. Now we're in the GFC, Wouter Klijn 09:48 yeah. Con Michalakis 09:48 And that was painful. So really, from September until April, September 2008 April 2009 this was one of the most acute periods of investing I've seen. I. All when, famously, Westpac, had a failed rights issue early on my career, and I think it was Kerry Packer heard to bail it out. We've had Asian crisis, 9/11 but this was, this was up there with one of the worst I've ever seen, and Statewide was in trouble. It really didn't have a diversified portfolio. Didn't have a lot of cash or a lot of bonds. It had to pay hedges by selling equities. Luckily, Chris Williams had joined me, I think October, November that year. Jimmy Vernon Payne is now a consultant at Jana. Bill Watson, I think he's at first super, or is he moving to, you know, I think something like that. And all of that was happening live, and we had to manage that. And that was a really difficult period. We had to write off assets, we had to rebalance the portfolio, but to put in governance structure. We can talk a bit about that later. That was a doozy. Wouter Klijn 11:02 So that was heavily equity focused portfolio, Con Michalakis 11:05 that was a heavily illiquid portfolio, but more importantly, didn't have cash or bonds, Wouter Klijn 11:10 yeah, yeah. Con Michalakis 11:11 We didn't have any fixed income. Fixed income was a bit of a saviour. The Aussie dollar collapsed, the international allowed you to international fell by more. So that was a difficult time, and that taught us the importance of the diversification, liquidity, managing portfolio shape, not for currently, but looking out forward, and having a risk management system in that you could understand and also live by. I would say, though, by the time we merged with Hostplus, we were one of the top five or six performing balance funds in the country in terms of peer surveys, your future, your super we're the best Aussie equity numbers over most time periods, the most fixed the best fixed income numbers. Pretty proud that by the time we had merged with Hostplus, we were one of the best performing funds in the country, but that initial six to nine month period was hell Wouter Klijn 12:06 yeah, I can imagine. I mean, I had in there that, like you must have done something right, because you survived for 14 years after joining state. Con Michalakis 12:13 Well, ultimately, the central banks and the unbelievable amount of QE and reinvestments and bailing out the financial system. You know, one of the first responders was the Aussie dollar rallying, and we kept the hedge, and we used those hedge gains to rebuild asset allocation. And then, frankly, equity started recovering. I think by May, it bottomed out and it was on the rallying. But yeah, for that period, it felt it was uncomfortable. Now, covid, so, so, so the time we got the covid, we were so well diversified. We had risk management planning, we had liquidity ratios, we had stress testing in in play. And I was only for a week. I remember it was pretty late nights, early mornings, late nights. Chris was then the deputy CI, Chris Williams, who's now Hostplus, was the deputy CI. And I remember was one morning, Chris goes, Okay, now I'm worried this. There's no market. There's no market in bonds. The market was unruly. And I remember being on the couch one night. I was sort of had Bloomberg on, and I saw this big headline, unlimited QE and I remember saying, Okay, this is done. It's over. The markets will respond. So covid was short in terms of the bounce back. What was then hard for most super funds was early access. How would people tap into super How would you manage that? We were moving then to weekly Investment Committee meetings. We had a risk scorecard checklist. We were going through valuation scorecard stress testing. I actually thought we played that well. What surprised us was how quickly the markets bounced, Wouter Klijn 13:58 yes, Con Michalakis 13:59 and we had underperformed just, you know, in that immediate period. And then there was a vaccine that was announced. We had quite a few value strategies. They did really well. And then we came through. Yeah, the time we merged, performance was pretty good. Wouter Klijn 14:14 So it sounds like that in a number of these like tricky situations, liquidity was a central theme in sort of trying to manage the risks in the portfolio, has that sort of changed your ideas on how to manage liquidity, and also in the current environment, where it's quite volatile, very concentrated markets, what is your philosophy towards liquidity? Con Michalakis 14:38 So front and centre, you know the changes, the big changes we've made at Funds SA, they say was governance. We've set up, we've we've, there was a lot of meetings here. So there was a lot of meetings. There were a lot of people in meetings. We've tightened the meeting schedule. There's less people than meetings. We've broken down silos, and we've introduced concepts like, okay, we've got a proper investment strategy that embraces diversification. We've got liquidity ratio and stress testing. We've got fee budgets. We've got active fee risk budgets that we're implementing. And so we spend, really the first four or five months of every year updating our investment strategy policy, making sure it's fit for purpose, and then basically the rest of the year, reviewing the asset classes that are sympathetic to the overall investment strategy, and in that risk portfolio shape, managing the portfolio, not for today, but over the next 12 months, we have an unlisted forum that goes further and making sure we've got a enough liquidity. What's our effects? Hedging policy, terming out hedges, making sure if markets move, we can take advantage of what's happening. And that's that's that served us really well at statewide. I know it's served Hostplus really well, and we're off to a good start here, ending March. Financial year to date, I would say our balance fund's in the top quartile. Early days, nine months and one year I've been here 14 months. But having a risk management lens and the and shaping the portfolio is and no more silos is a key part. Wouter Klijn 16:21 Talking about risk management. I've heard that you used to have a photo of Trump on your desk to remind you of risk did you bring that to Funds SA? Con Michalakis 16:29 No, I see enough of him. I see enough of him everywhere, whether it's news or media. I don't need a photo. It was a joke. I think the team went to some charity and they got a maga hat, and I had a photo of him and Putin, I think, on my desk, which was good, because 2016 election was unusual. If you remember how markets traded, they priced a Clinton win and then a Trump win in the reverse was like, bit like Brexit, actually. And so no, I see enough of him, and I see enough of his policies and and I see enough of the reactions to the markets to tweet, so I, I he's a constant reminder. I don't need him. Wouter Klijn 17:06 You don't need to be reminded of that. So you mentioned that setting down a proper governance framework was important in sort of reshaping the portfolio Statewide. Can you tell me a little bit about what you think are the essential ingredients of that governance framework? Con Michalakis 17:22 Yeah, sure, and I starts here with Funds SA so, you know, 14 months in, what did we do? Start with the basics. We actually wrote a plan. I wrote a plan for the board, and what we said was governance strategy, team, structure and within government, Jana coming on as a full of service asset consultant. I've worked for Jana for a number of years, and they've been a great partner, and I consider them not a service provider. They're a partner to us, and we, we, we, we, basically, we rest on their shoulders. We don't have to make things we we can get a lot of their IP and thinking and basically build on that in terms of governance. It was recasting the Investment Committee. There's now a smaller Investment Committee. We have an independent chair, David Holston, who was my asset consultant, then retired, then joined Statewide as the chair of the Investment Committee and board member. He's here as an independent but making sure that's in that's in play, doing things like Investment Beliefs, having detailed asset class reviews, bringing the team together. We have a weekly portfolio construction forum where there's the investment strategy team and the asset class heads. Once a month, we invite Jana as well to that, having papers prepared, going through the shape of the portfolios, what's happening in the markets, trying not to be short term, and managing this for the medium to long term, that's been the, probably the biggest changes here, plus the usual, introducing liquidity ratios, thinking of risk, thinking of how you're going to diversify the portfolio, and being small enough to take advantage of strategies and ideas, should they present themselves? They don't often, and we don't think we can trade our way through it, and we can talk about DAA coming up, but just being aware and being able to execute quickly Wouter Klijn 19:29 Before we jump into DAA, I want to talk a little bit about Funds SA in sort of the broader investment industry here in Australia, because it's relatively unique. You have worked at a super fund as well. At Hostplus, obviously, they are subject to a whole set of regulations where they need to pass a performance test on the Your Future, Your Super that has influenced how they allocate, especially on the passive, active side of things. At funds, I say you don't. Really have those restrictions. Does that give you an edge or an advantage in finding opportunities that super fund? Con Michalakis 20:07 Oh, yeah. So we're about 50 billion in assets, and over 90 per cent is the local state pension scheme, Super SA that we run money for it's regulated by the state. So we're like a state, sovereign, if you want to, in that sense, and it has constitutional protection, which is a unique feature. I do think, not being having different being regulated by the state, we have unique and we have some unique tax advantages. Gives us a bit of an edge. We can think about how to invest the portfolio. We still shadow, for lack of a better word, we still shadow Your Future, Your Super we think about the risk we're taking from that lens, but we can free ourselves from the day to day regulatory of an official APRA burden, for lack of a better word, and that gives us, I believe, some unique advantages that we can we can exploit. Wouter Klijn 21:17 Yeah, Con Michalakis 21:18 That doesn't necessarily mean that some advantages can be also a balast, because it's active management is difficult. Can't just blindly do it, and hasn't worked for a long time, and it's particularly in recently, it's been a very difficult area. And you know, one of the one of the things we did in the previous review is we had pretty large active tracking error budgets that was purely active in Aussie and global shares. We've basically cut that down by a half to almost two thirds and and one of the reasons is we've introduced passive we've introduced quant systematic, and we have an active sleeve, and we want to let it go, just, just so we, you know, again, diversification, even within Aussie or global equities, it can't be for one or the other. Wouter Klijn 22:09 Yeah. So is that active component more of a satellite allocation, is it a relatively small? Con Michalakis 22:15 It's more sort of, yeah, core satellite approach to the active might be a bit more satellite. You can have some style neutral managers. You might have some small to mids value or quality growth. But we, you know, we manage that within a mix, and our tracking error, you know, is moving, you know, maybe in the past it was in the threes. It's now in this of the one, one and a half at both Aussie and global equities, Wouter Klijn 22:40 that active, passive element is quite interesting in the light of the current environment, because we've seen, you know, equity markets more or less rally for quite a number of years now, concentration in markets, which makes active management quite difficult. But if we would were to see a flip or some sort of recession, that's often where active management shines as well, where they can reduce sort of the downturn. Are we setting ourselves up for failure in that sense, because we're moving away from that active element, and then when a crisis happens, we might not have enough of that. Con Michalakis 23:16 I mean, we were pretty active at Statewide. We had quite working very well in Aussie and global. And as I said, global, by the time we had finished that net a fee Alpha was pretty good. Aussie was unbelievable. Closer to 2 per cent I would say to you, the world's changed. There's faster money, there's pod shops, there's instant reaction. We've seen it even. I mean, look at between March and April. You basically had equities, you know, fall anywhere between five and 8 per cent and in the first two weeks of April, they basically come back. And in coming into the third week, we're now setting new all time highs, Wouter Klijn 23:56 yeah, Con Michalakis 23:56 so the Fast Money response, and what I've I believe, is that you have to embrace dispersion, dispersion across styles, strategies and managers, and in this world of faster money, moving money, you probably want a bit of everything. And the idea that you can be totally active sounds romantic, but I think the path dependency will kill you. The idea of being totally passive, we have some tax advantages that doesn't totally make sense to be totally passive, and the idea of being totally systematic, well, fine, but there was a thing called a quant winter in 2007 and these things will happen. So why not have a bit of everything if you can, but be careful, you know, set your tracking error budget, set your allocations, and try not to one of the things I think that could be happening in industries. If something's not working, they're closing it down, and then they're just going straight to this that's working. Well, okay, that's creating flows and opportunities. When that sort of stops, that's going to create some opportunities on the other side. And I think the other side of that could be an environment where active managers who are targeted and doing well will do better. Wouter Klijn 25:26 Yeah, yeah. So as part of that, move to towards more passive, basically reducing tracking error, but then we see funds doing a little bit more on the dynamic asset allocation side, where partly is sort of trying to implement some total portfolio thinking, putting trades on top of the portfolio that are almost a little bit hedge fund, like relative value trade, global macro trades. What's your view on that? Is that something Con Michalakis 25:56 This is going to be fun. So one of the things I one of the things when I came at Funds SA is that there was, there was a lot of siloed behaviour. So there was the asset class, people were doing their own things. Then there was sort of an overlay, doing their own things. What I brought is, everyone's in the room once a week, and we're thinking of what's the long-term strategic asset allocation. Now markets move so you move away from that, what's the commitment to if you've got private capital investments, whether it's equity infrastructure, what's being drawn down, what's being distributed? There's foreign exchange movements, how you should think about the foreign exchange. There's also demographics. There are flows in that. Are flows out they're switching as well. And so I come across from a, I'm going to call it TPA Lite, Wouter Klijn 26:47 yeah. Con Michalakis 26:48 So I come across from a total portfolio. What are our exposures? Where, where would you want to be? And if we don't really have strong ideas, run them very close to the strategic assets. After all, it gets reviewed every year, right? We've spent a lot of time spending that as what a research, time looking at that with our asset consultant. The board adopts it early in the year. And if we don't have an idea, stay close to that, then markets drift. And it's all about the rebalance, the idea that you're going to do dynamic tilting, or that you're going to do overlays on top, or you're some sort of macro guru. I call that the Comic Con, right, of asset allocation. Everyone dresses up in their famous in their favourite character. One's a dynamic tilter, one's a post Keynesian, one's a Keynesian. One's a value guy, one's a trend. Great. You can have it. It's all yours. I just think it's noise. And good luck trading that in the last three or four months. In fact, good luck trading that since Liberation Day, and good luck trading that since covid. Because how many people would have told me bonds went from zero to four or 5 per cent and equity market set new time, all time highs? So I think we take a broader portfolio lens, manage that from a portfolio construction level, figure out where the opportunity sets are. Allow a little bit of flex, but you're not going to see us trading frozen concentrated orange juice and pork bellies. Wouter Klijn 28:22 So do you see DAA as a form of market timing? Yeah, Con Michalakis 28:25 They can have it. You know, I've heard about other funds. You know, they do SAA, TAA, DAA, macro thematic. Yeah, all yours. It's up to negative. Good luck to them. Wouter Klijn 28:37 So I had taken you as a little bit of a TPA cynic. But obviously you're Con Michalakis 28:43 Not totally a TPA cynic. I just, you know, I read the study, and I did start at Watts and Wyatt, and there's Thinking Ahead Group. I think the ideas of TPA are good. The complete adoption, am I going to be the purest TPA, and I know there's been some great funds out there that have done it, that's theirs. I live in a world where we have different clients who have different needs. We have one client who has a sort of an absolute hurdle cash flow for 30 years before it goes negative. I have super clients who, you know, they want us to manage a CPI target. They want to manage against peers. They're switching in between funds. There's demographics. I look at everything, not just through a pure TPA. Call it TPA Lite, Wouter Klijn 29:30 yeah. Con Michalakis 29:30 And you know that study that showed all the TPA funds outperforming before I had a good look at it, it felt a little bit like, nothing against my old colleagues, but that looked a little bit like consultant swab. Wouter Klijn 29:42 Yeah, I looked at that report as well, and I think they came up with 180 basis points or something, but it seemed to be just an aggregate of the funds that were included in that group, Con Michalakis 29:53 Slight survivor bias, right? Wouter Klijn 29:54 Survivor bias, but also not necessarily relating it back to TPA. It's just, you know, here's a group of TPA. People. And I think there was even a Swedish fund in AP7. I think it is, which is, to my knowledge, highly geared equity fund. It's not quite comparable Con Michalakis 30:09 yeah, comparable we, we look at portfolio construction across the thing, we think about what, what, you know, what are we doing to diversify? What are we doing to beat objectives? You know, sometimes your illiquidity mismatches on what's what's a good proxy, where's the actuals? You know, like you maybe want to have some more linkers than nominals in your bonds at the moment, because it's working with better within your overall fixed income allocation. That's how we think about it. We want to term out our hedges. But the idea of being pure TPA Lite, or pure What's your equity equivalent ratio? Yeah, you can have it. Whoever does that. Good luck to them. Wouter Klijn 30:45 Yeah. Do you think that is to a degree related as well to how large investment team is? Is it easier to do TPA and sit around the table in a relatively small and mid-sized team? Con Michalakis 30:57 So I've been very lucky that within Statewide, Hostplus and Funds SA, we have relatively small teams, and I think that means there are no silos. That means that we can be far more sort of linked up, to use the term in terms of how we're building portfolios, and have the key people, the discussions in the room. I think that's an advantage that we enjoy wherever you use external managers. We do the implementations internally, of course, but we It allows us to just think a bit and build portfolios, as opposed to trying to manage a lot of people. Wouter Klijn 31:39 Yeah. I think in a past interview, you sort of stated the importance of stating your opinion and letting the board know what your thinking is. Is that you know possible in every organisation? Or does that need to be created like a culture created around speaking your mind? Con Michalakis 31:57 Oh, again, maybe luck, all three funds I've worked for boards wanted trust and transparency. There's the Funds SA. It's seven individuals. It's incredible board. And one thing I enjoy, you know, from the chairman, John the CEO, and our board members, is, obviously, I'm not a shrinking violet. So they enjoy the two-way communication, and I think they they want transparency, and with transparency, you can build trust. And so they like the fact that we can have these discussions. Same at the IC. I do think smaller committees allows to have better conversations. That's so the board is, you know myself, the deputy CIO, whoever's presenting, if there's an asset class, the IC, there's there's John, myself and David Holston, the deputy, Kelly, who is sort of like our she makes the trains and run on time in the implementation group, and it just jells at these meetings. It just allows good discussions ample time to have that. And you build trust because they know what you're thinking, you know what they're thinking, and you get, I believe, a better outcome, Wouter Klijn 33:14 Now Funds SA has gone to quite evolution in recent times, apart from the organisation growing quite rapidly over the last couple of years, you also had a new chair in. Guy DeBell, had a new CEO with John Although John Piteo has been there since 1995 I believe. Con Michalakis 33:35 Yeah. So I think it's two years so relatively new, yeah. So John, Guy, there's a couple of new board members. Been a few new executives, obviously, new CIO, new deputy CIO, we've added to our implementation team, where Kelly's almost like she's like our COO within the within the investment team. I do think it's a sense of renewal, but I'm probably not the right person, because I've only it's 14 months, but I gather that over the last two years, the Funds SA has changed. It's in a sense that it's more focused on investment returns. Clients are important, and the people who are responsible for managing this business wrapped around making sure we've got appropriate it's really good data and tech that we have here. So yes, I'm part of that change. I think investments has changed a lot, and the team has done a good job, really. I mean, there was a lot of changes, changing governance, beliefs, strategy, no more silos that they've had to go through a lot of change in that responded world to all of that, plus having me Wouter Klijn 34:55 Fair enough, there's also a lot of change happening in the industry itself, and one of the things that a lot of people talk about these days is AI, artificial intelligence. And I sort of, when I was preparing for this interview, I found an old interview with the AFR, and you said that innovation and disruption were the two most abused words in the industry. Do they? Does it apply to AI, what's your view there? Con Michalakis 35:22 Okay, I read that article, and I reckon that's aged like a bucket of prawns in the sun. I reckon I was wrong. Okay, so, so this is, let's this is, this is where, you know, you sort of read that went, Oh, I think we are in the age of innovation and disruption. And I severely underestimated, I think that was 2012 Yeah, maybe not. Yeah. A bit later, I think there's been a lot of disruption and innovation, whether it's the digital whether it's obviously now with AI, I think AI is a, is a, there'll be new versions of energy, there's there's ways of living. There's also some bad disruption in terms of, we're in a multipolar world. You know, the cost of warfare has gone down, so the marginal propensity to war goes up. You know, we grew in a pretty balanced world post the war, that we knew we had one world, and now it's, it's bifurcating into various regions and so, so I think I was wrong, having said that, you know, is it as innovative as we've got the round will and introduce fire? Probably not. But the world is changing, and I think we should embrace that, particularly if I think about Australia. And as an allocator, you know, the world has changed since GFC, in some ways, not for the better. We have to deal with energy resilience and climate. We have to deal with critical minerals. What does ai do to the workforce? What does it do for people who gain from the expected productivity gains? Does it go to capital or labour? If it goes all one way to capital, not labour, there will be riots. There will be a greater disparity in terms of wealth and income. People will be unhappy. There will be volatile elections, social media and the rise of that. So I think there's a lot going on in the world, and we just got to make sure whatever as innovation happens, that the gains are shared. Wouter Klijn 37:47 Do you think it changes as well the asset management game, especially on sort of the active management side, where access to data is easier, it's harder to gain an edge. Con Michalakis 37:59 So I think the biggest winners in that have been the quant funds and the systematic funds, who are naturally very data enriched and aren't afraid to embrace large language processing models, systems. Much more sort of, might be a bit of P-hacking to use the stats term, but there's, there's a lot more sort of mining and using of alternative data, they were much better than the fundamental types. Probably the systematic quantum are much better job in risk management, more than anything else, the risk management's kept them in the in the game, more than, say, the fundamental types. They're learning those lessons. But you know, when we see, we look at it here, internally, at Funds SA, and then when we see with our managers, it doesn't matter if it's a credit manager, an equity manager, a passive manager, voting of shares. People are using AI in their business. They're using it initially as a tool. We use it here across there's a lot of people, vibe, coding, building macros, building things. It's it's changing. Do I think there's a bubble in parts of AI sector? Absolutely. Do I understand the valuations of some of these large language models that are burning cash and on record valuations? I do not. There was a shoe company the other day on the New York Stock Exchange that was going fail, going bankrupt, pivoted to AI stock went up 5x right? Clearly, there's some nonsense going on. But whenever there's an innovation cycle, or whenever there's disruption, you do get, you know, the old Manic Panic and crashes Kindleberger, you know, one of the bubble things is there's an innovation cycle, and that's part of the game. Wouter Klijn 39:51 Yeah, yeah. In some parts of the industry, there's a bit of a reminiscence of the dotcom bubble where, you know, you just had to come to your company name and the share price went up at the same time. You know, you see chips are still TSMC came out today, and I think they still had a record profit on selling the chips to the AI sector. So there is a real story there as well. Con Michalakis 40:19 It's a real story. So Nvidia, the foundries in Taiwan, like TSMC, these are these companies are printing real profits, right? They and Google's another one. So, you know, it's not bubbles can sometimes be overused. But there's, you know, there's some interesting valuations away from them that, you know, it's hard to get your head across, Wouter Klijn 40:40 yeah. But do you think that that shifts the structures in the equity market as well? There seems to be, you know, the size factor comes back, but almost in the opposite way, where, you know, large caps are dominating, outperforming, Con Michalakis 40:53 I think when it gets priced in, and we've had a well priced in, I think there will be again, when you get so much, maybe the value person in me, the valuation dispersion, the opportunity sense, will come in. And lately we've seen that with the EM bounce back pretty hard. We're starting to see a little bit of, we're certainly seeing a lot of good alpha, but also some good returns out of the small to mids. So, you know, we had the rise of the Magnificent Seven. The first version of that look a bit bubbly. It's sort of corrected, and now we're getting the sort of the AI type plays. It's it's part of cycles. You can't pick them. You can't pick them on the way up. Good luck picking them on the way down. You just have to be conscious of what positions you take and make sure that at the margin you can sort of lean against it. And, you know, I have opportunity on the right tail in terms of VC or some of these companies, and then on the left tail be diversified and managing your active exposures. I do think the business that we're in of managing capital, whether you're an asset owner or a fund manager, will be changing over the next five years. Wouter Klijn 42:09 In what way? Con Michalakis 42:09 Hard to say how it morphs. But you know, if the agentic AI and the models and the and you can develop personas, and they have memories in those models, you know, do you need as many analysts? Do you need to see? I mean, it starts giving you that. So while that rises, you will need the correspondent rise and people almost acting as human whisperers of AI and that output to boards and individuals explaining what that means. So, you know, there's, there's going to be a coincidental rise of those two, Wouter Klijn 42:43 yeah. Con Michalakis 42:43 But you know, the first one has more of an employment impact than the second one, Wouter Klijn 42:47 Yeah, yeah, for sure. So we're not at a stage yet where you should just hold passively the top 20 or top 50 stocks and just let them get on with it? Con Michalakis 42:55 I don't think I mean passive is a valid part of of any portfolio. But again, I'm not a person you know full TPA or full passive or full active, you know, like I you can have it all right, don't? You don't have to vote against it, but in a default setting where you don't know what you're doing, you don't know where the world's going. Sure, passive and systematic will give you that that beta exposure, but you know, you probably at the margin, can do with a bit of active. Wouter Klijn 43:31 Yeah, yeah, sure. Okay, so you said you were wrong on the innovation and disruption. You've also been quite critical on crypto. Were you wrong on that as well? Con Michalakis 43:41 No, that's a load of nonsense. And the thing look, crypto, if you want to have it as a digital Ponzi scheme, go for it. Shoot your lights out. Congratulations. But it's not money. That's the thing that bugs me. When people turn around and say, crypto, or even the gold bugs, gold is not money, and crypto is not money. And we saw that when we went through and with oil in the crisis. The first thing people wanted was cash. And basically, and I would sell all the other nonsense because they wanted cash. I You don't do gold back that. You don't do crypto back there. I'm not, you know, stable, this whole sort of stable area, interesting, the way, sort of FinTech, and that's processing interesting, but, you know, there's been a lot of nonsense in that you can have it that's that's happy to provide the chips and the shovels and the data that they need. But, you know, sustainable crypto, give me a break. You're burning. Energy is already scarce, and what's that used for? Wouter Klijn 44:41 I think you called sustainable crypto a vegan tomahawk steak. Con Michalakis 44:45 And once it was, apologies to vegan Tomahawk steaks, which probably, you know, tastes a lot better than the rubbish that's built out by some of those crypto types. Wouter Klijn 44:54 Fair enough. Another sort of point of discussion in the industry at the moment is private credit. It, and we've seen some liquidity issues with some of the funds. But what's your view on that? Is that a problem with private credit, or just the wrapper that? Con Michalakis 45:09 So I should say at Funds SA we have zero Aussie private credit. Wouter Klijn 45:14 Okay, Con Michalakis 45:15 I feel pretty good about that, actually. So zero, we have about 60 basis points of global private credit. So we're in an interesting situation, but we've put on some really well established global private credit. We've just put on some clo equity, both secondary and primary. I actually think the opportunity space looks good for us because we're underwriting into that. We don't have any existing ones. I think some of the commentary written about private credit has come from it's interesting. You've had all the big, large players in private credit saying, yeah, there are problems, but it's not systematic. Who's on the other side is some sort of global, small, mid cap manager who's never done credit, and they love saying it's a bubble, it's going to die, right? And so what do they know, right? I mean, I mean, the reason they're upset is probably because private credits up there are higher up the cap structure getting their returns. Don't believe private credit, per se, is the SPV of real non-recourse real estate debt of 2007 that's going to cause some sort of crisis. Banks, private credit managers, long term sort of locked up capital that does this is it will, will look will make sure that the system does what it has to do. Are there problems? Yeah. Then one of the big problems is that there was a lot of these BDCs. And when you have a listed entity with unlisted assets, and you offer a liquidity redemption window, it's always the same thing. In any crisis, in any dislocation, it's either leveraged money or money that's not there for strategic reasons, that wants to depart, that creates the opportunity for others to come in and take advantage if they have to sell out of discount. Now are there private credit loans or issues, whether it's been in SaaS software disrupted by AI, or, frankly, bad lending. Course, there are, are there in 5000 equity stocks in the global capital market? Are there 50 or 60 that are in big trouble, or at 70 or 80 that could be in fraud? Course, they are. So you know, you're always going to have problems right in loans. But is it a big systematic issue other than the retail, you know, illiquidity, BDC type, or occasionally bad loans, sure, but I don't think it's a systematic issue. Wouter Klijn 47:52 Do you see it potentially as throwing up some opportunities for a fund like you? Con Michalakis 47:56 Oh, yeah, we're taking it as we speak. You know, we're allocating to special sits managers or people who can provide capital and solving for the opportunity. And we're, you know, again, we've come in underweight, so I should be saying private credit is really bad, but I just don't believe it and we're gonna, we'll take advantage of the opportunity across our manager set. We're pretty excited by it. Wouter Klijn 48:21 Yeah, yeah. Fair enough. So going forward, what's on your agenda for Funds SA? Is there still a lot to do in the portfolio? Con Michalakis 48:29 So I'm pleasantly surprised how well the performance has been. We're off to a really good start again. Strategy, governance, team. Jana non silo, I really would love to have the third fund I've worked for to continue to have very lucky at stay white, first quartile. Hostplus is a machine, right? It's, I still speak to some of my old colleagues, that is one of the, one of the great funds, and will continue to do all because it knows what it's doing. Yeah, we've turned it around here at Funds SA and my focus is to keep that turn around really happy where we are. But this is like a cricket game, right? It only takes one bad ball and you think you slug and you're bold and you look like an idiot. So happy where, where we've where we are in the process. Early days, very early days, but we got to maintain that focus. Managing portfolios for our clients and members is a privilege, and we can't take, we just can't stop. We got to be on the game and making sure we're aware of what's happening. Wouter Klijn 49:37 So you mentioned Hostplus, when you look at Hostplus, it does really well, but it also has a very clear sort of target client base. They're young people. They have a long runway, so they can take a lot of risk, which has led to the asset allocation that they have. I think at Funds SA, it's probably much more of a mixed bag in terms of. The demographic of their member base. Does that make it more difficult to set a strategy? Con Michalakis 50:06 Yeah, so Statewide also didn't have a lot of cash flow, right? So being a smaller team, the unique tax advantages and obviously they're not being regulated by APRA and the setting up the governance structure, I think gives us, and being 50 billion and not 500 billion, and not trying to manage really large cash flows, it allows us to be a bit more nimble and take advantage of the opportunity. Should we get it? And so, like, last year, I was that all of funds. So whether it was the investment team, the finance and ops team, the legal and odd, you know, we've had a couple of opportunities, and we turned them around, going through the process, you know, Investment Committee negotiating commercials, operational due diligence, commercials, and we can turn around within there's one we turned around in eight weeks, Wouter Klijn 51:06 yeah, Con Michalakis 51:07 and the the manager said, We've never seen this before. And they manage some sovereign wealth, money, some large pension. Funny. So having the ability to invest, sticking to your beliefs, I think is a Core Advantage. One of the questions I get asked a lot, and I think you were going to ask me, is, you know, what's the best investment you've made in your career? It's the people. Wouter Klijn 51:34 Yeah, Con Michalakis 51:34 It's the people. So having being surrounded by really core bunch of people that you can trust. I had that at Statewide. I had that at Hostplus, and we building this at Funds SA as a core, bunch of people, close to your consultant, close to your investment committee and board, and being on this and being committed and not stopping, like being at it, just focused on doing this. That doesn't worry me, because I think we know what we're doing, and it's starting to show on the results. Wouter Klijn 52:08 Yeah, yeah, for sure. Con Michalakis 52:09 And you can be niche, you know, we can do a 20 or 30 million VC and 20 or 30 million co invest at our size, and we can do a couple of these, but if you're 300 billion or 150 to get access, and to do that, it's much harder, and just sizing that and taking advantage of that opportunity set, it's I find it easier to run less money than more money. Wouter Klijn 52:34 Yeah, yeah, for sure. Now, usually I don't let people get away with just talking about the best investment. Can you tell us what was your worst investment and what did you learn from it? Con Michalakis 52:43 My worst investment, and what did I learn from it? So throughout all the career, probably single strategy hedge Funds was the worst investment. I'm not going to name names, but at Statewide, we had single strategy and you know these, they're all great, big names, big personalities. They promise you diamonds and they give you rocks, right? And we moved away from that at Hostplus. And this is, again, this taught the importance of working with great people. There's Greg, Sam and myself. It was Chris at when I was at statewide, and Dan who it continued lessons just wasn't working. We moved with John to a sort of an allocator model where they were closer they could implement, they could do overlays that was Blackstone here at Funds SA and say Peter, who runs the alts team, has moved from those single strategies to MAN and Blackstone, they're highly specialists. They know what they're doing, and it's worked very well, as opposed to trying to manage these on your own, which are really difficult, Wouter Klijn 53:53 yeah, yeah, I can imagine. Con Michalakis 53:55 So I gave you an investment, and the asset class so far, it's turned around. I feel good about that. The other one was, I remember going down the rabbit hole on tail risk. Wouter Klijn 54:08 Was this the crisis mitigation stuff? Con Michalakis 54:13 Yeah, yeah. And, you know, you put it on, it works until it doesn't, and then doesn't work. Your people lose going, and then you take it off and, you know, we never got to invest, thankfully, at statewide and Hostplus, and we had a tail risk here at Funds SA, we took it off and we put, put it to productive capital that can make money. Because, remember, you are diversified. You know, the one thing we spend with members is take that, take a traditional balance fund. Equities are down eight, 9 per cent you're about half in equities. You've got fixed income cash now, when bonds move away in a stagflation that could, that could hurt. You've got a bunch of infrastructure and property real assets tend to do okay, so you don't feel the full effect of that. That's the beauty of diversification. And you know, you have to remind people, so the idea that I'm gonna and I'm. Sorry to tell him, and I hope he doesn't call me, you know, idiot, moron, imbecile, than he does, but it's just too hard, Wouter Klijn 55:08 yeah, Con Michalakis 55:09 To be fair, and to be fair to him, he does say you should be invested in equities and have this, yeah? Well, we just do balance funds. We've got high growth funds, balance funds, conservative funds. You have the journey for a member. We've got different tailored solutions for clients, so sticking to your strategy and being diversified works. Wouter Klijn 55:28 Yeah. Now we might finish up with a bit of a personal note. I think a lot of people, apart from, of course, knowing you as CIO, also know you from your Twitter feed? Con Michalakis 55:39 I've locked that now, are you probably on there, so you still see it? Wouter Klijn 55:42 Yeah, I actually do. But you know, you got a lot of opinions on there. What do you see of the role of that? And do you use Twitter as well for, you know, getting some market insights? Con Michalakis 55:55 Well, you get a lot of information very quickly. You also get unfortunate, a lot of fake information. Con Michalakis 56:01 But I remember many years ago, I did an interview with the Advertiser on this. It started off for football and music. It just morphed into fin Twitter back in the glory days, which was pretty bare knuckles and fun. I've actually met a lot of people through that. Met them around the world. You've met interesting people. You then go to private sort of messaging. So just gotta it's like anything in life, you can use it for good and use it for bad. Use it for noise. Mine's more selective. Wouter Klijn 56:34 You say it started with music. And I saw some of your comments are around Joy Division, punk music. And I was looking at that, I'm like, That's not just standard business school playlist, Con Michalakis 56:47 But you'd be amazed. Our chairman famously was interviewed, and he's a big punk rocker, really, Guy, Guy, you know, he will wax lyric on Husker Du or, Wouter Klijn 56:58 Really? Con Michalakis 56:58 Pixies, my old co-deputy, CIO, Greg, at Hostplus, we could lose three years just talking about Nick Cave or Joy Division. So, no, no, you'd be amazed. You'd be amazed. How many people come out of their shell when you start doing the music. You'd be, it's more diverse than you think. Wouter Klijn 57:21 Oh, good, good. Con Michalakis 57:23 Including the metal types, you'd be amazed how many metal types. I'm not going to out them, but there's some crazy ones out there. Wouter Klijn 57:30 Fair enough. Fair enough. Now I looked at it and I'm like, Oh, I can now safely bring up my vinyl record collection at some stage, which features a lot of punk, but we'll leave it for another time. Thank you very much for this conversation. Con Michalakis Was a lot of fun.

In this episode of the From the Archive series, we look at a 2019 interview with Gus Sauter, the former Chief Investment Officer of Vanguard, who worked for more than 25 years at the company. Sauter is also an adviser to the Australian Retirement Trust, then Sunsuper. Index and passive investing have gained momentum in recent years and it is estimated that about 60 per cent of investments follow passive strategies today. Considering this sheer weight of money and the move of more Australian superannuation funds to passive investing in recent years, it is easy to forget that index tracking and the popular investment vehicle for doing so, Exchange Traded Funds, were once controversial. In fact, Jack Bogle, the founder of Vanguard, was not a fan when Sauter launched the ETF business for the company. In this interview, Gus takes us back to those early days and revisits the active/passive debate, a discussion he never tires of. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Podcast overview Gus Sauter 1:00 You started a bank at age 8, is that true? 3:00 Then a goldmine in your 20s? 4:20 Gold is an Armageddon type of investment; if the world collapses, gold is probably going to be fine 5:50 My first stock 6:30 I've had the active vs passive debate literally thousands of times and 'no' I'm not tired of it. 7:00 Passive is a good investment strategy, but it is never going to be top performing in any given year 9:00 I'm not totally on board with the efficient market hypothesis 10:00 Why indexing works 12:00 But does the market capitalisation method work in fixed income, where you skew to the most in debt entity? 14:00 Over time, markets have become more efficient, compared to the 1980s. 15:00 Did Jack Bogle cut his holiday short to find out why you were adopting ETFs? 16:00 Jack disagreed on ETFs 17:00 The crisis of 1987, and the subsequent redemptions from mutual funds, shaped my thinking on ETFs 19:30 Is there more institutional takeup of ETFs in the US, than there is in Australia? 20:00 ETFs are not a product; they are a way to distribute index funds. 21:00 Not a fan of smart beta 27:00 You don't think there is necessarily a correlation between GDP growth and stock market returns? 28:30 You can take a great firm and make it a lousy investment by overpaying for it and visa versa 31:30 Working with Sunsuper 33:00 Do you see a lot of similarities or differences between the issues that investors in the US and Australia grapple with? 35:00 Should pension funds in Australia be more dynamic in their asset allocation? 37:30 What have you learned from past crises? 42:00 Jack said: "One day indexing is going to be really big and we'll have US$ 10bn in assets" We now have US$ 4 trillion. Full Transcript of Episode 133 Wouter Klijn 01:00 Gus. Welcome to the show. Gus Sauter Well, thank you. I'm glad to be here. Wouter Klijn 01:52 Let's start a bit with the start. I'm going to take you right back to age eight. There is a website that is called Buggle heads, and it has your buyer up there, and said that at age eight, you started taking deposits and making loans to neighbours, effectively starting your own bank. Is that true? And what is wrong with playing with Lego? Gus Sauter 02:16 It is true. I'm hesitant to admit I think I probably broke several 100 banking laws. But yes, I didn't think my neighbours were going to turn me in. They would give me $1 or two, and I would turn around and deposit it in the bank and earn interest on it, and then turn around and give them the interest that they would have earned. So yeah, I was a little enterprising at eight and not too much into Legos. Wouter Klijn 02:40 So where did you get the idea from? Gus Sauter 02:43 You know, just from my parents and going to the bank with them. And I guess I was just curious about how money could make money for you and and really, that was the genesis. Wouter Klijn 02:53 And then it also says that around in your 20s, you formed your own gold mine, but what inspired you to make that investment? Gus Sauter 03:04 Probably naivety. I was working as a commercial real estate developer in Denver, and we were building, really about 11 story office buildings, and I was working on the financial side of putting these deals together, and this opportunity came along to develop a gold mine, and I figured, well, I'm the financial side raising capital to build buildings. Why can't I raise some capital to build a gold mine and and so I put a venture capital deal together. Took me about three years to run it under. Turned out to be a little bit of a frustrating point in my life. Wouter Klijn 03:35 I can imagine. So looking back, what is your view on gold today? Because a lot of investors think that gold is a bit speculative. It doesn't have any inherent value. How do you look back on that? Gus Sauter 03:47 Yeah, so I started that in 1982 and that was really kind of the height of the gold mania, the gold rush, and I was looking at a little bit more like a mining company, as opposed to the lustre of gold itself, although I must admit, if we were mining for salt, I probably wouldn't have created the firm. So my view then was to hopefully make money mining gold and selling it immediately, not holding on to it. My view is that gold is kind of a Armageddon type of investment. If you if the world collapses, probably gold is, is fine. My view is the world is not going to collapse. And so I, you know, gold doesn't give you any sort of rate of return. It is, you know, as you indicate speculative. You buy it with the idea you can sell it later to somebody at a higher price. There's no dividend on it, no interest. So I think if people do have it in their portfolio, it should be a small, small part of the portfolio. Wouter Klijn 04:47 Yeah, well, I'm glad the world is not coming to an end. So we had banks, we had a gold mine. You mentioned real estate. How did you get started in the asset management industry when my gold mining venture went on? Gus Sauter 04:59 I had a good friend from business school who had kept in contact with me, and he went to work for Pimco, who is now the famous bond management firm, and he kept after me, and kept telling me that I belonged in the investment management industry. And actually, quite honestly, I felt that as well. I bought my first stock when I was 11 or 12 years old after after the banking experience and and I loved investing, so I followed his advice. And interestingly, I had some opportunities, perhaps, to go with PIMCO out on the West Coast, in California, but I grew up in Ohio, in more the centre of the United States, and I wanted to go back home. Unfortunately, there just aren't many investment management firms in Ohio. So I worked for a bank in Ohio in their trust investment area, and got experience. Wouter Klijn 05:47 And I think that that first stock was that a basketball team. Gus Sauter 05:51 The basketball team was actually my second stock. Yes, my first stock was a snowmobile company, and my second one was the Cleveland Cavaliers. I'm proud to say I was one of the original owners of the Cleveland Cavaliers. I grew up 90 miles south of Cleveland, so, yeah, Wouter Klijn 06:07 So taking it to Vanguard, not looking at individual stocks, but we're looking at indexes, and even to deal this day, we still have this discussion about active, passive. You know, what is better? Do you get tired of this conversation? Gus Sauter 06:27 You know, I've had the debate 1000s of times, literally 1000s of times, as we were trying to build indexing back in the 80s and 90s, it was not well received at all. And it was really a brick by brick business building venture, and I was invited to many, many conferences, and interestingly, they would have me on a panel, and I'd be in a debate with somebody else, and it would always be a top performing, active manager. So you know, you're always kind of with with your back in the corner. Indexing is a very good strategy and appropriate for most investors, but it's never going to be top performing in any given year, it's going to be a good performing investment that really compounds over time into top performance. So I actually, I do love the debate, because I think it shows the advantages of indexing and also allows for the advantages of active management to complement indexing. Wouter Klijn 07:18 And it seems that we have moved on a little bit from one against the other two, where I think we see more especially amongst the larger funds that don't always have a choice to go 100% active, that they say, well, we'll do both. We will have a core allocation to passive, and we'll do some things around it in the active space. Do you feel that the this debate has become more sophisticated around this issue. Gus Sauter 07:42 I do. I think a lot of investors have realised that there are significant advantages to indexing, and it should be a core portion of their portfolio. It's a great foundation, because it's going to provide you with very competitive returns that will outperform a majority of investors in the marketplace. So it's a great place to start, and you have a good deal of confidence that it will provide that rate of return for you in the future, at the same time the satellite portion. So a core satellite approach, you can use the satellite portion to invest in actively managed funds to enhance your returns that you get from an index fund. So if you if the index fund is your your ballast, or your foundation, hopefully you can add some incremental return above and beyond that, without too much risk, by investing in active as well thinking about indexing. What is indexing? Wouter Klijn 08:28 And I think in the past, you have made a strong point around an index is a market capitalization weighted construction. Why do you feel strongly that it has to be only that type of model? Gus Sauter 08:45 So it turns out that there are two rationales for why indexing should be an attractive investment number. The first one is based on the modern Efficient Market Hypothesis. I personally believe the markets are quite efficient, but not perfectly so. So I'm not totally on board with the efficient market hypothesis. If you if you believed in the efficient market hypothesis, then clearly the only thing to do is index. I mean, that states that everything's fairly priced and you shouldn't spend any money trying to outperform because you're not going to be able to do it. The other argument is what is called sharp math, or Bill sharp was the inventor of this simple concept that in aggregate, investors get the rate, the market rate of return. I mean, in aggregate, investors own the market. They own it by market capitalization. In other words, they own more stock in in, let's say, Facebook or or Microsoft or bhp, than they would in a small company. So that, by definition, is telling you that investors, in aggregate, own by market capitalization, some will outperform, but others will underperform by the same amount. I mean, to the extent everybody on average gets the market you can't all be above average when you introduce. Costs into the equation, and costs are really significant. I think people really dramatically underestimate the impact of costs. Then all of a sudden, the marginal outperformance before costs become underperformance after costs. And that's really why indexing works, because it's extremely low cost. It's a handful of basis points, or a fraction of a percentage point that you pay in costs, and you get largely the market rate of return, and you'll outperform a majority of investors because of that, but that argument is based on market capitalization weighting. There are, as you're implying, other ways that people are coming up with indexes equal weighting, or things called fundamental indexing. Those really give you something very similar to what you get with capitalization weighting, with tilts to it. So in other words, there are segments of the market, there are large cap stocks, there are small cap stock, there are value oriented stocks, and there are growth-oriented stocks. So all of these different segments of the market will perform a little bit differently from the market as a whole. And when you weight things differently from a market cap weighting, you're actually inadvertently tilting towards one of those investment styles. So when you equal weight an index, you're getting a tilt towards smaller cap stocks. And it turns out that you can just invest in a small cap, a small cap index fund that is capitalization weighted, and get a very similar return. Same thing when people tilt towards value, when these fundamental indexes, they're basically a tilt towards value. You can get the same return if you use a capitalization weighted index that is tilted towards value, so the capitalization weighting is less expensive. You don't have to rebalance as much. It's lower cost than fee wise that most of these other types of indexes charge. And it's it's more tax efficient because you basically buy and hold so I think you can accomplish if you want a small cap tilt or a value tilt, you can do it with capitalization weighted indexes. Wouter Klijn 11:59 I think part of the debate around market capitalization model is around. Is this the best way to construct an index? And I think where this debate becomes most clear is within the fixed income space, where there are issues with having the largest exposure to the most indebted entity in the index, even though that represents the market. Do you think that's a fair comment? And can we still call them indices? Gus Sauter 12:26 So you know, going back to the sharp math, the bill sharp math, which is a mathematical tautology, again, you know, in aggregate, investors are going to get the market rate of return when we start to think of other asset classes other than stocks, like bonds, fixed income. The concept still applies. If you want to be a top performer, outperforming the average capitalization weighting still makes sense. It's true that you put more weight in in companies that have or countries, for that matter, that have greater debt. And people have said, well, so you're taking more risk because you're investing in the most heavily debt laden companies or countries, but at the same time, that's already implicit in the pricing. So in other words, if there's additional risk associated with investing in either that company or that country, it's going to be reflected in a higher yield, a higher rate of return. So so you're really being compensated for that. And the people who say, Well, you know, you're just taking on greater risk, you're being compensated for taking on greater risk. And again, the only way to ensure that you're going to be a top performer over the long term mathematically is by relying on that sharp math and owning the entire market capitalization, weight weight market. Wouter Klijn 13:42 So this is where the efficiency of the markets come back in, where it says, Okay, this is greater risk, but it's priced accordingly. Gus Sauter 13:51 Yeah. So you know, as I said earlier, I don't believe in perfectly efficient markets, but I don't think there are grossly inefficient markets either. And actually, over time, I think the markets have become more and more efficient. I mean, I think back to the 1980s when I started in this business, and quite honestly, active management was a lot easier back then than it is today, and that's because there were greater inefficiencies. So there were greater opportunities to take advantage of mispricings. Today, those mispricings are very small, and even if they're not precise, they're not grossly wrong. And so, you know, it's very, very seldom that you would find a company or a country that is much riskier than its yield would indicate. Wouter Klijn 14:33 I would like to take you back a little bit to innovation in the index space, and especially the exchange traded funds. I understand that you were one of the earlier believers at Vanguard within this vehicle, but I also heard that when Jack Bogle, the founder, found out that you were going into ETFs, that he cut short his holiday and came back to grill you on why you're going down this route, even though he was supposed to have retired already by that stage. What happened there? Gus Sauter 15:01 Yes, Jack was retired at that point, and Jack always went on vacation for the whole month of August. He had a house up in the mountains, and he went away for the month of August. We happened to announce that we were going to launch ETFs while he was away. I mean, that was just pure coincidence. And since he wasn't working with the company anymore. He wasn't aware that we had been working on this for, actually a couple of years. It took a long time for us to to launch because of our unique structure and getting it through the regulators. But so Jack did find out when he was on vacation. I don't know that he actually came back early from the vacation, but, but the day he got back it at Vanguard, and so he still had an office at Vanguard where he did his research. And we have a building that has the the dining area, the dining hall, that most of the employees congregate for lunch, and it has an upper level and a lower level. And I entered it the lower level to go grab some lunch, and Jack happened to be standing in at the upper level, at the top of the stairs, and he saw me at the bottom. And this this foyer is typically filled with lots of people around lunchtime, and Jack has had a booming voice, and he held out, gosh, what the heck is going on around here? So you know, Jack was vocally not in favour. Or, you know, I'll say it's that Jack was against ETFs. Jack and I agreed on an awful lot of things, but we disagreed on that one. Wouter Klijn 16:33 Did he ever turn around on this topic? Gus Sauter 16:35 No, he was very vocal, you know, till his final days that he did not like ETFs. Wouter Klijn 16:42 So what attracted you in ETFs as a vehicle? Gus Sauter 16:45 I started with Vanguard in 1987 to be precise, October 5, 1987 some of your listeners will recall that October 19 was the crash of 87 two weeks after I started. And I think we're all shaped by our experiences, and that was a scary one for me. I was actually managing the very small equity group at that point in time, but it put a lot of pressure on us. And, you know, we had some withdrawals, and I was trying to sell stocks to meet those withdrawals that day. And that really kind of shaped my thinking. When I started thinking about ETFs, I started thinking that we were we had just come out of the late 1997 period, which was known as the Asian contagion, and the markets became very volatile. Then we went into the summer of 98 which was the Russian debt crisis, again, volatility in the markets, and I was worried that we might experience another crash of 87 type of event. So I started thinking about, how could we enable investors that wanted to get out of our funds, enable them to get out of the funds without impacting the fund itself. When an investor gets out of a fund, you have to sell off some of the investments in order to fund their redemption. So I started thinking that if we had a share class of ETFs in the same fund. In other words, you could invest in the Fund two different ways, either directly with the fund, like you typically would, or through the ETF share class. It turns out, because of the mechanics of the ETF share class, if an investor happened to own that share class, they could sell that on the stock exchange, which is where you trade ETFs, and it would have zero impact to the fund. And so I reasoned that if investors were so inclined to sell, they would be attracted to the ETF share class and not to the conventional share class, and that would enable them to have all the flexibility they want without disrupting the investors that were long term oriented and leaving the fund with additional costs. So they really complemented each other. Wouter Klijn 18:46 Yeah, and is that impact mainly in terms of taxation? Gus Sauter 18:50 It's, it's both taxation and transaction costs. Yes. So the taxation piece would be, if you have to sell off an investment that is appreciated in price, you have a capital gain you have to pay tax on. But at the same time, if you have to sell off, you have transaction costs of selling the investments as well. And so we would avoid all of that by if people were in the ETF share class. Wouter Klijn 19:11 I think to a degree, the initial take-up here in Australia was mainly retail, and we don't see a lot of institutional investors using ETFs other than temporary parking money or tilting how's the situation in the US? Is there more institutional take up? Gus Sauter 19:29 There is a little bit more institutional take up in the US. So we see institutions using them for any number of reasons. Sometimes they use them for long term investments. Sometimes, as you indicate, just short terms, they might be migrating from one type of investment to another, or from one manager to another. You can imagine a large institution that has a manager, and they might fire the manager, but they need market exposure while they're looking for a new manager, and so they might move, for short term, into ETFs. So I'd say ETFs. Are used considerably by institutions and tremendously by the advisor community in the US. Wouter Klijn 20:07 So what do you think is going to be the next innovation in indexing or in ETFs? Is that around active ETFs, or perhaps the Smart beta ETFs? What is your view on that? Yeah. Gus Sauter 20:18 So the interesting thing a lot of people talk about ETFs as being a product, and I've been pretty vocal saying they're they're not a product. They're a way to distribute a well known product. In other words, it's a it's really just a different way to distribute an index fund. If you look at all the ETFs they can be done in a traditional mutual fund, ETFs in the United States are legally organised as mutual funds with certain exemptive relief. So they come out of the same part of the tax code. To me, ETFs are really just another way to distribute. I do think they will grow into a way to distribute active funds as well the Smart beta concept I'm not a big fan of. In fact, we had what's become smart beta in the early 90s. We started, I mentioned earlier about the different segments of the market, and that's a little bit of what smart beta is all about, is targeting different segments of the market. You know, talked about fundamental indexing. That's fundamental indexing turned out to be difficult to market, so you rename it smart beta and like, why would anybody get dumb beta if you could get smart beta, but it's really just getting different exposure to different segments of the market, and you can do that through capitalization weighted indexes, which we have offered since the early 90s. But I think my objection is they're being marketed as something that will provide you long term outperformance, and I just don't think that's going to hold up. And I think investors are expecting more than what these products can deliver. Wouter Klijn 21:52 You talked a little bit earlier about the market structure as well, and that you said that in the past, it was probably a little bit easier to be active, and today, markets are a little bit more efficient. There has been a lot of discussion as well about the impact that the large technology firms have on the structure of the market with capital light models, and potentially has changed the structure of the market as well in the sense that there's less ability to participate in the growth. Do you worry about these types of developments? Gus Sauter 22:27 I don't. I think that technology has been an advantage for investing and has reduced costs significantly. So I think on the transaction cost side, it used to be that humans were involved in all trading. And if you wanted to buy something, you had to buy it from a market maker, and or conversely, sell it to a market maker. Now it's done electronically. Almost all trading is electronic nowadays, and it cuts out a layer of profit that that middleman would would earn. And so transaction costs have plummeted. I mean, literally, from what would have been 1% or more if you, if you bought a stock, to now maybe a quarter of a percent. So that is a huge amount of savings to investors. That's a benefit. I think your question is also about investing in technology companies, they are light in capital. As you point out there, it's more human capital than physical capital. That's I don't think that distorts the market. It's just a different way of creating a business. And ultimately, you're investing in businesses for the profit they earn. And it doesn't really matter if the profit is generated by human capital or machinery, like a manufacturing company. So from an investment standpoint, you just have to analyse it differently. I think you were also asking a little bit about, do you get to participate in the early stages of, say, it being kind of venture capital, a lot of firms, Lyft just went IPO last week in the United States. Lyft is like Uber, if Lyft isn't here in Australia, and the people that created Lyft, it went for $22 billion IPO. So these are called unicorns, anything that IPO is for more than a billion dollars, and the venture capital investors do extremely well and and then ultimately, investors, public investors, get to participate after the initial public offering. You know, I think that's just the risk one takes in venture capital for every unicorn we hear about, there are 1000s of dead unicorns along the road. So you should be compensated for risk. And even when these companies do go public, they still generate good profits for investors. I mean, look at companies like Facebook or. Amazon or Google investors, public investors, have made a lot of money investing in those, those companies. Wouter Klijn 25:07 Now, you did work with the Securities and Exchange Commission in the US on equity market structure issues. What did they focus on? Gus Sauter 25:17 It was a number of things. So I worked for help four different commissioners, four consecutive commissioners of the SEC over a decade or more, and they were working on a lot of structural changes to the marketplace, you know, going from that old structure that I mentioned, where everything was driven by humans, and prices were priced in eighth so it was $10 point 125, cents, 12 and a half cents. They created decimalization, so things started being priced in pennies. They brought in electronic trading. They tried to make sure that electronic trading was fair across different platforms. So there are, there used to be three exchanges in the United States. There are probably 50 now, or maybe even more than 50 at this point in time, and it's not fair if you trade on one exchange when there's a better price on another exchange. So they were trying to link the exchanges together to ensure that investors would always get the best price they could. So I sat on a number of panels for the SEC and gave my thoughts and opinions as to how I thought things should be done, and had the opportunity to speak directly with all of the commissioners during that time period. So it was a lot of fun for me to as a practitioner, to help out with the regulators as they were, I think making great improvements in our marketplace. Wouter Klijn 26:36 Yeah, expanding a little bit on this idea of markets and exchanges as a vehicle to participate in profit. A lot of the discussion around emerging markets is about the economic growth and GDP growth and how you can participate in that as an investor, but I think you are a little bit more cynical about the direct relationship between economic growth and GDP and how that translates into markets. Can you expand a bit on that? Gus Sauter 27:06 Yeah, I can give you two examples that explain that GDP growth, economic growth and stock market returns really aren't correlated. So think back to the global financial crisis 10 or 12 years ago, as you recall, Everybody I talked to around the world felt we were going into a very slow growth economic environment, and I agreed with that view. And it turns out we were all right. We've been globally. We've been in a very slow growth economic environment. And then, if you'll recall, at the same time, because of that, people felt that we would have very low equity returns going forward because of this low growth. I was arguing that, no, it would actually be the exact opposite, that you would have high returns going forward because of the perceived risk in the marketplace. We'd had the crash of the tech bubble in 2000 to 2002 and then we had the financial crisis. And I think investors perception of risk was extraordinary. And you know, if you think, Well, if you were expecting a low return in equities, let's say equities have returned historically about 10% and if you expected, say, 5% would you invest in equities when you could get a 4% return on bonds, which, have, you know, a fraction of the volatility. Nobody would invest in equities. They'd put all their money in bonds for, you know, you wouldn't take all that volatility risk for an extra 1% so I was arguing that the stock market had repriced itself so that it could provide great returns going forward. It's all about pricing. That's what determines future returns. You can take a great firm and make it a lousy investment by overpaying for it. Conversely, you can take a lousy firm and make it a great investment by underpaying for it. So it's all about where you price things initially, and the markets had pulled back dramatically, pricing things very low to provide great returns going forward, which we've had over the last decade, extraordinary returns. Another simple example that I give is the period of the 20th century, the 1900s the UK economy grew 1.8% per year. Their GDP growth was 1.8% per year, and the US economy grew 3.2% per year, much faster growing economy, if you compound that out over the 100 year time period, the UK economy grew about seven fold. The US economy grew about 17 fold during that same period of time. During that period of time, the UK equity market returned about 10.1% per year on average, obviously, with volatility. During that same period of time, the US equity market returned 10.1% per year with volatility. So there really has been no correlation between economic growth and equity returns. Wouter Klijn 29:53 You mentioned there as well that the important element in there is risk. Is it a case where. Perhaps people focus too much on on volatility as a measure of risk, rather than taking into account all the other elements, including valuation. Gus Sauter 30:08 Yeah, I think people do do focus on volatility. And if you've got a long time horizon, you don't really need to focus on it. If you've got a short time horizon, I think volatility probably is important to you. If you need your money a year from now, volatility is definitely your enemy. If you you happen to get a bad return over the next year and take your money out, you've got less money to take out. So. So volatility is important, depending on your time horizon, if you're 25 years old, saving for retirement 40 years from now. It doesn't really matter if the market goes down dramatically in the crash of 87 or the the crash of the tech bubble or the global financial crisis. All that matters is where the market is 40 years later, when you you're retired. And actually, if you look at a the stock market itself. Look at the price levels of the stock market over the last 50 years, all of those market crashes look like a blip in the in a heartbeat. When you look at them, they're really nothing when put in a long term perspective. But so people probably do focus on volatility a little bit too much, but people tend to be too short term oriented, too they don't think long term. Wouter Klijn 31:24 You are here in Australia, partly because you're an advisor to the Investment Committee of Sun super. How did you get in contact with them? Gus Sauter 31:32 I retired six years ago from from Vanguard, and Sun super was a client of Vanguard. I had not actually had I spent a lot of time in Australia during my working career, because I did have an investment team in Melbourne. So I got here a couple of times a year, and did meet a number of clients at Vanguard's. But I don't believe I had actually ever met Sun super. Turns out, when I retired, Scott Hartley, who was the CEO of Sun super, was, I think, looking for somebody to lend advice to the Investment Committee of Sun super somebody who had perhaps a slightly different point of view. He was looking for somebody who could, I think, play a slight devil's advocate role, maybe offer a slightly different point of view. And while you know, investing is investing, and we've all had the same theory of investing, you do have a little bit of a different experience depending on your environment. So, you know, my work experience is probably different from what you might experience in Australia. And so I think Scott felt I might be able to add something at the margin to Sun super as either a devil's advocate or something that they just hadn't thought about. Wouter Klijn 32:39 So did you have to play devil's advocate a lot so far. Gus Sauter 32:41 Oh, you know, I I chip in every meeting, and you know, I wouldn't say anything earth shattering, just something that a lot of times there's perceived wisdom. And sometimes I question it. Sometimes I might even believe in the perceived wisdom. But, you know, I just want to be a hair shirt and challenge the thought, so see if people can justify the thought. So I, you know, I try to play a meaningful role without being obnoxious. Wouter Klijn 33:13 So do you see a lot of similarities or differences between the issues that the Australian pension funds and perhaps us institutional investors grapple with… Gus Sauter 33:25 I think the nature of superannuation is a little bit different from institutional investors in the US. So ultimately, Superannuation is about members, whereas institutions in the US frequently might be an endowment, a foundation, a defined benefit plan, a pension plan, and of course, you have those here as well. But Superannuation is not like that. Superannuation would be more similar to our 401, K plan structure, and where you're dealing directly with individuals and members. And so I'd say it's very similar to that, which is, in our view, it's a little bit more retail than institutional. But I'd say it's applied a little bit differently. Here in the US, it's typically stocks, bonds and cash, and here, through most superannuation firms that I'm familiar with, in addition to those big building blocks that everybody's familiar with, they also invest in private investments as well, and alternatives also. Wouter Klijn 34:30 Yeah, I think in the past, you also have put a lot of emphasis on the importance of asset allocation within an investment strategy. And I think in Australia, there's still a lot of funds that have a static asset allocation, high percentage of equities, little bit of bonds. Do you think that makes sense, or should there be a more dynamic form of asset allocation to play into the different circumstances in the market? Gus Sauter 34:56 Investing is a social science and not a hard science, if it were. A hard science, I would say, you know, you should be dynamically adjusting your portfolio given the circumstances. Unfortunately, if you ask 10 economists, what's going to happen in the economy over the next year, you'll get 11 answers and and that's the problem with with investing, we just don't know what's going to happen. I mean, everybody's got an opinion, but frequently the consensus is wrong. So if you were correct and knew that the market was going to go down, and if you're correct in that assumption, then yes, it would make sense to dynamically adjust your portfolio and lighten up on equities. Unfortunately, people overestimate their you know, their knowledge is, there's a it's called in behavioural finance. It's called overconfidence. People suffer dramatically from overconfidence, and they typically do the wrong thing at the wrong time. And so, you know, think to yourself, how many people do you know you've heard of that sold out in 2009 got out of the stock market in 2008 or nine after the market had crashed. And then, I mean, people were asking me, in 2012 When do I get back into the market? Well, the market was already up 100% by 2012 and they've been sitting on the sidelines. So that's the danger of trying to dynamically adjust your portfolio. It's just that we just don't know what's going to happen. Wouter Klijn 36:25 Yeah, I think there's an interesting illustration of that in the annual report of one of the largest Australian super funds. And this is a super fund that has what I call a direct investment option, where they allow the members to manage or pick some of the investments directly. And you could see that over the course of the financial crisis, it's exactly what they did. They sold out at the lowest point and sold back in when already stocks had gone up for most of its recovery, and so destroyed quite a bit of value there, which I think everybody's prone to but it's an interesting question around these direct investment options as well. Gus Sauter 37:05 Yeah, that's, that's, that's a tragic story. I mean, you know, that impacts people's lives and their, ultimately, their retirement. And it's, it's really unfortunate. There's been a whole study in finance called behavioural finance that looks at these issues, and hopefully in the future, we'll learn and be able to counteract them. Wouter Klijn 37:24 Yeah, now throughout your career, you've seen a few crises. Is there anything that we can learn from them? Every crisis is different, but are there some shared elements that people can guard against, or is it more a question of sensible asset allocation? Gus Sauter 37:42 You know, I think it does boil down to sensible asset allocation. At Vanguard, we always talked about stay the course. And the only reason for that is, as I mentioned earlier, because we just don't know what's going to happen. I think the crash of 87 I going into that, you know, I didn't think we were going to get the returns that we had gotten previously. I didn't see a crash coming, and it happened all in one day. And so, you know, it was too late to respond after the fact the tech bubble, actually, we at Vanguard were concerned about that. I mean, that's, to me, that's one of the most visible things that you could observe. I mean, valuations were just ridiculous, and we did. We didn't know how it was going to play out. I mean, we knew that returns were going to be less going forward than historical returns. We didn't know if it would just be you'd get 3% for the next 10 years, or whether you'd see a 43% decline in the market. Well, we got the ladder. Unfortunately, we didn't know that. The other, the other situation I saw that really, you could see, I think pretty plainly, was one I mentioned earlier at the bottom of the market in the global financial crisis, that equity returns were going to be good going forward. But usually, you know, in my career, the only two that really seemed probable to me was the decline of the bubble or the imminent decline of the tech bubble, just returns were just going to be less, and in financial crisis being an opportunity to invest at the bottom. But I didn't see the financial crisis coming. I mean, we knew there was a lot of turmoil, but I didn't see the destruction that we had. So, you know, you didn't have cash sitting on sidelines to bottom, anyways, if you didn't get it out of the market beforehand. So, you know, our view is, really, unfortunately, investors typically are best off if they stay the course. I mean, that's just what we observe historically. Wouter Klijn 39:38 Yeah, and doing a bit of crystal ball gazing. Are there any sort of risks that you think people should look out for today? Gus Sauter 39:45 You know, it's interesting. The markets have been, actually pretty, pretty reasonable, not, not too volatile. You know, we've had a few spikes here and there. But actually, if you're the last five years, historically, that's we've experienced low. Volatility. I think it's more of the same for the foreseeable future. I don't see what upsets the apple cart from an economic standpoint. You know, typically economic expansion ends when either the central banks are trying to fight inflation, which they're not. I mean, they're hoping we get a little bit more inflation, in fact, and the other would be when consumers are so stretched from borrowing that they just can't spend anymore. And while I am a little bit worried that debt levels have increased, I don't think they're at crisis levels, and hopefully we don't get to crisis levels. I mean that that's what happened in the financial crisis, but so I think it's a little bit more of the same kind of muddling along, probably okay returns in the stock market and slow growth for the next year or year and a half. Wouter Klijn 40:50 And summing it all up, I thought I might ask you as well, looking back over the long career that you have, could you share some of the moments that you find most memorable of them as well, and perhaps some points where you said that was a hard period, but I learned a lot from it. Gus Sauter 41:10 Yeah, well, there are so many things that I remember. I mean, you know, obviously the crash of 87 was really scary, and I was two weeks into my job, and I wasn't even thinking about, could I be fired or laid off, because all of a sudden we've got a lot less assets. But fortunately, we stuck with it. So that's certainly my mind. You know, reflecting back on my career, I think the most fun was actually the people relationships, the people I worked with, a great bunch of people still have very strong friendships. Going back, I also enjoyed talking with investors. For the most part. I was, you know, back at the office, overseeing the investment team, but but I would get out and talk with institutional and retail investors from time to time, and I really enjoyed that. And I guess a few particular instances, I remember one day Jack Bogle, early on in my career, coming into my office and standing in the doorway. We had just crossed $2 billion in our s, p5, 100 index fund, the only index fund at that point, and and he said, Gus, you wait some day. Indexing is going to be really big. We'll have $10 billion someday. Jack boogle was not really prone to understatement, but he missed that by by a bit, because he's now Vanguard has $4 trillion worth of indexed assets. But I'll always remember that one, and I guess that you mentioned something that I really learned from that might have even been a scary experience. The financial crisis was extremely, extremely scary, and I had the opportunity with our CEO, Jack Brennan, to speak with the Treasury and various regulators during that period of time trying to figure out what was going to go on. I remember driving in to work at about four in the morning, because that's when our opportunity was to talk with the Treasury. They were working all night long, and I was sleeping for a couple of hours, but it was pitch black out, and I was thinking to myself, you know, the world may have changed going forward, and that was scary. And, you know, I learned I don't want to repeat that one. Wouter Klijn 43:19 No, I can imagine that. Well. Gus, thank you so much for this conversation, and it was a pleasure to talk to you. Gus Sauter 43:28 Well. Thank you very much. It's been very fun to be with you.

Greg Cooper is Chair of financial services giants Perpetual and Colonial First State, but is perhaps best known for his role as the Chief Executive Officer for Schroder Investment Management in Australia. In this interview from late 2019, only weeks before COVID-19 broke out, we spoke with Greg about whether public markets are broken, the state of active management and his interest in the venture capital space, topics that are still very much alive today. Enjoy the show! __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Greg Cooper podcast overview: 1:00 Starting out in actuarial studies 3:00 Focussing on Japanese equities 4:00 Compared to 1986, Japanese equities are still at the same level 5:00 What were some of the highlights of your career at Schroders? 6:50 We've moved on from strategic asset allocation 7:55 As a CEO, don't be afraid of what others think and try to draw out ideas 9:35 Are public markets broken? 11:00 Not having a well-developed VC industry means that a lot of good ideas get starved of capital and eventually go offshore 11:30 Will that change when the effect of QE goes away? 15:00 No investor is entirely passive. 16:30 Passive rose, because active had too large a share, but you can't have a 100 per cent passive investment market 17:30 Will value-style investing come back? 21:30 You have an interest in fintech and hold a board position at OpenInvest? 25:00 Joining the TCorp board and chairing the investment committee Full Transcription of Episode 131: Wouter Klijn 01:12 I'm here today with Greg Cooper. Greg, welcome to the podcast. Greg Cooper Thanks, Wouter. Wouter Klijn So can you tell me a little bit about how you started in the asset management industry. We had some former guests on there that started with, you know, creating banks at eight. What were you doing at eight? Greg Cooper 01:26 I certainly wasn't creating banks. Probably more surfing and and that kind of stuff up on the beaches and the Central Coast than anything. I mean, my career in investment really started in the latter stages of high school. I was at one stage looking at becoming an accountant. And then my maths teacher at the time had said, Have you thought about actuarial studies? I didn't even know what one was at that point in time, and, you know, and so I looked it up, and things kind of sort of went from there so that, I suppose that was the real genesis of things year 11 and 12 at high school. Wouter Klijn 01:59 So how do you transition from an actuary training to an investment career? Greg Cooper 02:04 So I mean, I started out in the more traditional actuarial fields. I was working for Taos Perrin the time as a defined benefit actuary, and it was at the point in time, I was in the early 90s when the SG was just coming into play defined benefit plans, some were being wound down, but there was a lot of work to do in the DB space, but as SG kind of kicked in. Then there was a whole pile of, you know, actuarial work to do around, you know, justifying minimum contribution levels and so forth. And then, you know, one day, one of the investment guys had come over to in the investment asset consulting area, come over and asked me if I was interested in doing some research. And it was on Managed futures at the time. And, and I kind of said, I said yes. And and started doing and I really enjoyed it. And that was kind of the first foray into investment consulting. And so sort of from starting out in the actuarial field, I was lucky enough to get off at a roll up in Hong Kong with with towers. And I sort of took the view that the traditional actuarial work was, was, was a good mainstay, but was not likely to be a growth engine. And moving into the investment space was, was a lot more interesting, and it also worked from a commercial perspective.Wouter Klijn 03:15 Yeah, did you ended up doing anything with those managed futures research? Greg Cooper 03:19 Well, apart from it was kind of the early stages of hedge funds, I guess. And it was at the point where saying, you know, alternatives kind of had a place in a portfolio that was, that was the primary emphasis of the research. So, you know, it's interesting. And obviously, you know, alternatives nowadays have become a much bigger, much bigger part. But back then, it was really just looking at that small hedge fund, like type diversifying characteristics and see whether they fit it in a portfolio. Wouter Klijn 03:44 Yeah. And then from there, you went to Schroeder's and started doing Japanese equities. Why Japanese equities? Greg Cooper 03:51 Yeah, good question. It was really partly as a function of the role that was there at the time and Schroeder's. I come out of asset consulting, I was much more interested in working in the asset management side of things, the role, while it was in Japanese equities, it was much more about the product side of things. So it was more like being in charge of the business, of running an asset management sort of sub strategy, if you like, rather than specifically worrying about, you know, Japanese equities or European equities. But it was very interesting, because at that point in time, Schroeder's was the biggest manager of Japanese equities. You know, you were just coming out of the 90s, which had been a bit of a lost decade, but, but in the latter part of the 90s, you know, Japan had taken off with the likes of SoftBank and so forth. So, you know, there was this real kind of boom happening, and it was just a really interesting time to be involved in, in in the markets, but particularly Wouter Klijn 04:48 in Japan. Yeah, any views on Japanese equities today? Greg Cooper 04:51 Well, it hasn't been a terribly good investment since that time. I remember one day sitting with one of the team, and he said, he said, Oh, you know, he said. I started in Japanese equities in 1986 and the markets pretty much at the same level it is was then. And I think we're always say the same now, so, but it's, you know, it's a very interesting case study in what happens in a deflationary environment. And, you know, when assets get overvalued, you know, you can have everyone thinks that equities kind of go and, you know, 10 years in equities, you'll make your money, but you'll make money. Wouter Klijn 05:21 I was just about to say, Did I just hear you say that equities don't go up always. That's right, Greg Cooper 05:25 so, you know, and it's a fantastic case study, but also one, I mean, sort of investment aside, it's a good one to think about, that, you know, despite, you know, the economic criteria not looking that good. You know, the social cohesion in Japan, everything else is held together very well. And so, you know, life isn't all about just economics. There's more to it than that. Sorry, all the economists. Wouter Klijn 05:49 So you spent almost 20 years at Reuters, climbed up to be the CEO of the Australian business, and also had a global distribution role. What are some of the highlights you look back on your career. And also, do you have any tips for aspiring CEOs, Greg Cooper 06:06 I suppose, in terms of highlights, you know, it was just, it was fantastic, and still is fantastic being involved in, in in sort of the dynamism that is the whole investment marketplace. I mean, in particular, just look at, I mean, not just Australia, look globally, but certainly in Australia, you know, the rate of change that's taken place with funds. And, you know, back in the late 90s, early 2000s you know, there was obviously a much larger number of very, very small funds. And you look at where we've come to now, I'm having conversations about internalising and, you know, financing specific assets, and you know, the size of the asset pools and so forth. So I would say, you know, over that whole span, it's just been a very exciting time, and I think that will continue. It's no less exciting looking forward than it has been in the past. But just the sheer growth of the industry has been fantastic terms of some particular highlights. I mean, I always quite enjoyed standing back and looking at sort of the way the industry was was developing, and coming up with suggestions for maybe how things could be done better, or where, you know, the industry had adopted certain practices that I didn't think were the right sorts of practices, and it was much more fun kind of standing back and trying to point those out and offer suggestions for better ways forward, rather than just joining the chorus of sales people out there. Wouter Klijn 07:21 Can you give an example of that? Greg Cooper 07:23 I mean, the key one that you know, and I write a lot of research papers around this, is the i concept of around, sort of objective Based Investing, and the idea that benchmarks and the whole strategic asset allocation process, which we've grown up with in the 80s, didn't always work. And you had in Japan is a great case in point, you know, a fixed, strategic asset allocation with a large exposure to equities through the 90s in Japan killed you. And so you know that that, to me is, you know, it's resonated very well in the industry, and I think it's a key part of sort of thinking about how to do things differently. And so, you know, sort of, it's not to say that strategic asset allocation is that that style of investing is bad. It's just to say that I think we've moved on from there, and there and there are better ways to think about this, and there's some consequences that come from that, and that's worth bearing Wouter Klijn 08:07 in mind, the consequences. Yeah, so in your answer, it sort of shows that you, you've always been quite keen on fostering a culture where it's open for discussion, and there's pretty much no topic of debate. Why is that so important to Greg Cooper 08:21 my mind. You know, we work in an industry where there are lots of really intelligent people, and no single person has all the right answers. So the more you can foster debate, and the best way to foster that debate is to have a fairly transparent and open culture, then ultimately you get a better outcome. And it might be sort of painful in the near term to hear, you know, if your particular idea shouted down or what you're doing, you know isn't you know doesn't resonate with everyone, but I think fundamentally, it gives you much better outcomes, and when, when people are, you know, more open, transparent, and in particular, prepared to bear criticism to their ideas. That's how you that's how you drive change and move things forward. So you asked about sort of tips for aspiring sort of CEOs, and that would be, you know, a very clear one to me is, don't be afraid of what others think and try and draw out that. And certainly don't create a culture where you know yours or a small number of views preside. You want to create a culture where you hear right through an organisation, because then, particularly today, like the world's changing so much, sometimes the best ideas come from, you know, some of your really junior people who are right at the coalface. So you want to, you want to make sure those ideas get aired and have as much resonances, you know, some of the more experienced ones. Wouter Klijn 09:36 Yeah. So is that a matter of staying competitive, or is it also more generating sustainability within a business that you can see risks or potential challenges coming that are further ahead. Greg Cooper 09:47 I think it's both. I think, you know, this industry is nothing if not cyclical. We see markets are very cyclical. You know, performance of asset managers is very cyclical. You know, the active industry is probably having a pretty hard time. Of it at the moment, I see that as a very cyclical outcome, and I just think that if you're not open to, you know, sort of change happening, then you know, particularly when times are good, and that's often the time when it's hardest to make changes in an organisation, because everything seems to be going well, but that is often and always the most dangerous time when everything's going really well, because you tend not to see the risk. So just trying to, yeah, it's not to say you get it right all the time, definitely not, and it's difficult, absolutely. But at least, you know, keep your eyes open. Wouter Klijn 10:30 So one of these big topics we've recently spoken about is the functioning of the public markets. And we see that more companies stay longer private. There seems to be a bit of a challenge in raising capital through the public markets. What is your view on that? I think you have a bit of an idea that maybe the public markets aren't where Greg Cooper 10:50 they used. Yeah, look, I think I wouldn't say the public markets are broken, but, but I do think there are some real issues in the way public markets are functioning. And if one goes back and sort of says, Well, what was the point of a public market? It was to allow capital to be held in the hands of a very, very heterogeneous group of individuals, and for new capital formation to happen. The way the broader investment market has changed is you've got a smaller number of very large holders, and almost by definition, those holders end up becoming more passive in their equity holdings. They have to become much more active in a governance sense to compensate, but they become much more passive in terms of their equity holding, just because they have to be so I think that that has changed the way you know public markets function, and will continue to change them. And at the same time, you know whether it's regulation or other things sort of driving, you know how new capital gets formed, people are more prepared to sort of keep their companies private and accept some of these large investors because they just don't need to go to the public markets. And the private markets tend to give them a bit more flexibility. So I think that's changing the whole dynamics of it. Where I see a real danger is in the smaller end of the corporate capital formation process, where how do new ideas get funded? And I think in other jurisdictions, particularly in the US, where they have a really well formed venture capital industry, we don't have that. And I think there's a danger in Australia that not having a well formed, or even a barely call it embryonic VC type industry means that there'll be lots of good ideas that get starved of capital and potentially go offshore, and that's bad in the long term for the economy, and bad certainly for those funds in the long term. Wouter Klijn 12:38 So to what degree is this also the influence of quantitative easing, because you could make the argument that, well, it's easier to raise capital from the private markets when capital is so cheap, but once that goes away, then perhaps the public markets start functioning, and the way they should be, well, there's Greg Cooper 12:54 certainly more capital around. There's no question about just given what's happening in terms of QE. But but whether we have QE or not, you will still have larger asset pools. So in a relative sense, you know, you just have to look at the Australian market. You know, the top 10 asset pools, you know, represent a significant chunk of the Australian equity market. So that feature occurs no matter what, with or without QE. So I think, I think QE has pumped, yes, more capital in the system. But I wouldn't blame QE for where we are. And I don't mean blame in a negative sense. I mean it's just where we are is a function of the rise of large asset pools. And that's that's not a bad thing by any stretch. It probably leads to, you know, better overall capital allocation decisions, because they've been made more professionally, rather than by, you know, a vast number of more amateurs, but, but it does have that consequence of potentially, certainly in Australia, starving the more junior end of the market of capital. The other Wouter Klijn 13:54 consequences is that there's more money flowing into passive and you've did some research around how this could potentially also distort markets, especially the public markets, where they come up with all sorts of different flavours of essentially similar indices, but it also then channels potentially funds to, particularly a couple of companies that occur often in certain indices, and basically get funding on the basis of that, rather than of their fundamentals. Yeah. Greg Cooper 14:21 So I thought, like any, any capital allocation process that's rules based is prone to, prone to some form of danger. So if you just keep following those rules blithely, and the whole, remember, the whole point of passive was about allocating, you know, in a in a certain way, a market cap weighted sense, across the broader economy, almost. And it works when you've got very large and diverse equity markets, but gradually, as the proportion that is passive becomes larger and larger, and indeed, in fact, in certain markets like Australia, where they're sort of more concentrated, that can have a consequence that it starts to distort certain companies in the way that they're weighted. In the indices. And then, I think the rise of passive as a sub. Don't use the word asset class, but, but where you get, like, you know, sort of a passive exposure to a certain thematic that then overweights the companies with no real bearing on their economic impact, and and you just get this weight of money. And then the other passive money comes in and has to allocate more to it, because to it because it's got a higher weight. And so you can end up with a with a disproportionate allocation in certain companies. And you've seen that, I think, in some of the tech names and even some of the dividend payers, whenever a thematic comes through, it gets a lot of money, and then, by definition, those companies get pushed up in price and get overvalued. Wouter Klijn 15:42 Yeah, yeah, yeah. I can remember that at one stage I saw there was a sushi ETF coming out, and I was wondering if that's really a product The world needs. Yeah. Greg Cooper 15:51 I mean, those are, those are marketing concepts. You know, the idea is that passive was meant to be low cost exposure to a broader group of investments. And I think that's been sort of slightly skewed when you start talking about real flavour of the month passive strategies. Wouter Klijn 16:04 So the other argument for passive investing is that it's simple. It simplifies the investment process, and often, when there's too much complexity in a portfolio, it's hard to keep track of it all and also to basically communicate it to stakeholders. How do you look at complexity? Are we giving up too much by just having passive strategies? Greg Cooper 16:24 Look and passive has a very good place in some portfolios. And bear in mind that actually the bigger investors, as we just talked about, have virtually no choice but to hold passive or quasi passive exposures. The point that I would make about passive is that no investor is truly passive. You have money coming in if you're in your accumulation phase. You have money going out if you're in a decumulation phase. So you have to manage the cash flows and where you allocate capital to and take it from. Shouldn't be entirely a passive decision. You should have some view on where you know what price you're paying for assets you know, and particularly when you're allocating amongst equities, bonds, property, cash, whatever you should have some bearing. So you can't be entirely passive, I think, in a total portfolio context, and even where you are, those big passive holders have to take a much more active role in a governance sense. So, you know, to me, passive is just, you know, it's a it's a simple way of implementing a certain part of your investment strategy, but it's not your investment strategy. It's just a way of implementing a piece of the investment strategy, and as long as you bear the total portfolio in mind and your objectives and all that kind of stuff, passive has a has a place to play in that, but it's but it's not the answer to everything. Wouter Klijn 17:40 So you're not concerned about the predictions that I think it is by 2021 we will see more money in passive than in active, Greg Cooper 17:46 Not at all. And I think, again, I would, I would sort of come back to the point about markets being somewhat cyclical. And I think the passive will rise just because active, you know, probably had proportionately too larger share. But there's a point where passive can't, you know, you can't have 100% passive, or the markets don't function. So, you know, and whether that, I don't know whether that numbers, you know, 40, 5060, whatever. And I kind of almost, you know, it's not that relevant, because we'll never get to really high levels, just because something will happen that causes a change and the cyclicality will kick in. Wouter Klijn 18:21 Yeah, you mentioned that cyclicality, looking at investment styles, value hasn't worked for probably the past decade. What are your thoughts around that? Is that something that is structural, or is that cyclical? Greg Cooper 18:33 You can make an argument for both. I mean, I've seen plenty of arguments about it being structural just because of the way value is defined. And I think, you know, if we think about value in a, you know, sort of booked value context, or, you know, or in businesses which, have, you know, high tangible assets and low intangibles, then certainly there's this, you know, that's, you know, there's a change that's taken place in markets where intangibles are now, you know, of extreme importance. And so how you define value, I think, has probably changed over the course of that, but, but, you know, value as an investment philosophy is, you know, a very sensible strategy buy things that are cheap. I mean, like, it kind of makes intuitive sense, and I don't think that will ever go away. I'd be far more concerned about buy things that are expensive, things that are cheap, but values also had, you know, it's had long periods where it doesn't work again. That's the cyclicality of markets, yeah, Wouter Klijn 19:28 but it is within these big technology companies, where there's so much depending on the IP that arguably, it is harder to value what an IP is actually worth and when it's at a discount Greg Cooper 19:38 or not. So I agree. I think that's the issue. Is, is the definition of value, and how do you how do you place a value on certain of these organisations? Is the more difficult thing, but also too. I mean, I think certainly at the moment, markets have gotten a bit carried away. And whether it's QE or, you know, the some of the passive bits that we talked about, or just sort of momentum. Generally encouraging more investors to invest in it's could be a whole combination of things, but it's quite clearly that there are some levels of what I would call exuberance in certain parts of the marketplace. And while that hurts in a value context, you know, value is always going to be or any investment style hurts the most at its peak or at its trough. I should say, you know when the when the alternative is at its peak, that's, that's the point of Wouter Klijn 20:27 maximum pain. So do you think that the process of value can be adjusted to reflect the current market conditions, or do you get very quickly to a point where you basically have style drift? I think I'd Greg Cooper 20:40 be very careful about saying current market conditions, because, because that that I think does infer style drift, I think it's more about, you know, making value work for the nature of markets, and recognising that the term of value, and particularly getting this rise of intangibles on the balance sheet requires maybe a bit of a different way of thinking. But I'm sure there's plenty of value managers have already all over that and captured it, and some of these things probably still look really expensive. So, yeah, I think, I think again, styles are cyclical, and value and quality in particular. You know, if I had to have a bias in my portfolio, would be slight advice to value and quality than I would be to certainly to momentum. Wouter Klijn 21:17 So one of the things that you, you're interested in is more in this private market aspect. Can you tell us a little bit about what you're Greg Cooper 21:24 doing there? Well, it really comes back to the whole sort of VC space, and how do you encourage better capital formation? And particularly, as I said, in Australia, I think you know, you've got a well established VC market in the in the States, potentially, sort of, as the assets have grown in that space, probably, you know, managers charging too much for the for the service, much like, sort of what happened, I think, in private equity. But in Australia, we don't have it. And I just think that there's, there's really something that can be done. And where you've got a small number of large asset pools, you know, we really should be looking for ways to allocate capital to that space and try and generate some sort of venture capital ecosystem, albeit without necessarily, you know, I think this is our chance to kind of invent that space without imposing, you know, a more traditional third party fee model over the top. Wouter Klijn 22:16 Now, one of the activities you do is, you're a director of a FinTech company. One of them is open invest. What is your interest there in this particular space? Greg Cooper 22:26 So that was much more specific in the asset management space, and we talked about some of the issues that active asset managers, or just asset managers generally, were facing, and the rise of large asset pools, particularly in Australia, making the institutional market less of a source of funds for them, but at the same time in the, you know, what I'd call, sort of the retail and wholesale markets, you've seen this, this real explosion in SMSFs and and so forth. And I would say, actually, a large amount of professional or non professionally invested assets. And so the idea behind open invest is to have a simple mechanism through which people can allocate to a diversified portfolio and get a lot of the benefits that come from a more traditional portfolio structure, but build it very cheaply. You know, one of the things that gets me is when I look, sort of, you know, all the regulation, other things that have had gone on in Australia, in the retail marketplace, Royal Commission and so forth. You know, the cost to member hasn't really gone down. And it's like, well, you know, surely we can build things, particularly with technology, that deliver professionally managed portfolios to individuals at a much cheaper cost. And that's, that's the concept behind open investor. Wouter Klijn 23:38 It's an interesting model, because I think it shows what a lot of FinTech companies trying to do, in the sense that you have sort of a traditional model, where you have a distribution platform, you have the asset manager space, but then there's elements incorporated of social media, like features, so you can like things, you can share things. In essence, what is happening there is that you try to create communities around certain products or services. Is that sort of what interests you, or is it more directly coming from? Greg Cooper 24:09 Yes. So the point to me is really about, you know, simple, well designed portfolios being delivered to the general public in a relatively cheap format. And I think that's, you know, we were great at creating themes, and, you know, charging, you know, probably excessive fees for that as an industry to individual consumers and trying to stir up, you know, momentum around those particular themes or concepts, whereas actually, what I think we really should be doing, particularly with a more fiduciary type of mindset, is simple, you know, typical balance type portfolios that are well diversified and well structured and delivering them at a pretty reasonable fee, and that's the concept. And you know, with that, you need to have things like content layer. That sort of give you all of the right sort of behavioural impact with your customers and so forth, and deliver the messages out there in the right way. But the real premise is you have to do all that sort of stuff to deliver a simple, well diversified, professionally managed portfolio at a cheap cost. Wouter Klijn 25:17 Yeah, absolutely. But I was also thinking about that struggle for getting people's attention, and it can be very powerful to have something that's just sitting on your phone, and you can talk to other people, and you basically can go there without necessarily having to invest in a fund. You just you can just check up on it. That must be a very powerful Greg Cooper 25:36 feature, I think. So, yeah. I mean clearly that, you know social media, more generally, is changing the whole way in which consumers interact with each other, way in which they interact with third parties, and that will continue. People come up with new ways of delivering content to the end customer. You know, things like web 3.0 and things blockchain and so forth, could even mean that, you know, some platforms are no longer the right delivery mechanism for for all sorts of content, because it becomes much more individual to individual. But I but, yeah, I mean, I think what you're seeing is an explosion in the way people want to interact. And definitely have to look at my kids, you know, they spend an awful lot of time looking at their phones and interacting through their phones, and it's just, it's the norm. Yes. Wouter Klijn 26:23 So you just mentioned the fiduciary side as well, and you've joined the asset owner side as well with T Corp. Can you tell me a little bit about how you came to T Corp and what your role is there? Yeah. Greg Cooper 26:35 So I've joined New South Wales Treasury Corporation as a non Executive Director. I was lucky enough to get approached by them in my sort of last few months at Schroeder's, when it was, you know, all very public that I was retiring from executive life, and I think it just turned out to be a good fit. I mean, T Corp is a fantastic organisation that's going through some pretty fundamental changes, particularly in the investment model as a result, you know, of the merger between what was workcovers, now I care state super and the original T Corp portfolios. And now it's, you know, looking at a an asset size in excess of $100 billion and needs to be managed in that form. So it's a really exciting time to be there. The team's been built out. It's, it's, it's a great role. So as well as being a non exec, I'm also chair of the board Investment Committee. Wouter Klijn 27:29 Yeah, the executive team seem to have a real drive to build us out into a global quality asset management firm, coming from sort of that more sleepy government organisation, probably. But yeah, I probably but, yeah, I probably wouldn't Greg Cooper 27:41 describe it necessarily as sleepy, but, but certainly quieter, and the asset size was significantly smaller if you go back five years. And I just think that that, you know, we've seen a pretty fundamental change in their business, or driven by the right sort of economics and and that's a great time to be there and be involved in the transition. There's also, you know, it's a very interesting business, Teik court, because it's also the government's debt issuing authority. So it's got a very large, you know, issuance side to the to the balance sheet as well. So it's a fundamentally different organisation to most asset owners in that you've got, you know, these two fairly large parts to the business. Wouter Klijn 28:22 So it took a while to get your head around all the different moving parts. I would say some of it, Greg Cooper 28:26 you're still getting your head around. You always are. But I think, you know, that's the that's the great thing about, you know, these sorts of roles and the challenges. And, you know, particularly in moving from a third party asset manager to an asset owner, there's, you'll learn new things all the time, yeah. Wouter Klijn 28:40 So what else is on the agenda for you? So you have directorships? Can we see you at any other roles? Greg Cooper 28:49 Well, I think in terms of sort of building out a portfolio, you'll see me pop up, I suspect, in one or two other places, as in a non executive or advisory type capacity, as well as that, I've got some personal business interests with the family, which, which keep us occupied for a little bit of the time. And as I said that, you know, the whole thing we talked about in terms of the venture capital space is something that interests me in terms of helping, you know, build out that ecosystem in Australia. And I think, you know, it's, it's a, it's a really exciting time in my career to be involved in a whole range of different things, rather than, you know, sort of singly in one sort of more commercial type arrangement. Wouter Klijn 29:30 Yeah, yeah. Excellent. Well, Greg, thank you very much for your time. It was good speaking to you. Greg Cooper 29:36 Thanks, Wouter, that's great.

In this episode, we go into our archive to October 2019, when we interviewed Fiona Trafford-Walker. Fiona was one of the key consultants behind the success of Frontier Advisors and spent 25 years with the asset consultant, advising many of the largest funds in Australia. She has been named several times among the most influential consultants in the world and was a driving force behind the fight for equitable fees in the industry. In this interview, we delved into the changing role of asset consultants, questioned whether too much time is spent on manager selection and examined the struggles of value-style strategies. Fiona has since retired, but is still active in the industry through various director roles, including for Victorian Funds Management Corporation, Perpetual and as a member of the IFM Real Estate investment committee. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Episode Overview Fiona Trafford-Walker podcast: 2:30 I'm an accidental asset consultant 4:30 You're named as one of the most influential asset consultants in the industry. What makes a good asset consultant? 5:35 You have to be willing to collaborate 7:00 Technical skills are very important, but equally important is time in the markets 7:30 The changing role of asset consultants over the years 9:30 As asset consultants have increased their senior staff, have conversations become more focused on strategy? 10:30 There is still the need to have a blend of specialist and generalist skills 11:50 Are we already heading to having a panel of asset consultants? 13:00 Is there a good balance between the time spend on manager research and that on asset allocation? 14:30 What type of data should inform changes in asset allocation? 16:00 There is not much you can do about geopolitical risk; predicting what politicians are going to do next is pretty hard. 16:30 But trade wars are a real thing that have an effect on markets 18:00 Are the struggles of active managers, particularly value managers, structural or cyclical? 19:00 There seems to be a need to tweak the value process to allow for the new capital-light business models. But at what stage do you get style drift? 21:30 Frontier Advisors took the decision to build a platform with all their research on it, quite a brave step in an era where softcopies get distributed easily. 26:00 You spent some time arguing for lower fees in the industry. Are we at the right level? 27:30 The real change has been the internalisation of asset management by some funds. 29:00 Can internalisation refocus asset management on the long term? 30:00 Bottom draw mandates 31:00 To what extent should asset owners engage with the companies they invest in? You are on a number of boards and see both sides? 33:00 Governance certainly has changed as asset owners realise they are the beneficial owners 35:00 To what degree can you divest from companies as a fiduciary? 38:00 The challenge of developing retirement products 41:00 At the moment, the willingness to do things together [as funds] isn't there. 42:00 What is next in store for you? 44:00 What issues come up in mentoring new asset consultants? Full Transcript of Episode Wouter Klijn 01:12 I'm here today with Fiona Trafford-Walker, who is a director with Frontier Advisors. Fiona, welcome to the podcast. Fiona Trafford-Walker Thank you. Walter, happy to be here. Wouter Klijn So 25 years of Frontier advices, has it gone quickly, or do you think it's a long time ago since you started out? Fiona Trafford-Walker 01:28 I think the answer today is both, when I think back that it's been 25 years, I feel like, wow, that's such a long time. It's about half my life. And if I think about it like that, it feels like it's a very long time. But also, I think it's gone very, very quickly when I think of what it was like to start the organisation with Ray King, obviously he was very integral to starting the asset consulting business inside industry fund services, which became frontier. And I remember very clearly the first day walking to the office in Carleton. There were two of us in this room working out of there. And then I think of how, you know, we grew over the years. Some terrific people came on board, and then all of a sudden, it's 25 years later. So in some ways, it feels like it's a long time. Otherwise, it feels like it's gone very, very fast. Wouter Klijn 02:13 Yeah, if I can take you back a little bit to the start of your career, I read this funny quote one time that you did an interview with The Sydney Morning Herald, where they asked you how you became an asset consultant, and you sort of made this comment where you said, yeah, it's not really something that you aspire to in university. It sort of happened. Can you tell us a bit about that? Fiona Trafford-Walker 02:33 Yes, that's definitely true. I'm a great accidental asset consultant, I think, for a few reasons. One, it's not something back, you know, 25 years ago that people really knew that much about it was a relatively new career. Back then, the asset owners were much smaller. The system was very different. And I was interested in financial markets research, and I grew up in North Queensland, where the career prospects for that sort of thing are obviously relatively narrow. So I knew I had to move, and I knew it would have to be Sydney or Melbourne, and so just applied for a number of different jobs. I remember going for my interview again with Ray King, because he has employed me twice now, and sitting in the office at Towers Perrin in Sydney. And you know, Ray was asking me all these questions, and I couldn't answer most of them, and I thought I'd completely mucked up the interview. And next thing you know, they're offering me a role. It was a research role, and it was in the investment consulting business in towers parent, but sitting alongside that function, and my job was to do specific research that might help the consultants provide advice to their clients. And there were two of us in what we called the Global Research Unit, which I used to think was kind of ironic, given there were two people in Melbourne in a global unit. And after six months, the person I reported to Ron Bird, decided that he would move into funds management. And so I think they looked at me and said, Oh, well, we'll just move you into the asset consulting business. So I moved in, and I was there at Towers Perrin for a couple of years, and I just really, really enjoyed that work. I think what resonated with me was the chance to do research and practical research that could then be used to influence client portfolios and then outcomes for members. And I think I just not made that connection well enough before in those first six months. So I moved into the asset consulting division, and then in the middle of 1994 when Ray left to start industry fund services, I moved over with him, and the rest, as they say, is history. Wouter Klijn 04:32 So you've been called one of the most influential asset consultants in business. What makes a good asset consultant? Fiona Trafford-Walker 04:40 I get asked that question a lot now, and I think, I think what happens as you get older, people ask you all these questions, and so I've had to actually think quite a lot about it, because it was not something I ever thought about a lot beforehand. For me, I just did what I thought was the right thing, and it sort of happened to work out. But as I look back, I think. There's a few key characteristics. One, I think, is you have to be able to listen to people, and not only listen, but you have to hear. So listen to what they say. Sometimes their words aren't exactly what they mean. So you have to be able to read the room and understand what a question really means, and then you have to answer it and be clear in your answer, depending on the audience, use the right kind of terminology. So for example, in a trustee meeting, where you might have a lot of people who don't have an investment background, speak in very plain English so that people can understand what you're recommending that they do equally. If you're speaking to a much more technical audience, for example, internal team, then you tailor the way you speak to answer the questions and have the discussions. So listening and hearing and communicating, fundamentally, I think, is really, really important. The next thing I think you need to be really good at is collaboration, because as an investment consultant, asset consultant, you're giving advice, and a client may or may not take that advice, so you have to be willing to work with them to get a good solution that works for them. And sometimes you might go in with the best of intentions, the best advice you can possibly develop, but a client might say that doesn't work for me for these reasons, and so you have to always collaborate and move and shift and evolve your advice to make sure that you can continue to influence the clients. I think also, there are some fundamental skills around you know, the technical skills you really need to have, and they have changed over the years. So, for example, when I first started, I think we still use lotus, 123, but I'm not actually sure, because we didn't use it very much. And then we graduated to excel, and when we were interviewing people, when, for example, about 15 or so years ago, we'd interview people, and we used to do these tests in Excel, and they would have to do a VLOOKUP and those sorts of things. Whereas the technical skills nowadays, not only in the use of various pieces of software, but also the financial technical skills, are much, much stronger, and we see the young people coming through. They've clearly exceptionally skilled. And for people like me who don't necessarily have all of those technical skills, it's about other experience and skills you can bring So, experience with clients, time in the markets, I think that makes quite a big difference. And I look back now over, you know, nearly 28 years of of being in the markets and seeing things, and I think having that perspective is also something that's quite valuable. So you Wouter Klijn 07:23 show that have there have been some changes within the essence consulted industry, and I think some of those shifts have been quite big. As the pension funds become larger and become more almost financial services companies. How does that affect the role? Fiona Trafford-Walker 07:42 It's had a very profound influence. And if I think back over the various phases, so the first phase, when I first started, you would be the expert in the room. You would take your papers, the clients would thank you. They would pretty much do everything you said, and you would go away again, and then you would come back to the next meeting. And as those businesses became more sophisticated, they employed their own people. The work shifted. So some stuff that we used to do, they then took on. And at first it was some of the more straightforward things, for example, processing applications and letters and those sorts of things. But increasingly, you've seen a lot of skill developing in those internal teams. And so the role of the consultant now is very much to work alongside those teams in what I think is a very complimentary manner. Because if you think about it, and the way that I think about this, and I know that I'm absolutely biassed in thinking this is that I think there's always value in an external perspective. But clearly I'm biassed because that's what I've done for 25 odd years. But I look and think if you want to really kick something around, you know, getting people who are working for you, inside your organisation also working for you, but from the outside, you're all still working for the same reason, the same purpose. So I think working alongside those internal teams has meant, though, that the level of skill, the level of experience, the specialisation, has really had to change in asset consulting businesses. So your business model has gone from one which was probably a more typical pyramid, where you've got a few senior people and many more junior people, to being like an inverted pyramid where we've got many, many more senior people now who all can have a counterpart type relationship with the other people in the funds. And sometimes I go to some of those meetings, and they are talking at a level that is really, really deep. These are highly specialised people, and that's one of the most profound changes. I think. Wouter Klijn 09:35 So does that focus in the discussion then also shift to a more strategic type of discussion where you talk more at a high level about decision making, rather than the implementation. Fiona Trafford-Walker 09:45 Yeah, it varies. So some of those discussions, if it's specialist to specialist, they go so deep that I can't follow them, particularly on some of the newer areas, and that works for them. And that might be about a technical. Matter. It could be about implementation operations. It could also be strategic, if you sit alongside that. Though, when I think about strategy for the funds, I think that there are a group of people who can step back from that specialisation and bring what I call a truly generalist perspective. And it used to be, everybody was a generalist, and then everyone said, Oh, you've got to be a specialist to be successful, whereas now I think you can be successful and be either, or, some lucky people are actually both. That's pretty unusual, though. So people who can sit at the really the CIO type level, to sit back from the portfolio, to think about how the whole thing fits together, that's where a lot of the strategic discussions still occur. And those skills are not as common in the industry as they were perhaps, perhaps 10 years ago, as people have changed and people have left, but there's still that need, I think, to have the blend of of the generalist and the specialist, so you can have all kinds of conversations about how you make money for your investors, how you protect their returns, or, you know, whatever your goals are. Wouter Klijn 11:01 Yeah. Now a number of years, I did an interview with Damian Maloney, who was then the CEO of Frontier Advisors, and he sketched a vision where, or a vision a future where he thought assets consultants will no longer have this exclusive role with one particular fund, it's more likely that it becomes like law firms, where there's a panel of different asset consultants and they specialise in different things. How far along are we in that? Do you think Fiona Trafford-Walker 11:28 We haven't got in our client base many of those kinds of relationships we tend to rather than working in a panel? And it might be because there aren't that many consultants you can actually put into a panel, we tend to work with the internal teams who might then go and get specialist advice from someone for a particular reason. So for example, if they're doing an infrastructure deal, they might go and work with a traffic consultant or an airport consultant, something like that. But the concept of a panel where you have panellists who might be doing similar things. We haven't quite gotten to that, but I think broadly, there is a sense of a panel where the internal teams that are very active internally and, you know, and that's not the majority. At the moment, there's still lots of funds that are, you know, run very, very leanly with a lot of outsourcing, but those internal teams, I think, are increasingly surrounding themselves with expertise as they need it. And then, of course, the trustee surrounds itself with expertise as it needs it. So we have relationships with internal teams and also with boards and investment committees. So you're seeing a little bit of the panel approach in that sense, but not where you kind of line up and you go and get one report from one another report from another. It seems to be much more targeted. Wouter Klijn 12:41 Sometimes, asset consultants are seen as gatekeepers, probably especially by the fund managers want to get on the approved list. When you look at the dimension of the time spent on manager selection and, for instance, asset allocation, keeping in mind sort of the research that's done on the impact of asset allocation. Do you think there's a right balance there, and to what degree, if you do focus a lot on asset allocation, can you be dynamic in that? Fiona Trafford-Walker 13:10 Yeah, look, I've never thought that there was the right balance we you know, one of the very first papers that I did was really to try to replicate some work done in the States, about, you know, where do returns come from, and particularly where does the volatility of returns come from? And there was some early work done which showed that particularly the volatility of returns came from the asset allocation, and within that thinking about your strategic allocation, because that was the nature of that paper back then. This is what this is, 25 years ago that has evolved to being around strategic and dynamic asset allocations. That said, the role of active money management in that can still be really value additive. You know, it can be the cream in the coffee, so to speak. And so anything that helps you get you where you need to go is worth looking at. So for me, it's about the balance of time. And I think that over the years, you know, we would always have been better to have spent more time on asset allocation, like, what's going on the world? How do you position your portfolios? And for some reason, it was just never really seen by the industry as something where you should spend a lot of consulting dollars or internal dollars. I think that's changed now with some of the numbers are coming out, and you can see the difference in performance. That said, my personal perspective is there should always be room in your portfolio for good money managers who can make money over time for their clients. And I think that the time on manager research to find those firms is well spent, but probably we, collectively as an industry, spend too much time trying to find out who those firms are when. If we could deploy some of those resources into working out what's going on in the world and how to set your asset allocation, and I think dynamic is a really, really important dimension, then that probably would be better over time. Wouter Klijn 14:57 So what should inspire some of these. Changes on the dynamic asset allocation. And I think particularly about we did a poll recently amongst investors and asked them what the top risks are from whether you're going to make your return or your liabilities. And the number one concern was geopolitics. And I can sort of understand from there could be a tail risk potential event. But then, when we asked if anybody made any changes based on geopolitical events, there were very few that actually did. How do you incorporate it and what should inspire changes in an asset allocation? Fiona Trafford-Walker 15:35 Geopolitical risk, I think is really hard. I mean, I feel quite lucky. I work with some terrific people, and particularly the director of investment strategy, Chris Trevilian. He runs our Capital Markets team, and they think a lot about some of these tail risks, not only some of the structural changes in markets and in economies and in the world. So for example, things like demographics and climate change and others. Then you do have things like geopolitical risk. You've got quantitative easing and these sort of weird things that create enormous amounts of noise, and they do change the way that market and market participants respond to things. So we look at geopolitical risk and we think, well, we can't do much to manage that like it exists. We have to think about, how do you defend against it? Diversification is a good way of defending against it. But if you're trying to predict what politicians are going to do next, it's pretty hard. But then sometimes those risks creep into what I've loosely called real things, like the trade wars, for example, now that that is a real thing having a real impact on markets and on economies and on exchange rates and and and on people who are fundamentally affected by what happens in, you know, their own businesses. You know, small businesses in rural USA, for example, and businesses in China, and increasingly, businesses here. So we try to put the things we can understand but not control into one area so the least we know what's going on, and then we try to work out how might that squeeze out and affect the advice we give clients. And geopolitical risk has featured in a lot of the quarterly market outlooks that we do, but we try not to set portfolios based on things like that. But you have to have an eye on it these days. It's a brave new world, I think. Wouter Klijn Yeah, that said there's an argument that, you know, fundamentals should come to the fore at some point, like at some point, but it's been a bit of a long time now. Fiona Trafford-Walker So, you know, the rubber bands getting longer and longer, but we are in very unusual circumstances, and I've spoken a lot with investors about the absence of value working in the markets for at least the last 10 years, and there's a number of changes within the market that could make the argument that this is a more structural development. One is, of course, the capital life model of technology companies. There seems to be also more stricter regulations on how much management of a company can tell a fund manager without having to disclose it to the rest of the world. So there seems to be a number of elements that are not really in favour of active management. Wouter Klijn Are you concerned that this is a structural issue, or do you think this is mainly still a tale from QE and cheap money. Fiona Trafford-Walker 18:21 I think it's probably the latter for the most part. But I do think that, you know, there are some structural changes going through markets, and I think technology is one of them, and understanding the impact that that will have on, for example, people who work in organisations and the work that they do, and how that might be displaced and what happens with them. So I do think there are some fundamental changes coming through, really, on the more of the social side, and that will change the way that companies operate, the way companies think, and also, I think the what asset owners and shareholders think and expect. So we did quite a big paper a couple of months ago just looking at active management, because the last 12 months was really, really terrible, and I think the worst year in the last 20 so it's really easy to look at that and go, Well, it's broken. But I think again, if you look through the fundamentals and think good active managers, if they're doing good research by good companies at decent prices, then the value style over time, to me, still is something that has a lot of merit, but, you know, maybe there's an openness to something like, you know, a new value style that does allow for some of these structural changes. And I think that technology, and, you know, machine learning, robotics, AI, those sorts of things are complicated, and they will change business models. And I think being open to that is probably the best defence. Wouter Klijn 19:43 So there might be some changes within the investment process, within value. To what degree can you adjust that process? And at what point do you say, wait a minute, you got style drift going on here? Fiona Trafford-Walker 19:57 Yes, the old style drift used to be something that fund managers were hung, drawn and quartered for. I don't hear people talk about style drift that much anymore, to be honest with you. I mean, maybe someone like Fraser Murray, who runs our equity research might hear that more than me, but certainly when I used to do manager research, that was something we were very vigilant to look out for, mainly because when you're putting together portfolios for clients, you have managers playing certain roles. And so if one manager you think is going to do something, but they creep to do something else, it does cause you problems with your overall portfolio, because you end up with too much of something you might not have wanted. That said, I think that it's always healthy for any firm, not only a money manager, but even our consultant as well, to say, well, is the way we do things still sensible? And so if you are going to have any kind of drift in your business, and we are drifting now, maybe called pivoting, I don't know, which is a very cool thing to do, you talk about it and go and engage with your customers and clients and say, look, we've been doing things this way for such a long time, but we think the world has changed, and we're going to evolve to do something different. And I look at the business model at Frontier, for example, and the work that was done, you know, when Damian was a CEO, which is going back to 2011 around technology, we were always way behind on technology. And He came in and sort of had a look again, the value of an external perspective coming in and saying, we need to really wrap that up. And would have been easy for us to say, well, we're a consulting firm. You know, technology is not our thing, but in fact, that's been incredibly empowering for us. But you've got to take your staff and your clients on that journey so it becomes something you can do together. And I think it's the same philosophy about money management and styles. Wouter Klijn 21:45 Yeah, the technology platform, in a way, was quite a brave step, because I remember that when it was introduced into the market, and the idea that clients could log in and see research there, that they thought, well, if they see it on that system, then it's very easy to print it out and it gets all spread around and lose IP and but I think at the moment, it's actually turned out to work quite well. What do you think made it work? Fiona Trafford-Walker 22:13 Oh, look, you're absolutely right. When we first talked about doing it. And, you know, back back then, the way that we used to think about consulting, and I think all the other firms would have been the same, is that you that you, you had your processes and people and everything, you developed your IP, and you protected that very zealously, and that's what you sold. You sold time, and you sold IP, and that's all you had to sell. So when Damian came in and said, you know, we should actually put this on its head, we were like, wow, we're going to be kind of giving IP away. Is that? How's that going to work? I think the philosophy that we had was that if we shared it, we would back ourselves to continually develop fresh IP and fresh ideas, and that people, in seeing how open and transparent we were, would say, well, these are good people. They do good work. I want to work with those people. So the sharing of IP was something that was that Damian drove back then in a very different way to the way that we used to collaborate and share the IP. It was one of the hardest transformations in the business, though, for a few reasons. One is we did actually have a database, which we affectionately called the prober, because we would be out there probing managers for for information about their processes. And the prober was just a an Access database. It was a very internal database. It was full of typos, grammatical area errors, inappropriate things that should never have been written. Thank you. Mike fish, and so we we decided we needed to go back at least three years to build something that people could see what they were going to buy. So we printed off all the notes for the last three years, and a number of us then went through and actually edited every note. It nearly killed us. It was just it was very difficult, but we ended up with something that has, I think, become, if I do say so myself, I think it's become the standard in the market for you know how you communicate with clients, how open you are, how how you can prove the value that you add. And I think that then led to being not only an internal system, but an external system on manager research, but now increasingly on capital markets research. So all the asset allocation we do is all done through the system, and that system is being enhanced all the time. So it was a very big transformation, and it was not easy, and it really took probably about five years from when we started to getting to the end and saying, I think this actually works pretty well now, but it was a very significant change and and it's been very, very positive, yeah, and it's enabled us to get efficiencies which we would never have been able to get before. So the concept of productivity actually is now quite a valuable one inside, inside frontier, whereas before, we just could never work out how to be much more productive, other than getting other people to do the work. Now we have this major tools. Wouter Klijn 25:01 It's very important. So in a way, it motivates people to constantly look for new ideas and new research and produce that Fiona Trafford-Walker 25:09 Yes, yes. And if I think back to one of your early questions about what makes a good consultant less so individually, but as a as a firm, you know you have to think of new ideas for your clients, and you don't need new ideas all day every day. You really need a couple of really great ones each year, maybe even one a year. I'm not even sure the number, but if you know you have a process that develops IP good ideas for clients, then the clients will look at you and say, Yes, I want to deal with those people because they're smart. They'll help me do my job better. So I think that that has enabled us to think in different dimensions about development of IP and ideas. Wouter Klijn 25:47 You've also been quite active in the whole debate around fees and been driving funds to look at those arrangements. Can you tell us a little bit about how you think where we ended up is the right space? Because partly, there has also been a large unexpected impact from regulations with the introduction of my super. Fiona Trafford-Walker 26:06 Well, not only my super but things like RG 97 and other things. So if I think back and it's 10 years since I wrote that first paper, and 10 years since Ken marshman, who was my counterpart at Jana at the time, and I sat down and had discussions about this as an industry issue, and the perspective we always took that did get a little bit lost at times, was it was always about net returns. It was just, what did you pay to get those returns? And was there a fair and transparent sharing of the, you know, the economics? So we developed six principles, which were very much around fairness, transparency, the right to commercially negotiate, all those sorts of things. And I think, though, as I look back, and I'm actually very close to finishing a paper that sort of updates on where we are 10 years on, I think on some measures, it's been very successful. It's made people think about just how much they pay for what they get, and is it worth it, and some things are worth paying for. You know, there are some terrific firms out there that do great work. It's research intensive. They deliver for their clients, and yes, you should definitely pay for that. But there are others where you sort of think, well, does that really a good sharing? And I think it's enabled a lot more discerning, I think, between firms that are worth paying for and those that possibly need to just sharpen their Proposition A little bit more or think about the products that they offer. So I think that's helped the biggest shift, though, I think that has caused real change in the funds management community is the internalisation by the asset owners, and that had sort of been flagged by a few some, in fact, some did manage money internally back then, but it wasn't a very public thing, and it's been increasingly flagged by some of these very large asset owners. And I think that as that became a lot more prevalent, I think the funds managed community look, looked and thought, well, the money is going to flow from us to them, and that's exactly what you've seen. And so that, I think, has made people sort of sharpen their thinking about, not only about their products, but about, you know, the economics, the prices they offer. But it's pretty hard to compete, in some cases, because the internal model is a relatively cheap model. I think what I would like to see in the next five years is full transparency from the asset owners who do manage money internally, just to be clear, that they're the same standard is being applied around the search for excellence. You know, by whether you're in an inside an asset owner business or you're outside, in many ways, what you're really doing is transferring risk from outside to inside. So you just want to be clear that that turned out to be a good thing. Wouter Klijn 28:44 Do you think that there are any concerns over whether the standard might slip? You could also, because that's a discussion that's often had where you say, well, it's very hard to fire the internal team because your colleagues work with them and they have influence. But you could also think about it. Well, the industry has for a long time been focused on very short term results, and maybe this will enable to put some strategies in place that are much longer term, that look more at buy and hold type of strategies, and potentially drive also some change there. Fiona Trafford-Walker 29:18 Yeah. Look, I really hope so. I think that you know the certainly institutional investors like super funds and other long term investors, that the one major advantage they have is time. And if you have time on your side, then that's an incredible opportunity you can exploit. And a big way to exploit time is to be a truly long term investor and to ride the cycles of business out. If you've got a company going through a tough time, understand it, but don't bail because your tracking error has gone up, or you've got a report to provide to a trustee, or something like that. And so in many ways, it's not completely fair, because, you know, that's not necessarily the way that an external money manager gets treated somewhere. I think it depends on how well they sell their story, but for the most part, the focus on the shorter term numbers, I think, has not been a positive thing here. I do think with internal money management, that it's a great opportunity to enable true long term investment to occur. And I used to call them bottom drawer mandates. And my idea, like in the mid 2000s was you would just go and buy chunks of businesses and literally stick them in the bottom drawer, good quality businesses just doing their job, performing well, clearly, if there's some kind of event, yes, you need to get it out of your bottom drawer and have a look at it. But otherwise, it seemed to me that the ability to provide capital for such long periods would be very positive, not only for capital markets, but for the community, society. For business, this flow on effects are quite significant. If businesses know they can truly invest for the long term, then it's just a win win for everybody. So hopefully we'll see that. I think increasingly we are seeing in the processes being developed by the asset owners, that definitely is something they're capturing. So that's really positive. Wouter Klijn 31:04 So with the internal teams investing, they're closer to the market as well. And one of the things that is interesting, I think, there, is that they become much more aware of their responsibility as an owner of these assets, and engage more with the companies. To what degree do you think that that's desirable? Should they engage and try to get better outcomes in as far as they can? Or should I just leave companies to do that? Fiona Trafford-Walker 31:32 Well, for me, it's about responsible ownership, and I think, I mean, I see these things from two perspectives now, because I'm actually on two company boards, and I'm also on the board of another investment organisation, and so I see a perspective I didn't have before, which has been really, really valuable. I think companies need to be allowed to just get on with the running of their businesses, just in the same way. Our Super Fund is a company, and should be allowed to do the same thing, but at the same time, they need to be accountable for what they do. Need to be transparent and to move with the times. So, for example, the shareholders are saying, What are you doing on climate change? Well, answer that question. Be clear about it. Commit to being responsive if if they have questions about, How do you treat your workforce? Well, answer those questions. And I think there's a bridge to be made between the asset owners and corporate Australia. I think it's they still have to work at how to kind of operate with each other. That said, I don't think that you want the shareholders kind of sticking their noses in too much, and vice versa. We have to learn to coexist. I think, Wouter Klijn 32:47 Yeah, I think it's interesting, because in the recent years, we have seen more emphasis on governance, and sometimes it can be a bit vague in what exactly people mean by that, but at the same time, there's some real consequences to ignoring that part. So this morning, we just had news come out that some of the pharma companies are now being held accountable for the opioids in the US, and I think Johnson and Johnson has to pay more than 500 million and but there's another company, and that has apparently offered a 12 billion settlement to settle all of the cases that are against it, that's that's obviously having a real life impact on these companies. How do you look how that has developed over the course of your career? Is that really true, that there is more emphasis on it, and is there a clear way of doing this? Fiona Trafford-Walker 33:40 Yeah, oh, there's definitely more emphasis on it. I think, I think, like when I first started, the fund managers couldn't, you know, had the relationships with companies, and they decided how they would vote and and that was something that was highly delegated. But as the the asset owners got bigger and bigger, and they realised, well, we're the beneficial owners of these shares, we ought to decide some of these things or be part of that conversation. So they started voting their proxies, but that typically was around things like remuneration, or a director standing, or something like that. Then the next wave, though, has been, I think as responsible investment has become, really quite a powerful movement, I think, for one of a better word, where they're saying, hang on a minute. There's a lot more going on in companies, and we own large chunks of them. And you know, for example, many have signed up to the United Nations Sustainable Development Goals, the United Nations sponsored principles, responsible investment. And that means you have to do something. You have to ask questions, put your money where your mouth is, literally. So we are seeing significant change, I think now, particularly by the big asset owners, to think about where they put their capital, what businesses are they supporting? We have a number of clients who think a lot about the just transition in a climate change context, because. Because clearly many of them have members and employers who might be affected by that so thinking, Well, how do they participate in that process? So might not be something that happens quickly, but something over time, and how can they help them make that transition as effectively as possible? So that is much more powerful today, and I think that's entirely appropriate when you are the trustee of multiple billions of dollars of other people's money, you have to think about, you know, how you how you invest it, where you put it, what you expect companies to do with it, Wouter Klijn 35:32 Yeah, in the local context, we've seen a lot of emphasis being on cutting out tobacco companies from portfolios. And it seems that the next discussion is focusing more on a low carbon environment or portfolio. To what degree do you think that these types of actions align with the fiduciary responsibility as well? Because yes, there's obviously great risks attached to it, but there's also a point where you say, Okay, you can't just keep cutting out chunks of portfolio. How do you deal with that? Fiona Trafford-Walker 36:05 I find that one really tricky. So I, I would always rather engage to help improve something. But there are some businesses. So for example, tobacco is one is they're always going to make cigarettes or vaping or whatever, and other things called so they're not going to fundamentally change their business model. You have to decide, do you want that in your portfolio or not? And some of those things, for me, anyway, get into kind of an ethical debate about whether that's good or bad. Some of it, though, is more tangible. So for example, you know you can point to, you know, things like lawsuits and, you know, future lawsuits. And so it can become quite a real thing. So it goes from being ethical to being actually something much more financial. Tobacco, I think, is in that category. But most, most businesses, it's not that straightforward. It's so for example, AGL is one I think, that got a bit of press a couple of years ago, where the easiest solution would be to say, well, we don't like what you're doing with coal, so we're just going to divest. Whereas a better solution was, which actually, I think, is what occurred, is to say, how are you going to transition? And they committed to a transition plan. And so, you know, you've made an impact there by saying, all right, you know, how do we help this company transition over some reasonable period so that we get where we want to go, and we've influenced the business. To me, that's a good use of that, of that power, and that, you know, the votes. But I think it's from a governance point of view. It used to be, it had to be, you know, members best interest, and a very fiduciary duty. And I think that has morphed a lot. So the concept of fiduciary duty, I think the lawyers would say it's still the same, but there's now community expectations, and there's a bigger overlay on that now that I think has made some of those decisions a bit easier than they might have been, but I'd always rather engage if you can, some companies don't want to engage, or if they do, they decide they just don't want to listen, in, which case you just invest somewhere else. There's plenty of companies, companies companies to invest in. Wouter Klijn 38:03 Another problem, or more of a challenge that industry is facing today is the development of retirement products. Now, apart from sort of the product issue that there is investment challenges as well to it, why do you think it has been so hard to come to a solution to this? I mean, people have been retiring, right? Fiona Trafford-Walker 38:22 Yes, yes. I think what I put it down to is we all got so excited building what I think is fundamentally a really, really terrific accumulation system. I mean, I think it's easy to beat ourselves up, and you could always do things better. That's definitely true. But fundamentally, the system we have here is really, really good. It's sort of one of the top three or four in the world, as assessed independently, many, many more people today retire with much more money and therefore dignity in retirement than they would otherwise have had. The coverage is much better in terms of the workforce and in terms of women. So I think we kind of got a bit excited building that that we sort of thought, well, we could just take those concepts and apply them in retirement. So, you know, the easy solution was, well, the money was small, so we'll just do a different tax assumption, and we'll put some products that work. And I think we always knew, or the industry always knew, that that was just a bit of a band aid solution. And though, as people think about it, I think the real challenge, though, is in retirement, you need to have much more fun consideration of your individual financial circumstances. In accumulation, you don't necessarily need that. You need to know a small number of things about someone. They choose the right option, they build their pool. But in retirement, you need to know, for example, any other money? Do they own their home or not? Are they in a relationship or not? All those sorts of things. And most people don't go and get financial advice. And so how do you help them in retirement? Build something that I think is the industry calls sort of mass customization. I think that's really hard. That said there. A lot of really smart minds working on this. Now, the money in the funds in retirement phase is growing rapidly, so the Critical Mass is is being developed. And so I think it will not be too long before we see some really, really good products coming out. But yes, I think you're right. It's definitely underdone. Wouter Klijn 40:19 It's an interesting sort of issue, because we had the my super legislation come in, and so there's now this sort of legal definition of what a default option should look like. And I think sort of that concept was taken then, oh, let's do that for retirement. But you can't necessarily do that because of the vastly different circumstances that people are in. Do you think that one solution should be more that it's based on a concept or a platform that has then multiple different solutions hanging under it, or is it possible to have a my pension default? Fiona Trafford-Walker 40:53 Well, look, I think also all those things are possible. I do think that to build some kind of platform, you do need quite a lot of collaboration to get critical mass across some of the funds, to make sure you can do things like pooling for longevity and all those sorts of things. And I think at the moment, the willingness to work collectively and to pull money doesn't necessarily seem to be there. I think the lot of the funds are trying to really do their own thing. So I think there's an opportunity to do something along those lines. I think possibly it's technically a lot more complicated than then it might first appear You're right. You should be able to have, well, we have my Super Why can't we have my pension? And I think it's probably quite technically difficult compared to an accumulation phase. Then again, as I said, so many smart people in the industry are trying to work out how to continue to look after members. I think we've looked after members really well until the point that they retire, and it's that next phase when, arguably, they actually need You more. You know, I think, because that's a can be a tricky time for a lot of people. And as they retire, then, as they age, thinking about, how do they get health care advice? How do they get aged care advice? It's this, we don't necessarily look after people at that point very well at all. I think so. Wouter Klijn 42:10 Fiona, what's next in store for you? I think you recently have relinquished the role of director of consulting and taken on a few board positions as well. What can we see from you in the future? Fiona Trafford-Walker 42:25 Yes, you're right. I am. My role has changed. And so I handed all of the consulting responsibilities and practice responsibilities over to Kim by water in 2017 and as I mentioned earlier, Chris took on investment strategy and and other people took on other things. And so I've been really excited to see how well they've done and how, you know, they've made their own mark, and they've thought about what the company should look like and what those roles should look like, and I think they've all done a terrific job. And so my role has moved to be more strategic. And when I can't do it on this, on this, because I'm not on a video, but whenever I say strategic, I do the bunny ears, because no one exactly knows what strategic means, but it's turned out to be things like working with clients on governance issues or investment issues or behavioural finance issues. It's helping them think about what their internal team should look like, what their delegation model should look like. I don't do a lot of can. I don't do much Consulting at all anymore. On the client front, I mentor some of the staff inside frontier, which has been great. You know, they're a fabulous bunch of people. And I'm on the investment committee, so I think more of that kind of thing is, is really interesting, and I really enjoying that corporate work as well. So that sort of you know that balance would be good, but I'm one thing I have learned over the last 25 years, it just doesn't pay to plan too much. And people often say to me, or did you? Did you plan this? And I'm like, No, I didn't plan any of it. But as opportunities come to you, be open to them. And as I say to people, you just got to be yourself and back yourself and have a go and you know, so I'm open minded to things, and I'll just see what happens. Wouter Klijn 44:07 So you mentioned the mentoring element. Are there any specific things that you see in this new cohort of asset consultants that stand out? Fiona Trafford-Walker 44:18 The biggest thing that I talk to the people that I mentor about is it's their own confidence. And I'm not sure if this is necessarily the people that come into the asset consulting business or whether it's just the people that you know that we attract at Frontier or not, but a lot of the younger people, I look at their CVs and their skills, and they're so, so incredibly capable, but they're also just a little bit uncertain a lot of the time. So I spend a lot of the time talking to them about how to get their capability and their confidence in line with each other. And a lot of that is just helping them think about, you know, as you do things, think, okay, yeah, I did that, and I might not have been able to do that. I. Month ago, and now it's all fine, and you sort of build this on this bedrock of capability and confidence. So that is something that I work with them on. I think that technical skills are exceptionally strong, and I think the key though will be to take those technical skills and turn them into consulting skills, because consulting is a funny thing. It's, you know, it takes time. Some people are naturally good at it. Some people it's not their thing. And in firms like frontier, now there's lots of opportunity to do lots of different things, so you can focus on consulting and research and other things. But it's you turning that capability, the technical capability, into something that you can go to a client and the client goes, Yeah, I want to hear what you have to say, because you're really smart and you've really thought about this, from my point of view. But I think they are very purpose driven. I know that that's a stereotype of, you know, the Generation Z and the millennials, but they are very purpose driven. That's it. I think a lot of people at Frontier repurpose driven as well, so we sort of blend together well, I think. But they get terrific bunch of people, and it's, it's, I really enjoy working with them, and I really enjoy learning from them as well. Because sometimes, as a mentor, it's easy to sit there and, you know, tell people I did this and I did that, but that's not that helpful. I like to hear what what they're doing, what they're worried about, what are they thinking? What's their experience, actually? And, you know, it's big difference. Sometimes the age difference is 25 years. So their world is very different to my world. Yeah. Wouter Klijn 46:35 So next generation is ready to take on the challenges. Fiona Trafford-Walker 46:39 Absolutely, I think they are ready, they're capable, they're willing, and I think, you know, they're excited by the opportunity, but the firm in the next 25 years will look very, very different. I think, you know, changing, evolving, continually evolving, is really, really important, and that flexibility and resilience will be important skills. And I see lots of evidence of that, Wouter Klijn 47:01 Well, Fiona, it was great having you on the show. Fiona Trafford-Walker 47:04 My pleasure. Thank you.

In this podcast, I'm speaking with Kim Bowater, who is the Director of Consulting at Frontier Advisors. Kim has spent 23 years at the firm and saw the asset consultant grow from a small advisory firm with just 13 people when she started in 2002 to the leading asset consultant it is today. She is one of the driving forces behind a number of key initiatives that have supported Frontier's growth, including the establishment of a technology platform that allows clients to access research online and the initial set up of the retirement business. In this episode, we discuss how the continuously changing industry affects the role asset consultants play, the impact of AI and gender diversity within the investment industry. Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Overview of Podcast with Kim Bowater, Frontier Advisors 03:00 I come from a science family; I'm the only one that went into finance 06:00 When I joined Frontier there were 13 people 07:00 Frontier's new independent CIO service 10:00 You led the first phase of Frontier's technological overhaul that saw the implementation of a digital platform for clients. How did that come about? "I put my hand up." 14:00 We are a reasonably open book in terms of our research and ratings 16:00 Does this platform allow you to address knowledge management of the organisation 15:30 We've developed an AI agent, called Frank, that allows us to access all of our data in a streamlined manner 20:30 Ashby Monk said asset consultants might be in trouble with the rise of AI. Do you agree? "No!" 23:00 You've started Frontier's retirement business. What are your thoughts towards product development and investments? 25:00 Retirement is a meaty problem 26:30 Annuities haven't been helped by the low-yield environment that we've had for so long, but in principle, we do think they have a role to play 32:00 The industry has changed quite a bit, how do you look at the future growth of Frontier? Where is it going to come from? 38:00 How do you look at the gender balance in the investment industry today? Full Transcript of Episode 127 Wouter Klijn 00:00 Kim, welcome to the show. Thanks. How are you pretty good, pretty good. Thank you very much. Thanks for having me. So why asset consulting? I think you started originally out as a actuarial consultant. How did you become involved with the asset consultancy side? Kim Bowater 00:18 Yes, well, I am, yes, I did maths at university and took up an actuarial consulting role, which was coming from a scientific kind of family, a bit of a leap into the unknown. It worked with defined benefit funds, so in the superannuation space. But after a few years, I felt like I was more attracted to the asset side rather than the the liability side. So started the CFA course, and then kind of naturally moved into to asset consulting. It was, it was relatively kind of organic, one step at a time, then then in an intentional path. But here, but here I am still. Wouter Klijn 00:59 So what sort of science is your family into? Kim Bowater 01:02 My father was a a senior lecturer of Applied Chemistry, and my mother was a Pharmacist, and she had a science degree as well. Yes. So there was no one in finance in my family. I thought, let's give something we've got. We don't know what it is, but we'll give it a go. Wouter Klijn 01:20 Is that your form of rebellion? Kim Bowater 01:22 Yes, they were intrigued too, Wouter Klijn 01:25 Fair enough. And now you've been with Frontier for 23 years, so you don't see that too much anymore in the finance industry, where everybody has like to be your gigs. So 23 years, that's, that's quite a long time. And you've, you've, now, you know, climbed all the way up to part of the leadership team, part of the Investment Committee, but when you sort of look back on that period, was there anything that stood out for you? Is like, these are some of my standout moments? Kim Bowater 01:55 Yeah, I mean, it's, it's been a good journey. I think Frontier also changed a lot, and our clients, particularly in the Super space, have changed a lot over 23 years. So it feels like a role that's had a lot of change in it, rather than kind of just one firm. I think when I when I started, we were under the leadership of Fiona Trafford-Walker, who, you know, many people will still remember as a leader in the industry and frontier, had a had a really nice culture. I thought client focus, kind of team oriented, but forward looking, kind of challenging ourselves and and I think kind of one, it's not necessarily a serious tan at moment, but I'm quite proud of of the fact that we've managed to have a culture that's endured with those characteristics. That's something I'm quite proud of. Frontier has always been a good place to be part of, and we still hear that today. Wouter Klijn 02:58 Yeah, I think Fiona was one of the first people that I interviewed, I think, for this podcast series A while ago. But yes, it's still one of my favourites. Kim Bowater 03:08 I think also, you know, just thinking about the evolution of advice, the different environments we've been through, you know, COVID, GFC, all the evolution in the superannuation space that's impacted on investment processes and governance and portfolios is something that, you know, we've really focused on working with clients to help them succeed. And I think, you know, I feel that's been a really rewarding journey, I think, for funds themselves, as well as for ourselves, who are, who are also here to kind of create good outcomes for members. We've we've done very well, you know, in our in the external survey of asset consultants, which has been the Peter Lee survey for a long period of time, and that's always been a kind of standout moment for me and the team, you know, to receive really positive feedback from our clients that we're actually, you know, adding value, because you're always a step remote. Step removed as an advisor, in a way, I think, as well from, from looking at Frontier as it's grown, you know, when I joined, there was maybe 13 people. Oh, wow. It was a pretty small, you know, we all did something, you know, we did a range of things. It was mostly super now, you know, two thirds of our clients are outside of super across a whole range of areas. We're working with clients in New Zealand and Japan the Pacific. We have an office in Japan and now recently announced a new independent CIO service. You know, all of those are really significant kind of standouts. Wouter Klijn 04:38 That was quite an exciting announcement. Because, I think to a degree, it does change the business of Frontier a little bit. Because I think so far, Frontier has been able to provide advice, but not necessarily implemented advice. And now with this team up, where you bring in the investment team of state Super 14 people come. Coming over, you actually will be able to implement that as well. It's quite a bit of an evolutionary step for the business. But what do you see, sort of the future? How, how do you think that this might add to growth? Kim Bowater 05:12 Yeah, I mean, it's exciting. We've always, you know, we've been an independent, kind of institutional advisor, so not not having implemented product business, and we're going to continue to be an independent advice led consulting business. And this really, you know, in our mind, extends the reach of that it's not implemented product solution, but we have found that there are asset owners. It's less, less kind of common in superannuations that have grown and have internal teams, but outside of super and some at the smaller end, perhaps, you know, want external advice, want an institutional advisor, but don't really have all of the tools to implement it or execute a bit reporting or custody or execution. So this just provides some extra service levers that we can work with organisations that need those components. It's still, it's still advice LED. It's recommending portfolios that really align to their needs and objectives. And previously, the only other solution they've had is to go into an implemented, like a Balanced Fund, kind of wholesale, kind of group product. And this is, this was providing, I think, a really, potentially, really attractive solution. So from a from a growth standpoint, I think it extends the reach of our our institutional advice, to the border, to broader markets where they need some additional service capability as well. Wouter Klijn 06:38 Yeah, yeah. And from what I understand, this mainly is targeted, sort of the smaller end of the spectrum, like the charities, maybe some family offices. Is that right? Yes, yeah. And does that also allow you to then tap more into sort of the private wealth space? Kim Bowater 06:53 Yeah, potentially, we've been working in the private wealth space for a while now. That's obviously a growing area, and they're also, you know, a group's interested in in working with an organisation like us as they've got bigger so and they they also can have other additional needs, like reporting and various things that that this can assist with. So it just provides a greater flexibility of us to to help our clients with all of the different aspects that they need. Wouter Klijn 07:25 Yeah, and it's very aligned structure as well, because State Super has now become a co-owner of Frontier, yes, and it's been a long-term client as well. Kim Bowater 07:35 So it's yes, it's exciting and and to have you know a team with Charles and 14 people join us is really exciting, too. Wouter Klijn 07:44 Yeah, yeah, for sure. So if I may take you back a little bit about your journey at Frontier and changing essence consultant environment, I think what I saw one big change that Frontier has gone through over the years is when it started to implement the technology platform where, basically, clients could log in, find recommendations, find all sorts of information, and also with the help of a few foreign partners, I think, on this platform, and You were actually the one that led the first part of this project, weren't you? Yes, how did that come about? Kim Bowater 08:26 I put my hand up, or it might have been volunteered. I can't quite remember. I mean, the the genesis of it really was we were, we were finding that, particularly in superannuation, as investment teams were growing, that there were the people that we were advising to that, you know, had their own, you know, had a range of working needs. So some of them would want, you know, direct, curated advice from us. Some of them wanted to do their own research, but leverage our breadth of work to do that. So technology really enabled a different mechanism in which kind of the work that we were doing in our research teams could be shared, and it could be utilised in a way that, you know, individuals wanted to. So the first project was really looking at the manager research database, and we had an internal system. But this was really looking at, well, how do we, how do we strengthen that and have a really good system that can be used externally? So it was, it was an interesting project. It took a lot of mapping, and I think it strengthened our own internal processes as well, and kind of built it out so it could be evolved from here. So be that into kind of areas like private wealth or offshore in Japan, it's been really good to have done that, that really early work. And it's It now includes, that was just the database really to start with, but it includes a range of kind of tools and and systems, portfolio analysis, you know, real life. Sets database all sorts of different things that we use internally and that our clients can use. So it's really added, I think, a dimension of flexibility in terms of how clients can work with us. Wouter Klijn 10:12 Yeah, usually technology doesn't make the headlines in this space, but I remember quite vividly when I realised how important it was when I actually was doing an interview with one of your competitors, and the news had just come out, and I sort of brought it up, it's like, Oh, if you've seen the frontier is doing this, and they're like, it's crazy. We never, we never give our research reports out, and we have one copy, and we hold it very tightly. We never put anything online. And they just have a system where you can log in. And they thought, you know, this is going to make it really hard to get back and talk to fund managers, because if you give them a negative rating, they'll never talk to you again, and now you're just putting it all online. Was that ever a consideration, a conversation, that maybe the reports would more easily be disseminated? Kim Bowater 10:59 I mean, it's a secure system, so we were not worried that it would kind of be available to everyone. But, I mean, ultimately we were, we were not, you know, closed about, you know, what our ratings were. So if we were asked by a manager, we would, we would talk about that. So I think we've always kind of taken an approach of, you know, we've all got a role to play in working with with asset owners, and we should be transparent about how we're thinking about things. And, you know, I think that builds better relationships, even if you start with a negative rating or not rated situation we were, I mean, there is a, there is something to be said around, you know, do you want to do? Do you want to do all your thinking and work before you kind of get into a communication with a client about a new idea, or manage a recommendation, or, you know, investing in Bitcoin, you know, that sort of thing. Do you want to kind of have done lots of work before you even have that conversation. Whereas this has all that meeting notes, it has a whole range of things. It has thoughts processes in along the journey, so to speak, and and so that was a conversation, because I think when you're just providing advice, you kind of do a short list. So it's managers, you do a short list, you provide a recommendation, and it's kind of the end of the process. But we were finding, you know, particularly for asset owners, with super teams, with client with teams, investment teams, with more sophisticated internal processes as well. You know, they were wanting to have a conversation very early in the stage in the process. And so, you know, we're a reasonably kind of open book. We'll start kind of with, you know, we we have, we've got these questions about a topic, and then, you know, ultimately you get to the end of a rating or a view to invest. But I think it's important, with all the questions in the world and things that we don't know, investments are, you know, inherently uncertain in terms of where they'll go in the future. So I always think, you know, being able to ask the difficult questions that you don't know the answer to is just as useful as you know, having done all the work and having the final answer that you think Wouter Klijn 13:15 yeah, so you haven't got any pushback from managers on... Kim Bowater 13:15 No, no. And you know, we try and you know, we try and be transparent. We, you know, in terms of not just our ratings, but, you know, areas of focus as well. With our research programme, there's a lot of managers and products out there. We can't cover everything. So we just think it's useful to have a two way dialogue with that universe. And yeah, no, they haven't. They haven't had any any particular pushback, yeah. Wouter Klijn 13:44 So it started out as sort of organising the database, but over the years, it has grown quite a bit. And I think you already mentioned there's a lot of different tools in it, meeting notes. What is your current thinking about what sometimes referred to as knowledge management, because, to a degree, it retains the institutional memory of Frontier as a business as well, where, I think previously, sometimes when you know in an organisation, when when somebody leaves a lot of information leaves with them, but having this in place, in sort of central place, does retain some of that has your sort of ideas about knowledge management changed in that perspective. Kim Bowater 14:28 Look, I think it's been, it's been an ongoing quest, you know, to manage your data and knowledge well. And you know, technologies continue to evolve. We're in a process of really centralising all of the data and and knowledge and past work that we've done on the cloud, and really looking, you know, you need efficiency of data access, security, data governance and being able to extract better insight. So having things. Obviously dotted about in in the manner of old, is is not the best way to extract data. And so we're, we're in the middle of a centralization project at the moment. We've also got a private AI tool, which we've called Frank, after an internal competition Wouter Klijn 15:20 I've met Frank, I think, at the last annual conference. Kim Bowater 15:24 And you know that that that allows that kind of data set and knowledge to be to be accessed through that tool and and for all of us, really, in a more streamlined manner? Wouter Klijn 15:36 Yeah, now AI is something that is obviously on a lot of people's minds in a moment more whether it's a bubble and it's about to burst. In terms of application to this, to the data, where do you see the biggest gains? I mean, you just mentioned this agent that has been developed, but where do you see, sort of the biggest benefits? And part of the reason why I'm asking it is because I was reading a report recently from MIT, which basically looked into companies running AI pilots, and it's sort of concluded that 95% of businesses got no benefit out of it, which is not that great number. So keen to hear what your experience is. Kim Bowater 16:20 Yeah, look. I mean, I think it's a, it's going to be a journey, and we're in a really, really relatively early phase. So, you know, Frank, for us, is a really useful tool to, I think it'll create efficiencies in data access. You know, it can apply style, kind of guide to it. So there's just a kind of wording benefit. We view generally AI just to kind of take a step back, it's as a strategic priority. We think it's an area where there's a lot of change, where we need to be thinking about what it means for our business. So we're working on that, that strategy at the moment, and we're also thinking about a lot from an investment and economic standpoint, I think we have a range of kind of projects underway. A lot of it's kind of in that kind of efficiency space, or in the can, can we use it to provide a different perspective to the one we might have come up with in a qualitative sense, and understand why? So it's a kind of robust, adding robustness to our own processes. But all of that's quite, quite new, and we're seeing it, you know, kind of expand out into so many different areas in the world and businesses. And there's obviously a governance and a risk aspect to it as well. So we're using it as a tool, a supplementary tool, but you know, I think we'll take learnings from that and continue to develop it from there, without kind of getting too ahead of ourselves on it. Wouter Klijn 17:52 So I did a recent podcast with Ashby Monk from Stanford University, the long term investing Institute there, and he is very interested in AI, and in think he has some projects going on with some businesses on the side as well. But I basically asked him, Where do you think AI would fit within sort of the pension industry? And he started describing basically the idea that you could use it to get alternative viewpoints, in the sense that you could very specifically make it a specialist, but also more general at, you know, board type of advice. And he started describing where it could be used. And I said that again, this sounds like an asset consultant. And he sort of agreed. So I said, So are they in trouble? And he said, Oh, they might be. Are you? Are you worried about that it gets to a point where, you know, it replaces advice. Kim Bowater 18:44 Yeah, no, no. Look. I mean, who knows, who knows where it will go, and I suspect you know potentially some of the power of it in things we can't, you know, yet envisage, but I do think it's potentially useful to provide separate different perspectives and all of those things, but investing is such a challenge, thinking about particularly the total portfolio and how all the different components come together, where the risks are, where the opportunities are, what the different competing things to weigh up, you know, risk and return and fees and all of the things, particularly in Super that you need to weigh up, you know, it's a complex problem, and AI, I think, should be useful in in processing some of that. But I don't think it takes away from, from, you know, the insight that an experienced investment person will will have, and I don't think, you know, investment committees will, you know, have an AI advisor that they'll be as comfortable with compared to a, you know, an experienced asset consultant, where they're looking for an independent perspective from their from their internal CIO. Wouter Klijn 19:55 It can obviously lead to some efficiencies, but I think at the moment, as well, the system. We're still at a stage where it makes a lot of mistakes. Yeah. So I find that whenever I use it, I almost spend as much time correcting its mistake than I actually gaining in benefits. And it sort of has this idea that we still need more evolution in that space, because at the moment, it's like broadly right but specifically wrong. And yes, but I'm very interested in this space. So yeah, we'll be interesting to see what happens there. Another sort of big development is, you know, the retirement space. Obviously, the regulator has put out some requirements there for people to at least develop sort of a strategic plan. I mean, it has changed a few times. There were sippers. Now there is covenants, but the idea is that we need to basically have a more mature approach in that particular space. Now, I think you've also set up the retirement business for frontier. Tell me a little bit about how that started and what sort of your thinking is towards this space. Do we need a whole range of new products, or is it more tweaking for a specific set of circumstances? Kim Bowater 21:13 Yeah, it was, yeah. Some time ago, we started to think about retirement in some ways, from an investment or product standpoint, given where we're from the investment side, and what, what that meant in terms of the member experience. What was different about it is the, you know, you think a lot about my super and different options and their collective vehicles, but retirement has a an, you know, a lot of of challenges that go to the individual member and what they need. And I think the so we, you know, life cycle is, is more common than it was back then. But that was something we we did some, some work on and, and then also, you know, in retirement, what, what does a member actually need? And what would that mean for for the investment product? And there's always that challenge around different circumstances and pension and all of that sort of thing. It's been really slow, I think, and in its evolution, part of it is, you know, there's been a range of other things that supers also been focusing on, but I think we're now getting into a stage where we are seeing, you know, the maturing of the system, lots of members moving into retirement and and so, you know, I can see why the regulatory focuses has been increasing. So the retirement income covenants now been out for three years, and I think what it's captured is the kind of multi dimensionality of the of the issue, you know, understanding the members need. So there's, there's a whole thing around, kind of, what data do you have on the members, the cohorting of members, how do you communicate with the members? Like, what, what is the fit for purpose assistance, which may go to product or advice? And then kind of, what's, how do you assess whether it's been successful? So moving, getting all of those elements lined up and interacting is a, you know, is a meaty challenge, and and when I think the the industry is is still working on but, yeah, it's not specifically, I think a product problem, though, obviously, investments need to be made and solutions need to be found. But it's, it's the combination of, you know, the advice putting understanding the cohort and their needs and then having their solution to put them in, the ongoing support from there. Wouter Klijn 23:42 So there's been a lot of talk about the product space. And obviously one type of solution would be something that's akin to an annuity. But then again, I also think then of the UK experience, where for a long time, annuities were mandatory, and the moment they stopped that it was kind of like everybody. So they're not a very popular product for most people. Do you see a role for annuities, or are they just not popular enough? Kim Bowater 24:10 Yeah, I mean, I think I've always felt like there's, they have a role as part of the solution for a particular type of member. We we've done a couple of kind of workshops with groups of funds over time, led by David Carruthers at Frontier, and one of those was about longevity and what a longevity solution would look like. And you know, because in principle, it does seem to make sense for those looking for some certainty, I don't think it's been helped by kind of being in such a low yield environment for so long, and where other markets have been so strong. Because I think when you weigh up the relative choice, maybe just being in a Balanced fund or a slightly more conservative fund looks pretty good and you don't have to lock up. Your money. It may be if we hit an environment where certainty, you know, has more value, that annuities will will have another, another kind of flush of interest, but, but I think the the most recent work that apron ASIC have done showed, you know, quite a lot of people approaching retirement age don't feel like they have sufficient funds. So you would think that that certainty would be valuable, but it's, again, it's, you know, with the covenant providing the tools for members to kind of work through the various solutions, I think is, is where the purpose of an annuity, and potentially the arguments that would make members pick it up will come retirement. Wouter Klijn 25:45 Is quite a complex space, because there's a lot of different levers to think about. But from an investment perspective, is there a chance that we may be also overthinking this? Because when you transition to retirement, obviously you're going to have an income stream coming out of it. But at the same time, you're probably going to be needed to be invested for still quite a number of years. If you're retired at 60, you probably got another at least 10-15, years where you want to have some exposure, probably through growth assets. That's the time where your balance is the biggest. So you get the most benefits from it as well. And at the same time, I also think some of the conversations that you know you have with members on just the super animation side is is hard enough to explain the differences between the investment options later on, bringing in income streams, annuities, you know, pooled vehicles. Are we maybe just overthinking it? Yeah. Kim Bowater 26:43 I mean, potentially, you know, advisors have always had this kind of, you know, historically, this bucketing sort of approach, where you just have some money in cash, and then you have the longer term in a in something that's more growth oriented. And, you know, there's an intuitiveness to it. From a member standpoint, it doesn't necessarily need to be an incredibly complex solution. Wouter Klijn 27:04 Yeah, I think it was the old equip that used to have this approach where that plan is just, if they had to start from basically from scratch, they would just do a third, a third, a third, third cash, thirdly, fixed income, first growth assets. And that seems to still work pretty well, yeah, yeah. In that sense, maybe it is all too complicated with adding a lot of product. Kim Bowater 27:27 And I think, you know, we have seen, I think, in life cycle or age based default type structures, they used to de risk quite, quite early into retirement. And I think they've recognised the point that you've made, which is, you know, there's still a long period in retirement to go. So you don't necessarily want to de risk, you know, at 60, you want to maintain your growth exposure, because you've potentially got another 20 plus years to go, as long as you can kind of take the, you know, any volatility that comes with that you're you can be better placed over the long term to maintain a, you know, a good, balanced portfolio. Wouter Klijn 28:09 Yeah, and you mentioned earlier, as well the life cycle funds, which is sort of an instrument vehicle, where you could potentially see a stage where you could have this seamless transition, where you don't have to necessarily think about it, because once you get to retirement, it's already de risk. You just have to change sort of the structure that it's helping at the same time it's it's kind of interesting to see that around the time that my super came out in the legislation, a lot more life cycle funds came out as well, which, okay, you need a new default. So that might be a good starting point to think differently about. Are we still on the right track at the same time, these things are very hard to compare with other products. Is there also a bit of a you can hide a lot in a life cycle fund? Kim Bowater 28:55 I think there's probably a range of of rationales for a life cycle product, the super industry certainly become, you know, more peer aware and competitive, and, you know, there's a lot of focus about making sure you're a strongly performing fund. So in some ways, that's that's kind of fed through the industry from a from a regulator perspective, I think funds also, of course, need to judge kind of what's their membership base. So if your main membership, by default, goes into my super you know, what do you do if, say you've got a lower risk, an older, more conservative membership base, on average, compared to, you know, a younger more risk taking potentially membership base in another fund and your those two defaults are being compared against each other. It may make more sense to have a life cycle product that can respond within the default to the different types of of members. It exist and still being kind of comparable, you know, in a, you know, balanced survey type construct. Yeah, I think, you know what I originally when we first did the work on life cycle, what I liked about it was that it had a sense of from, just from the member perspective, that this, you know, age is something you do when your assets are bigger. You know, you don't want to be losing taking on too much risk. You might want to, you know, have more moderate risk, and the fund is managing that for you without you having to think sort of people don't spend a lot of time thinking about their super default option and whether it's fit for purpose. You know, after a decade of when you set it, and I think that's right, because we still see in Super a tendency for for members to increase switching in challenging market environments. And that's often the worst time to switch, because they do it at the bottom. You know, it happens at the bottom of the market after the GFC, a lot of people we didn't see, you know, they didn't switch back for a very long time, so that the risk of not having enough in retirement is really coming to bear there because of switching due to risk concerns. And so if you're in a life cycle product where some of that risk concern is is being abated because you're near a retirement and you're in a bit less risk than you were naturally, I think you know, it can provide a greater sense of, you know, willing to stay with it for members when you get into more tricky environments. Wouter Klijn 31:29 And I think the same is true for sort of the younger cohort, where I think a lot of life cycle funds tend to be a bit more aggressive there. So a lot of growth assets in the early years, which you know if I think if young people make a choice, they tend to go more conservatively, rather than more aggressively. So it's probably good to have that setting up front, that if they don't do anything, they're in a high growth asset. And I think that's recently David spoke about that as well, where, separately, with his work with the actuary Institute, where they're looking at what is the chance of actually making your investment objective? Well, if you're in cash, you're not gonna make and that's a different risk than how volatile is your investment, right? So it also works for the younger cohort. I think there maybe finishing up. We can look a little bit about where frontier is now, obviously away from the early days where everything was super it's a much more diverse business. Now. There's a big insurance business that has been built up. You've been active in the private wealth space. What is, sort of your sense of where the industry is evolving? Because at the same time, we have the consolidation fewer funds, and we've seen also more fluidity, I think, between what was used to be silos. We had the retail funds, we had the industry funds, we had private wealth. But now people tend to move more across. So all of the organisations seem to get more sophisticated. What does it mean for your client base, what is sort of your outlook on where you might grow, and how the first fight it is? Kim Bowater 33:07 So I think, I mean, we've really broadened our business. So we obviously have a heritage in superannuation, and that continues to be quite a large part of our business, including offshore as well. But we've really broadened and as as a business, as a consulting team, into more specialisation of asset owner type. So we have quite a an experienced insurance and liability driven team, mostly of actuaries that really are very in tune with investing for those sorts of requirements and what that that market is, and we have a team that's focused on the smaller asset owner space, be it, you know, universities, that They can be quite sizable, charities, family office, wealth, and I think with that group, which is kind of quite diverse in and of itself, what we're seeing when they've come to us over time is they they've got to a size where they can kind of contemplate an institutional advisor, and they want to really strengthen their arrangements, their governance, their portfolio, make sure It's fit for purpose. And that's kind of where we frontier comes into play. And I think what we're seeing is the growth in in assets enables that so in wealth as well. We're seeing a movement of talent between, you know, super and consulting and wealth, and we're certainly seeing wealth really look to kind of strengthen its own processes and portfolios. And that's that's really important. I think that's really exciting for the investment industry. Fund managers as well in Australia, you know, who have been in the institutional space and in a consolidating supermarket, but now you know, have this. Broader opportunity set as well, and and, you know, wealth platforms that are really looking to kind of make sure they're they're bringing a strong, robust institutional quality to their client base. Wouter Klijn 35:12 Yeah, yeah. So we started off saying, you've been 23 years with Frontier, you've seen a lot of change in the industry. And I remember reading earlier this year for International Women's Day, you you wrote a piece that when you finished your CFA in 2001 there were only two women in the Melbourne chapter for the CFA. I think that has changed a bit. But what is your view at the current state of sort of the gender balance in the investment industry. Are we getting there, or are we still a long way off? I mean, Kim Bowater 35:47 it's certainly a lot better than than then. That was a bit of a surprise, because, you know, in science and, you know, actuarial, actuaries and such, it was much more balanced. And it took me a little while to figure out too, because frontier was always, you know, had leading female investment, people with Fiona, but others like Kerry Williams and Sarah Khan, so we were a bit of an outlier and and often, you know, people mentioned that specifically as having kind of more women, which was great, I think. But yeah, it took me a little while to realise the investment side was, more broadly, was was a bit poor. And I think we're seeing more women, particularly in asset consulting and in asset owners. I think then the fund manager side, it's still, it's got better, but it's off a really low base. And I think there's a range of data we continue to track that. I think the CFA does work on that as well. Lot of male oriented, dominated investment teams. And I just think, you know, diversity of thought and diversity of perspective is really important in investment decision making, and you can't just have and likewise, you know, gender has a role in that, and just to kind of having one woman is not sufficient to to open that diversity gate and for other types of diversity too. So I think there's, there's definitely more to go. I think there's a lot more, you know, senior, experienced women and in the industry that people can look to, and that's really important too, to see what success looks like, and see different ways of being in a senior role. So I think that will feed on itself still. But you know, every organisation should be thinking about about that aspect. It's something we cover in our manager research as well. We think, you know, just continuing to discuss that topics an important way that change occurs. Wouter Klijn 37:42 Yeah, it's interesting to hear you say that you didn't initially realise, because obviously Frontier has that heritage. And I mean having Fiona Trafford Walker there, I think she, you know, is one of the big figures of this industry. Was there a point where you sort of went like, oh, not every organisation has a Fiona. Is there sort of that realisation that you went, Oh, this is actually quite a unique situation. Yeah. Kim Bowater 38:06 No, it was, well, I mean, certainly at the I mean, investment teams when I started at Frontier, were very small. They mostly male, but very small, so it wasn't kind of a fair judgement. But, you know, boards and investment committees were mostly male fund managers. Teams were mostly male. I remember going on a research trip. We're becoming a range of asset classes, but mostly private markets. And, you know, I think we met with around 30 firms, like, so, a lot of different investment people through those meetings. And I got to the end, I thought, Oh, we've met with, like, maybe three, three, you know, maybe not 300 people, maybe over 100 people from investment teams. And I think three were female, right in the whole trip. And I thought that's yeah, it just kind of once, you kind of didn't notice it for a little while, then you're like, Oh no, that's not Yeah, that's just low, that's a low level. So it, it kind of came to to bear from a couple of different, different elements, but I think a lot of work's been done on that. I think organisations see the the merit in, you know, a broader perspective and team and, you know, so we're, we're on a, we're on a positive journey, I think, with it, yeah, yeah, excellent. I don't really know what it is about investments that would make it like this, to be honest, but Wouter Klijn 39:28 Well, I do remember that one of the early podcasts that actually Daniel grioli did for me, he was talking to Denise Selden, fund manager in the US, and she started out with, I think, encore on the stock exchange floor, and that was at a time that women were not allowed to, like, visit the same cafeterias or something. I think there was a sort of form of segregation. So at least we've come a long way since. But yeah, we still got some way to go in other aspects. Yeah. But Kim, thank you very much for your time. It was great talking to you and yes, thank you for coming on the show. Kim Bowater 40:06 Thank you. It's been great.

In this special edition of the [i3] Podcast, in collaboration with the UTS Finance Department, we explore how the neoliberal model of economics, which largely ignored politics and focused on financial metrics, has eroded over time and made way for the rise of populism, which has exerted its influence on economies around the world. Why did the guardrails that neoliberalism provided slowly disappear and what are the consequences of this? Is there any model that will replace it? Political Economist Elizabeth Humphrys, Geopolitical Specialist Philipp Ivanov and UTS Industry Lecturer Rob Prugue delve deep into this fascinating topic as part of the Circle the Square roundtable series. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Podcast 00:00 – Introduction Wouter introduces the special i3 Podcast edition, produced with UTS Finance. He outlines the episode's theme: how the post-war neoliberal guardrails that long supported economic certainty have eroded, creating persistent uncertainty in markets. He introduces guests Elizabeth Humphrys, Philipp Ivanov and Rob Prugue. 03:04 – Origins of Neoliberal Guardrails (Rob) Rob explains the emergence of post-WWII guardrails: Bretton Woods institutions, NATO, the World Bank, IMF and other frameworks enabling stability and collective economic growth. They created a predictable environment but gradually weakened. 06:05 – Australian Context & Rise of Neoliberalism (Elizabeth) Elizabeth describes the long boom after WWII, its collapse in the 1970s, and neoliberalism's emergence. She explains how the Hawke Government in 1983 implemented major reforms—floating the dollar, tariff cuts, privatisation—enabled by strong political capital and union involvement. 10:09 – Global Perspective (Philipp) Philipp explains the Cold War dynamic: US-led order versus the Soviet bloc, with non-aligned states largely weak. Post-1970s Soviet stagnation and 1990s globalisation cemented US dominance, setting the stage for the "golden age" of the neoliberal order. 14:21 – Pax Americana and the Peace Dividend Rob discusses how guardrails encouraged discipline: countries deviating too far politically were penalised by markets. But global shifts, manufacturing loss and deindustrialisation gradually hollowed out these systems. 16:02 – Contestation of Neoliberalism & Social Impacts (Elizabeth) Elizabeth stresses that neoliberalism was contested from the start. She highlights social movements in the Global South, rising inequality, and sharp pain in Eastern Europe during rapid liberalisation. Domestic consequences—job losses, wage stagnation—fuelled political distrust. 22:03 – Globalisation, Inequality & a Multipolar World Wouter links globalisation to economic displacement. Philipp outlines four major geopolitical mistakes after the Cold War: Assuming China would remain benign Dismissing Russia Taking the developing world for granted Ignoring the power of nationalism and inequality 27:26 – Where Are We Now? Have the Guardrails Fully Collapsed? Rob argues that the guardrails can't simply be rebuilt—political divisiveness and grievance-driven politics are now embedded. Trust in US institutions and commitments (e.g., AUKUS) is eroding. 30:45 – Are We Heading Toward Chaos? (Elizabeth) Elizabeth argues capitalism is resilient but political legitimacy is collapsing. The promise of neoliberalism—trickle-down prosperity, stable institutions—failed large groups of people, fuelling anti-politics, housing unaffordability and climate-related tensions. 37:17 – Beyond Traditional Politics Elizabeth notes the breakdown of mass-membership parties and unions. Declining voter turnout and low trust create fertile ground for populism and fragmented political identities. 40:13 – Global Fractures & Major Trends (Philipp) Philipp highlights five converging forces shaping today's uncertainty: Economic fragmentation Great-power competition Societal divisions Climate change Technological revolution (especially AI) 45:28 – Technology as an Amplifier Rob and Philipp discuss how technology intensifies divisions but is ultimately a human-driven tool. AI raises the stakes of geopolitical competition, especially between the US and China. 53:14 – What Could Future Guardrails Look Like? Rob foresees three emerging forces: Rise of nationalistic policymaking Oligarchic influence filling the institutional vacuum A tri-polar world (US, Europe, BRICS) 55:24 – Can Australia Rebuild Guardrails? (Elizabeth) Elizabeth doubts that politicians currently have the vision for a new national project. She emphasises conflicts between economic growth, climate needs and powerful resource sectors. 59:24 – The Populist Base Rob asks whether a new base of disillusioned voters is forming. Elizabeth agrees: anti-politics creates a vacuum easily filled by opportunistic populists, on either left or right. 1:02:03 – Role of Media Rob highlights how politically aligned media ecosystems widen the vacuum and intensify division. 1:03:10 – Conclusion Wouter closes by noting the episode doesn't provide solutions, but maps the journey from stable post-war neoliberalism to today's entrenched uncertainty. Full Transcription of Episode 125 Wouter Klijn 00:00 Welcome to a special edition of the [i3] Podcast, produced in partnership with the University of Technology of Sydney's Finance Department, which includes the Anchor Fund, an educational investment fund managing real money, which is run by students and overseen by Associate Professor of Finance, Lorenzo Casavecchia of UTS. So this episode aligns with the second instalment of the UTS Circle The Square sessions, which are a thought-provoking series of roundtables on economic, financial and political ideas. You can find them on YouTube, and of course, [i3] is very happy to support them. So today we will delve into the neoliberal model, which, post-war, has provided guardrails for economics to operate in and allow investors to focus on the usual numbers, earnings, inflation and growth. But these guardrails have been eroding under the influence of various forces, including the rise of populism, and this has led to an almost permanent state of uncertainty. And of course, we all know markets don't like uncertainty. So how did we get here? What has changed, and why did a neoliberal model held together for such a long time in the first place? So this episode sits a little bit outside of our usual investment talk. It's more about the system underneath the data, applied political economics, and we're asking why the guardrails that once held in place neoliberalism have been thinned out and what is left behind. So I'm joined here today with three panellists. So first off, we have Elizabeth Humphrys, who is the Head of Discipline for Social and Political Sciences at the University of Technology Sydney. Elizabeth is a political economist who focuses on the impact of financial crisis and climate change on labour relations. She is the author of the 2019 book 'How Labour Built Neoliberalism'. We're also joined by geopolitical strategist Philipp Ivanov. Philipp has been globally recognised as an expert on international relations, particularly China and China-Russia relations, and he has worked in Russia, in China and the United States. So he will provide us with a global view on this issue. He's also an Industry Fellow at UTS. And finally, we've got Rob Prugue, who is an Honorary Industry Lecturer at UTS, but who most of you probably know as the former CEO of Lazard Asset Management for the Asia-Pacific region. He's one of the driving forces behind the Circle The Square roundtable series. So welcome everyone. Okay, so we're looking at uncertainty in markets, which, to a large extent, has been caused by the dismantling of the guardrails in which the political debate have moved. Now let's start at the beginning. What were those guardrails and what kept politics out of the market for such a long time? Rob Prugue 03:04 I think the best way to explain this is it's it's nascent, and where I least I see it began, and it probably began post-WW2, when the West in particular, needed to rebuild itself after near a decade long World War and the destruction that obviously it needed to be addressed, and having learned the lessons of previous mistakes such as League of Nations or working in a bilateral World, the West appreciated early on. In order to counter the Soviet force, it needed to unify, and as part of that, it needed to build a system that would rebuild an economy by lifting the ship rather than individually handing out life preservers and life jackets to sectors, or worse, certain people. As a result, guardrails were built to make sure that this was a system that benefited the totality, rather than specific groups, and over time, that worked well. This is not to suggest that neoliberalism didn't have its challenges. Of course, we had wars. Of course, we had economic cycles. Of course, we had large unemployment. But when you compare it to pre-1946, and the fact that you know now, the world had access to nuclear destruction, all things considered, neoliberalism certainly post-WW2 had its benefits, and that peace brought a national prosperity. The guardrails were there, not necessarily as instruments of curtailing growth, but think of it as. Golf rules. I'm not a golfer, but when you go out in the golf there are certain etiquette and rules that are applied. The guardrails have that. But then they built systems and infrastructure to again, manage that. It's as simple as the World Bank, Bretton Woods, World Bank and IMF, the United Nations, the international scope, the World Health Organisation, to name but a few. But then progressively, even domestically, you had these guardrails, and that despite its shortcomings relative to pre-1946, level allowed the West to unite as a group, allowed the west the formation of NATO, the formation, again, of these other organisations. And that benefited many, until it didn't. Wouter Klijn 05:53 Yeah, Elizabeth, if we go to you, do you want to provide a little bit of a local flavour to that and put it in the context of the local labour policies. Elizabeth Humphrys 06:05 Sure, I think for Australia and other what I'll call, like highly industrialised countries, not so much like just the what we would call the West. After the World War, there's this long period of growth, largely fueled by the rebuilding efforts in some ways, after World War Two, but that protracted period, like the, you know, in my work and in political economy we call the long boom, it sort of came to an end in the early 1970s with the oil shocks, issues around inflation and other sort of not just issues external to the economy, but perhaps contradictions within the economy that sort of came to the fore. And I would characterise that period as more taking, taking its its lead, perhaps from Keynesianism, like these are these bodies of policies are never implemented, as in a textbook, right? They're contested, they're partial. They vary between countries. But the end of that period, in the early 1970s really, for me, that's when neoliberalism starts to cohere, not just as an ideology, but as a political project that begins to be implemented in different countries, and it looks different in Thatcher's Britain, for example, or Ronald Reagan's us, to how it looks in Australia. And it's really only in 1983 with the election of the Bob Hawke government under the slogan bringing Australia together, that we start to see some of the kind of like Big Bang economic reforms that we associate with neoliberalism, like floating the floating the dollar, foreign bank, banks being allowed into the country, reductions in tariffs, privatisation, these sort of all flow from then. But what's really important to understand is these things are not just about what the ideology of an individual political party is, but often who has the political capital to implement those policies at that time. So even though, of course, Fraser was much more conservative than Bob Hawke on a range of issues, he didn't really have the political capital he was in a war with the unions to introduce the big reforms that were being called for via government, government inquiries, when Bob Hawkes comes to the table and that bringing to Australia together, slogan, it's really to the way I would term it, restore profitability of the system that the rate of profit from investment needs to be restored, or accumulation needs to be restored. And Hawk says we have the answer that, in collaboration with the unions who have been on the front foot in the 1970s demanding a bigger share of the pie, a bigger share of GDP going to workers wages vis a vis to profit. He says, we can help deal with this unrest. And really that's the political context for me that sees this weird situation where we both get the advance of neoliberal, what we would call neoliberal policies that I mentioned a moment ago, but also at the same time, a return to centralised planning, centralised wage setting and bargaining with the support of some of industry, the metal Trades Union, for example. Sorry, the metal trades industry body was really central, as was the metal Trades Union, into bringing in this new kind of arrangements under the hawk heating government, which, of course, longest labour or social democratic government, 13 years from 83 up until 1996. Wouter Klijn 09:51 Yeah. So if we then draw back to a global picture, and you know, Philipp, I introduced you as an expert on China and Russia relations, do. Can we even talk about neoliberal guardrails in those countries, but also broader? How do you see the global perspective from that? Philipp Ivanov 10:09 Yeah, well, I think from the from the End of the World War Two, just drawing on what drop told us, you know, you have this dynamic of competition. So you have the two geopolitical blocks. You have the US-led system, and you have the Soviet Union and its allies, and then you have a whole group of non-aligned states. Now we call them kind of geopolitical swing states, using the Goldman Sachs sort of terminology, but back then, they were called non-aligned. So the India and China can be in that category as well. Then us creates the international institutions that Bretton Woods institutions, but it's institutions that are mainly built by the West, but, but right at the beginning, in the 1940s and 50s, there was a genuine desire for this institution to include everyone, including the Soviet Union. So there's dynamics of competition on cooperation. Was still was still there the non-aligned states, and particularly big ones like China and India are quite weak and underdeveloped, so their role in international system is really not that important. So it's really the world is dominated by this, these two rivals, and then as Soviet economy and political system starts entering stagnation. In the 1970s you know, us, led bloc continued to prosper, and with that, the Bretton Woods institutions and the systems that you know that we today discussing as neoliberal systems, largely, you know, by the 1980s you know, the Soviet Union enters into this period of deep and as we now know, the final decline and and the US led system strived and prospered, and it enters its golden age, which is essentially 1980s and 1990s you know, the age of globalisation. And you know, of course, it's uneven. It's an unequal as the rest of for the rest of the world. But we see, you know, by the 1980s we see the sort of this golden age of US led order, including the political order as well that which has elements of neoliberalism. So you have the globalisation, both economic but also political and cultural. You have US Strategic Hege money, essentially, is only one prime one superpower. We have absolute primacy of the US dollar, you know, of US culture, to some extent, of the US, economic systems and rules and structures, you know. And then we start seeing the rise of China. But it's the rise that was back then, seen as benign, you know, the consensus was that the China will become the United States, just like the United States or any other democratic nation, as its economy became a market economy, you know, you we had, you know, from 1990s to about 2007 we have a stable and predictable Russia that relatively benign, with a few exceptions. And then you have convergence of most states, including what used to be called non-aligned states in the 70s, you know, around the US led system, largely with exception of maybe some countries like Afghanistan or Nicaragua and so. And then the rise of the technologies as well, which, you know, played a big role in that convergence, the internet and then social media. So then that's kind of where we ended up by 2005 or so, you know, when I think that order started to unravel. But I think that will be your next question, yes. Wouter Klijn 14:21 So to what degree is this, this framework synonymous with like, you know, what people refer to as the peace dividend, you know, Pax Americana and the great American Peace. Is that all overlapping? Or do you see this as a separate system? Rob Prugue 14:36 Any government that swayed too far away left or right from the guardrails, got penalised in the borrowing cost. So whether you're left or right, you had policies that you needed funded. Some of these policies couldn't be self funded through taxation. They needed to borrow money, and so there was a shared vested interest for since basically much. Of the post-war period, until the guardrails began to be dismantled. And within that dismantling of the guard rails, we now began to see certain sectors benefiting at the expense of the rest. And as that continued, we saw more and more disenfranchised so the rust belt of the US, they felt the pain as the factories were being closed and moved to China. Australia used to have some manufacturing. Now we're, you know, now we're mining and service, very little manufacturing. So you can see how this sort of morphed itself very slowly, one drop at a time, until that glass got full. Yeah. Wouter Klijn 15:47 So Elizabeth, if we take a domestic view at this, how did those guard rails sort of got eroded here? Because I think you tie it back in with some of the weakening of domestic institutions, Elizabeth Humphrys 16:02 Yeah, I guess, like, I come at neoliberalism in a more critical fashion. So when we're talking about the guardrails, the setting up of those guardrails, or the setting up of frameworks, was always contested in the first place. It's not like we can presume there's a shared interest, even between unions and business or the or even within the corporate sector, between finance and manufacturing, right? These things are always contested politically. So for me, I think we need to think globally that the implementation of neoliberalism had its antinomies. It had the negative things or the negative consequences. And some of this included from what I would call from below, right. So around 2000 we actually see the outbreak of mass social movements moving from the Global South, Latin America, from, you know, the the so called IMF riots, the water wars in Bolivia, into the streets of Seattle and eventually into the streets of Melbourne, contesting the roles of things like the World Economic Forum, the World Bank. We've got to understand this is nearly revisit as contested in both its implementation and it's sort of thinning, as we've been talking about. And the timeframe this happens on in different countries varies. So, you know, we bring up Russia and the Eastern European countries. Neoliberalism comes later in those contexts because of authoritarian rule before that, it comes later to the Mediterranean, because we have Mussolini in Italy, we have Franco actually, neoliberalism is is sort of not delayed, but it's on a different time frame. But the very fast implementation of neoliberalism in Eastern Europe means that the pain that people experience as ordinary workers is really, really sharp. It's on a protracted timeframe that the gap between the rich and the poor. So, you know, we measure these in the Gini Coefficient. This, this becomes drastic, and we get situations like, you know, New Zealand, before neoliberalism, it had a Labour government like Australia implemented in the 1980s it's more equal than Australia. Australia is less less an equal country, but actually neoliberalism there leads to New Zealand having a greater gap between the rich and the poor compared to Australia today. All of these things play out because they have social and political consequences. And I do agree it's not like anybody came along with a plan about how to dismantle the sorts of structures that were built up in the 80s. But I think there's one important thing I always try and remember neoliberalism as a sort of policy platform argued that that a greater amount of decision making should be in the hands of markets as compared to in the hands of government. We understand this as the small state, lower taxes, deregulation, privatisation, but this, this is a shifting of responsibility for a range of decisions, even, you know, floating the dollar into the hands of markets. This has a political consulate consequence that when people in the Rust Belt start to experience the world as they're working harder than ever and getting far less. And you know, my dad at retirement, he was an oil refinery worker. So like, you know, I experienced neoliberalism firsthand growing up in a working class family. They they see their lot as undermined in in that period. And so it's not just a like we can't take a sort of pathologized approach to Why do these people look to politic populism, or why do people look to be dissatisfied with the political system or the financial structures? Is we've got to see it as their experience in the 80s and 90s led to dissatisfactions which play out now politically and so for me, the it's not just about how corporate interests or particular interests in the more elite sections of society or in in global supranational bodies like the IMF, World Bank, UN even the ILO right, which is a tripartite body between unions, government and industry, these things aren't just contested there and understood politically and discussed there. They are discussed every day by people who used to work in manufacturing jobs, or like my dad and all his friends who worked at the mobile refinery in Melbourne, which is now now closed, after decades and and generations of families working there, this leads to to a really sort of, for me, a confused way of understanding the consequences of neoliberalism. We can't just build back what you used to be there. Decisions are made on both what policies are fit for purpose in the moment, which is why you can get people to look the ALP in the 80s, to look to both Keynesianism and neoclassical economics at the same time, they're looking for policies that are fit for purpose. So it's no use having a kind of more paranoid who are the Who's this group of people who are bringing us this new world order? For me, it's a bit conspiratorial. I actually think mostly people, governments, policy makers, business, are looking in a self interested way, sometimes in a national interest, way for what policies are fit for purpose. And to me, that's led to a thinning of policies in relation to what we understood as those classical, more hegemonic neoliberal ideas and policies, but also to the more hegemonic social democratic ideas that have existed through the long 20th century. Wouter Klijn 22:03 Yeah, and to what degree can we tie this back as well to globalisation? Obviously, when globalisation kicked off, there's a lot more challenges for people to keep manufacturing in their own economies. It goes to cheaper labour, countries that sow seeds for also dissatisfaction and ultimately rise of popular populism. To what degree can we tie that in in this debate, and maybe Philipp for you as well, the other part of his the post sort of war guard rails America was a dominating force at that time. Now we're living in a very different world where, as you indicated, you know, China back then wasn't as big as it is. Now we're living much more in a world where there's a multi polar world, where different forces have different influences that are all eating away at the previous system. Philipp Ivanov 23:07 Well, we talked about the sort of economic guardrails. We talked about socio economic or social political guardrails. But there's also geopolitical guardrails that were ignored, I think. And there are four, in my view, that are quite fundamental, particularly from the collapse of the Soviet Union. It was sort of four fundamental mistakes were made, I think, by the triumphant West. Number one is the idea of China is the factory of the world. That is, that it's always going to be benign, convergent power that will largely look at the West and will largely follow that path. I think it's been a fundamental mistake, as we're learning now. Number two is ignoring Russia as a decline in power that no longer important, no longer influential. That sort of can be ignored. You know that old thesis by some of the American policymakers, that is, you know, it's essentially a petrol station masquerading as a country. Bad mistake, in my view. Number three, taken for granted the rest of the world, including countries like India or countries of collective Middle East or Africa, thinking that they essentially are converging around globalisation, which they have been, until they start converging, or until they looked elsewhere for alternative governance models or sources of growth or source of sources of equality. Right? And then I think the fourth one is really ignoring the kind of fundamental historical forces of power of nationalism and of inequality. And I think inequality plays a big, big role in that unravelling, you know, but also that sort of that nationalism, that idea that nationalism is no longer relevant and only appears occasionally, you know, around particular issues which we know is not true. And you know, you look at the world now, it's very nationalist world. And the kind of the raw power dynamics are on display. You know, it's the largest number of wars and conflicts at the moment than any time since the World War Two. And you know, the inequality, apart from, obviously economic inequality that we see around the world now. But it's that strategic and power inequality is that there's a sort of this politics of strategic grievance. You know, who is, who is kind of, who is reaping the benefits of the power and influence. Now we see it in China. They call it the age of humiliation that they're trying to repair. And, you know, rejuvenation of the great Chinese nation. That's how President Xi Jinping describes it. It's the sort of the the top of the mountain, if you, if you, if you look at the world, you know, we see it obviously in Russia. You know that the collapse of the Soviet Union, according to the Russian president, was the greatest geopolitical catastrophe of our time. So that politics of grievance caused by that perceived inequality of power, of economic wealth, of sort of influence and respect. I mean, that plays a big role. So I think there's some these are the, I guess, both the guardrails that were we as a collective West forgot to, you know, construct and to follow. But it's also, I think some fundamental mistakes in collective policy making. Wouter Klijn 27:26 Yeah. So do we have a sense of where we are in this erosion of the guardrails? I mean, are we getting towards the end of an era? I mean, is the rise of populism and perhaps the second administration of Trump the culmination of this development, or are we somewhere in the middle? Rob Prugue 27:45 I, as I've said before, I can't see how one can unscrambled eggs. I think the divisive politics of today is well ingrained, so much so that even traditional parties right now more so visible on the right than on the left are being it's almost like a hostile takeover by not necessarily an ideologically driven group, but to paraphrase Philipp, the politics of grievance. So Philipp correctly mentioned the politics of grievance as it relates from an international playing field, but domestically, we have it here. Elizabeth touched on that as well, where certain groups felt left behind, and that even continued much further in the 90s and 2000 with more of the regulatory guardrails which were meant to be a levelling playing field, because, after all, even the IRS the SEC in the US are being pulled back the Department of Education. It's almost, as I said earlier, government guardrails are equivalent or synonymous to bureaucracy now, and so how do we rebuild that? I don't think, personally, I don't think we can, because now at least we've gone to, at least with regards to the states that it moves so drastically away from the systems that they themselves built and marketed globally has been dismantled. So if you're outside the US, you now have to ask yourself, all right, we do a treaty. Will that treaty or that deal, still be viable? And we see remnants of that here in Australia, with regards to AUKUS and the submarines, as I think, I can't remember who it was, they correctly pointed out that there's a law in the. West that they must fill their needs before they can sell it to others. That law and the US submarine fleet needs major rebuild probably means we're not going to get those submarines anywhere near the timeframe that has been sold. So I'm not saying that the submarine is it. I would hate for anyone to cherry pick what I said, but rather look the totality, and that is, can we go back, given how massively the US has dismantled it, even within its own borders? Wouter Klijn 30:34 So what are the implications? Then, for today? Are we, you know, slowly heading towards total chaos? How do we deal with a post certainty world Elizabeth Humphrys 30:45 capitalism is more resilient than, I think, total chaos, but I know, like progressives are very fond of that, Gramsci quote about that when systems decay, these morbid symptoms appear when there's no kind of hegemonic order. And I do think it's kind of applicable to now in that we, we had a sort of well understood and accepted form of social democratic government of different varieties. Not the US is not exactly social democratic, but it was, it was sort of accepted, and there were consent from the masses. Right? To put it in those terms, for those systems, we're not in that period anymore, right? The government legitimacy is at an all time low in across the Anglosphere, where, where, where we are. And then the point about global grievances is very well made, right? We live in a with the consequences of colonialism that led to an unequal share of wealth and the extraction of wealth from certain geographies and its removal to others, and the build up of wealth in in what we will call the poor the core and and it's not grievances about payback, it is grievances about wanting equality, justice and a bigger share of the pie, is how I look at it. And we should see that they're not just legitimate, but completely understandable. So that promise of neoliberalism that you know that remember Thomas Freeman saying in 1996 that no two countries that have had a McDonald's have ever gone to war. Now we know that this is clearly not the case, right? But that was a promise, right? A promise of a peaceful future from the neoliberal order that trickle down our economics is a promise of something that is desired by the majority, and when they cannot be delivered because of the constraints of the system. I would argue this has this plays out politically. So for me, you know, there's this fascinating study done in the US around what I would call anti politics, and others might call populism, where they looked at these these, they had interviewed people over multiple generations about all sorts of issues. There's massive database of these interviews with ordinary UK people, and what they found in terms of politicians, is that politicians have always sort of been on the nose, right? They've never been particularly loved, but the difference now and Peter Marr, Peter Mayer and and other leading figures in in the UK have said, is the difference is that the political system itself is on the nose. Now. This is the difference in the present period. And so actually, the question of restoring faith in politics and in the Australian political system as well, is is a difficult question to solve. When people feel that politicians are self interested, that they are not from the ordinary people, that they don't represent them, that they're not trusted. This is a massive ball of difficulty in terms of policy making, right? So we get a situation, I think, where people generally want the playing field levelled in all sorts of ways. But can the system actually do this and maintain growth we have in the wings. We in the wings are massive issue around climate change, environmental damage and growth itself, with with vested interests from certain sections which are key in mining in Australia, who make massive profits with very few people employed in those industries. So we, we, there are choices to be made in Australia, and I think potentially because of geopolitical needs, because of domestic profitability and growth needs. Often those discussions about what the future could. Look like in terms of being equal, dealing with climate change, come into conflict with those other things. Like, I don't want to go out and limb, but I don't think we'll ever see those submarines. The timeframe might be never, but it for me, me, the heart of the problem is that promise of in the domestic sense, that promise of the neoliberal future of trickle down, of bringing Australia together, as Hawke said, and the failure for that to eventuate still lives in the minds of people of my generation who grew up in the 70s, but my parents and then, of course, young people now who see that they'll never make it into the housing market, right? And not, I don't mean the the ones we teach at our uni, in our in our courses, right, who come from much more middle class backgrounds, but the chances that your average person owns a house who's 20 today are actually really delayed, if ever. But I do think it's not just about selling bureaucracy. Governments still make choices. So like the the housing discussion about how we will use the future funds to fund to fund housing through investing and earning interest, this is a very different kettle of fish to a policy of just going and building public housing right now, that is an ideological choice about who should do the building and who should own those properties. So there is still a live discussion, I think, and it's not about going backwards, but whether we actually want to say, yes, social housing, public housing can be built by governments with their expertise and owned by them in the future, rather than the private sector trying to solve this problem. So that issue of who, who's responsible for social policy the market or governments? For me, this still persists. It doesn't often get a hearing and election time in those terms. But, yeah, we can't go back. We can't unscramble the eggs in that way, but we actually can go forward in building a different set of policies through, I think, considered debate from all sections of society, you'd hope. Wouter Klijn 37:17 It almost sounds like you're describing an era where we're moving beyond politics, where people no longer feel affinity with political parties, but more of an era where people are interested in particular interest groups or particular issues, is that maybe where we see the rise of populism as sort of a disguise of the rise of special interest groups, rather than politics as we knew it, Elizabeth Humphrys 37:44 I think we have seen one fundamental change that the political system that Gramsci was talking about when he was in jail under Mussolini in Italy, of mass membership political parties and mass membership trade unions is over right membership of the ALP, membership of the Liberal Party, these are at all time lows. Membership of civil society organisations have been declining. And this has been well documented across the US so and the UK, most of actually Europe, not just the English speaking parts and so, I wouldn't say necessarily it's a rise of special interest, but the old political order is seriously frayed, if not seriously damaged. Now I think we don't see it as clearly in Australia, because we have compulsory voting, but people voting has been going down. It may pick up at some point, but it is on a downward trend across Western Europe, across the Anglosphere. This is a this, this disengagement from politics and seeing that your views might be represented in a parliament, because that's what not voting is, not thinking you have relevance or that you can can impact this is this is a, this is a really profound issue. And so when we put all that together, this kind of fraying of the political system, disenchantment and outward hatred of the political class in some sections, right? You know, Trumpism is one example. Brexit is another. Palmer and his party here, there are lots of examples of the old ways of doing things, of a two party system in this country being, you know, seriously undermined. Primary votes for the major parties are at the lowest point historically in Australia today, that tells us something about where people see their interests as being represented, and if they don't find an avenue to feel represented, yes, then populism and what kind of anti politics is, I think, one way that. See that play out? Wouter Klijn 40:02 Yeah, Philipp, maybe you can add to that, because obviously, you know, I think Trump is sort of the biggest symptom of the rise of this populism. Where do you see the fractures internationally? Philipp Ivanov 40:13 Yeah, well, I think that with what we just discussed is also has, sort of, it can be described maybe a little bit simplistically, and this sort of across the five big trends. So number one, you have the economic fragmentation. And within each of this trend, I have to add, there's contradictions, there's tensions. So you have the economic fragmentation is sort of de globalisation, which is, you know, again, debated and debatable, because within each of these movements of economic fragmentation, we see some contradictions. For example, there is a push for sovereign capabilities or de industrialization, but at the same time this economic independency, or core dependency, still exists, still very strong. Then the second big trend is the major power competition, particularly US, China, but also Russia against the West. But even within this, you know, rivalry still coexist with dependency, and I think the US China relationship is a perfect example of that. Then you have the societal divisions that Elizabeth talked about. You know, despite the growing wealth, and say, across most of the western world, there are these grievances, there are cultural, sort of cultural divisions, the political divisions, religious etc. And then you have the two sort of underlying trends. One is climate change again, which is a really divisive trend, because, on the one hand, it's a global, shared problem, but there are politics of grievances and inequality that play a big role. Who has to pay for for fixing the climate change impacts and issues that are associated with climate change. And then, of course, the technological revolution, again, you have this incredible connectivity. You know, the whole world is converged, even the poorest countries. Everybody is on the internet. Everybody is now going to be a part of that? Well, not everybody, but most countries will be a part of that, AI ecosystem. But there's, of course, there are divisions, there's inequalities. So if there's five big trends converging at the same time in this very compressed period of time, but each of them, we don't even have an agreement on their direction, on the trajectory, you know? So each has this contradictory forces within them, and then, and so it creates this sort of really uncertain environment, and, and I think this is probably the best way to describe it with period that we are now, is this some kind of transition. And the question is, well, not so much a question, but I think we do have agency. What comes after? You know, it's we shouldn't be so sort of pessimistic and and passive that, you know, these trends would necessarily result in, let's say, a major war or climate catastrophe or some kind of societal collapse. We as countries, and each country, it's each government, you know, we have agency and how the next the next decade, will be shaped, you know, and I think that kind of, I think that that message often gets lost, you know, because we are so focused on uncertainty, so focused on reacting to this wave of shocks and issues. But, you know, we have the we have the opportunity to shape it, what the next, what the next decades will will look like, but it doesn't. It's not the message that I think people hear from the political leaders. You know what to going back to what Elizabeth said, and so it creates certainty. Degree of pessimism and passivity. I guess maybe that that is one of the explanations of why people don't vote or don't participate in civil society institutions. You know, or you know that might explain tribalism. On either on the internet or in real, real life, because they people feel that they don't have agency to shape what the next period should look like, including their own life, because they think that these big trends, these big shocks, are just so overwhelming, and they see their government don't have a coherent vision to shape it, Rob Prugue 45:28 To me, the greatest threat as an investor, I would pose it in a term that I like to use, political convexity, that In the ear of Pax Americana, even through disruptions, there was a path, and the markets knew what that path was. As we started breaking away from the path, we brought in uncertainty. Initially, the market accepted that, but now the market is jumping much more quickly at any any shock than was visible in the past. Some of that may be, as Philipp mentioned, International. Some of it may be domestic, as Elizabeth mentioned, as someone who grew up in Washington, DC in the 1970s I could see much of these transitions. And I was there at the end of the Vietnam War. I was there when the US went off the gold standard. I was there doing Watergate. I was there doing the US embassy in Iran. So I could, as a young adult or a child, I could see that. But now, as touched by Elizabeth, you this, this grievances. There was, there was at least a safety net of some sort, a perceived or otherwise, but there was a safety net. Now I don't think people think there is a safety net, and so is when the, what I call the resource belt, hear about the move towards cop 30, or the push towards solar panels, or even the push towards EV it's kind of laughable that, you know, it's not a debate between Holden versus Ford. It's a debate between combustion and greenies that that's just incoherent. I don't understand that kind of debate. It's we've, we've turned politics almost into religion, where if you challenge my thoughts, you are challenging my beliefs, and therefore you're an enemy. And you're seeing that playing out brilliantly in the divided conservative movement here in Australia, between what I would briefly call the city conservatives and the resource conservatives. And within certainly the resource conservatives, this disenfranchised, these people who no longer feel to have agency. They will listen to whoever promises them, and you'll note that they don't necessarily challenge them anymore. We used to in Elizabeth's father's era, in my father's era, we challenged our politicians. We didn't just take what they said for granted, sure there was an alliance and sure there was a certain level of belief, but we were willing to challenge the politicians. Now you don't see that, and as a result, you see in this this morphing of populism rise up on empty rhetoric and selling scapegoat ism, and you know you're hearing it, because they don't talk about their vision, they just talk about what's wrong, and they make the person feel heard, and that is a huge political pull for someone who feels they have no agency. As a Latino, I remember, you know, I call this ping pong politics, where you go far right, far left, far right, far left. And although in Peru we have five year terms, not four year terms, a little bit longer. You don't, in the last six presidents, five of them are in jail, and not always because of corruption is fabricated or real. It's like, I'm going to get rid of you so you won't come back and dismantle what I'm building. So it's a democratic coup of sorts, where not a coup of military, but a coup A coup of ideology and empty rhetoric. And that's why I have grave concerns of the rise of the populism. And no one on the left should be dancing with joy that the Liberals are being divided in two, because in that that vacuum will be filled. And I rather least you know, have an understanding where you know who's managing that vacuum, than handing it over to empty rhetoric. Philipp Ivanov 49:58 No absolutely. I totally agree, I guess, on the point on technology, the sort of often we hear about its destructive role in particularly in Division in our society across religious or cultural political lines and but, you know, I think we overestimate in its role. It's definitely a very powerful amplifier of political divisions, or major power competition, any of these trends that I mentioned. You know, technology is a big amplifier and a big, big factor, but we're the one where humans are driving these trends. First and foremost, it's not these trends are not driven by technology. Technology is a tool. It's a very powerful one. And then we're about to learn how powerful artificial intelligence is as a tool, because that takes all that technological revolution to the whole new level, because it plays with cognition, with reasoning, it's something that we have at the moment, at least little understanding and little control of but, but the role of technology should always be discussed in the context of the role of humans. First and foremost, it can't be discussed as a sort of a separate issue that kind of exists in its own universe and drives its own trends and shapes and and influences how societies and nations work. No, it's not like that. It's our tool. We created it, we shape it. And you know, now we've created a new one that we're still learning about and probably will be learning for generations to come. But I think that, you know, taking it to the kind of the world of geopolitics, it is a powerful factor in the way that countries now look at each other, and we know that the technological competition is essentially at the heart of the tensions between the two superpowers that we have now, United States and China. It's really the tension is not about the land. The tension is not really about ideology, but the tension is about who controls the future and who controls the resources and technologies to control the future. And so you know that so our the US China, competition is first and foremost, the technological competition, then geopolitical competition. Wouter Klijn 52:58 Yeah, so talking about the future. We're in a period of transition. We would it's not really clear where we're going or what the next system will be, but do we have a sense of where potentially the new guardrails will come from? Rob Prugue 53:14 For me, look, that's a million dollar question, and I will try to take a stab, if I may, and say I could see three things forming at once. Firstly, a more nationalistic approach to the world. Australia, first, America, first, more self serving interests driving it. Then, as the guardrails have been dismantled and left a vacuum, my concern is that vacuum will be filled by oligarchistic approach in Australia, the mining in the US, the broligarx was called the bro look, the tech leaders, where self serving interest will take that role to fill that was previously done by other department, government departments, perhaps, or influence it, or drive it. And then from a global political point of view, from a multilateral world to a bilateral, unilateral world, where you basic, I could see three blocs forming, the US Europe and The BRICS, where you have three economic powers right there, and how the three will intermingle, how the three will work together. Will the EU come as they did under the the Plaza Accord or the Louvre Accord? I doubt it possible. But I doubt it um. Um, and all these things. When you look at it, the totality means that there's greater uncertainty, and greater uncertainty means that the dividends from the Pax Americana are gone. Yep. Wouter Klijn 55:14 Elizabeth, do you want to contribute to that? Where could potentially guard rails come from? In Australia? Are we just going to have a dominance of mining industries? Elizabeth Humphrys 55:24 There's not much of a future if we're only relying on that. But I think politicians are aware of that, right, like we've had a century of politicians being aware that Australia is too dominant on primary industries and resource extraction, but it's not been able to resolve that policy, either through the Keynesian long boom or through the neoliberal era. There are tensions particular to the Australian economy that I'm not confident that the politicians even know how to address. I you know my expertise is not in not in what guardrails give confidence to international markets. So I'll leave that to you guys to sort of respond to. My thinking is always about can, can, can governments or political sectors lead national projects that that, that that are that cohere and bring justice. We don't just want coherent projects that trample over minorities. We want these, these, these projects that take us forward. For me, that accord era of Hawk and Keating was the last time there was a truly kind of Grand National attempt to have this project that would address those contradictions of the Australian economy at that point, replan industry, give labour a fair share, protect its wages in a high inflation environment, you know, success or not, or criticism or not. Aside, I'm just saying that, that that, that lack of vision we've lived with what for now for 30 plus years. And so when we look at politicians now whose horizons are quite low, who, who they talk about, like the, you know, the small target strategy in elections, none of this gives me much confidence, but and also we just got to remember it's it's not always just about the individual politician who goes down in the history books. It's often about sections of society, what I would call a social base. Right? The social base of the unions gave the Labour Party its power through that long 20th century that's gone. What social base? What? What large groups in society are going to lead to secure futures? I'm not sure where that is and just on climate change. Of course, it's never about fossil fuels versus green greeneries, greenies. Renewable energy is itself a profit making possibility, right? And I think that that that markets understand this, right? But often we're having this debate about so and so versus so and so. For me, my research is about how climate change and its heat is a massive OHS problem for the future, which the insurers are concerned about, politicians barely on their radar. You know, there's a lot of hidden things, but hidden profit making in the in this. So really, this is a war between people who want to make profits between from renewables and people who want to make profits from fossil fuels. But we don't often really talk about it in those terms. We're talking about tree huggers versus, you know, multinational oil. Rob Prugue 58:55 But Elizabeth, aren't you also concerned that you talked about the base? Isn't it also possible that there's a new base forming that is that disgruntled, the left, those who are left out, those who have been disenfranchised, and therefore that they're going to be in the populace who are, are are, let's face it, opportunists. They're not ideological driven. They're opportunists. They will tap into that make promises. Elizabeth Humphrys 59:24 Absolutely. You've not read my work, but you're you're in the vibe of it. If there is a vacuum, it will be filled. And what I see anti politics, or you're calling populism, creates an environment that is not of the left or the right people, then individuals or political parties try and capitalise on that, so we can have both Trump in the US and Syriza in Greece, or Podemos, the mass movement out of the progressive Square protests in Spain. It is not automatic that it goes to the left or the right, and these are they. But the problem for these individual politicians or political parties is if they cannot deliver on their promises, this just leads to, often, their their quick ousting. Right now, Trump has has survived longer than most promising things to the rust belt, but then barely delivering these, tensions can't be paper and over forever. And so part of I think, the the contestation in the US is because Trump can't deliver on the populist promise of those which he was first elected, and now this has led into a much more racialized kind of policy framework and punitive policy framework that we see in the current era. Sometimes I think that even the geopolitics is about managing the domestic, internal contradictions and problems that Trump has. But he's I just really, I just reject an approach that really sees the problems as lying with an individual figure like Trump. So the people want to say Trump's crazy, or pathologize him, or pathologize his voters as being you know, those articles, people who vote for Trump have a 10 point lower IQ. This gets us nowhere, right? They're less educated, they are voting out of their interests, their life experience, and who they're hoping can realise a different future. And in that sense, every voter in the US here, any other country, is up for grabs in in in a period of turmoil. And we want, I think we want civil society organisations, politicians and just generally, community leaders as trying to map out paths economically and socially that take us forward. You know that, and there's nothing automatic about that to my mind. Wouter Klijn 1:01:59 Do you want to respond to that? Rob Prugue 1:02:03 One point I would add to that is media. Yeah, you know the so we don't, we may have algorithm and social network, but we have politically divided media as well. On the one hand, you have the right of, you know, News Corp or channel nine, and then on the left you have the guardian, or in the US, of course, you have Fox News on one side and MSNBC on the other. And this has happened for a long time in the UK. It's now spread throughout the world. But all these things and again, make it the vacuum is getting larger and larger, and Elizabeth raise a really valuable point at the end of the day, someone's going to fill it. And if it's filled with someone without a unified vision, then this, this turmoil, will just continue. This, this divisive world of us versus them will just continue to burrow in, and from I guess, a market point of view, continue to drive this uncertainty. Wouter Klijn 1:03:10 So we end up there with a lot of questions. We never promised any answers. We just tried to describe sort of the movement, from that post war, neoliberalization to where we are now, which is a almost permanent state of uncertainty, but hopefully we've given you something to think about. So with that, I would like to thank Rob Philipp and, of course, Elizabeth as well. Thank you very much for this debate.

Note: This episode was recorded before the release of ASIC's Private Credit Surveillance Report 820. The ASIC report mentioned in the podcast relates to the Private Credit in Australia Report 814, released in September 2025. In this episode of The [i3] podcast, I'm speaking with Linda Cunningham, who is the Head of Debt and Alternatives for Cbus Super. We talk about some of Linda's core beliefs when it comes to debt investing, including the banking 101, to be very careful when borrowing short and lending long at the same time. We discuss the importance of cash flows and ensuring the ability of a borrower to pay their interest. We discuss liquidity mortgage funds and private credit funds aimed at retail investors, as well as the occasional funky fee structure. We even talk about how Linda once provided a loan to finance a catamaran called the soggy moggy. Enjoy the show! __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights _____________ Overview of podcast with Linda Cunningham, Head of Debt and Alternatives, Cbus 03:00 My father was a bank manager and I wanted to get into banking at an early age 04:00 In year nine, I had a discussion with a teacher about the difference between a bank and a building society 05:30 Late 80s, the property market was booming, but interest rates were high. One of my jobs was to drive to Geelong and go through the credit files. One of the lessons out of that was how important cash flow is for a loan. Where is the interest coming from to pay you? 11:30 Matching liquidity profiles, the case of AXA products marketed to retail clients. "Having daily liquidity is great, until it is not" 17:30 You can finance anything, I've financed a catamaran, but it is about where it sits in the portfolio 18:30 Setting up the internal credit capability for Cbus. "You are coming from a bank and so you don't think about who is going to communicate with the borrower what the interest rate is" 19:30 "I started in 2016, but we didn't write our first loan until 2019" 20:30 Financing a catamaran, the 'Soggy Moggy'. 22:30 Debt is not like equities; you can't just go out and buy a ready-made portfolio 32:00 There is no pressure for us to allocate money [to loans], we can give that money to managers 34:00 On occasion, we are seeing some 'funky [fee] structures'. 36:00 Private credit is not new; there have been mortgage funds operating in Australia for at least 30 years 38:00 What is getting more focus is: where is the private credit sector getting its money from? 40:00 I do worry about the flow-on effect from what is happening in retail products 41:30 The market is very competitive on loan transactions at the moment, are people pricing risk appropriately? 45:00 It takes someone really strong, who gets paid on funds under management, to say no to the funds, whereas at Cbus we don't have that tension. I can look at other credit managers 49:00 On the internal front, we would like to do a little more construction deals. We think there is going to be a little more residential over the next year or so 50:00 We are not sure if in affordable housing equity is the way to go. But we do think that with debt you get an appropriate return for your risk Full Transcript of Episode 123 Wouter Klijn 01:16 In this episode of The [i3] podcast, I'm speaking with Linda Cunningham, who is the head of debt and alternatives for Cbus Super. We talk about some of Linda's core beliefs when it comes to debt investing, including the banking 101, to be very careful when borrowing short and lending long at the same time. We discuss the importance of cash flows and ensuring the ability of a borrower to pay their interest. We discuss liquidity mortgage funds and private credit funds aimed at retail investors, as well as the occasional funky fee structure. And of course, we delve into the state of the private credit market and ASIC's recent comments on the sector. We even talk about how Linda once provided a loan to finance a catamaran called the soggy moggy. Enjoy the show! Linda Cunningham 02:06 Linda. Welcome to the podcast. Thanks for having me, Wouter. Wouter Klijn 02:09 So your journey started a bit unusually compared to maybe some of your peers. I believe you started in the industry when you were just 15 years old. How did that happen? Linda Cunningham 02:20 That's correct look, and I'm going to age myself here, but we are talking, you know, the early 1980s I had grown up. My father was a bank manager, so I had, from a very early age been exposed to banking, and by the time I was finishing year 10, I had a decision to make, which was, you know, Did I did I want to go on to year 12? Did I want to go on to university? I knew I wanted to end up in banking. Superannuation funds didn't really exist at that time, but I knew I wanted to get into the lending side of things, and I had the opportunity to actually start working in the local branch at the bank, a different bank to where my father was, and I enrolled to do a TAFE course. So I did a Gosford Teik, an accounting course three nights a week for four years. So once I finished that, I enrolled in doing my degree by we'll call it remote learning. In those days it was called by a correspondence. Yeah. So by the time I was 23 I had been working for eight years, three years in a branch and five years in the corporate banking area, yeah. And I had my degree. Wouter Klijn 03:40 Excellent. And I think there was an anecdote where you even on the school playground would discuss monetary policy or something. Linda Cunningham 03:49 Look, I do remember, in a commerce class in year nine, having a debate with my teacher about the difference between a bank and a building society. And apparently I was, I was quoting the Banking Act of 1959 in those discussions to tell him there was a difference, right? Wouter Klijn 04:09 Right. Not your average conversation, I think, for a teenager. Linda Cunningham 04:12 No. But look, it had been something that had always interested me. And look, I still now people have various dreams. One of my dreams is always rolling coins. So yeah, rolling up the 20 cent pieces and 50 Cent pieces into the pieces of paper. I can still do that in my head, Wouter Klijn 04:31 Very good. There's probably muscle memory comes into play with that one. So having started relatively young, you've seen probably a few financial crisises. I think the 1990 collapse of the Geelong based pyramid building society was one of them. Can you share some of your learnings from some of these downturns with us in terms of how it shaped your outlook on investing? Linda Cunningham 04:56 And look, that was absolutely a very interesting time to be in the lending space. I had moved from New South Wales to Victoria with my work. And, you know, late 80s, everything was booming in property, everything was booming everywhere. But you also had interest rates pretty high. And, you know, the market was, was, was very hot, and the bank I was working for had exposure to all of the pyramid associated companies. So there were actually four building societies there. And we were actually doing what these days would be called a warehouse loan. So we're effectively providing them, you know, with the loan, 80 cents in the dollar, based on a, on a on a pool of mortgages, and those loans, the underlying loans, would be some commercial property. They'd be residential. It'd be a whole mix of things. And one of my jobs I got to do was to get on the freeway and head to Geelong every few months and actually sit there and look through the credit files. There was you couldn't get them on Excel. You couldn't log into a data room. You'd actually go in and sit there in the premises and look through those credit files. And I think for me, one of those, the sort of lessons out of that was, was really how important cash flow is for a loan. You know, if you are, you know, in our case, we're expecting, you know, the borrower being, say, pyramid building society, to still pay our interest. But you know, if you've got a pool of loans that are in there, that are just secured against a vacant block of land or a non income producing property, where is the where's the income coming from, where's the interest coming from, to actually be able to pay you? And I think that was, that was probably one of the strongest sort of lessons that I actually had, was really how critical income is. And I would say that was even important. If you looked across, you know, the banks books at that time, and a couple of other names you've got to mention from that era. You can't not mention the state mortgages tri Continental, all of the state banks, like I work for State Bank of New South Wales, which actually was in a pretty good state, but we're probably still in that time whereby we actually had a large proportion of our property based loans, which were from an LVR perspective, we had breaches, right? And it was one of those situations where you we actually did okay, like those loans were were pretty good, because the income was still solid on them. The borrowers were still earning enough income from these assets to actually be able to pay the interest. But, you know, they suddenly went from having a loan to valuation of, you know, 60% to 80 or 90% breaching covenants, etc, just really because of the rapid change in interest rates in the market and the impact on on property values, Wouter Klijn 08:02 yeah, and I think that importance of knowing where the income come from and the underlying assets that sort of carries through through time. Because I think we recently spoken about a loan, and we won't name any names, but it basically looked like a term deposit. But when you looked under the hood, it was something very different, with very different liquidity profile, Linda Cunningham 08:24 Absolutely. And look, that's, that's not a new thing. You know, it has its place. It is just understanding how you're matching what you're what you're doing. I mean, we, we do do construction loans, and generally most construction loans, particularly you, if you're building, say, an apartment complex or something like that, your your only income, your only earnings that come in is when your pre sales of those residential apartments settle. So you are capitalising interest on on your loans. Now I think that's absolutely fine if you're understanding what you're investing in and understanding what you're expecting out of that investment, Wouter Klijn 09:09 Yeah, and as long as you understand the risk profile, because you know, if you expect the term deposit, then you find underlying assets that have maybe seven, eight, sometimes 30 year maturity rates, then that's quite a mismatch, of course, and it sort of comes back to what I think I've heard you talk about, this sort of banking 101, where you basically have said you never borrow short and lend long at the same time. Can you explain a little bit that philosophy and how that comes back today in your approach. Linda Cunningham 09:42 I mean, when you think about banks or or any form of money lender, you know the reality is you, you need to raise your funds from somewhere, and then you're lending it out. And most organisations, or most of those structures, banks, in particular, I mean, banks run raise funds for. From long term capital markets. They have equity in place. They have subordinated debt in place. They have term deposits from from people. But they're, they're consciously thinking about the overall asset liability matching. And I think that's, you know, that classic thing I worked at AXA, so I moved to AXA once I left banking. So I moved there in in 2000 or 2001 I was there for over 12 years. So that obviously covered the GFC as well. Yeah, and look, you know, AXA had what they referred to as an income the mortgage funds were income funds, Australian mortgage Income Fund. Those funds were providing commercial loans to small corporates. So you know, they were traditionally the sort of four to $20 million sort of size loans. Really good book, really good quality book. There are a few others in the market, like perpetual, very similar. I mean, probably 40% of the assets in that portfolio were actually your neighbourhood shopping centres. You know, the ones where you've got Coles, Woolworth, your chemist, your butcher, those sort of things. So good income producing assets. But those products were to retail and wholesale investors, and as part of the characteristics of those funds, they did have the ability to have daily liquidity, and that's great, until it's not. I mean, there was nothing wrong with those loans that were in that book. And for you know, the entire life of of that particular fund, it had been in net inflows every single month, up until September 2008 and then by 2008 you had the Australian Government introduced the deposit the deposit guarantee, straight away, that really reinforced for people, the difference between something like a mortgage fund or a private credit fund or any other sort of funds. And you've got to remember, these things have been around for decades. You started off with debenture funds and so on, suddenly realised that it's very different to being with the bank. And look, you know that that fund was, was frozen in October 2008 we at that stage, we had one problem loan across the whole period of time, one problem loan, but our investors had to wait, you know, three to four years to actually get their money back, because we had commitments in place for loans. And often loans will repay you early, but you can remember it's it's also GFC, it's hard to refinance. So borrowers weren't going to repay you back early unless they, you know, unless they wanted to. So, you know, I think that for me, really highlighted that aspect of, you know, borrowing short daily liquidity and offering a product or that, or investing in something at the back of that that is a longer term investment. Wouter Klijn 13:24 Yeah, yeah. Because, essentially, to provide that liquidity, then you either have to build in a cash cash pool, which will have a drag on returns, or you rely on new investors coming in, which is, you know, of course, not guaranteed, but, but those structures are still around, right? Linda Cunningham 13:44 Look Absolutely and we already use the word pyramid, but it is. It's one of those things I mean loans, private credit is good. Loans are good. You've got to remember, we're still talking generally at the top of the capital stack. So the asset class, I like, it's, you know, just making sure that investors understand what what they're getting in assets. These assets will produce income coming off them, so there's always a little bit of income coming out. But unless you're actually getting loans that are repaying during that period, or, as you said, new investors coming in to pay out the old investors. It works until, as I said, until it doesn't. Wouter Klijn 14:34 Yeah, no, that's, that's very true. I can remember that period. Actually, I was just starting at Morningstar, and suddenly all these funds started to lock up. And there was plenty to write about to tell you that, but it was a very interesting period, for sure. Linda Cunningham 14:50 Look, I remember it quite vividly. I mean, I was, I was involved in actually looking at some of the hardship requests that came through. And. That is absolutely devastating to see that, you know, there were people who had sold their home, and the advisor had told them to put it in this account because it was, you know, it's like a term deposit, or it's a cash account. Don't worry about it. And then they go to buy a new home and they don't have their money anymore. Situations where people who had saved a deposit had been saving it because the interest rate was that little bit higher, they'd been saving their deposit there they couldn't access their deposit. There were situations where people had been putting aside money for their wedding, money set aside for funerals, other family events that were taking place. And when you read the the hardships, provisions, I mean, that's, you know, it's very tough, and you feel for people who just haven't understood or haven't realised that this situation could happen, that when they do want their money back, they won't get their money back. So it is about, you know, is it right for the person and how much, how much they should have in those kind of structures? Wouter Klijn 16:11 Yeah, and that brings a very sort of practical face to liquidity. Because I can also remember, you know, this, you know, the famous book, The Big Short, where they're talking about these investments in subprime loans, and basically they put this trader forward as this genius trader, but his funds locked up. And you sort of justify that by Well, if you go out now, then you lose all your money, but if you stay for a while, then you make a lot of money, but the investors might have different liquidity requirements, so you can't just tell people like you're not getting your money back, right? Linda Cunningham 16:46 No, look, it is. It is just challenging. I, as I said, I think loans is great. I'm I'm too conservative. You know, it is about I like loans. I love looking at them, you get to see so many different asset classes across my career, working in banks. Look, I've done things from hotels to hospitals. I've done seed lots, I've done abattoirs, I've done a catamaran. There's some really interesting things that you can finance. Because the reality is you can finance anything but, but it is about where it fits into a portfolio. Wouter Klijn 17:32 Yeah. And that brings us sort of to the direct lending business, because you originally joined Cbus in 2016 to set up the direct lending business for the fund. What were some of the main challenges to get this off the ground? Linda Cunningham 17:49 Look, I would say it was, it was very much at the beginning of sea buses, internalisation journey, I probably thought that there would be, when I arrived that there would be more processes and procedures and things like that in place. The operational background that Brett Chatfield is is is very determined and very clear on what he wanted to achieve. So when I arrived, I spent quite a lot of time working with him in terms of, you know, just setting up the whole, the whole processes, the procedures, the Credit Framework, you know, the delegations, the whole process for a credit cycle. I mean, we do have, you know, a credit process and framework, which is, you know, 4050, page document that gets updated each year in terms of making sure that everyone in the team is consistent in how we think about, you know, the debt side of things, and what we look for, what you've got to address in your credit manuals or in your credit papers and things like that. So there was a lot of work that was was done in putting that in place. But also, you come from a bank, you don't even think about who is going to produce the interest statement for the borrower, who is going to communicate with the borrower and what their interest rate is. So there was a lot of work with our operations team to make sure that we could actually put those, those things in place. And of course, don't forget your regulatory things. You know, all of a sudden you're going okay. So do we have lending as a designated service on our AML KYC policy? Where are we on the regulatory side of things? So I started in the end of 2016 we didn't write our first loan until the beginning of 2019 Wow. Wouter Klijn 19:43 Okay, that's how long it took to set up all the processes. Linda Cunningham 19:46 Exactly. Look at the same time. And you know, that was, I was looking after the rest of the global credit sector at that stage. And so, you know, we you still had your day to day, you know, with your managers and things like that going on. But it was very much we need to take our time in setting this up, thinking about where we want to play in the market, and how and and when we want to play. I think, yeah, important aspect of it. Wouter Klijn 20:15 Do you still remember some of those early loans that you made in 2019 I presume the catamaran that you just mentioned was not until later. Linda Cunningham 20:24 The catamaran was back in my banking days. Okay, I'll confess this thing ended up being called the Soggy Moggy it was. It was a catamaran that was supposed to sail from Victoria to Tasmania, and it was a deal that State Bank of New South Wales did with, think, at the Bank of Tasmania, or whatever it was, a state government sort of initiative, let's say it was fine. We got our money back, because we actually had a put option on that catamaran for it to be sold to a European company that was actually going to sell it across the English Channel. So it was fine, but yes, that was that would not be something that Brett or Christian or even Lee now would be very comfortable in in us putting in the book. Wouter Klijn 21:18 That's That's unfortunate, because I've just got a plumber around who I talked to and is in sea bus, but so I can't tell me on a miniscule part of catamaran. So, but what were some of those early direct loans that you got involved in, in 2019 Linda Cunningham 21:38 Things that we got involved in those early days were things like mainly syndicated transactions. We were very clear that if we were going to do bilateral loans with people in the market, that's really labour intensive. So for us, this is an institutional loan portfolio where we're looking to participate alongside banks in the syndicated loan market. So we've been in, we're in shopping centres, office buildings, a couple of transactions that we didn't end up doing, that we bid on and then were under priced in. So a couple of those loans are still in our book. Yep, been good performers. Very happy with what they've done. They've performed the way that they were supposed to to go, but it was, it was slow, but that's what the organisation was really clear. It wasn't about. You know, debt is especially this type of loans. Is not like equities. You can't just go out and buy a ready made portfolio. And aim was to think carefully about what, what we put on the book. Because when you write a loan, you you are in the situation that Australia is not a big trading market. You can buy and sell loan, but not a lot of that takes place. So if you invest in a loan, you have, you have to live with that loan. So it was about making sure that we were cautious about what we got invested in and at the same time. And the thing that, I guess continues to this day, is we don't have to write a loan. We would like to grow our loan book. It's an important, and we think, a valuable part of, sort of the global credit sector. But the same time, if we actually don't see that we're getting good opportunities or good deals to do, the team's not given dollar targets. The team's given a return target, and you know, a long term objective as to where we see that as a manager weight so if they're not seeing good deals, and you even, recent times, we've seen that we've knocked back deals not because they're not good borrowers, but because, really they have the structure hasn't been right, and the pricing is not reflected the risk. Wouter Klijn 24:04 You did make some some loans during the covid pandemic, which you know probably wasn't that long after you actually started first investing. What gave you the confidence to do that,? Linda Cunningham 24:17 Really, that was, I would have to say, Kristian was, was really strong leadership across that period of time? And you can't you've got to forget. You've got to remember that what was happening in the superannuation industry at the time we had early release happening, and my team also manages the cash for the fund. So front of mind, we were seeing all of the requests coming in for early release. That Kristian was, you know, this is a time of challenge, but it's a time of opportunity as well. And he was very clear that he wanted us to be that's the entire investment team thinking about what the opportunities were. So I think from the. You know, around about the 20 months from April 2020, we did probably about $1.2 billion worth of investing in the direct debt strategy. Okay, we did a couple of residential construction projects where we sort of, you know, we had definitely had one transaction, which had been knocked back by a bank because of the covid pandemic and the uncertainty about what was going to happen on construction sites and so on. But we didn't couple of others as well whereby, you know, we just knew that you needed to get these things built. They were good opportunities. They were, were comfortable with pre sales, were comfortable with the builders. It was great opportunities to do transactions and provide good, solid returns for the members. And look, it wasn't just loans. We're also our portfolio is quite has a really broad remit. So we're buying corporate bonds as well at that at that particular time, and getting some fantastic opportunities to get funds invested for the members. So you've got to remember them. Yes, you had members leaving, and you had to make sure you're meeting those but you also had managed members who were staying, and you needed to take care of the returns for them as well. Wouter Klijn 26:22 Yeah, yeah, I can imagine, with Cbus being, you know, for the construction industry, that there's a fair few sole traders as well that probably made use of access to the early release and hardship rules, maybe because they wouldn't be able to get out and perform their jobs. Linda Cunningham 26:40 Look absolutely, I think that was consistent across the whole sector. You know, those early days you were stopping and trying to work out, well, how many of our members may be eligible for this? And if you remember, some of those rules were really just a self certify structure. And you know, a lot of people who were nervous about what was going to happen, and it's about, I need this opportunity is in front of me. I need to take advantage of it. While is there Cbus, as well as other funds, have also done the numbers to see what that has impacted on the long run for people from their superannuation balance perspective. But at the time, I guess you know, that was the right thing for people to do. Wouter Klijn 27:29 Yeah, so Kristian Fok was driving some of these initiatives saying, like, let's look for opportunities as well. Was it hard to sell that to the IC and the board? Because it was a very, sort of nerve wracking time. Linda Cunningham 27:41 I think Kristian was had the support of the board. This is, this is a numbers game. You know, you need to understand your members. You need to understand that book, but it was very important that you don't forget what you're here for. And I think, you know, there was very much that steady state, obviously the returns in March, April, May, etc. Thing. If you look at the numbers and you see there is the recovery, you'll see that it was it happened quite quickly. And if you were too nervous, you would have missed out. So it is about being confident. Kristian and Brett were very good in terms of driving that staying invested. Wouter Klijn 28:29 And you mentioned during the time there were just certain assets that needed to be built. Can you tell me a little bit about your approach to funding construction projects? Linda Cunningham 28:38 Sure. And look, there were some of the other fun things I've, I've done across my career in banking. You know, in the early days, I ended up in the property team in Sydney, which was quite interesting, and then down here in Victoria as well. So I just as background, I've been involved in things like construction of crown in Melbourne, 333, Collins Street, Dockland stadium, Park, Hyatt. So I've always loved the construction side of things. And I think that was another that was another carrot for me in terms of joining sea bus, the fact that I knew that Brett was very keen that we do participate in the construction space, but I'm an old banker, so we are quite conservative in terms of how we approach construction. And here at the at present, we've got sort of three construction deals on our book. One of those is a residential construction and you that has pre sales in place that that cover our debt. So we will do some construct residential construction deals that don't have 100% pre sale coverage. And that's a really that's a real testament to the the internal knowledge that we have within. Sea bus, because you need to have confidence that you can get this building, that this building can be built, and that people will buy the product. And so it's really important from the internal conversations we do have about any of our construction deals, but just coming back, the other two deals that we've got are actually industrial properties, and they're both ones which are operating businesses running really well, and they're expanding, and so they've actually got pre commitments in place to take that additional space. So it's construction that is not speculative, that that's not where we're playing, but it's a good, you know, component of of our book, we've done construction for social and affordable housing. And that was another one that was done in the in the depths of covid. Again, looking at it, we actually had a takeout from our community housing provider to buy that on completion. So we knew that if we could get that finished, we actually had the takeout from community housing provider who had their debt locked in to be able to buy it. Wouter Klijn 31:10 Yeah, yeah. And that's how you manage your risk. So you have this internal portfolio, but you also make still use of external fund managers. How do you think about that mix? Is there sort of an optimal balance between internal and external investments from a debt side of things? Linda Cunningham 31:29 I mean, the overriding statement is, is what's in the best interest for the members? So we do have a longer term manager, weight, which sees that our internal strategy growing over time, but that's always asterisked with if we can see appropriate opportunities for that portfolio. So we do think having the mix of internal management and world class external managers is ideal. It enables us that flexibility to make sure we're getting the right return for risk all time. So we're seeing what our external managers are doing. We're talking to our external managers on a regular basis, and some here in Australia, some are offshore. So we actually have that global approach to how we're investing. So if we were looking at transactions here in Australia, and we're saying that just doesn't make sense, we can't see things that make sense. There's no pressure for us to write a deal. We can allocate the money to managers. And I think that's, you know, that I see that as really is the sweet spot. There is no it is not that we have to internalisation for the sake of internalisation. It is about getting that right return for the members, but, but I'll say, we do. We do benchmark ourselves. So in other words, we run, what are the costs of running an internal strategy compared to what it costs us to get external managers in place? And you know, we're always conscious of of that. We talked about some private credit managers before we get a lot of people who would like us to, you know, allocate to them rather than having an internal strategy. And we've seen some really competitive pricing. But it's interesting, when you read the the asset report in terms of fee structures and where things get hidden and all of those, we're very much about transparency. I mean, none of the managers in our credit space are on any form of performance fees or anything like that. It is give us your rate, and we will pay that all of the income on our loans come to the members. There is no, there's, there's nothing funny, and we've seen some, let's call it, funky structures offered to us, which we sit there and go, This doesn't fit in with RG, 97 Wouter Klijn 34:19 What sort of funky structures? Speaker 1 34:22 Oh, you know, where they'll take part of the upfront fee, or they will offset fees with other charges and other things that come in place. Yep, that's not we're not comfortable with that. And and the other thing you have to think of with, with, with some of those is we might pay a bit more to somebody else, but I'd prefer to be paying a bit more to have confidence in a manager than other managers, who won't charge you very much, but they give you rubbish. You know, that's an easy. easy decision. Wouter Klijn 35:01 Rubbish is still rubbish. Speaker 1 35:03 Rubbish is still rubbish. And the cost of buying that rubbish and having it in your portfolio, you know, the losses that you might incur, in no way can you justify having a slightly cheaper fee but picking up rubbish? Wouter Klijn 35:19 Yeah, no, for sure. So let's delve a little bit deeper into sort of the private credit sector, because it has been very popular. We've just seen the release of that ASIC report that highlighted some questionable practices. I mean, overall, they were relatively positive, but I did see some issues there, and often heard criticism or comment around profit credit is, well, it's still relatively new. It hasn't gone through a business cycle, and you don't know, you know what the level of defaults will be. And I think when we sort of prepared for this podcast, you said it's not that new at all. It's been around forever. Can you explain it a little bit? Linda Cunningham 35:58 Absolutely, we're already talking about a pyramid building society and those in estate mortgages. If you think about it, there's been debenture funds or mortgage funds operating in Australia for at least 30 years. I mean, even if you you look at IFM who've got their specialised credit funds. I mean, that's been operating since 1999 that has been playing in a mix of public and private credit for a very long period of time. You're talking about 26 years now that that's actually been operating. So I think private credit has always been around, and what's my definition of private credit, very similar to assets, and it's basically anything that's not done within a bank, and I actually think there's a need for funding outside of the banks. And you think about why this occurred, and you think about the asset report also talks about Australia having about 50% of the private credit is real estate based. And I think that does come back to you know, the difference between how a housing loan on a bank balance sheet, what capital you require for a housing loan compared to what capital you require to do, you know, commercial property loan. Yeah, I think that has been a big driver in provide or in in there been an appetite for for people outside of banks to provide the funding. And I think that's a good thing for the market. It's a good thing for the stability of the banks and so on. It is just probably what's become more of focus is, where are the where it's the private credit sector itself getting its money from. There's obviously institutional investors Wouter Klijn 38:01 From you? Speaker 1 38:07 And look, we prefer, we prefer in in that space to choose our own, be selective, and tune us our own assets, and do it directly when we're not interested in having a manager really in that space for us, but I think it has been around for a long time. But yes, there's not been as much oversight of the sector. There hasn't needed to be the GSC, there was quite a lot. I mean, you had funds at that particular time, you know lm finance up in Queensland. Always think of the Queensland gold chains, white shoe brigade. If you look at LM finance, you, you look at Storm Financial, you look at any of those names, you, you'll see these same patterns repeating themselves. Wouter Klijn 39:01 Yeah, I remember Storm Financial was, I think we wrote about that for years. That was, that was a big one. But it also at this time. I think part of the reason why the report also came out is what we talked about earlier. There is now participation from retail investors into the private credit space, and so new vehicles have been constructed that live on advisor platforms, and they tend to have daily liquidity and back to the old mortgage funds like there's only a couple of ways to provide that liquidity, and it doesn't come from the underlying assets. So do you worry about seeing sort of this increased retail participation in the private credit space. Linda Cunningham 39:45 So I guess where I sit. I'm I am slightly like removed from it. I I worry about the retail investors that mentioned the days with AXA. But it probably even goes back to my days been on the counter and seeing people come in every second Thursday to cash their pension checks. You There are a lot of people who are relying upon income and want their return. And I just, I worry about that side of things. I worry about the flow, potential flow on effects. You know, there are good lenders out there, but it is about, you know, is the product matching it? Are the way they funding it appropriate? Yeah, that would be sort of that biggest question Wouter Klijn 40:31 What are some of the other concerns you have about private credit funds. I understand that some of them might have some leverage in them? Linda Cunningham 40:39 That's a good question. That is certainly a trend that we are seeing. There is a lot of debt that's been put into these funds, also known as a NAV loan. On the positive side, it can help the manager to smooth the cash flows and possibly boost the returns to in the investors. But on the downside, that debt ranks in front of the investor. So I worry that's not fully understood by wholesale investors. There could also be some risks for institutional investors who support a manager that offers a wholesale product. In this scenario, you're likely to see loans being shared across the platform, across the wholesale and the institutional investors. So how are decisions being made on those underlying loans in a scenario where the fund manager is needing to get loans or part of the loan repaid as quickly as possible to meet redemptions, yet the institutional investor might have a more patient timeframe. Where we are in the in the current environment, is often the products are not paying a lot more than, say, a term deposit or something. So people are looking at them and going, well, that's only a little bit more. That's obviously not much riskier. Or, you know, it must be okay. And I think that distorts the fact that some of these structures are there's a level of fees and expenses and things like that that are coming out before the investor actually sees their return. So they're not seeing that. In reality, say we're getting a pass through of all of those things, their return would be a lot higher. Alternatively, and this is where the market is very, very competitive on loan transaction at the moment is, Are people pricing risk properly? And that's, that's where it starts impacting, say, on us and the transactions that that we're doing, you know, at the moment, there's a lot of competition in the in the Australian space. You've got foreign investors, institutional investors here. You've got a lot of the foreign banks here, and you've obviously got your private credit funds, your Australian banks. Australia's a small market, there's not a lot of transactions, so you are actually seeing people competing to do transactions. Wouter Klijn 43:22 Yeah. Does that have sort of a flow-on effect, in the sense that underwriting standards might drop a little bit Martin's coming in, does that have sort of that cascading effect? Linda Cunningham 43:34 It absolutely does. And so that's why, that's where it does impact us. We do see that, you're, we're in syndicated deals. So we, we're seeing who's in those deals and who's in those transactions. There's been a number recently, you know, in the last few months, where, by we've knocked that participation in a transaction, not, you know, it's, it'd be a good borrower, but the pricing for the way it's been structured, and when I, when I'm in structured, the covenants that are in place looser than They should be, and that might be okay, the borrower might not do the bad, the wrong thing, but they're very loose covenants, and the pricing is low, and we can look at that and we just say, look, thanks, we won't participate in that transaction. So the team's really quite disciplined. You know, we've got a broad group of people in that team now with broad experiences and things like that. But no one feels the pressure to they just want to do, you know, good transactions and that are appropriately priced. Wouter Klijn 44:46 Yeah. So do you see more of that happening? Do you see more loans, where you think like: 'I'm going to skip on this one' ? Linda Cunningham 44:53 Some of those are easy decisions. Where it gets where it gets harder is where Look, you're always going to want the loan to pay you a little bit more than what it does. I mean, that's, that's your borrowers always want to pay less, and lenders always want to charge more. So there's, there's, there's a space where that is really a clear decision. And there's borrowers whereby you know, you're prepared to give them a little bit of a leeway because they're good operators and things like that. But there's other transactions where you just say that that doesn't make sense for for where we see that risk, or the potential risk of that transaction, we will just walk away and again, because we're not we don't have to play in one space. I always think back to the days when I worked in the bank, if you're in the property section of the bank, and the bank says we've got enough property and not doing any more, what are you going to be doing if you're in a credit fund and credit returns are not looking good, what are you going to do? You've got investors that have given you money that want to get invested. You know, it's it's quite challenging. It takes someone very strong who is earning their money on funds under management. Say no thanks to the funds. Whereas that's not, that's not a challenge that we we have at sea bus, because I can look at other I can look at credit managers and allocate to them, or I can sit down with, you know, Justin Pascoe and the asset allocation team. We can talk about credit markets generally, what we're seeing the themes, and we just think about, well, you know, should we do we want to do, go underweight credit at this particular time. How do we want to position ourselves? You just got to maintain your discipline. Wouter Klijn 46:45 Yeah, for sure. And you do come at it from a different angle than, I think, a fund manager as well, because you're investing for members in sort of a context of a multi asset portfolio, and I think you've stipulated that the credit part of the portfolio, the fixed income part of the portfolio, it's not a standalone option, it's part of the multi asset portfolio. Does that make you look different at how you invest in credit and in certain transactions? With that idea that maybe more a diversification lens rather than a pure credit lens. Linda Cunningham 47:22 Look, absolutely it is when our manager, when our members invest, majority of our members go with one of the pre mixed options. Okay, and so all of your pre mixed options, most of them, will have some exposure to credit, but as part of that overall portfolio, you know, our total credit component might be six or 7% of it, so it's not a significant component in in the first place, they have exposure to equities, infrastructure, private markets and so on. Where, where credit does cross over is the fact that, if we are in public credit, it's tradable. Sometimes it's not tradable when you want it to be tradable, but, but generally it's tradable. It's like equities. It trades like equities, but on the private side, you have to be conscious that you're actually using some of the funds illiquidity budget. So when we do do private credit, whether we do it in house, ourselves or via a manager, we are conscious that we are making that long term commitment. We're allocating money to something that may not pay us back for three to five or seven years time. And so we actually treat that as an illiquid asset, so we expect it to give us a premium over a liquid asset. We also when we look at the overall sort of risk side of the fund, we do, we do take into account that is illiquid. So you always sit down with the Private Markets team. We're having discussions all the time about how we think about our illiquid component of the portfolio. So it's got to compete, to an extent, with other illiquid assets, whether it is the property, the infrastructure, private equity, Wouter Klijn 49:15 yeah, yeah, that makes sense. So last question, what is on the calendar for the rest of the year? Do you have any research projects coming up? Any reviews of sectors? Linda Cunningham 49:26 Look it's really a business as usual time the sectors we think are well set up, and we talked before about the fixed income sector, our fixed interest sector is just govies, so that's where we make our duration call. Our credit sector is just credit, and it is predominantly floating rate credit. But those sectors are set up well, we're happy with the managers in it, but it's a matter of monitoring and just and just continuing to make sure that they're, they're fit for purpose and set up the way that we want. On the internal side of things, we're keen to do some more construction deals. We like to think that there's going to be a bit more movement on in particular, residential construction over the next year or so. So there's a focus there, and the team, obviously has been we've been working on the social and affordable housing side of things. We'd be keen to be involved in that space that's been particularly challenging, but it's a continual head down and see what we can do and see if we can make it stack up. Wouter Klijn 50:35 Yeah, yeah. What's the interest in affordable housing? Is that from a credit perspective, or is there that element of ESG to it Linda Cunningham 50:44 Look, it's predominantly from a credit perspective, but we do think about a sort of if we can make it work, it's a win, win, win. So we need to get fundamentally returns for the members, and we think that's why debt makes sense. We're not sure that equity, especially in social and affordable housing, is the way that we want to play. But for debt, you can get an appropriate return for you. Or risk, we'll look at doing it, but also the construction side of things. If we can create jobs for the members, that's also a win. And the third point really is that societal, there is a need for some more housing across the board, but in particular in that social and affordable space. So if we can support that, we're very keen to do. Wouter Klijn 50:21 So, yeah, absolutely, yeah. Well, Linda, thank you very much. That was a fascinating conversation. So thank you very much for your time. Linda Cunningham 50:29 Thank you. I appreciate the opportunity to talk to you.

In this episode of the [i3] podcast, I'm speaking with Mary Power, who is the Head of Property Research at asset consultant Jana. We cover the struggles of the property market in the early 90s, when Mary started out in the industry, and the learnings from that time. We take a look at how investors have dealt with 13 consecutive rate rises, starting in 2022 and we cover portfolio construction issues, including blending listed and unlisted property assets, the convergence of real estate and infrastructure, while Mary also predicts that up to 50% of Australian property money might be reallocated to international assets as super funds grow bigger. ________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of podcast with Mary Power, JANA 03:00 Getting into the industry 04:30 The early 1990s was a dramatic period in the office market and as a young person in the industry that experience was fascinating 07:00 I think we have turned a corner in terms of unlisted property 8:00 In June 2022, we headed into 13 interest rate rises, which was a significant head wind for the property sector. 10:00 The REIT sector is very sensitive to interest rates 11:00 Are REITs equities or properties? 12:30 Property people don't price off the cash rate; they price off the 10-year bond rate 14:00 The Melbourne property market is still a little bit difficult 16:00 People aren't getting their forward projections of labour seating in offices right 19:00 I think it is very hard to promise quarterly, ongoing liquidity in a portfolio with large assets 25:00 There is a big push for the build-to-rent sector to mature in Australia 31:00 Super funds could move up to 50 per cent of Australian property money offshore Full Transcript of Episode 121 Wouter Klijn 02:01 Mary, welcome to the podcast. Mary Power 02:04 Thank you very much, pleasure to be here. Wouter Klijn 02:07 So you've been with Jana for more than 15 years. What got you into property investing or property research in the first place? Mary Power 02:16 Oh, I might have to let you in on a little secret. I I've actually had two stints at Jana. I was actually at Jana in the between '94 and 2000 as well. So yes, I was how did I get into property? It's a great question. I had a friend whose father was a valuer, and I commenced the property valuations course at RMIT, and he got me a cadetship at Urbis, known as at Cox then, and I was hooked. I was enjoyed it immensely. And love the idea of the commerce and the built form coming together. Yeah. So I, I really enjoyed it. And I, I joined at a time when the property market was exuberant in the late 80s, and then it went into the early 90s, which was the recession we had to have. So I saw the best and the worst at the time. And I always say I learned all my skills over those eight or nine years. Wouter Klijn 03:12 Yeah, and apart from the environment at a time, has the investment side changed much? I mean, do do the valuation practices change the deals, change the structures. What's that like? Mary Power 03:26 It's a great question. In fact, a lot of it's changed, and a lot of the fundamentals remain the same. So lots of change, lots of so if you went into the early if you went into the early 90s and we had that recession, which absolutely impacted the office sector. In Melbourne alone, there were six office buildings that were built, and they would have been built on, not with pre commitments that you would have today, so built by developers who then had to entice tenants in. So a mill, we say, a million square feet, or square metres of Office became was built, and then the rest became vacant. So vacancy rose to about 25% and in fact, rents halved. So it was a really dramatic period in the office market. And it was, you know, as a very young person learning it was, it was, it was fascinating. What had happened over that period. We didn't have a Funds Management basis. Then the I think, as we headed into the 90s, I think amp and national mutual were about the only funds managers that were available. Most of property was held within a Balanced fund. And of course, over the course of the next few years. If you fast forward to 2025 the Mercer survey is, in fact, about 94 billion. That's without Goodman, I think that adds another 18 billion on. So, you know, you're a very substantially funds management platform has emerged over that period, over that last 30 years. And you know, it. It now consists of specialist sector managers plus diversified managers. So it's been amazing. Wouter Klijn 05:05 Yeah, sounds like the office sector has gone through a few problematic periods and more exuberant ones, because we've seen, of course, with covid and as well that it got strongly impacted we were working from home. Did that experience earlier on help you going through the covid period? Mary Power 05:26 I think covid, I always say covid was a black swan event. No one had, noone had predicted it, but the balance sheets and corporates and and employment data was all in good shape. It wasn't the same. In the early 90s, we had very high unemployment, up to 11% most people I knew had someone had lost their jobs, and these were very smart people, and we had a lot of corporate issues going on in the early 90s. That wasn't the case in covid. We were in pretty good shape going into the into the covid. So I think whilst it was annoying, and we hadn't seen it before, it was nothing like what I'd seen in the in the early 90s. So that gave me some comfort at the time, yeah. And of course, we had, you know, the new phenomena of working from home, which was something we hadn't had before. And of course, you know, various states had different lockdown periods. Melbourne had a very severe lockdown period. And of course, it's taken some time for people to return to the office. Yeah. Wouter Klijn 06:28 Fair enough. So if we fast forward to today's environment, I looked recently in sort of the superannuation returns for the full financial year, and spread out by the different asset classes. And what sort of struck me is that unless that has been relatively poor performer in recent years, last two years, negative, this year, low, single digit, but at the other side, first time it's single digits again with positive results, have we turned the corner there? Mary Power 07:01 I think we have, and I think you know what happened in 2020? Was covid occurred, and there was this, you know, significant lockdown over quite a long period of time. Never good for the built form that have leases in place. They have contractual leases in place, but you still need people to buy things at shopping centres and office buildings to be occupied for those leases to be sustainable and and of benefit to the tenant. So I think that was very difficult period. I mean, I'm would, I would call the Property Council at the time, they had to negotiate with tenants, 1000s of and come up with a code of conduct of how to interact with a tenant during this, you know, significant period of disruption. And to their credit, they did do that within a reasonably short period of time. On the other hand, infrastructure asset had one contract with talking about 1000s of contracts through the property sector. So it was, it was very, a very difficult period, but I think they did a great job. And then, of course, we headed into in June 22 the start of 13 interest rate rises, which, of course, was a significant headwind to the property sector, because it had performed quite well, even through covert up until the mid, mid 2022 and then we started facing into to higher interest rates. And the higher interest rates, in fact, had been quite difficult for cap rates at the time as a differential. So we know what happened. Cap rates expanded, capital values went down in most cases, the income line, the leasing line was was not too bad that that sort of stood up. You know, it was really the rapid interest rate rises 13 right? Interest rate rises in a short period of time. That really was the problem for the property industry, yeah. Wouter Klijn 08:50 And then if you look at the listed side of the property sector, somehow they did much better. So I looked at Australia's property that increased by 13.8% and then I think international listed property went more than 9% why is there such a strong difference between the listed space and the unlisted space over that period? Mary Power 09:12 So I think, you know, the listed is highly correlated to equities, so you have a big influence. You know, I go back to March 2020, and the a rate sector fell by 46% so that was a very, you know, that was a very stark fall compared to what the unlisted property index was doing at the time. So the A rates are, you know, they've got some interesting characteristics. For instance, the Goodman group makes up about 39 40% of the a rate index. So that will rise and fall depending on on how government have performed over over a period of time. So I think the other thing is that, you know, the a the rate sector, while it is very much correlated to to equities, it's very interest rate sensitive. So you get interest rate, you know, interest rate. Cuts like we've had attractive, very attractive for for the rate sectors, you know, good for repricing of debt. Good indicate, lead indicator. And I think, yeah, the rates can be a good lead indicator for unlisted property. Yeah. Wouter Klijn 10:15 So do you subscribe to the idea that REITs are equities in the short term and property in the long term, or are they just always equities? Mary Power 10:24 Yeah, I think that's a great question. I think over the long, long term, you'd think that they do. You do have a quite a strong correlation, you know, to property over the long term. I think though, you need to be able to withstand having them in the portfolio. You do need to be able to be aware of the volatility. So if you're sitting there in March 2020 you have to ask a trustee or a fund how you know how comfortable you are with a 46% drop in your rate portfolio over that period. Because I think the way we structure a diversified portfolio is we try to buffer, we try to include asset classes like property and infrastructure and private equity that actually buffer equity market risk, so it actually allows you to have strong equity market exposure, but realise that in a downturn in equity markets that you've got these other unlisted assets that actually provide a buffer and should not decline as far As your equities do Wouter Klijn 11:21 Yeah, so we've just seen a quite controversial cut in interest rates from the RBA. And then I think there was a lot of comments that I didn't cut the time before that, but now we just seen that inflation figures came out, and they are sort of, I don't know if spiked is the right word, but it went from 1.8 to, I think, 2.9 What are your thoughts around that? Is that an indication that that won't be cut for a while? And how does that affect the property sector? Mary Power 11:52 Yes, always cautious on commenting on interest rate cuts. But look, I'd like to think that there, you know, are some more coming. I think the benefit of of the cash rate being cut is obviously in the debt markets, so very attractive for pricing of debt. So that's a that's a big positive property. People don't generally price off the cash rate. They obviously price off the 10 year bond rate. So the 10 year bond rate at, you know, 4.29 4.3 has been reasonably sticky above that 4% mark. There was some excitement when it got under under four, you know, you know, more than 12 months ago now 18 months. But I think you know, to get true increases, it would be great for that 10 year bond rate to come down. The only other benefit, of course, is, of course, the cash rate with with gearing and debt, allows you to be accretive, especially when the markets have bottomed. So you know that that is an attractive feature if you add gearing onto your base, base return. Wouter Klijn 13:01 So we've seen a lot of volatility in recent years, and I think you've spoken in the past about the importance of cell evidence stabilising to get a better sense of where the sector is. Is that happening? Are we getting to a more stable environment? Mary Power 13:19 Your short answer is yes, the MSCI Mercer unlisted survey for property is indicating that this is a third quarter of positive returns. So that's fantastic. So yes, we are. I think there's pockets, there's sub markets. Now it's not everything. Not everything is on the, on the on the rise, and I think our one call out at this moment would be the Melbourne office market at this stage, again, back to covid, longer to come out. You know, had severe lockdowns, longer time returning to work. And there has been some punitive tax, taxes that have been introduced into Victoria around the foreign owners surcharge, and that has deterred offshore investors from coming into into Victoria. So we've seen lot less sales in Victoria than anywhere else. So the sales evidence allows the valuers to actually have some some sort of basis for undertaking evaluations. Melbourne is still a little bit difficult. Yeah. Wouter Klijn 14:21 So those numbers that we mentioned earlier about this that they're not unless Should we take them with a grain of salt then in the unlisted space, or have there been enough transactions that we can get a good sense of what happened there? Mary Power 14:34 I think we're in a reasonable place with with where we're at with valuations now and going forward, and the other the real green shoots for property are the fact that there's a lack of supply. So what kills property supply in a recession like the early 90s? Now, we haven't, we're not. Hopefully we're not gonna have a recession. And supply is is very muted. Is muted? Yeah. Yeah. So that's really positive, and so is the sustainability the tenants are requiring that. That's very important. So not every building is the same. So the universe of, you know, desirable buildings has actually shrunk on the basis of sustainability. And that, again, you want to be in those buildings. That's a good thing, yeah. Wouter Klijn 15:21 So you mentioned that the Melbourne office market, and it seems that there's more and more companies that sort of either referring the working from home or reducing the number of days that you can do that is that supporting the office market. Are we seeing some more positive numbers coming out there? Mary Power 15:40 Yes, yes. I believe so yes. And I think, you know, again, with this lack of supply, people are actually got their forward projections a bit wrong. You know, I was over in the UK, there was a big investment house over there that had been in Canary Wharf was coming back to London, and they miscalculated by some enormous amount of seating, whether it was 3000 seats or something. And instead of being able to go into one location back in the city, they actually had to spread it out across a number. So people aren't necessarily getting the getting the forward looking Labour Employment seating arrangements, right? So it's putting more pressure on, on building, on certain buildings, within certain sub locations, yeah, so that's a positive thing, because it'll drive rents. It will drive rents, and that will drive returns. Wouter Klijn 16:32 Yeah, yeah, yeah, that's interesting. So we talked a little bit about, you know, the unlisted and the listed space, but some of the recent developments we've seen as well, that fund has started sort of blending both listed and unlisted exposures. And partly that seems to be, you know, where they have the relationship and the expertise, they tend to go direct, but then in other markets where they might be less familiar with or don't have the relationships, they might have more listed holdings. What is your opinion on that sort of blended approach, and how do you implement it? Mary Power 17:07 Well, well, it often circles around two things. One, liquidity, they need some level of liquidity. And the second is that there has been a pushover a few years now for where funds have had an unlisted exposure that may have some gaps in it, and they call it a completion portfolio. They may complete the overall exposure on the exposure side with supplementing with some listed so let's say they're underweight industrial they may have gone across the globe and bought industrial stocks and use that as their proxy to build up that that exposure. I think that can work. It depends on your time frame. And back to your earlier question about, you know, is property is, is listed rates more like property on a longer term basis? Yes? I think the answer is yes. And I think if, but then you've got to marry that up with a fund's ability to absorb the risk of volatility in, you know, periods of stress, like we saw in covid. So it really comes down to the perception of risk and return and that level of bullet tolerance to volatility. Wouter Klijn 18:17 What does it mean for the liquidity profile? Is that harder to manage, because, obviously listed space is much more liquid. How do you manage that? Mary Power 18:24 Well, that is a very topical question at the moment, because there are, you know, funds that are looking to change their liquidity mechanisms, rather than one long Cliff event, they're looking for quarterly liquidity, or allowing investors potentially quarterly liquidity with a cap, not just, you know, they can get at any stage. I think it's very hard to promise liquidity ongoing quarterly with large assets in a portfolio, because I don't know practically how that works. I think people that need liquidity should almost be sticking with REITs. Yeah, the only other areas that I've seen is where they've actually buttressed some debt exposure alongside the unlisted that allows some runoff characteristics as as loans are realised, and that will give some some level of liquidity going forward. Wouter Klijn 19:18 Another development that we've been looking at is, is there starting to become an overlap between infrastructure and real estate assets? And for examples, we've seen situations where there's empty land on at airports or at ports, and perhaps that can be developed for property purposes. What do you see there? Mary Power 19:45 Yeah, definitely, definitely. I think going forward, there will be a blurring between property and infrastructure, and I think it will be possibly, sort of viewed through the lens of the cash flow. Because I think one of the things that. Uh, even this last period of the last five years has demonstrated is that, you know, the cash flow needs to be able to withstand things like capital expenditure, and that's a dint to the cash flow. So if you look at infrastructure, mainly it's contracts, and they're pretty stable, and you can actually increase the gearing quite substantially. Property you need to be able to allow for these capex requirements, whether it's incentives or actual expenditure on the on the building. So I think where you start to get some purity in the cash flow, like you do almost with infrastructure, that'll be very interesting area of interest Wouter Klijn 20:39 in the past, infrastructure property either set in separate asset classes or were an alternative asset class. But we see these days more the rise of sort of mid risk in these assets being labelled as mid risk. Is that sort of an indication of that trend that I coming closer together? Mary Power 20:57 Yeah, I think that's that's really important, because I think what's happening is that, you know, illiquid assets now, particularly in property infrastructure, almost need to compete for a place in the portfolio on a whole of portfolio perspective. So if you've got an infrastructure investment and a property investment, you need to look at those on a risk and return basis. So, you know, I think that blurring and that competition between the two asset classes will continue going forward. Wouter Klijn 21:27 Might it also be heightened the competition for these assets by if we get to a stage where there's more and more people retiring looking for income streams, portfolios probably being more geared towards income streams. Do you think that that will contribute to the competition for assets? Mary Power 21:43 Yes, definitely, definitely, and that stability of income. Wouter Klijn 21:47 So maybe we don't need annuity products, just more property assets? Mary Power 21:51 Yeah. And some of the annuity providers had had the basis of the annuity has been, has been property assets, yeah, at all a part of it, anyway. So yes, I think that's, that's, that's quite possible. Wouter Klijn 22:04 Yeah, very true. So if we look at the environment again today, what are you finding? Where do you find more interesting opportunities? What sectors look attractive at the moment? Mary Power 22:16 So yes, we have been looking across the globe at all various sectors. And I was going to say, 18 months ago, we went to Europe. We were very excited in Europe. In 23 mid 23 Australia had had fallen by minus 1.6 the UK was down minus 17, and the US was down minus 10. So I thought this looks very interesting in the UK. Not always. The UK is not always interesting, but it was certainly interesting at that time. And we identified an opportunity. Was an opportunistic opportunity, where they where we invested, where our clients invested, on a, on a, on a multitude of different sectors. But the attractive feature was the discount and the ability for interest rates to fall over time, which was, which was pretty, which was pretty compelling on both fronts, and it's going to be a great vintage for investment over that period. Yeah, yeah. Closer to home, we've looked at and in, and funds have invested in convenience retail, which is a smaller retail, and the attraction of that is its necessity. You've got to buy there, you know, you need to get your usual everyday goods there as a as opposed to expenditure, you know, experience based retail. And I think that that's going to be very solid performer, particularly in a falling interest rate environment. So that's that's been very attractive. We also like the idea of the of the being smaller assets. You know, more assets, smaller assets. You know, big assets can have big problems from time to time. So smaller assets can be quite attractive. And we found that to be quite, quite a good way. You know, area to be looking in. Wouter Klijn 23:59 Yeah, last year there seemed to be a lot of, I call it hype around, sort of the bill to rent in the US, but in Australia, it seems to be still a relatively immature market. Is that starting to change, or are we still at the beginning of it? Mary Power 24:15 Look, I think we're still at the beginning. I mean, I was at Ann Rove and spoke at a on a panel last about last week. And I sort of had to remind myself and sort of others that, you know, we've had sort of five years taken out of the investment timeline over the last five years. So I think we've got to remember where we've been, to think about where we're going. And I think, you know, the US has got a 30 or more than probably 40 year history in multi family. The UK is probably 1015, years into it, and Australia is very immature at this stage. And I think there's a few reasons. I think we've had this period of disruption of five years or more. We've. Had, you know, such negative returns that people aren't allocating. And I think that building costs have escalated so much as well, and development sites have gone down as well in price. So I think, you know, there's a whole lot of things, but I would think if you look forward over years, it will start to mature. I mean, it has to mature. You know, the housing Australia Future Fund is very prominent. We've looked at half deals which are an interesting structure, they're more they're a debt structure, so a blurring of two asset classes, property and debt. So I think that over time, it will mature, and it's certainly a big government push for it to mature? Wouter Klijn 25:41 Yeah. So we talked about a number of opportunities in the different sectors, and I think if you look at property versus sort of other asset classes like equity or bonds, it tends to be a little bit more transactional focused. How do you look at opportunities in terms of a portfolio, and the construction of the portfolio. Do you just have to wait for certain deals to come up? Or do you really think, okay, we can't this might be an interesting deal, but from a portfolio perspective, it doesn't make sense to add this at this stage. How do you deal with sort of those tensions? Mary Power 26:17 Well, the usually the first question that's asked is, what's the deployment capability over five years? So if you've got a lot of deployment if you've got a lot of deployment capacity, that's a great thing, because you can actually plot out where you want to be over time. If you haven't got any deployment capability, you're actually waiting on redemptions to come back. That's a that's a very hard it's a much harder game because you gotta wait. Gotta make sure the timing is right. You know, there's not a there's not a defined, actually a defined date that you know you're going to get your money back. So matching deals and and flows is is very difficult. So if you've got big deployment capabilities, I think we've been very keen to be students of the rate markets and the debt markets, to look where where things are moving to. And in fact, we've done a lot of work in the US. Where we've gone into, went to single family housing, medical office, senior housing, storage. So we've gone into a lot of areas where the rates were lead indicators for those, for those sectors. So the emergence of the alternate sectors, which is what they're called, really has has been expressed through the rates, which has been interesting. Wouter Klijn 27:32 And how do you look at the tension between sort of large funds and smaller funds, in terms of this, this portfolio construction question, because sometimes it seems that small funds have less ability to take on a lot of illiquidity. Is that true? Or how do you look at that question? Mary Power 27:47 Well, I think you've really got to start. I like to start at the basics. What's the investment objective for the fund, what's their tolerance for volatility, and then how many, how much equities and bonds do they have in the portfolio, and then how much illiquid assets do they have? Do you know, if they're running in liquid exposure of 40% that's very high, and that could be across property, infrastructure, private credit and private equity. So you need to sort of start with the basics of each fund and how they're the composition is at the at the time, look at their investment objective. If they've got a CPI plus two, it's very different to a CPI plus seven. Yep. You know expectation. So, so you need to be able to construct your portfolio based on what their expectations are for risk and return. Wouter Klijn 28:33 And another trend we've seen recently is there's a lot of talk about total portfolio approach, or the joint up investing, and sort of the conversations I had around that is one sort of hurdle that I need to overcome is to speak the same language around investments, and that can be quite different, whether you talk about property or you talk about equities or fixed income. How do you see that conversation taking place with sort of China's clients? Is it hard to make the translation exercise? Mary Power 29:03 I don't think we've had a problem with that. I mean, you know, we look at discount rates across infrastructure and property, you know, forward looking PES in private equity. So I don't think that we've had much of a problem with the language going forward. So I think we understand, you know, discount rates, cap rates, growth rates, I mean, yeah, discount rates, cagers, leverage all really important parts of, you know, of the investment subset across every, every asset class, really? Wouter Klijn 29:41 Yeah, yeah, for sure, if we sort of look a little bit ahead, how do you think that the blend between sort of super funds, exposure to Australian property and international property will develop over time? Are we seeing less investment in Australian and more in international like we see? Probably more money shifting into international equities, or what is sort of your view there? Mary Power 30:06 Well, I think the I think it is inevitable money will go offshore, and it has the bigger fund, the big, big funds with lots of deployment capacity are likely to take up exposures in areas that they can't get here in domestically. So that's some of the areas that I spoke about earlier, single family housing, medical office. So so those that have developed up and have a, you know, some level of track record investment, you know, you know, the markets are quite deep, so I think money will definitely go offshore. What percentage of a total property allocation would go off? I'd say up to 50% could okay. It could be anywhere between 30 and 50 Yeah. Wouter Klijn 30:51 And do you expect to see a shift as well in the mix between unlisted and listed? Or is that more up to the individual fund? Mary Power 30:59 It's very much an individual fund, fund basis, very much an individual fund. Again, you know, perhaps if there's a reason they need liquidity for within the portfolio, they might elect to have an allocation to rates. Wouter Klijn 31:14 Yeah, yeah, for sure. Well, Mary, thank you very much for participating in this podcast. It was great to have you on the show. Mary Power 31:20 Oh, thank you very much for having me. Thank you.

In this episode of the [i3] Podcast, I'm speaking with Richard Brown, who is a Client Portfolio Manager with Janus Henderson Investors. And today we are going to talk about global small caps. We look at whether small caps are affected by the increasing concentration of the equity markets, particularly in the US, where technology stocks have dominated returns in recent years. We talk about catalysts for unlocking the current small cap discount versus large caps, including the rate environment and the current business cycle. And we take a look at a few case studies of where to invest and where not, involving fuzzy pandas, Italian industrial stocks and JB Hi Fi. This episode was sponsored by Janus Henderson Investors, and as such, the sponsor can make suggestions for topics, but the final control remains with the Investment Innovation Institute. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights ________ Overview of Podcast with Richard Brown, Client Portfolio Manager, Janus Henderson Investors 02:00 The appeal of small caps and the case for egg producers 08:00 Does the concentration in equity markets and the increasing value of the Magnificent Seven require you to adjust valuation models for small caps? 09:30 The small cap discount to large caps has reached quite an extreme by historical standards 11:30 More clarity on the direction of rates would help small caps 13:30 There is an opinion that if rates stay higher for longer, then that would be bad for small caps. That is something we fundamentally disagree with. 14:00 The consensus view that small caps have underperformed as rates have gone up, that just hasn't been true versus history 18:00 About 30 per cent of small cap companies in the US has had a negative EPS over the last two calendar years 20:00 The two catalysts for small caps: clarity on rates environment and confidence in business cycle 23:00 Are the future small caps all about AI? 26:00 Examples of AI small caps; filling in doctor's insurance papers 36:00 Healthcare, REITs and the dangers of playing the sector game 41:00 Examples of what not to invest in: the case of an Italian industrial company 43:00 Fuzzy panda, short-selling and meme stocks 45:00 Is there a small cap premium in the Australian market? Maybe, but JB Hifi has been one of our strongest performers Full Transcription of Episode 119 Wouter Klijn 00:00 In this episode of the [i3] Podcast, I'm speaking with Richard Brown, who is a Client Portfolio Manager with Janus Henderson Investors. And today we are going to talk about global small caps. We look at whether small caps are affected by the increasing concentration of the equity markets, particularly in the US, where technology stocks have dominated returns in recent years. We talk about catalysts for unlocking the current small cap discount versus large caps, including the rate environment and the current business cycle. And we take a look at a few case studies of where to invest and where not, involving fuzzy pandas, Italian industrial stocks and JB Hi Fi. This episode was sponsored by Janus Henderson Investors, and as such, the sponsor can make suggestions for topics, but the final control remains with the Investment Innovation Institute. Richard, welcome to the podcast. Richard Brown 02:10 Hi Wouter. Thank you. Delighted to be here. Wouter Klijn 02:14 So why small caps? How did you get involved in this particular area of investment? Richard Brown 02:18 Look, I think small cap is one of the most interesting areas you can be involved in, in capital markets, in truth, huge inefficiencies available for active stock pickers. You know that can certainly peak at peak interest. But you also end up looking at some very bizarre and unusual areas of the market. You know, egg producers, other companies working in particularly niche areas of the market. And you know that that that sort of area of small cap has always sort of piqued my interest and draw me to this area within within investment. So, yeah, I've been working with in the equity market since 2010 and really for the vast majority of that time, it's been with a focus on the small cap area. Wouter Klijn 03:00 So is there a current investment egg produces? Richard Brown 03:04 Well, actually, after a long standing investment there, we've actually had to just take profit after we saw some very strong returns driven by a strong pricing environment that states on the back of an outbreak of bird flu over there. But so I was quite sad to leave that investment, but it was a good one to us. So that's a good reason to be selling a stock. Wouter Klijn 03:24 Yeah, it would be interesting doing due diligence on a company like that, but maybe we can bring it a little bit to a higher level the current environment for small caps. I mean, I think markets are in a very interesting stage at the moment anyway, because we've seen a huge concentration in the US markets. We have it a little bit here in Australia, with a lot of money going into one particular bank, CBA, that seems to crowd out a lot of stocks. How do you look at the current environment for small caps in sort of in that environment where you have this domination of the Magnificent Seven. You got other stocks in, you know, Taiwan with TSMC. Do they still have a chance? Richard Brown 04:07 Yeah, I think so. And you know, undoubtedly, this is a question that comes up time and time again recently, because the vast majority of asset allocators attention are towards the mag seven. And look, that's hardly surprising, as it gets given this huge AI innovation wave that we're really only just beginning to understand. But for me, what's quite interesting is, you know, a lot of people preface that discussion by saying, well, small caps have underperformed large caps, and I think it's quite important to pick that apart, because what we focus on is really the operational performance of small caps, and that's what attracts us to this area, because it's been very strong and high growth for a long period of time. And actually, if you look at this period of so called underperformance versus large caps, actually that operational performance has been fine. It's been very solid. It's been roughly on the same trend as what we've seen over the last sort of 50 or 60 years. Yes. So it's really a case of those returns in large cap being super normal. And for me, you know that that's certainly something that I find quite reassuring as a small cap investor, that if we just continue plotting this sort of steady course, this AI innovation wave is going to, is is going to is going to chug along there in the background. But you know, small caps can still play their part, and indeed still are for asset allocators in their portfolio. Yeah. Wouter Klijn 05:29 So we've seen strong returns in equity markets in recent years, and I think it hasn't happened too much in history that the s, p5, 100 at three consecutive years of double digit returns and four years is even rarer. But what do you think this environment does to the valuation of small caps? Does it? Did you need to adjust how you evaluate small cap models in this current climate? Richard Brown 05:55 No, we are quite dogmatic in our approach in truth. So our valuation models are totally unchanged. And really what we do is we focus on looking for high return businesses that have positive incremental returns that are not yet reflected in their underlying valuation. And we would do that at the crop of markets, and we would do that even when markets maybe appear to be overheating. So indeed, that hasn't really changed the way that we're valuing stocks at this moment in time. And you know, when we take a step back and say what the valuations look like for the asset class as a whole, like you say, it's been a it's been a period where a number of other asset classes have been making new all time highs and potentially reaching bubble territory in certain areas of the market. So small cap, we're on roughly our long run average, if you're just looking at forward forward PE and that's true of most regional markets as well as global small cap markets as a whole. So what that has ultimately meant is that the small count, small cap, sorry, discount versus the large cap area, the market has reached really quite bizarre, extreme by historical standards. And you know, the real catalyst for that came through the aggressive rate cycle that we saw through 2122 if you look back prior to that. And again, this applies to most regional small cap markets across the world. Small caps were trading on a premium versus large cap, because that strong, operational, higher level of earnings growth that small caps tend to achieve was 10 tended to be rewarded with it with a higher valuation. Yeah, as we stand here at this point in time, we've had that aggressive rate cycle come through now, now a massive discount applied to the small cap space. So I think is a good time to be looking at it. Wouter Klijn 07:39 So is there any sort of market event or as a catalyst that might unlock the discount and bring it more in line with historical averages? I mean, you were talking a little bit. Maybe we're getting to bubble territory in large gaps. Do we have to wait for sort of a correction in those stocks? Or could there be something else that would bring the discount closer to historical averages? Richard Brown 08:03 Yeah, it's a great question, and in truth one that we've sort of been scratching our heads about a little bit already over the course of the last 12 or 18 months, as we would have expected that valuation discount to already been narrowing, but we haven't really seen that at all yet. For us, it's really going to come down to two main catalysts, I think, to see asset allocators really move back into this space. And the first is clarity over the direction of rates. And that's something I think is worth digging into in a little bit more detail, actually, and it's and its impact on the small cap market. And of course, when you look at rate forecasts at the moment, I mean, they're changing almost daily with the latest unemployment numbers or CPI pruned out of the US, or indeed, whatever next press statement we get out of the White House with regards to the lineup of the Fed, but I think more clarity on the direction of rates is one which is going to act like a trigger, as well as more confidence in the economic cycle overall. You know, small caps are more cyclical in nature versus their large cap years. So we do need to see more confidence that GDP growth is going to be be solid or strong into the future. And I think that's going to catalyse that return to the asset class and narrowing of that valuation. Wouter Klijn 09:12 And what is your sense about the rate environment? Because we saw here in Australia a situation where the RBA, the Reserve Bank, the central bank here has just cut rates, but the decision before that, they left it neutral, and they got a lot of commentary around not cutting in that meeting and leaving it to the latter one. But then, more recently, we've seen inflation figures coming out that are well surprised on the upside, and were far higher. From memory, it jumped from 1.9 to 2.8 and I think we've seen in the US similar sort of worries about the inflation rate there with the US tariffs. It does change this day to day, but do you have a sense of where it might go? And of course, also then the impact on. Small companies who, as you said, you know, they tend to suffer a little bit when rates go up. Richard Brown 10:04 Yeah, yeah, absolutely. And, you know, as you've outlined there, I think it's rarely been as complicated as and on a knife edge with each of these announcements, it's actually quite nice seeing my bond colleagues actually having to do some work for once, having sort of just sat around for two decades, having a very boring period for them in their markets. Look, if you were to push me out, the view of our team is that the direction of rates is still down. We don't think that we're going back to zero. And a lot of people's conclusion from that is in a higher for longer rate environment, that will not be good for small caps, and that is something that we fundamentally disagree with. And the reason for that is we think that there's a few lessons here from history. So if you look back at the last time rates stayed at the these higher levels, well, the most recent period was back in the mid 2000s a fantastic time for small versus large. And then if you go back even further, even before I was born in the early 1970s when rates were sustainably much higher for much longer fed Fed funds rate peaking at 19% through the late 1970s and into the early 1980s again, really strong time for small versus large. So I think the sort of current consensus view is small caps have underperformed as rates have gone up. That just hasn't been true versus history. Now, what could be the reasons for this? For us, it very much boils down to the funding on the balance sheets of these small cap stocks. A lot of them have far greater levels of floating variable rate debt rather than fixed rate debt, so and shorter duration. So what you tended to see there is the small caps were feeling this funding pinch much sooner than their large cap peers, and that's why they've underperformed on the way up. It also means that actually, if we see that reversal and rates begin to come down a bit, they'll feel that that funding benefit a lot sooner. What actually matters if rates just stay higher for longer, isn't whether you've got fixed or variable, floating rate debt. It's actually your your debt pile overall and there. And this is, I think, a common misconception, again, driven by a lot of the exaggerated statistics coming out of the Magnificent Seven market, which is a huge net cash area of the of the large cap sphere, small caps actually have less leverage than large caps overall. So in a buyer for longer rate environment, small caps actually should be in a relatively good place to be able to handle that. The one caveat, obviously, is in a higher for longer rate environment, you you need pricing power, and that's something that we spend a lot of time trying to identify. And start by identifying those stocks with a high ROE or an improving high and an improving roe. And indeed, you've got to be careful in terms of the valuation you're paying, because the cost of capital, of course, matters again. So for us, those those two things are critical when we're selecting our stocks, but for the asset class as a whole. Think small caps are actually in a good place with regards to higher for longer. Wouter Klijn 13:05 Yeah, that access for capital is quite important for small caps. And it made me think as well, we've seen sort of conversations around companies staying private for longer, taking longer to go to a list on the on the market, particularly sort of during the low interest rate environment. Has that changed the small cap universe at all? Has that had an impact at the margin? Richard Brown 13:31 Is what I would say there. And undoubtedly, stocks are staying private for longer, VC funding in that space, particularly in the tech area of the market, that is a phenomenon that that has continued, and at the margin, that is a niggle and the frustration, because some of those stocks might present quite interesting stock opportunities for your diligent stock picker. What I would say is it, it matters even less for us, I think, and that is, a lot of those stocks are stocks. Probably we wouldn't be particularly attracted to we're looking for companies with a very long history of profitability, very consistent operational performance, and a lot of that funding and stocks staying private like I say, come from more the sort of unicorn type stocks that we see out of the tech area of the market, so probably stocks that would interest us a little bit less than and the other thing that I would say on the matter is, and you know, I've heard this narrative a few times. I've wondered if it's being pushed a lot more by VC or private equity rather than your your average listed small cap manager. But look, there's 4000 stocks in our investment universe. The fact that a few more aren't coming to that market isn't really meaningfully reducing the number of stocks that we can go out and find that look very interesting and priced in effectively. So no, I think you know, it's a niggle at the margin, but not something that particularly frustrates us. Wouter Klijn 14:58 So you mentioned the importance of profitability. Does that mean you avoid unprofitable companies? Or are there some selective opportunities? There? Richard Brown 15:07 No, that's right. So we do. We avoid unprofitable companies, which has become an increasing influence, especially with regards to our US allocations. Right now, at this moment in time, roughly 30% of US small cap. Yet, you heard that right? 33 0% of the US small cap market is it's got negative, negative EPS over the course of the last two calendar years. So that's quite concentrated in a couple of sectors, healthcare, biotech and tech. And there's many a good manager that will go into that area and pick the winners, those ones that are going to turn from negative earnings growth up to 100 baggers because they've put a sensational turnaround in or found a wonderful new drug. But that's just not something that we think our skill set is well aligned to. Is the truth. And if you look back through history, those companies with strong operating cash flows over the long term have tended to outperform the average stock with all cash generation. So for us, it's an area that we avoided, and continue to avoid now, in truth, that does present one risk to us and one risk to our strategy, and one that we're always keen to highlight to anyone that wants to invest with us. And that is, you know, if we do see rates going back to zero, this cohort stocks is probably one that's going to perform quite nicely, so we've got to be aware of that. It's something that we've got to watch in the market as it comes through. But over most market cycles, I think you're going to be paid to avoid that area of the market in general. Wouter Klijn 16:38 Yeah, fair enough. What about the merchant acquisition activity in the market? Obviously, that that has some potential to unlock value also takes companies out of the small cap space. What are your thoughts around that? Are we moving forward with it? Richard Brown 16:55 Yeah, this, this has been an area that's been, I think, relatively subdued in recent years, but there's still been a persistent tail. Tailwind for the area. You know, just by the simple arithmetic of small caps, there's many, many more buyers of the stocks I own versus, you know, no one's going to be able to buy in video of this world. So by that sort of, you know, just pure maths means that the small cap area of the market is going to continue to continue to benefit from this, but it's benefited less over the course of the last few years. You know, CEOs CFOs haven't been, or haven't had the confidence. You know, they've just seen their their funding go through the roof, so the first thing they think about isn't going out and making a new acquisition at that point in time. So again, it's linked to the, you know, the two catalysts I described earlier on for the small cap asset class as a whole. If, you know, we see a bit more clarity on rates, or indeed, rates coming down a little or more, you know, confidence on the cycle as a whole. I think you see that that boardroom confidence increase as well. And M A activity improved. And in truth, through, you know, we've been running this global small cap strategy for six years now, we've actually been a little bit surprised by how fewer stocks we've owned have been taken out. If you think about what we're looking for, we're looking for high return businesses trading on sensible or attractive valuations with decent balance sheets, and you think that would be a list of requirements quite high up on the agenda for private equity firms, other industrial buyers, etc. So my view there is that it's just one of those phenomenons that you struggle to explain, and elastic band will bounce back at some point over the course of the next few years. So yeah, we think that we're we think that that's on its way back, and we'd certainly be benefits of that in this space? Wouter Klijn 18:41 Yeah, yeah. Fair enough. Now, one topic that everybody seems to be talking about is artificial intelligence AI. And I was recently at an event where I was told that out of the venture capital deals today, 60% are taking place that include an element of AI, or are in the sector of AI. Is this an indication for what might happen in small cap space? Does it filter through as sort of, you know, are we going to just see this whole rest of AI companies coming through in small cap space? Richard Brown 19:12 Yeah, well, those that don't stay in private hands for too long for us to get our hands on them. I think that's right. But in truth, you know, I look at that, that VC funding cycle that you see there, and I actually use that more as a gauge of excitement levels within markets, or are we indeed reaching bubble levels. It doesn't quite feel like it yet, but you know that used to play out in terms of listed market valuations in the tech space, but now it largely plays out in terms of these funding rounds we see in Silicon Valley. For me, though, AI is more interesting for small cap, actually in a slightly different way. So first of all, there's the AI capex splurge that we're seeing now in data centres. And small cap are certainly participating that in that, not in the same way as a meta. Or Microsoft or or indeed, an Nvidia, but we own a number of stocks that are heating and ventilation providers, construction providers, fibre optics, all things that are going into these data centres, and they've seen a step change in their growth, and that looks very much set, set to continue. So that's kind of the first wave of AI influence on small cap and on our strategy. But the second wave, I think, is actually probably a little bit more interesting, and that is the integration of AI into a lot of these business models. And their small caps are of a size that they're able to be a little bit more nimble. They can be a little bit quicker to market in some things sometimes, and that, I think is going to drive a lot of operational efficiencies at these companies, but also revenue growth in a number of new areas. And maybe, if I were to just throw one stat around that, which I think is an interesting one, if you look at the US market today, the margins on us, small caps is around 6% if you compare that to us, large cap, it's mid to high teens, say, around the 16% mark. Now if you apply an AI efficiency gain of, say, 200 basis points, okay, bit of labour arbitrage there. In general, you're going to boost margins by 200 basis points. If you boost a 6% margin by 200 basis points, that equates to 33% earnings growth. If you apply the same to a 16% margin, you're seeing a far smaller impact on on on earnings overall. So the fact that small caps are very labour intensive, they are lower margin at this point in time puts them in a good place to benefit from the AI efficiencies that should come through over the course of the next few years. Wouter Klijn 21:45 Is there any indication of that already happening? Do you see companies where they have led to substantial productivity gains? And I'm asking that because there has been a recent MIT report where they looked into investment into AI, and it's sort of at a high level, concluded that 95% of investments are just not adding any value. And think like, wow, that's, that's a lot of wasted money, but it's, you know, what's, what's the picture in the small cap space? Yeah. Richard Brown 22:15 So what I would say is we get a clearer picture from driving revenue growth of new products at this point in time, you're asked to take a bit of a leap from the efficiency side. But looking at how I personally have started integrating copilot into my day to day, I think there are certainly, for me increasing use cases of efficiency gauge throughout my day. And you know, I think that's going to play out in a number of different ways for almost every company within the market, but to give you a few examples, maybe, of the sort of growth side of the equation where AI has been integrated, I think these can be quite interesting and quite informative. So we own a stock over in the US called Doximity, which is effectively the LinkedIn for doctors or physicians. And quite often, when I mention this stock on LinkedIn, I get a bit of a mixed response, because I think, yeah, it's bit like ma might either love it or hate it on LinkedIn, but it's proven incredibly popular over in the US with with physicians over there a lot, because a lot of these doctors work across a number of different hospitals, so it's nice to have all of their credentials just in one place, so a patient can look it up and and see what this doctor is particularly good at. And also, you know, as a doctor, you can sign up to particular news feed. So if you're an eye doctor, for example, you can, I don't know what an an eye doctor news feed looks like. Wouter Klijn 23:35 I think the feed has very small lettering. Richard Brown 23:40 Yes, but where's where AI is really interesting for these guys is that they've started selling to the doctor community in the US a AI bot that can effectively help manage their time. And it's in ways that at the moment, a lot of doctors are wasting their time with administrative duties. So the very obvious example is insurance forms in the US, if you're a doctor and you want to treat someone that is normally accompanied with a very complicated, long insurance form that they need to fill out. And as the CEO of the company puts worse, you know, AI isn't yet any good at writing a very interesting novel that you want to sit down and read, but it is absolutely fantastic at filling in insurance forms for for doctors. And you know, if you're a doctor, you certainly haven't become one to fill in forms. So they're delighted. Also means that they're able to see more patients each day. And you know, since they launched this product last year, you've actually seen a 20% jump in growth of that particular segment within their business over the course of last year. Maybe a slightly different example comes from, again, another US stock called oddity technology, and they are an online beauty company. So think of makeup and wellness products, and what they've done very successfully is built in a sort of person. Personalised shopper AI bot into their their offering, which, you know, we're beginning to see more and more from a number of consumer retailers online, but they've done it particularly well in that, you will go on, and I've, I've tested this. I'm not normally a buyer of these products, but I've gone on and tested this. And, you know, they ask, you know, when does your skin when do you get skin breakouts? When are you feeling particularly tired. You know, it's a bit of a an agony. On talking to you about all of the sort of aches and pains and woes your feeling with regards to your skincare, etc, and then they direct you to a very bespoke and specific product that is going to be going to be best suited for you. And again, the growth that you've seen from that company has been fantastic, even at a time where, actually, especially this year, this year, the US consumer, has been brought into question a few times and and also, you know, the broader beauty category has been been quite a tough one for a number of other operators. So it's a really good example, I think, of AI integration, but also the ability of, you know, if you, if you get the right stock, you can, you can still earn some really attractive returns back in broader sectoral or segment trends. Wouter Klijn 26:04 Yeah, I think the example of the shop bot, it sort of makes sense, because there's sort of a low risk to things going wrong, right? If it recommends the wrong product, then, oh well, you just return it. But the example that you gave about the doctors and filling in of the insurance forms that seems to be a little bit more higher risk, because you can't get that wrong. It needs to be very specific, and we all know that some of these language models hallucinate a little bit. You don't want to have that happen on an insurance contract. How do you sort of set safeguards around it? Or how does the company do that? Richard Brown 26:45 Yeah, and like you say, we've all got that funky reply out of chatgpt or copilot, or whichever one you've you've been deciding to use, and there probably will be, and undoubtedly will be, hiccups along the way on these things. It's where you've got to take a view on management and the quality of their implementation. And this is where we not only lean on our vast regional network of fund managers and analysts in the US, in Europe, in Asia, in Japan, visiting the Australian market to meet CEOs and CFOs all the time, and sit down and discuss topics like that with them, understand the due diligence that's been going on in the background, but also, you know, leaning into their track records and seeing, you know, like I say, we are not buying speculative stocks that are selling us a dream, but are sitting there, you know, Not, not making any money. We're we're we're wanting to invest in those companies that have already built our trust by delivering very strong and stable return profiles over the course of many years. So it's really a combination of all of those things, but I would say sitting across the table from a CEO or CFO is vital in getting those insights in terms of safeguards and the management of those risks, not just in AI, but across a plethora of different topics within the businesses. Wouter Klijn 28:09 Is there also any opportunities on sort of the energy supply side, because there's a lot of energy needed for AI, but they tend to be more larger utilities. Are there any sort of companies that maybe deliver special cables, or is there any opportunities in that space? Richard Brown 28:26 Yeah, so we've got some cabling and some energy infrastructure names. We've particularly added one in the early part of this year. Actually, that's more Germany facing because we're in the process of seeing a big fiscal splurge from Germany over the course of the next few years, and a lot of that will go into energy infrastructure networks, and that company certainly seems well placed with in that regard. But we also own another stock, again, based in Europe, that does the linings of LNG vessels. So basically, if you want to fill up a ship full of natural gas, you've got to make sure that you don't have any leaks, and there's quite a lot that goes into the technology to ensure that. And this company is effectively, although they don't admit it, got a 100% market share of that market worldwide. They say something like 90% I think just through fear of the regulator seeing that 100 number. And again, what have we seen there? We've seen a big boost in the LNG market on the back of Europe trying to wean itself off of Russian gas and having to source it from elsewhere. So there's there's elements of that within the energy market, and we're always keen to find those sort of idiosyncratic stock stories beyond just buying a commodity price. But I'd say for the small cap market overall, it's a relatively small portion of, small portion of our market, and a small portion of our strategy as well. Wouter Klijn 29:47 Yeah, yeah, that's interesting about the LNG company. I mean, maybe from a regulator point of view, that would be a problem. But what's the point of breaking up a small cap, right? It's already small cap. Richard Brown 29:56 So exactly, and, and, to be honest, if you're commissioning. A fuel commissioning a large boat for construction. Are you going to choose the lining specialist the first time they want to try this thing when it's going to cost you hundreds of millions of pounds to build this thing? Probably not, and your insurer probably wouldn't let you either. So no, they're they're in pretty good shape, those guys. Wouter Klijn 30:18 So if we look a little bit that sort of regional divisions. It seemed that in recent Well, probably last year, European and Japanese small caps seem to have done quite well. What's your sense of what's going on there? Why did they outperform? Richard Brown 30:35 Yeah, so we've seen, like you say, quite stark regional performance after a multi year period of US dominance. What has been the trigger for that? Well, in Europe, I mentioned earlier on the fact that Germany are turning the tax on with regards to fiscal expansion. And to be honest, when you look around at the developed world, Germany has been the dramatic outlier in terms of their their their budget over the course of the last few decades for long held cultural and cultural reasons there, but you know, under immense pressure, you're seeing Germany and Europe push through reform fiscal in Germany, but also a large degree of deregulation across the rest of the European bloc. And Europe has always traded on quite a significant discount versus other developed markets. So as soon as you reach that point, you only need a small piece of good news to see investors come back and start saying, well, actually, it's a very low valuation. If things do improve here, then there's some very attractive returns on offer. So you've seen investors come back to that region. We've seen many a full storm with regards to Europe, so they're certainly not out of the woods yet. But, you know, in terms of not letting a good crisis go to waste, we've heard a lot of good news out of the region in terms of, you know, trying to turn around what have been pretty anaemic growth there for many a year on the Japanese side, it's, you know, a slightly different story, and that, you know, you've seen that big governance change in governance structure drive there over the course of the last few years, but the sort of more recent Catalyst has been the fact that we're seeing wage growth come through, and that's making everyone quite excited about domestic consumption there. And that's normally when you see small caps perform quite nicely because of domestic their revenues are and at times, a little bit more consumer orientated than than their large cap peers. So you've kind of seen Japan sort of push through through the second quarter, and then actually, if we look over the last month, it's actually been the US market that's actually started to outperform again. Just as you know, you've seen slightly better economic data out of the US. You've seen trade negotiations largely Go, go in the right direction, and, and, and, and you see the US small cap market start to perform there. And really it's just as you list that sort of merry go round that we've seen this year as a sort of service, as a good reminder for for us in terms of how to manage this risk. And what we really try and do is is ignore all of that and. And and, what do I mean by that? I mean we run a region neutral portfolio. Okay, so 60% of our indexes in the US, you're always going to find 60% of our strategy in the US, about 17% in Europe. You'll find 17% of our strategy in Europe. And that's because you quite get, often get these swings in in in regional sentiment, it is not our edge to determine how sustainable they are. We think if we tried, we'd probably get it quite wrong. Actually, where we think that we're good is identifying these interesting small caps within each region. So let's not play that game. Let's have a region neutral portfolio and just just try and let the stock picking do the talking rather than any sort of top down view on on regions? Wouter Klijn 33:46 Yeah, yeah. And in terms of sectors, we talked a little bit about AI, but are there any particular sectors that look attractive at the moment, I sort of heard a lot of talk about healthcare, but at the same time, we've seen some large cap healthcare stocks that have done absolutely dismal. But what is sort of going on in that space? Richard Brown 34:08 Yeah, so healthcare has kind of split into a little bit in the small cap space. In terms of, there is a large portion of sort of biotech related names, however, for us on our team specifically, you know, coming back to and I'm sounding quite boring here, but that's probably good, because the sort of boring consistency of how we approach the market is kind of, I think, our edge actually, in our discipline there, we're looking for those names that have performed very consistently over a long period of time that is under appreciated by the market. So you know, as soon as you're running a sort of systematic model along those lines, large parts of the healthcare small cap space don't really screen particularly attractively to us, where much more is about, you know, the getting the next drug right, rather than, you know, assessing its its historic return profile for us in terms of what sectors look attractive. Well, again, we've large run largely as. Sector neutral portfolio, because we don't like to play this game all that much. But naturally, when you're a bottom up stock picker, you do find an aggregation of those stocks coming in particular areas. So we're overweight the industrials area at the moment. That includes many a sub industry, and there's some low beta stocks alongside the sort of high beta stocks that you would think synonymous with, with the industrial sphere. And then our only meaningful underway actually comes from the real estate sector, REITs, which is probably the biggest contradiction in our positioning right now, in that, you know, you push, pushed me earlier on, on, you know, do I think rates are going up or down in the next year? And you know, the broad consensus across the team is that we're probably more likely to see rate cuts than rate hikes. And with that in mind, you know, REITs have kind of been at the epicentre of underperforming as rates have gone up. They should benefit as rates are coming back down, but we've done a lot of work in that space, and very consistently when we put our most favourite stocks in that space up against the other stocks that we have in the strategy right now, they come out as a very distant second place. So for that reason, we've, we've continued to run with that underweight positioning, but they're really the two main sectors where we're taking a bet. Wouter Klijn 36:14 So Is that related that on the way to reach is that related to the discussion whether REITs are actually equities or property, which, you know, I've heard an answer to, but I'll let you answer it first. Richard Brown 36:25 Yeah. I mean, it's the classic, classic debate, isn't it? I mean, the truth is, I don't feel particularly strongly on in either direction. What really determines our investment universe is, is our index. We do that so that our clients have a very strong idea of the characteristics we should have dictated by the universe that is dictated to us by MSCI, and MSCI puts, puts, REITs into our listed space. So I'll sit on that side of the fence for now. But it's not, it's not an area that I feel particularly emotional about I think, etc, Wouter Klijn 37:03 Yeah, the answer I heard is that in the short term, it's it's equity, in a long term, it's property. But I don't know if that's true. Maybe I might put you on the spot here, but if you think about the investment process, can you give an example of a company that initially looked interesting but then didn't make it through the due diligence for for particular reasons? Richard Brown 37:28 Yeah, sure. And maybe, maybe just for the listeners, it's worth explaining that on on our strategy, we've we've got a proprietary screening model that is very systematic, and, you know, incorporates many of the features I've discussed already. Around are we paying an attractive valuation? But the second level is really these regional teams meeting CEOs and CFOs all the time. And in truth, their input is is invaluable, because there's only so much you can learn from historic report and accounts, and it comes in many different forms. But I guess one, well, a few recent examples, maybe so. An Italian industrial company was screaming value at the top of our screen. We think this looks very interesting from its return profile. It's trading far too cheaply. We then have our meeting with our regional team. We do the work on it. And what becomes very apparent very quickly is this, this, this company is very reliant on one very large client in the Middle East, in Saudi one, one big project that they've been involved with there. So the potential for re rating there, and the potential for that return profile continuing, you know, was heavily reliant on, just on huge concentration risk from a from a client point of view. So that's one that we decided to pass on and move on with that regard. Another, I think, interesting example, which is slightly different is that one of our stocks was subject to the short sellers report by a short seller called fuzzy Panda, which really tells you everything you need to know about capital markets. Today, the company was forced to post a riposte against fuzzy panda. This was an online educational company roughly this time last year, in fact, where, you know, if we were running it purely on a screening based model, without that regional team's input, probably would have sold it immediately, you know, given the uncertainty that that brought about. However, our team there had a long running history with the management there met with them very briefly after this short sellers report, went through every line item of the short sellers report and debunked all of the the challenges to the investment thesis they report back to to to us, and we retain the position, and it's been one of the strongest performers for us over the course of the last 12 or 18 months. So yeah, that qualitative input, that interaction with management, especially in the small cap space, is is truly invaluable to us. And the sort of hybrid of. Approach of a systematic screen with this qualitative input, something that we think is quite compelling. Wouter Klijn 40:07 Yeah, that name Fuzzy Panda reminded me a little bit of, like, you know, the names that you see on Reddit and platforms like that, and that made me think of meme stocks has that impacted the small cap space much? Because, I suppose with large cap, you don't quickly turn that into a meme, but small caps maybe a little bit more. Richard Brown 40:27 Yeah, again, I would say largely at the margin is the truth there and and again, you're going to get a sense of how boring we are. We just kind of carry on doing what we're doing and ignore anything that's going on like that, because normally, once something's remotely close to a meme stock, it's trading on a valuation that's probably about 50 times higher than where we would actually feel it's all comfortable. So yeah, you know, we've seen that, and you've seen that play out in terms of the financial press, but in terms of our day to day, we just kind of plod along and ignore that and carry on with our nitty Wouter Klijn 41:00 Fair enough, well, and as an asset owner, once told me, I want my invested managers to be very boring and that I can do the same thing over and over again and do it well. So that's not a negative in that sense. Richard Brown 41:11 Well, in an industry where very little is guaranteed, I can guarantee the boring, dull discipline that we will pin for the small cap market. So that interests you, please. Yeah, get in context. Wouter Klijn 41:23 So while I if you here as a small cap specialist, I thought I asked you to finish up a couple of questions about the Australian market as well, because the small cap factor is pretty much well documented in academic literature, very many successful funds, but it seems to be absent from the Australian market. There seems to be no small cap premium here. What do you think is going on there? Yeah. Richard Brown 41:48 Well, you know, if I, if I look at the MSCI indices, and we quite often do on on, on a regional basis, actually, I would say that the Australian market hasn't followed all that dissimilar path to what we've seen elsewhere. You know, pre 2020 there was a small, small, small cap premium from a from a valuation point of view, but that's, that's that's largely evaporated since 2020 and I think especially so in the Australian market. I'm not sure if I can offer too many conclusions there as to exactly what's driving that, but all I would say to listeners, is it's a market where we've quite very consistently found names that we find quite attractive. It's not an area we've been overweight like I say. We tend to operate on a largely region neutral basis, but it's one where we haven't struggled to fill our Australian portion in a number of sort of recycling through a number of the banks that we've seen there, some of the metals and materials names, but a coffee manufacturer, but also, you know, the great Australian institution that is JB Hi Fi, has been one of the strongest performers for us over the course of the last few years. No, I don't place the Aussie market in an outlier in that regard, and like I say, is one that's that's been quite good to us, so hopefully that continues. Wouter Klijn 43:03 Excellent, excellent. Well, Richard, thank you very much for your time. It was great talking to you. 43:08 Thank you very much. Take care.

In this episode, I'm speaking with Dr Alan Dupont, who is the founder and CEO of Cognoscenti Group. Alan is a highly respected geopolitical strategist and has advised a wide range of governmental and commercial organisations, including the Northern Territory Government, Asia Society, the Australian Strategic Policy Institute and Outcomes Australia. He has advised several Australian ministers of defence and foreign affairs, and in 2013 established and led the Abbott government's defence white paper team. Alan started his career in government, including as an Army officer, intelligence analyst and diplomat. In this episode, we take a look at the geopolitical turmoil around the world and its impact on economies and investment markets. We discuss the disintegration of Pax Americana, where the US had the balance of power since the Second World War. And we look at the redistribution of power around the world, including the potential of non-state actors to play a role. We examine US President Trump's use of tariffs and the dollar as financial weapons, and ask the question whether the performance of The Magnificent Seven is related to the tech war between the US, China and Russia. __________ Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights __________ Overview of Podcast with Dr. Alan Dupont 04:00 Early interest in geopolitics and working with Michael Hinze at CQS 06:00 We are slap bang in the middle of moving from Pax Americana to another system, which is yet to emerge. 08:30 Kondratiev Cycles and why they are important 10:00 Are we moving into the national security era, where security takes primacy over trade and commerce? 13:00 I don't think we are on the eve of a new world war. Putin is constrained in what he can do. 17:00 The scope of a fruitful relationship with China is limited by the very nature of its system 20:00 If Australia has to choose between the US or China, then we will get a polarised, deglobalised world and we will have to forfeit a lot of economic benefits from globalisation, which are considerable 21:30 There is a technological and financial war going on 23:00 Trump decided to weaponise the dollar for geopolitical reasons 24:30 Geoeconomics: the use of economic and financial power for geopolitical objectives 28:00 Alan, you called the Iran tensions a few days before the rocket launches happened. What gave you this insight? 32:30 China has its nose in most of the key technologies of the future world. But they are not ahead in the most important one: AI 39:30 Is the technology war part of the reason why the Magnificent Seven have performed so strongly in recent years? Full Transcription of Episode 117 Wouter Klijn 00:00 Hello and welcome to the i3 podcast: 'Conversations with Institutional Investors'. My name is Wouter Klijn, and I'm the Editorial Director for the Investment Innovation Institute. For more information about our educational forums for institutional investors, please visit our website at www.i3-invest.com. That's the letter i and the number three at invest.com. There, you can also subscribe to our complimentary newsletter. I3 insights in which we discuss investment strategy and asset allocation questions with asset owners from around the world. Now, as you all know, we love our disclaimers in this industry, so here's ours. This recording is for educational purposes only. It does not constitute financial advice and is intended for institutional and wholesale investors only. Please enjoy the show In this episode, I'm speaking with Dr Alan Dupont, who is the founder and CEO of Cognoscenti Group. Alan is a highly respected geopolitical strategist and has advised a wide range of governmental and commercial organisations, including the Northern Territory Government, Asia Society, the Australian Strategic Policy Institute and Outcomes Australia. He has advised several Australian ministers of defence and foreign affairs, and in 2013 established and led the Abbott government's defence white paper team. Alan started his career in government, including as an Army officer, intelligence analyst and diplomat. In this episode, we take a look at the geopolitical turmoil around the world and its impact on economies and investment markets. We discuss the disintegration of Pax Americana, where the US had the balance of power since the Second World War. And we look at the redistribution of power around the world, including the potential of non state actors to play a role. We examine US President Trump's use of tariffs and the dollar as financial weapons, and ask the question whether the performance of The Magnificent Seven is related to the tech war between the US, China and Russia. Let's get started. Alan, welcome to the show. Alan Dupont 02:36 Thanks very much. Wouter, pleasure to be here. Wouter Klijn 02:40 So I had a little bit of a look at your background, and you have quite a varied background, including starting as an Army officer and intelligence analyst. Is that sort of where your focus on geopolitics today come from? Or is it more related to sort of your study? I think you studied international relations. How does one become a geopolitical strategist? Alan Dupont 03:06 Well, good question, and actually started probably earlier than you think. I always was interested in global affairs when I was even a student at secondary school, and that flowed through into my time as an intelligence analyst, which really whetted my appetite for international affairs, because I was the Vietnam desk officer, and, you know, I was briefing ministers and involved in high level geopolitics from a very early age. And so I re credentialed myself after I got out of the army, I went back to university and decided this is what I wanted to do for the rest of my life. Then the question was, well, how would I be able to do that and earn a sufficient money to keep in the lifestyle that I wanted? Right? So anyway, it all worked out okay, eventually, with a few detours on the way. Yeah, fair enough. So you have a wide range of advisory roles, also to government. But one thing that stood out for me as well is that you are involved with a hedge fund. Michael Heng says, CQ, s, so there's a bit of an investment angle there. What's What's your role with the hedge fund? Yes, well, the the context is that later in life, I was appointed to the chair at Sydney University, and the chair was funded by Michael hinsey. And when I first met him, I said, Michael, do you understand that this is this is actually national security, not financial security? And he smiled as Yes, as I fully understand that. So that began a sort of a long association with Michael, and then one thing led to another, and he invited me to come on to his advisory group to give a geopolitical dimension to his investment decisions, which was quite path breaking at the time. So I agreed to do that, and I served on that advisory group for nearly 10 years. Learned a lot about investment head. Funds, what they do, and I hopefully they learn something about geopolitics. So that was how it all happened. Wouter Klijn 05:07 I think CQ s is global macro, isn't it? So it's more of a more in common with geopolitics than than, say, other types of in strategies. Alan Dupont 05:15 Well, well, Michael would tell you there, there's sort of, it's sort of a multi asset investment platform where geopolitics has taken into the decision making in a way that most other hedge funds don't. But, you know, really, I really think it's on the edges, because it's very hard to find a geopolitical trade, per se. You have to be aware of what's going on the world, but what's the trade? You know, it's quite difficult, so it took us a while to work that one out. But no, no, he's been quite sort of bit of a thought leader in the sense that he has brought the two dimensions together to the benefit of both. You know, so, and I think more and more investment companies platforms are starting to factor in geopolitics now for pretty obvious reasons. Wouter Klijn 06:03 Yeah, we've seen a lot of developments in that space. And you and I have spoken a little bit over the year about this concept of the end of Pax Americana, the great American Peace, and that there will be a redistribution of powers and potentially multiple power centres coming up, even maybe non state actors. Where are we in that shift away from Pax Americana? Alan Dupont 06:30 So where? Where we are at the moment is right, slap bang middle in the most disruptive part of this process of moving from one system to another one, which is clearly yet to emerge. So if you look at this historically, there are these great wave cycles that macro cycles that shape history. And every 80 to 100 years or so, the existing system starts to break down, and you get a lot of turbulence and unpredictability, just as we're experiencing now. And the bad news is it often lasts for 10 and 20 years before the new system emerges. So Max taxi, Americana, the American Peace is a system that was set up by the victors of World War Two in 1945 all our institutions and our norms were shaped by essentially United States and the West, and now that's under threat from authoritarian challenges and and even under threat from the US president himself, Donald Trump. I mean, in a way, he's trashing the legacy of his predecessors all the way back to 1945 and he's the guy who's really shaking up taxi Americana and saying, we're not going to be global cop anymore. We're not going to carry the burden for everyone else. We're going to look after ourselves, America first, and the rest of the world has to stand up and do what we've been doing. And you can understand why he's doing that, but that's that's another reason why Pax Americana is fragmenting. But will we see a Pax Sinica that is a, you know, a Chinese led world order? Possibly, a lot of people think so. I've got my doubts about that, but that's where we're at the moment. Wouter Klijn 08:14 So these big cycles in history, I think, that are called comrades cycles. Can you explain a little bit about how they work and why they're important? Alan Dupont 08:23 Sure. So there are two theories about the way the world works. One was articulated by a Russian economist named condratia, and the other by his geopolitical equivalent, who said, Well, the same thing is going on the geopolitical space. And when you marry up the two waves, if you like the the ups and the downs, they do tend to coincide. And I think the singular insight by both of them into the way in which the world works is that, like everything in life, things rise and fall. And it's no surprise that governments, empires, principalities, kingdoms, also rise and fall, as we know now in the distant past, empires like Rome rose slowly and they declined slowly over hundreds of years, whereas in the you know, the sort of Uber accelerated world in which we live, things happen much more quickly. So the theory is that every 60 to 80 to 100 years, the old system exhausts itself. And economically speaking, what happens is, you see, if you think, after the Second World War, the economy, global economy, boomed, tremendous advances economically, then it sort of platted out and lost a bit of steam, and globalisation, which was its handmaiden, started to come under under stress. And now people are saying, well, globalisation is dead or certainly not as prominent as it was before. And now we're into the national security era, where national security starting. To take primacy over a trade and commerce, and we can see that playing out everywhere, including with Prime Minister Albanese visit to China this week, where he's caught between a rock and a hard place. On the one hand, he wants more trade with China, but on the other hand, China is hardly classified as a friend, because he's been doing some rather nasty things against Australia and within the region. So how do you reconcile those two? And it's, it's really very difficult to do. Wouter Klijn 10:27 Yead, and with this shift to national security, I think one of the big impacts, as well as on Europe, where obviously Trump has said, You guys are going to have to spend more on on defence, I think there's the Ukraine war that sort of made him realise that maybe we should prop up our defences a little bit more. What do you think that is going to mean for the European industry there? We will see sort of a renaissance of the military complex there, or the industry. Is that going to drive growth? Or how do you look at that? Alan Dupont 10:59 Yes. Look, it's hard to really fully understand how fundamentally Europe's security environment has changed over the last few years, primarily because of Putin's invasion of of of Ukraine, but, but it's a way, it's been a wake up call for Europe, about the fact that they've been clearly freeloading off the United States for 75 years, and that has to come to an end. And slowly, grudgingly, they've come to that conclusion. And now, all of a sudden, with a bang, they've finally woken up, and the light bulb has gone off, and they realise that they've hollowed out their whole defence industry sector to the point where they can't even make as much ammunition as a North Korea. Okay, this is a bit of a problem, so that's been a big wake up cause. So I think this is a fundamental shift that defence the defence industry is going to become. It was already becoming a priority for most of Europe, not all of Europe. The Spanish, for example, said, Hey, we're not going we're just not going there because our social welfare state's too important. But to me, that's a false premise. It's not an either or proposition between the caring economy, the welfare state, and defence. You have to do both. It's a question the balance between them and Europe didn't have the balance right, and now it's shifting to rebalance. And that means defence industries, anything to do with defence, broadly defined, is going to get a massive stimulus. And we've already seen that, particularly in Germany. I mean, it's just amazing how much the Germans are now putting into the defence sector, very late in the day. But it is definitely a trend that's going to consolidate and accelerate, I think, over the next five to 10 years. Wouter Klijn 12:56 And I read this morning that Trump was apparently has said to Zielinski, when he was on the phone with him that where he basically asked the question, if we provide you the weapons, would you strike Moscow or St Petersburg? And it made me think, could this conflict grow into a broader conflict, potentially a New World War? Alan Dupont 13:19 Look, a lot of people think that it could. I'm not one of them. I'll tell you why. Putin's calculation is that he could get away with the invasion of Ukraine, because the West would never stand up to him, because he had nuclear weapons, so he rattled the nuclear weapons case for the last four years. But the reality is, if Putin was foolish enough to use nuclear weapons, it would be a suicide note for Russia, because he's not the only one with nuclear weapons, right? Yeah, so that would actually destroy his dream of making Russia great again. What's the point of blowing everyone else up, if you blow yourself up, right? Yes, I think they're always been constraints on what Putin will do in Europe, and the fact that the Europeans and and even the US were reluctant to take him on only encouraged him to keep pushing the envelope. But if the Europeans are standing up and Trump is starting to reverse his position. Now suddenly the task of, you know, making Russia great again becomes much more difficult and counter productive for Putin's own rule. So my argument is contrary to the view that we should concede to Putin the most effective way of stopping him from doing what he's doing in Ukraine and in beyond is to be stronger, to deter him and make him realise that he can't win. And I think Europe and the US combined are capable of doing that. It's not their economies combined. Economies are 10 times the size of Russia's Russia's economy. Is only slightly bigger than Australia's, so it would be completely foolhard here for him to study. Then go right now, I'm going to invade Europe, you know. So, so that's why I don't think it will escalate. My concern is we'll go into this. No, you know, sort of no man's land. Of nobody's winning, but nobody's losing sufficiently to bring about a peaceful settlement, which is what everybody wants. Yeah, it has a rings as well of the old Vietnam War to it, where it was a much longer drawn out conflict than people expected, correct? Yeah, yeah, interesting. So what's, what's the role of China in all of this? Because we have seen some support from China for for Putin. There's also, of course, concerns around the Taiwan situation, whether that would escalate and how that would draw other parties into the conflict. What are your thoughts around that? So my view is that China is a greater problem for democracies than Putin for the simple reason that China is the only near competitor to the United States. It's an emerging superpower, and it It dwarfs the capacity of Russia in any field, economic, financial, militarily, and why I see China as a problem is that fundamentally, its values and interests are completely opposed to those of Australia's and the US and most democracies. Now that's not a reason for not trading with them or having a stable relationship with them, but there are clear constraints about how far Democrats can go in having constructive relations with China. If China continues to be as assertive and aggressive as it is globally, trade coercion against Australia, what it's doing in the South China Sea. I mean, I could give you a whole list that. So it's not that I'm anti China or anti anti Xi Jinping, but I just see, think that the scope for a fertile relationship with China is limited by China's China's the the nature of China, China's system and its actions. But now the second point is this, China plays on a global chessboard, and all these conflicts are connected. What happening in Ukraine is clearly connected to to the Indo Pacific. China is supporting Russia. It's pretty clear. It's been careful not to go too far, but it's providing all sorts of material to Russia in the war against Ukraine. It's flooding Europe with cheap goods, subsidised goods, okay? It manipulates the market. Critical minerals is a classic example. One of the reasons why our critical minerals miners is having struggling with prices, because China has artificial depressed them to keep them to keep them out of the market. So all those sorts of things are going on in the economic sphere, and then in the financial domain, China would like to see the US dollar dethroned and replaced by preferably by the yuometer knows that that won't be possible, but certainly by a bricks currency, or some other alternative that doesn't favour the United States. So is that in Australia's interest? I wouldn't have thought so. But anyway, that's debatable one, I suppose. So my bottom line is that China wants to be number one. It wants to be the preeminent state in the system. It's entitled to have that aspiration. But the problem for the rest of us is, what does that mean for the rest of us? If China's going to be number one, well, then we're presumably going to be number 234, and five, right? And is that, if you're happy about living in the China world, that's probably great, but I personally would not be. Wouter Klijn 18:54 So how do these tensions interact with sort of, the broader trend of de globalisation? And I think you also, more recently, mentioned a term geoeconomics. How does that all tie together? Alan Dupont 19:09 Yeah, okay, well, the concern of a lot of people is that, okay, if there's not a game changer here, we're going to see a bifurcated world, okay, the sort of a bit like a rerun of Cold War, of a Cold War, and a lot of people think it's just cold war too. And I I'm sympathetic that I don't know quite whether it's a cold war, but it's pretty close to it. So if China wants to be number one, that means China has to be the dominant economy. It has to be the rule setter, rather the rules taken. It's all about establishing the rules and enforcing the rules. So it is conceivable the world could divide into, you know, a pro China world and a pro kind of Western world, and they grow further apart, and then we start to have serious decoupling. Of the economies, which has already started, we start to get protectionism, right? We're seeing that play out. I mean, Trump is the chief villain here with with his tariffs, but also China has been doing similar things in other ways, right? So both are responsible for that. So a divided world is not a good word for Australia to live in, because we want the benefits of both, as do most other countries. So if you have to choose between two different systems, that's bad news. So you just get a polarised, deglobalized world where we have to forfeit a lot of the economic benefits of globalisation, which were considerable, and then it starts to play into very it plays into everything, including technology, for example. Now AI, like is a classic example. So everybody goes around and says, whoever is the dominant player in AI is the, is the key technology of the future will rule the world. Putin's then she said that. So there's a arms race going on, the technology space. AIS is the crown jewel, if you like. But across the board, quantum, all, sort all, every major technology that's fundamental the future economy, China wants to dominate. It said that clearly, and so the US has said, Well, hang on, we're not going to let you dominate, because that means we're number two and we're subordinate to you, so so that. So the in the technology space, there's a war. There's an undeclared war going on. People call talk about the tech war, and there's a lot of truth to that. There's definitely an economic war going on, and a financial one as well. War as well. Now they're not what I use the term war. I use it loosely, you know, it's definitely competitive, adversarial behaviour. It's not it's not collaborative behaviour anymore. Yeah, and, and unfortunately, the trend is more of this rather less of it. So how do you break that nexus? Nobody's got the answer. My feeling would be somebody's going to have to win and come out on top, and that's the way it'll happen. Wouter Klijn 22:02 Yeah, I think in this financial war, you've spoken about Trump's willingness to use the US Dollar as a weapon, can you explain a bit your thoughts around that? Alan Dupont 22:13 Yeah, well, up until 2016 before Trump was elected, the first time, the US was very reluctant to use the principal tool, and it's geopolitical Toolkit, which was the US dollar. Yeah, that was a no no. Obama and predecessors didn't want to go. They didn't felt they had. Feel they had to go there, because they felt they still had. They were leading China comfortably. But as China developed and started to close the gap. When Trump came to office, he recognised, unlike his predecessors, that the the main sort of leverage that the US had over China was this was its reserve currencies. The US Dollars reserve currency status, which means, you know, most of the world's international transactions in US dollars overwhelmingly. So I think the yuan is still only about 4% of of international transactions. Us is about 60 something percent, right? So, so Trump decided to weaponize the dollar for geopolitical reasons, and he's any on the second time around Trump, 2.0 he's continuing with that. For example, he's threatened the bricks, the bricks plus group, that if you guys go down the road of a bricks currency, we're, we're going to whack 100% tariffs on you. All right, so he's using every tool at his disposal to reinforce America's position in the world, just as China has been doing for the last 20 years. So he's taken a life and lead from China's book, right? Yeah, this is unheard of for democracy to think like that. But that's, that's the way Trump's gone. And in a way, in my view, he had to go down that route because China was playing a different game to everybody else, and that meant everybody else is going to lose now, China subsidises everything. Strategically, it's China Inc. There's no such thing as a private company, as we would understand it in China, everything is subservient and subordinate to the will of the Chinese Communist Party, and Xi Jinping pulls the Levers as required for geopolitical purposes. So us is starting to do the same thing, and this is where geo economics comes in. That geo economics essentially means the use of economic and financial power for geopolitical objectives. It's been done before. If you go back to the 1930s no if you go back even further to prior to World War One, Germany, Imperial Germany, did it and then. Hitler's Germany did it, and other countries have done it historically. It's not new, but just the way. But the capacity to weaponize your currency in a globalised world is far greater. Okay, so that's so I don't this is we're going to see more of this in the future. I have no doubt of that. Yeah, it has turned out that especially the tariff weapon has is proven to be quite powerful. I mean, Trump has threatened, in many different ways to put different tariffs on then he, you know, goes back a little bit. But then there's, I think, with most countries still a 10% tariff China is higher. Wouter Klijn 25:39 Was it sort of clear that this could be wielded to such a great extent. Alan Dupont 25:44 So I think that people misread Trump views on tariffs. I actually wrote a piece saying this when, when he late last year. So a lot of people thought, one, that he wouldn't do it, that is impose new tariff regime. And secondly, that even if he did, it would be largely ineffective, because they only saw this being wielded in a kind of narrow economic sense. What they didn't understand that he's using for political and geopolitical reasons, right? And he's he's come out quite clearly and stated that so not only does he think that the US is going to make more money from this and level the trade playing field, because he feels the US has been ripped off by all these people countries that are running large surpluses, but he sees tariffs as a geopolitical tool to leverage America's strengths to get what it wants. And so he's using that as a big stick to beat people on the head. Now everyone's throwing up their hands saying, This is outrageous, which it is okay, and, and, and then there was the a period of time when they talked about taco, taco Trump. You know that he talked a lot, but didn't deliver. Okay, but then, after he struck Iran's nuclear facilities, no one's talking about that anymore. So the point is, Trump now people realise that he will do it. Yes, he might back off, he might play around with timings, and so on. But the end of the day, the world is going to be confronted with the highest level of tariffs that we've seen since the 1930s minimum level, base level, 10% probably on average, is going to be closer to 15 to 20% on on most goods traded with the United States. So that's a major imposition on free trade, and it's very, very consequential in a negative way for Australia as a trading nation. It's a big problem. Wouter Klijn 27:48 Yeah, for sure. So you mentioned Iran there, and it made me think you spoke a couple of weeks ago at our insurance investment forum, and that was before Israel launched rockets on Iran. And you already reflected then that there was this concern about the level of enrichment that Iran could do and whether that would lead to a more more conflict in the region. And then, not that long after it actually broke out. How did you predict that? Alan Dupont 28:20 Well, you know, as I think I said to you once, that it's always dangerous to make predictions, especially about the future. Okay, so I usually don't make projection predictions, but what I what I do do, is draw people's attention to things that have a higher probability of happening than other things, right? So I think the time, I think it was about two or three days before the strike, I could see that there was a window, a brief window of opportunity for Israel and the United States to basically do severe damage to Iran's nuclear enrichment facilities. And that window would close reasonably soon, and the the window had opened for two reasons. One, because Israel had taken out a lot of Iran's air defence systems in a previous attack. And secondly, the Israelis had inflicted enormous damage on Iran in other areas too, and its proxies, and so was relatively weak and right for the taking. The only thing was, how do they get Trump on board? And I think was sold to Trump on the basis that, hey, you can do it, and if you do it, you will have done what no other US president has ever had the guts to do, because Trump likes that kind of talk, right? Yeah, yeah. And we can take him out, and you'll be a hero, right? And we'll clear the path for you. So, I mean, it was, and then Trump will just basically said, Okay, we'll do it, much to a lot of people's surprise. And then, of course, we've had the subsequent debate about, well, what damage is really done, and can, can Iran get nuclear weapons very quickly, again, etcetera, which is. Separate issue. But the point is, in doing so, Trump demonstrated that when push comes to shove, he will take action, and so it's best to actually take him at his word and not just be dismissive of him as just all talk no action. Wouter Klijn So no taco Trump then? Alan Dupont well, I think that was always a very foolish acronym to be honest. Wouter Klijn 30:23 Fair enough. So I want to go back to earlier comment you made about technology and the role of technology in geopolitical tensions. Potentially a technology war AI plays a big role in that. And I think you've mentioned earlier as well that there is this report or paper by the Australian strategic policy institute that looks at key technologies, and it assesses 44 key technologies, and basically concluded that China is ahead on 37 of them. And if you look at some of the main ones that China is ahead on, it includes like advanced aircraft, engines, drones, advanced robotics, anonymous systems, they all seem to be technologies where one AI is important in but also that potentially have a dual use and a military angle to it. What should we read into this? Alan Dupont 31:18 I think what the US has has read into it, and and it should read into it is the fact that not only has China closed the gap on a whole range of strategic technologies, but it's possibly ahead in several and the gap may actually widen in the future because of the enormous resources China's putting into this. I mean, they have, I think they have more engineers, software engineers, and the rest of the world put together. So they've got just, it's just the sheer magnitude of the effort they're putting into the stuff is closing the gap. And so the consequence of this is that if they should come to dominate all these fields and increase the gap, then then they've won the race to be number one. I mean, you know, you can't come back from that if you get that, if they get too far ahead now. So the next thing I'd say is that that was one report by ASPI. It's a It's authoritative. It's well researched. I've had a look at it. But there are others who say, Well, they're not ahead in all those areas, or they're not as far ahead, and it's a bit bit more of a line ball. My own view is that China has got its nose ahead in the majority of the key technologies that will determine the future, the future world, but in the most important one, AI, they are not ahead, not withstanding deep seek and all the hyperbole around some small, little Chinese startup with a few million bucks somehow outperformed all the the monolithic tech companies, big tech that are spending billions of dollars on these frontier, you know, sort of models. I don't think that has happened, but I understand that China has certainly got, you know, impressive capabilities growing all the time. But I would say my own assessment is that the US is probably, probably three to four years ahead across the AI macro system, and it has no intention of losing that edge. So watch this space. Wouter Klijn 33:27 Yeah, yeah. So the US still ahead in AI China is quite good in sort of electrical vehicles. Do you think that that could cross over into, you know, military applications, where you combine electric vehicles, anonymous vehicles, with drones and potentially longer battery lifespans, where it becomes a problem? Alan Dupont 33:50 Obviously, they're all connected. I mean, there's a term that they use, the tech stack, yeah. So what that means is, if you really want to be a dominant player in any particular space or silo or sector. It's no good just producing the best widget for this year, you know, or the best bit of software for for last year, you've got to actually dominate the whole sector and all its manifestations. So the tech stack, you know, so, like in an EV, so it's not just the car, the drive system, it's sort of the robotics, the battery, you know, the battery technology, etc, etc. You need to have pull that together and be leading edge in all that, right? If you really want to win, that's what China's done, and it's very impressive, you know, you got to give them full marks for that. Whereas we, the rest of us, are sort of, you know, have a much more tactical, short term approach to these things. The Chinese take losses, subsidise and they for 20 years until they actually get to the point where they become, they occupy the dollar. On the position. That's the Chinese modus operandi right now. It's only dawned on its competitors, probably in the last 10 years, that's how they operate. So on scrambling around to catch up. But we don't have the capacity, the monopoly capacity, that the Chinese state does as an authoritarian state, that they can just decide and Xi Jinping can sit down with his Politburo and go, we're going to do A, B and C, and it just rolls out, yeah, you can't do that in the West. So we have to come up with an effective counter that plays to our strengths. And my answer to that is, okay, just as China has leapfrogged a lot of technologies to become leading edge or close to it, we need to leapfrog the tech stacks that China has assumed will be in place for the next 10 or 20 years. For example, EVs and battery technology. What happens in EVs? The kind of EVs we've got today aren't the EVS that everyone wants. In 20 years, there's new forms of breakthrough technology that transformed it. Batteries are different, no matter what. Even need batches and some other drives, a drive system critical minerals. You know, that's another area where China has a dominant position. But we need to ramp up in terms of producing magnets, the neodymium precio Dean magnets, which drive everything, getting from wind turbines to cars and to the military side. So this is your point about dual technology. People talk about, oh, the in the defence area or in this area, and that. Sorry. They're all connected these days, right? So if you look at defence spending, most of it goes on what, what I would call dual use infrastructure and technology. I'll give you a quick example, a ship lift. Lifts ships. Okay, it lifts any kind of ship by weight, not because it's a Navy ship versus a merchant ship or a fishing vessel. So, so if the Navy wants to lift the Navy ship, why should it build a navy only ship? Lift that, you know, a billion dollars, when it can use a civilian ship, lift that already exists. So when China builds the world's biggest ship building industry. Produces 50% of the world's big ships. All that capacity is there for their Navy as well, and that's why they've got such a large and growing navy. We in the West, the US, produces about 2% of the world ships. It cannot build enough ships. Honey builds any ships can't build enough submarines. You can only build just under one submarine a year, nuclear powered submarine. The Chinese are cranking out two or three of these a year, right? So you can see how these dual use capabilities energises and strengthens your military capabilities. That's how the US won the Second World War. The West, it out produced Germany, China is out producing the west by orders of magnitude on just about everything. And so therefore we have to have an asymmetric status strategy where we think, okay, we're not going to have a big, massive conveyor belt churning out ships or whatever it is. We're going to have 3d printers. Okay, lots of 3d printers, all decentralised, all producing bits and pieces for the big ship or the submarine. And that's starting to happen, but we need to ramp that up, scale it up. And it means you have to have some manufacturing capacity to do that. Wouter Klijn 38:41 When you look at sort of these developments in these trends, and then you take into consideration what happens in the equity markets, and I particularly think of the US equity market we've seen in the last couple of years, that the rise of the Magnificent Seven on the back of AI, but there's clearly, you know a broader trend going on there, where you know technology becomes more and more important. Do you think that the technology war and the war for chips and AI did that has correlations with the rise of the Magnificent Seven, and going forward, that technologies will be probably the drivers of equity markets, or is that a stretch? Alan Dupont 39:23 There's some interesting points there. So the way I look at it is, Look The Magnificent Seven, you know, are clearly, they're all American, so they're all, you know, the US wants to see their dominant position maintained. But the problem is on the social side of the house, there are real concerns about monopoly control, about protection of privacy of our data, etc, etc. So, so it's not like the US is 100% any us, even the Trump administration has. Concerns about them becoming too powerful. So what is, again, the balance between having leading edge big companies with huge resources that are essentially American or Western, you know, driving the tech revolution has shifting from China's. So yes, you want to see more of that. But how do we get the best out of both? And how do we put sufficient controls into protect privacy, which is important in democracies. The Chinese don't worry about privacy. It's not a factor for them. Okay, so, so how do we get that balance right but still win the technology race or be competitive anyway, in the technology race against the country doesn't have to worry about a lot of things that we worry about, so it has much more of a free hand. That's a real dilemma. And you can see that playing out in all sorts of ways. And then the final point I make on this in terms of dilemma, is what the what the US realised in the first Trump administration when they started to put blacklist some Chinese companies like Huawei, for example, to prevent them attaining a monopoly position or getting unfair advantage, what they found was they were shooting their own economy in the foot because so much of the export revenue earned by the Magnificent Seven came out of China. Yeah, Nvidia, for example, is a classic example sell, you know half? Well, I don't know about half, but certainly a large proportion of chips are bought by China. So Nvidia says, Well, hang on a minute. If we, if we sort of now blacklist, essentially China, we're going to lose a quarter of our revenue. How does that going to work? So you're going to subsidise, you know? So these are the problems you get. And the other thing is, if you completely cut China out of the market, then the Chinese will be incentivized to develop their own which is what they're doing. Yes, what's the balance? You know? So, I mean, I've got an answer for that, but that's, that's the that's the question, that's a problem. Wouter Klijn 42:09 Yeah, yeah. And I think we've seen already some of that. Again, earlier this week, some of the bands were lifted on the sale of certain high-end chips. So Nvidia is allowed to sell certain chips again to China, and immediately stock price goes up. Correlation there, right? Alan Dupont 42:29 Yeah, exactly. So it's not easy. It's very complicated world out there now. Wouter Klijn 42:33 It is indeed well. Alan, thank you very much. I know you're very busy, so I'll leave it at this, but we could talk for hours on end. But thank you very much for your insights, and it was great to talk to you as always. Alan Dupont 42:46 Okay, thanks, Wouter. It's a pleasure to talk to you. Wouter Klijn 43:02 Thank you for listening to the i3 podcast. For more information, please visit our website at www.i3- invest.com and don't forget to like, subscribe and review. Thank you very much.

Ben Darwin is the Co-founder and General Manager of Corporate at Gain Line Analytics and in this episode we're going to take a look at what makes teams successful and stay successful. Ben is a former Wallaby player, having played 28 test matches for Australia. He's a former coach and a performance analyst, having worked with a number of rugby teams, including a Japanese team, the NTT Shining Arcs and Suntory Sungoliath, he started Gain Line in 2013 out of a desire to introduce a greater degree of empirical analysis into professional sports. But his research goes broader than just sports, it also goes into the dynamics of professional teams across industries and the cultures they foster. In this podcast, we're looking at how this has implications for investment teams and also for super fund organisations. Overview of Podcast with Ben Darwin, Gain Line Analytics 03:00 I was always interested in Australian sports punching above its weight 05:00 I realised that my efforts as a coach did not necessarily have any influence on the outcomes 08:30 We would find that teams that didn't buy new talent and held on to the players they didn't want did better 11:50 Attribution bias, we overly attribute performance to the individual 13:00 With cohesion, I'm trying to measure the attributes that drive people's understanding of each other 14:00 We all misattribute what change does 18:30 When people try to make things better, they usually make things less cohesive 20:30 The dangers of growing organisations (super funds) too quickly 23:30 Growth is really hard 27:00 Cohesion is not the same as culture 37:30 Is it possible to build cohesion in a team with a high level of turnover? 44:00 The tumble down effect: one change causes more changes, which causes even more changes 48:30 Cohesion can drop 50% in a week, but it can't grow 50% in a week. It grows maybe five per cent a year 52:00 My experience is that economies of scale are vastly overrated 1:05:00 Often we are dealing with a competent person who works in a structure that makes them look like they are incompetent 1:06:00 Building interpersonal trust is great, developing clarity is better Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights Full Transcription of Episode 115 Wouter Klijn 00:00 Hello and welcome to the [i3] podcast, conversations with institutional investors. My name is Wouter Klijn, and I'm the director of content for the investment Innovation Institute. For more information about our educational forums for institutional investors, please visit our website at www.i3-invest.com There, you can also subscribe to our complimentary newsletter, [i3] Insights, in which we discuss investment strategy and asset allocation questions with asset owners from around the world. Now, as you all know, we love our disclaimers in this industry, so here's ours. This recording is for educational purposes only. It does not constitute financial advice and is intended for institutional and wholesale investors only. Please enjoy the show. Welcome to the [i3] podcast, conversations with institutional investors. I'm here today with Ben Darwin, who is the co founder and general manager of corporate at Gain Line Analytics. And today's topic is a little bit different from our normal investment focus podcast, because we're going to take a look at what makes teams successful and stay successful. So Ben is a former Wallaby having played 28 Test matches for Australia. He's a former coach and a performance analyst, having worked with a number of rugby teams, including a Japanese team, the NTT shining arcs and Centauri Sun Goliath, he started gain line in 2013 out of a desire to introduce a greater degree of empirical analysis into professional sports. But as research goes broader than just sports, it also goes into the dynamics of professional teams across industries and the cultures they foster. So in this podcast, we're going to have a look at how this has implications for investment teams and also for super fund organisations. So Ben, welcome to the show. Ben Darwin 02:21 Thank you so much. Wouter Klijn 02:22 So tell me a little bit about the origin story behind gameline. I just mentioned why you started it, but can you tell us a little bit about the history of it? Ben Darwin 02:31 I suppose I have to begin in a way, and I apologise to go back, but with my own history in that not being Australian and coming from the UK, I always sort of had a bit of a always felt like a bit of an outsider in my view of the world and becoming sort of, then part of Australian Rugby. I was always confused by this idea of, like, people say to me, you know, I go to the UK. Oh, geez. They breed them big in Australia. Actually, I was born in crew in the Midlands, like, I'm not even from Australia. And they would say, you know, you Australians, you're so good at sport and things, and I'd be like, I don't, I don't quite understand why. And so I was always interested by this idea about Australian sport punching above its weight, and why rugby particularly punched above its weight, and also why countries like England or France for that matter, or just generally, larger countries would would have all the resources in the world and not necessarily be as successful. And I remember a particular phrase by Peter Fitzsimons talking about England coming out to play, and thinking, is this the best they can put together? Because with, you know, they've they have a million rugby players. For example, in England, Ruffin, I think we have 60,000 so it's like, how's it, how's this taking place? So as a player coming into that environment, I was a little bit confused by it. And then you become, you know, one of the problems with sport is we all see things. So magically, we all see and we, you know, we see individuals as heroes, and not sort of think of them as everyday people. So you then sort of become part of that environment, and you meet the coaches, and you meet people as part of the system, and think, well, like, how is this successful? It doesn't, doesn't make sense. And not that people aren't talented, but the people you're up against being just as talented, if not more, talented, and not understanding why. So then I became a then I became a coach, because I had a spinal injury 2003 so I got very young into coaching, and the first club I was ever a part of, I don't think I won a game as a coach, so I'm like, Okay, I'm a terrible coach. And then I went to another club, which was the Western Force, which was a startup team, and we didn't win anything. And then I went to Japan and didn't lose for two years. Then I come back and coach somewhere else and win there. And then I coached again in Japan and didn't lose. And thinking, okay, maybe it's just me in Japan, but then I'd have other teams in Australia to do well or poorly. So I began to understand that that my influence on a team was sometimes good, sometimes bad, but that didn't necessarily lead to outcomes, and I've got so probably my worst coaching I ever did was in a team that did not lose the whole year. So my son. I was trying to derail them, and almost did derail them, to be honest, but they won despite me. And once you bounce around enough organisations, you start to kind of see some causality around performance. And sometimes teams win with good coaches. Sometimes they win despite good coaches. Sometimes they lose with good coaches. You talk to enough people with enough experience, they'll tend to tell you the same thing. So the last team I was part of, from a coaching perspective, I also became a data analyst, and that was the Melbourne rebels, and that one of the questions they asked me was after two years, because we spent a lot more than the market. We basically spent double what the market had in terms of talent, but we didn't win a lot of games. And so the question came up for me as an analyst, how long is it gonna take for us to win? So that question led me down this path, and I did one more stint, sorry, approaching at Suntory, like I said, and I came back to Australia and basically started the business because I didn't want to work in sport anymore, because I could not control the outcomes at all. Yeah, the team that last job I had as a coach, I was literally fired after we went undefeated. So I'm like, okay, bugger this. I could this is not working. So gameline is basically a consultancy company because then, because you see a lot of people in sport, when they lose their jobs, or in business, they become a consultant to kind of fill the time. This is basically that option. It's just gotten out of hand, but it's a stock gap that's gotten out of hand now for 13 years. Wouter Klijn 06:28 Yeah, it's got out of hand in a good way. Ben Darwin 06:30 Yeah, in a good way. So that's kind of how I arrived that point. But the original idea for the business was actually not cohesion analytics, as we call it. It was actually something entirely different, which was a model whereby clubs would come to us, and we would tell them who was, who was off contract. And the way I arrange the data is I always arrange the data visually so I could just easily find a player, and I arranged them by team, but I would couple all the all the players in that team together, and then I would notice contractual changes year to year between teams. And there was one particular team that that basically came to us and said, We want to gut the whole team. Can you help us find new players? And we tried to help them do that. And then they came back and said, We're really sorry. The owners got financial problems. We have to keep the players we don't want. So we knew what they wanted and didn't want, and it wasn't what they had they didn't want. And the next year, they went from, I believe, second last in the year they came to us, and the next year, they made the finals for the first time. And I don't think they've had the final since. So this one year where they stabilised because of an external force, which was the financials, made them keep the place they didn't want, they dramatically improved. And I'm like, okay, that does not make sense. And then there was another example. At the same time in 2013 of a team called the highlanders in Super Rugby, who had a recent period of under performance. And they were gifted through New Zealand Rugby, a large amount of players have been highly successful at the 2011 World Cup and and the the market responded by saying, Okay, look how much talent they have. So they went, I believe, from 40 to one, so with 2% chance of winning the competition, to six to one, which put the favourites second favourites. And they won three games, including losing to the rebels, which generally gets you five as a coach, right. But, yeah, but that that team two years later, without most of those guys, then won the cop. So I was really confused now because, and it was almost running against my own self interest, because we were trying to help players go into the marketplace. And what it was saying was, don't buy talent. Yeah, hold on to the talent you don't want. And so the more that people that imported, the less they could do. So sorry, the more, yeah, more people imported, the worse they got. And the less they imported, the better they got. So I started to run analysis on this, and just built some very simple algorithms, one called Twi, which the acronym I'll regret forever, particularly in financial services that we've that's what we've got and and we just started to find some commonality. And then we found weaknesses in that system. And then there was a it's been a continuous iteration ever since, on this kind of formula for success or failure. And then team started talking to us, but the core of that research was not out of sport. It was it was out of Grossberg work on portability talent. It was around military data on shared experience. It was around hospital research on contractual stability. It was on other military research around structure and size of teams, and we just then applied it to sport, and then it came back again, where we've taken it back to corporate again. But this the we just found it to be particularly long term, really strongly predictable on performance, but also we felt was getting to the heart of causality, because a lot of data in financial services and in sports. Sports industry is fundamentally measuring outcomes, measuring performance, but what we're trying to get to the heart of is what's causing that performance. Yeah, so we're not really interested. In, in the scenario of like a company is selling this much more, what, which is, why are they selling this much more? Or why are they having performance? So we're trying to remove ourselves from form. And the turn of phrase I'll use to that is, the closer we've what we're finding is the closer you would get to correlation, the further you would move from causation. Yeah, two things were so tired, I'll give a very simple example. This in sport, in rugby, the team that makes the most line breaks or gets the most run metres will generally win the game. Okay, well, that's pretty close to try scored, because you can't really make one score tries without making line breaks. So why don't we just say the team with the highest score wins the game? Okay, but that's really not getting to the heart of causation at all. Let's go right further back. Why are they catching the ball? Why are they able to pass the ball? Let's keep, keep coming back to the core about why the skills of the players develop so well. And so what we're we're really trying to is to move entirely away from form, because form has no hard end causation. Wouter Klijn 10:59 Yeah, yeah, you touch upon something there that I thought was interesting as well. You, you did a presentation for us at our strategy forum in May, and you were talking about this concept of spending a lot of money on talent is actually not necessarily helping the team perform better. And I sort of made a comparison there with investment teams, where you often have a star investor or a star fund manager, but if you take them out and put them in a different team, in a different company, they don't always perform as well or are as successful either. And you talked a lot about cohesion within a team. Can you tell us a little bit about what do you mean by cohesion, and how do you develop it? Ben Darwin 11:41 So that turn of phrase, and all of these pretty much terms have been used, you know, brought up by other people, but the turn of phrase attribution bias, I really like, which is we overly attribute performance to the individual, either successful or unsuccessful, to the individual, rather than the collective of the situation that person's performing in. So what we're trying to do is to understand what are the drivers of that individual performance. And so we know that a player is is much more likely to perform well when, for example, in rugby, you have a 910 combination, a passer and a catcher, if that passer has been passing to that person 9000 times before they're going to know where to put the ball. Okay, in financial services, for example, you might have a researcher. Relationship between a researcher and a fund manager, and that researcher knows how to deliver the information effectively. And you can use all of the terms and phrases that we like you know, and can get to a shorthand, or can look for the keys that this person's really interested in? Well, that's just a relationship that can work much faster and cover off more detail. And we also like how the things are handed to us. So whatever form this takes, whether it be sport or corporate, I don't really see too much of a difference. So what I'm trying to do in cohesion is I'm trying to measure the attributes which directly drive understanding between people. And there's different forms of understanding. So that understanding could either be interpersonal understanding, it could be system understanding, it could be role understanding, and then things like size of the team, which we can touch on later on, then structure, which is extremely important how different parts interact. In fact, there's a group I did some some work with in Sydney. Was a was a asset management company, and they had different divisions in the business, and realised the different divisions were not talking to each other, and another one would make a change, and the other one would say, Why didn't you tell us this was going to take place? This is going to take place, this is going to completely stuff our systems up. And they were like, we didn't even think of talking to you. And I mean, I've done work with an almond manufacturing company that had the same problem, right? It doesn't systems are systems are systems. And of course, there's different nuances to each scenario, but, but under we all miss attribute what change does in its many forms, and so cohesion is fundamentally trying to measure change as well as the level of understanding between the component parts of the team. So if I look at a if I look at a team, and we've done work with Platinum, for example, the Platinum team has a level of measurable understanding that we can map at any one point, and it's shifting all the time, up, down and and when a team doesn't change, it's shifting. So if you and I do something, if we do this podcast, there'll be misunderstandings. We do it again, and you'll go, Ben yesterday, I heard about this, but I want to talk more about this. Or you might say, I I know when Ben's talking too long, or, you know, I know with my wife, for example, you know when the when the left eyebrow goes up, that's a dishwasher related issue, right? We have this shorthand that we all misunderstand, right? If I could give you a really easy example of this, and I. Didn't present this at the thing, but I was, I was in the supermarket one day, and I normally shop at Woolworths in Blackburn, and I was up at Doncaster, which is a little bit further from our house, with our daughter, and my wife said, Can you do the weekly grocery shop? Okay, now, sometimes I sit my car on my phone after I've done a grocery shop, and my wife sells me say, Why are you taking so long? And on this particular occasion, I couldn't find anything in the Woolworths in Doncaster, right? And my wife messaged me, why you taking so long? It's like because bread's not where bread is. It's in my mind's eye. I had a picture because I know I actually do this sometimes at conferences. I say, right? Tell me who does the shop right, and which, which one do you go to? And they say, Woolworths here. I say, Where's the bread? They'll go, oh, seven. Where's the chocolate? All four, right? You have in your your head of mine's eye. So not every Woolworths is mapped out the same. And so there is a map in your head of what that looks like. Or, you know, you get in the car and the indicator goes off because the windscreen wipers on the other side now, right? Yeah. And so we we use the human brain, uses shortcuts all the time to help us, and it's discombobulating when it becomes ambiguous as to where things are, and all of a sudden we keep going to the wrong places, yeah. That's cohesion. That's a form of cohesion. I have a level of cohesion with that supermarket. Now, if I keep going to Doncaster, I'll build up a different cohesion. The problem is the learning and the unlearning, right? That's also a form of cohesion, and because if you've done something a lot before, now it becomes the problem, right? If I have a if I have a CRM that I'm using in my financial services business, and I changed to a new one, because it's better. The problem now becomes the old system, and my knowledge of the old system, the longer I've used the old system, the harder it is me. Whereas there's some kid who's just come straight out of uni, he's never used a CRM before, he doesn't have to unload, yeah, and all of this have this all the time, and it's moving all the time. We're learning, we're unlearning all the time. And so what I'm trying to do is just put all of that into a number, and that's how we're doing it. And it's really objective. It's not, it's not like I said, whether we like each other, it's not. And I'm not saying that doesn't contribute, but what I'm trying to find is, what can I measure and what can I see, and what does that do? Wouter Klijn 17:19 So can you tell us a little bit about the different ingredients of that measurement? Because, of course, cohesion can be between team members, but it can also be related to the environment in which they operate and even the organisation in which they operate. They all tie together in a way. How do you measure it? Ben Darwin 17:41 So I can't, obviously, go into the human brain, and I can't do questionnaires, because we're looking at 1000s on 1000s of teams every day. And we also don't The question is, don't always naturally give you the question. I mean, Enron was regarded as the best place to work in America, literally, as they were being indicted, right? So yeah, it's right to the phrase, so that's just not going to necessarily give us the answer. What I can measure is how long people have done something. I can measure how long people have done something together. I can measure how long they've been in those roles, and I can measure what they've done before. Okay? And each of these components will have a different impact on the performance. I can measure the size of the team. I can measure how long they got at work, right? Like, like, COVID produced some really interesting data for us, because things started to take longer, or it trapped people working together, yeah, and their performance improved, you know, because of that, okay, they were forced into groups they weren't normally part of. They were isolated. There's a really interesting test bed for us, because one thing that we actually find is when people try to make things better, they generally make things less cohesive. Cohesion is usually driven by disaster, bankruptcy, firings, inadvertent changes that improve, that improve systems inherently, but weren't meant to do so, you know, I was, I was looking this morning at sporting leagues in Australia, and one of the competitions that's improved dramatically in Australia is the NBL, and it did so because they It fundamentally. They tried to grow it too fast, too many teams came and went, and it went into chaos, and so they shrank it and stabilised it and made it better. The same things just happened with Super Rugby. They're talking about this being one of the greatest seasons ever, because it shrank and stabilised. Yep, you sack half your staff, they will, inadvertently, the numbers will go up for cohesion, you know, you shrink it, stabilise it, or right size it, as it's often the turn of phrase. But growth, as we talk about a lot, is the enemy of understanding. Trying to grow because you have to hire, trying to grow because you have more people, fundamentally works against the nature of cohesion. Wouter Klijn 19:55 So that's quite an interesting point, because we're at that stage. Much in the Australian super innovation industry, where there's a handful of funds that are growing quite quickly. And partly it's because of the demand that it inflows from Super innovation itself. And partly it's because they're starting to do some of the investment functions themselves in house. So they need to have the expertise in house. So there's, there's a couple of organisations that, literally, in a couple of years, went from maybe 2030 people to hundreds of people, in some cases getting up to 1000 people. What are some of the dangers of that rapid growth then? Ben Darwin 20:34 Well, I think, I think the military has got a lot to teach us about growth. And you know, what the military's always done is they've broken themselves up into groups. And you know, if we, if we go back to the the notion II had a really interesting conversation with some of the guys at platinum, and talking about the early days of platinum, and one of the points they made to us was, when there was six of us in a room, I could just turn the chair and get the answer, and they know we they would know what even the question was before I answered it. And you can't replicate that in a large organisation, right? And so they talked about the growth they had, and then it became too hard to get a room big enough to have the meetings of everybody, and no one get the herd right. And then it got harder to bring people into the organisation. So the things that you can do in the early days of your success are no longer achievable on a when you become a corporation, when you become a large organisation. So you have to then change the steps of which you go about. You have to have, you know, all hands meetings are pretty ineffective. So you have to understand who needs to be in the room. What is the information want to disseminate? We're going to have to give everybody this information first, whatever it might be. And we've been working in Formula One, and one of the teams that had been highly stable for a number of years, we said to them, Do you have an org chart? And they said, No, we don't. Don't have one. It's like, why? It's because we never needed one, because everyone knew where they were supposed to be. Now we've taken on a whole bunch of people. Everyone's asking for an org chart, and we're like, okay, maybe we do need one right now. So So growth will have to drive a change of the processes. I think one of the mistakes that early startup businesses make is they try to introduce the processes the large organisations have when they don't actually need them. You know, we had an investor coming to us and say, you need to do this, this and this, this and this. And it's like, you know, have all your notes taken for meetings. And you know, you know, you and your business partner, Simon, need to process everything so you can communicate properly. I'm like, but he hears my conversations because he's at the desk next to me. Wouter Klijn 22:35 Yeah, Ben Darwin 22:35 and and we talk every day because he drives me to work. We don't need some of these processes that we think we need. So I think, I think right sizing process is a really important point. If you then break your company up into different divisions, the danger then becomes the different divisions will divert in their behaviour from one another, right? So then you build a set of offices all around Australia, and I don't if you remember the McDonald's movie they made about the founder, no, they they the early days of McDonald's. They would build different ones around the country, and they'd come across and, like some of them, were serving fried chicken, completely deviating from the processes that made the organisation successful the first place. So having having the processes that allowed you to maintain cohesion. Because if you just become an amorphous mass, you have chaos, right? But if you, if you don't, if you break yourself up, it comes with its own challenges of deviation behaviour. So there's, there's all these things, and, like, I say, growth is really, really hard. Wouter Klijn 23:36 Yeah, is there sort of a optimum size? Because, you know that there is this concept that's often used within sort of corporate culture focused strategies, and it's a concept borrowed from anthropology, where they say, you know, once an organisation grows beyond the 150 people, it's no longer possible to know everyone within the company. And sort of the idea that maybe, in the olden days, tribes were consisted of no more than 150 people, and after that, they would split off. Is there sort of a, you know, sweet spot there? Ben Darwin 24:10 It entirely depends on what you're trying to do, and the and the complexity or the simplification of the task that is required. You know, military always tend to say, once you go beyond six, it gets really hard, but, but I'd just say mathematically, it just as it grows out, it gets harder and you get less time. Okay, so do you sport a doubles tennis team? Can probably learn to play together very, very quickly. But a a basketball team takes longer, a a symphony takes longer. A an AFL team takes longer. But if you take a symphony, for example, there's different parts of that symphony. There's the violin section, and they can take cues off one another. So it's it's always context, and it also we need to understand what is the context of performance. Okay? So to win the a league, you don't actually need a lot of stability. You saw the success that Auckland FC have had in their first year with some limited, what we call externally shared experience, prior shared experience with New Zealand. But the a league is not a very cohesive league to win the Champions League. You know, we were looking at the most cohesive team that's ever existed in the in the Champions League. And I think it was Real Madrid in 2018 and the numbers were extraordinary, because they're up against other teams with money and cohesion, you know, such as the formerly Manchester United used to be, or IX, for example. You know, they're really well built clubs, and so it it all depends on what your notion of good looks like. And to give an example, there's a there's a group of jet fighter pilots in the US, and they have called the Blue Eagles. I'm going to I'm going to get that wrong. Maybe we can correct me and I apologise, but I watched a documentary on them, and they rotate new teams every sort of two years. Yeah, they have a a level of closeness. They can get to each other in formation that at the start of the year they won't even attempt. So they're trying to get inside five metres, and they're trying to get inside one metre from each other. And they slowly progress through the year that by the end, if they can get to less than one metre from each other, then they're in a fantastic place. But they don't attempt that at the end. So that's what their good looks like. If your good is inside 10 metres, you probably do in a couple of weeks. Yeah. So and also depends on what are we up against? So the AFL is the highest stability league in the world, and part of that is that their teams are so stable that even to get competitive in that league takes five years, right? Where's the a league? Six months, you know, three months you can make you into competitive. So none of this is is a or b or black and white. It's like there's levels of this and and the other part is, too. Is what are you doing ... how much complexity does this job require? How complex is this task? Need that we have how we have to work together in order to get to a level of success? Wouter Klijn 27:10 Yeah, you also make the difference between cohesion and culture. Culture is something that think is increasingly more on the agenda, because if you have a good culture, then a lot of benefits stem from that. And it's increasingly seen as not just like a soft skill, but it's, it's, you know, an important way of creating a sustainable business. But it's not the same as cohesion. Can you explain it a bit? Ben Darwin 27:39 Well, I think the one of the one of the challenges that we see, particularly in sport, is it's very difficult for people sometimes to understand success or failure. And so they'll say, why is this team so great? Because, you know, they've had a lot of success, and they go, Okay, well, they got a great coach. And then that coach will leave. So for example, if we use football Liverpool, right? They had a great coaching clock. He left, the new coach comes in, and there's like, well, it's gonna take a long time to come. And they won the league in the first year, right? And so it's like, okay, well, maybe it wasn't him, maybe it was something else. So then what they go is, okay, well, the club's got a great culture. Now, one of the things I might find is when teams are winning, people do point to them having a great culture. But my experience, and particularly when I was at the Brumbies, you know, we would, we were just as much of a set of rat bags, if not worse, than anyone else, right? But people wouldn't believe me. They would say, you know, how are you? You know you must your team's winning, therefore must have a great culture. And I'm like, have you met our players? Right? Have you? Have you been with us on end of Season trips? Like we're just as badly behaved as anyone else. But one thing that happens that I I'm lived in Newcastle quite a lot, and one thing I would find is, if the team was winning, the town would protect them, right, right? They would hide the behaviour of the fires. Oh, boys will be boys. When things are losing, you're on your own. Now, full of bad behaviour comes out. So in terms what I find behaviourally is that if things are winning, the bad behaviour takes longer to get out, but it's still there. Now, the next part is, what is culture? I mean, what do you believe culture to be? Wouter Klijn 29:24 Well, I actually have a background in anthropology, and it's probably the most discussed question in anthropology, and to my knowledge, they never really came up with with one definition of it. But, you know, basically it has to do with a set of relationship, a set of customs and sort of historic knowledge of those type of interactions. Ben Darwin 29:46 So one way of describing it might be, for example, normative behaviours. Well, you cannot achieve normative behaviours with a bunch of people thrown together, right? You get chaos. I. I talk it was like being like a refugee camp, whole bunch of different, you know, influences and a mishmash of different cultures, so to speak, different sets of behaviours. You throw them in together, and then what happens is the environment will then drive the behaviours right, and you keep people together long enough, and that will start to become a normative behaviour. So for example, in small towns, if you and I move to a small town, because we all have to see each other every day, you say hello to each other every day, right? You take care of your neighbour, right? Because we know that's the best thing for us to do in terms of our survival of the town is not to foster a bad reputation in terms of our interpersonal, you know, behaviour amongst one another. So we become more service orientated towards other people the town. Now the driver of our behaviour, then, is actually the size of the town, right? So, so I see cultural funds as an outcome of of the circumstances in which that team exists. So small teams will build understanding faster. Their normative behaviours will be adapted to quicker. And then, for example, if you set in place rewards, you know, like this is why we had a Royal Commission in financial services, right? You you build certain rewards, people start behaving in certain ways, and so and so. But if you and I go from that small town into a city, we cannot say hello to everyone, we cannot look after everyone, it will destroy us, right? So you then you stop saying hello to everyone, and again, that's an outcome. So I see, often times, culture, the normative behaviours, as an outcome of the drivers, right? And and those normative behaviours sometimes are good, and sometimes they're not very, not very good. And an example I give sometimes is, you know, there was a team in the AFL of the West Coast Eagles who who were very well known, I was living in Perth at the time for their off field behaviour. And one of the players recently went to jail and said, as part of his criminal case, I was told by the senior players, if you're not going to to take gear with us or smoke crystal meth with us, then you're not going to be part of this team. So he did it, and he The team played well. They won the grand fall. They made the final 16 of 19 years, and they're in the compost, or six out of 18 years. And they they won three grand finals, and they were very, very successful. Now, a lot of those players then left off the back of that, and the and the cohesion dropped, yeah, away and they they're now stuck in a bit of a hole themselves, and they're not getting great outcomes. So I think one of the challenges is, is if culture is the normative behaviours, sometimes those normative behaviours are driven by the conditions under which they are built, but also part of those conditions is the amount of turnover that you have in that environment. And so I think there can be, you know, with the background that you have. And I don't, you know, I don't have degrees in this, right? I'm just trying to be as objective as I can be. But I think there are times when we mistake behaviours for causality, right? So, and I'll give you an example. They did a study on hugging in the NBA, yeah, and they found that the teams were hugging each other were winning, right? And we know that hugging gives you oxytocin, makes you feel good. And they thought that might be at the heart of success, so they coded it. And they looked at the teams who are hugging before the games and touching each other on the bum and all this sort of stuff and high fiving and saying, Well, maybe this affecting their performance. And there's a link, there's a link between doing it and success, but if you then go and say to a team, you need to hug each other more, right? Which is what then happened, and teams I've been associated with started doing it. It wasn't going very well because the players were not comfortable to do it, yeah. What was actually taking place is the teams have been together for a long period of time, knew each other, and the hugging like if you saw me on the street now, we wouldn't have right? We're not quite there yet. Maybe, maybe we have coffee 10 times. The 10th time we'll have a hug. Okay, yeah, but we would have built understanding over that period of time. That is what I believe was taking place, is that the teams who buy product of being together for a long time knew each other, therefore they were hugging. But that was not a driver of the outcome, and I think that a lot of these ideas around culture I built on that. Now, if I might divert, I mentioned to you earlier, I had a story about culture, yes, so in the world of in the world of Twitter, I caught quite a bit sometimes, and, and there was a turn of phrase that comes up quite a bit. And I've even had this I met with a guy who was part of the Big Four, you know, any said, you know, I believe that that cohesion can have a profound impact on performance. And he said, Well, what about culture? Each strategy for breakfast? Like, yeah, it's a phrase, right? So that phrase has been attributed to Peter Drucker, yes. And so this person on Twitter was saying, culture is strategy for breakfast, therefore you're wrong. Like, okay. So I wanted to look it up. And so I looked up that there is actually a Drucker Institute. And someone had put on Twitter that the Drucker Institute on the front page has cohesion eats strategy for breakfast. I'm like, Okay, well, if they're writing it, then you must have said it. So I then went and found this other podcast where they said we looked in everything Drucker ever said. And he never said it, but he did say, I'm paraphrasing here, culture is extremely difficult to shift, yeah, which I definitely agree with. And so I emailed one of the university professors. Now, I don't have a degree, and I'm always very intimidated by dealing with anyone who has university degrees and professors, and my mum actually has a master's in ancient history and archaeology. But one thing I've always been interested is, like, you know, the whole thing about peer review and about research and, you know, writing bibliographies. Okay, so I emailed this guy and who had, who had written this, this piece for the the Drucker Institute, and I said, Did you and I said, Did you know Drucker never said that? And he said, to be honest with you, I never thought to check. I just Googled it, and in google it says he said it. So I put it on the front of it, and then all of these other university professors came onto this email chain, and then one of them came out and said, No, here's the guy who said it, someone from MIT. Drucker never said this. And there was all these kind of people saying, Okay, well, maybe we're not mistaken. I was, like, stunned, because if there's anyone ever that makes sure they do research as university professors, and even they were falling into the trap that we all do, of course, which is, you just Google it and that makes sense. Wouter Klijn 36:32 Yeah, it's shorthand, yeah, yeah. Ben Darwin 36:34 And so I think that happens a lot. You know, there's so many phrases that people use and say, Okay, well, that phrase is the evidence. Like, maybe it's not even the case. We just say it, right? Wouter Klijn 36:43 Yeah, yeah. It's just a way to quickly come to conclusions. I think, yeah, there's a whole range of quotes attributed to Einstein, to Mark Twain, to Keynes, that all things that they've never said, but they're still good quotes. Ben Darwin 36:58 Yeah, one of my favourites is that no one ever built a no one ever built a statue to a critic. And Roger Ebert, the film critic, actually has a statue of him sitting there, so it's one of my favourite ones. Wouter Klijn 37:08 That's great. That's great. So you mentioned earlier there as well, like turnover. So when we go to this concept of cohesion is driving performance? Is it possible to build cohesion in a team or in an organisation that has a high level of turnover? Ben Darwin 37:28 So again, there's a nuance to this, which is one, what are you up against? You know, the team that has the least turnover, you know, will probably build the most levels of cohesion. I think one of the key components here is, where are you drawing your talent from, and what has that talent done before? Yeah. So there's different components to people and and if I just give the easy example of if I take somebody who's been part of Magellan for a period of time, and then they come across to a platinum they're going to bring things with them. They're going to bring previous experience, they're going to bring bring biases, and they're going to bring fantastic information. But what's important to understand is that it's different, and that doesn't necessarily mean it's going to work at your other organisation. And I apologise I probably said the completely wrong thing in terms of organisations. But the point being that that it's not just turnover, it's also from where you grab your talent, the position, you know, one thing we find is very much in sport, is certain positions require understanding, or less or more understanding the context of the group of what you're going into. So when we did, when we looked at football, so, so Grossberg said that he felt that the research he did on Morgan Stanley, sorry, not felt the research he did on Morgan Stanley, said took someone three and a half years to peak performance. We did the same thing in the EPL. The answer was 2.9 seasons. But it was, it was conditional one, where are you coming from? Where are you going to? What is the state of the team you're entering? The more stable the 10 you enter into, the greater the chance you have of performing. Well, there's a turn of phrase called the Bayern Munich mirage. So if you come what you're coming from, is what I'm talking about here, is they say that in football, once, if you leave Bayern Munich, you'll never be the same again, because they have had, particularly 2010s at a period of high level of sustained stability, which went on to the German national team and and so if you leave that environment, you won't be able to, and that's attribution bias, right? You won't be able to perform to the same standard and then different different parts. So strikers, for example, it's easier for them to change clubs than midfielders, because that's the management position, right? And each industry will be affected in different ways. Generally, in rugby, cohesion manifests itself in defence. I've just been working on the NFL, and it actually works itself in attack, because you have to work together more on attack than you in defence. So each each part will have a different component, the position will have a different component, and then you slowly start to work out what those different parts are. Wouter Klijn 39:58 Mm. So within corporate teams, what would sort of be, you know, quick and easy wins for people to build cohesion. Ben Darwin 40:08 So the first thing we always begin with is, what am I looking at? What I mean by that is, is that we tend to all attribute performance with that term, attribution bias to the individual and to try to understand as best we can, is this, what is creating this success or failure in this person? And so if, if they have come from another system, what are they struggling to adapt to? So and we're not saying don't bring people into other places. That's fantastic, but if they've been using a different CRM, for example, a different organisation, they're going to struggle with yours, right? So they're going to take three times as long, and they're going to take longer than the kid you just got out of university. But there's some things that this person knows that that kid doesn't know, so the juice might be worth the squeeze in this particular case. So we need to give them more time. So don't compare the young person to the older person. So if you the first thing is the context of the individual's performance, the second part is the context of the team. They might have gone in to an A team, right? So you go into play for the Melbourne storms of the world and people generally perform, well, okay, whereas and different teams inside your organisation will be built differently. And then, if I use the rugby league turn of phrase, you then go to play for a West tigers, you then don't generally perform well, okay, but you need to understand that performance in that context. What is the context of how they're performing? Why are they performing the way they are? And then also understand that turnover is never black and white so and to give an easy example, everyone's got choices all the time, and organisations will say to us, we're so unlucky. We've had so many people decide to travel in the same year or so many people decide to have kids. Okay, now my wife and I have four kids, and you know, there's certain points in time where my wife's like, I'm not enjoying work. Why don't we turn another kid? Right? So, so, you know, you know. So sometimes people might decide not to have another child or not travel because they're enjoying work so much, they don't lose their opportunity at the organisation they're in, or they start to think, you know what, I'm not enjoying myself, so I might go and do something else, or, you know, get picked up. So turnover is turnover, in my mind, right? In sport, yes, you have injuries, whatever it might be, but if people are doing things they haven't done before, sometimes they're more likely to get injured. So I think it's really important to look at at the context of what you're ending up with, and why are we losing people so much, or why are we getting people so much? And I always say, like, just because somebody, you know, if somebody is creating turnover in their behaviour, then you probably need to exit that person. So it's not saying don't ever have people leave. And once we understand what we're looking at, and once we understand the decisions we're making and and to look at turnover in a very opaque level, then the thing is to understand, okay, what changes Am I looking to make, and what is the speed of that change? And one thing that does also happen is that people are always going to be their own biggest fans. You know, with sport, we know at the parents, right? The parents are going to so we talk about, if you import talent above someone else, the people below will leave. We talk about, sign one, lose three. And to give a very easy turn of phrase, let's say, you know, in a business perspective, you sign a very talented 50 year old and you lose 230 year olds, right? That 50 year old comes with you for five years, and he does okay, but the 252 30 year olds have gone off and started another firm, which is now one of your competitors against you. So you lose those two guys, the 50 year old their leaves, and you're like, we don't have those next guys ready to go, because those 230 year olds left. So because we don't have any with that level of talent. HR, go find someone for me tomorrow. That person comes in, and then they introduce a new CRM, that all of a sudden, 10 of your people are now underperforming. And so you he says, I need to sack five of those guys. I need to bring people with the last organisation we're in. And then Away you go, right. There's a whole we talk about the tumble down effect one. Change creates more change creates more change. So there always needs to be a context of, if I'm going to get talent, what is that talent? And even if that person is the nicest person in the planet, and I've been that guy, and you've been that guy, and you know, this is not about people being good or bad, it's just, what is the context here of, what will this do? Yeah, and so that is not necessarily thought about enough. I'd say, Yeah, Wouter Klijn 44:41 I think there was an interesting slide as well that you put up at your presentation where it showed the interconnectedness between different employees. So if you remove one person, it might affect, say, four or five relationships, or maybe a bit more. But if you remove four or five people, then suddenly it starts escalating, because there's. Of you know this, this almost compounding interest type of relationship, where you remove a handful of people, and it can affect up to 5060, different type of relationships, and it's much harder to to deal with and to replace than just with the single individual. Can you explain it a bit more? Ben Darwin 45:17 yeah. So, so, you know, literally, I believe sometimes multinationals can be brought down by these sort of things, right? Can I use a sporting example? Is that? Of course, yeah, okay, so, so Alex Ferguson had this really interesting impact on football when he was coaching people, inadvertently were having a bias towards Scottish coaches. There was nine Scottish coaches in the top two divisions of English football. There's now one. But when he was coaching, everyone believed he was very that was maybe part of the deal, right? They'd hear a Scottish accent. They go, Okay, we want that. So when he left and and he brought it, they brought in Moyes, who was also Scottish, who was having success at Everton. Okay, now this is from the best I can glean, and we have some insights, and some people we work with in football that can help us with a lot of this. So we kind of, we're not just guessing, but one of the things Ferguson did was like, don't change too much. And then Moyes wanted to introduce the things he did at Everton to the group, so he didn't change the team, but he changed the way they played. So now that group is and also understanding that Ferguson had been able to weather the storm of the new ownership of the club, right, which is we, you know, we know what's going on now with menu, and we're now at the peak point of that tumbledown effect. It's now at the end of its cycle, moist change the way they played, and the players could not adapt fast enough to the way he wanted to play. So his response was that was going to be okay. Well, I'm going to bring in people who can right? And I remember talking to somebody at Manu at the time saying they're completely changing how we recruit now to match this new way of playing, right? So, so now that doesn't work. They they move him on, and then they bring in another coach. And my memory's gonna fail me here. They bring in another coach, so German style, for example, of coaching, or Dutch style coaching, and that guy comes in, and now all their recruiters are recruiting to the wrong model, because they're recruiting to the Everton model. Yep, yeah, they're going to change again. Yeah. They're not quite sure what they're supposed to be looking for. And then they got half the team. And so the cohesion numbers are just dropping and dropping and dropping, and they've been dropping ever since. And so they're spending money to bring in the new talent, because the talent they just acquired is not performing very well. And so everyone says the biggest problem at menu is recruitment. Okay, so that doesn't work. So they go another coach again. They go another coach again. But the the ownership at this point is just trying to squeeze every dollar they can out of the organisation. And so we keep having to buy to find the answer, which is creating less stability. Now, one of the biggest drivers of skill acquisition stability if I, if I'm dealing with constant change, I don't get better, because I'm spending all my time adapting to new environments, right? And so those young people come into a Bed of Chaos. They don't become good at what they do, so they can't create talent to sell. And it just has that tumble down effect. So it can literally begin with one thing, which is maybe Scottish coaches are great. Let's get Moyes to all of a sudden, now the club is basically having to sell its entire list. And the hardest part now is, you know, it's very difficult to have a conversation with somebody at that level of crisis. You want to stop it at the head and say, just think about what you do next, right? Because these, the way we describe cohesion is it can drop 50% in a week, but it can't grow 50% in a week. It grows 5% a year, right? So it grows slow, but can be destroyed fast, like you're building a house, right? Can't build a house fast, but you cannot open pretty quickly. So that that kind of small components can lead to underperformance, which will lead to more change, which will lead to greater under performance. And now you get chaos, clouding, causality, right? And so what they tend to do is we need to go get the players who are playing well somewhere else, who then don't play well for you, or we go get a coach who's coaching well somewhere else. And the classic in rugby league at the moment is you go and get the assistant coach from the great club, and they don't necessarily perform to the same level. That happens everywhere all the time. Yeah. Wouter Klijn 49:29 So do you think there are learnings in that for mergers and acquisitions in the corporate world we see currently, within the super innovation system, there's lots of funds that are merging. Some of them are very different. Organisations come from the different industries. How, how you bring that together is quite tricky, and sometimes it's better. You know, especially in corporate, corporate acquisitions, they don't always add value, and more often than not, they don't add value. So. Is there some learnings there that makes, perhaps, easier to do mergers? Ben Darwin 50:06 This answer I could give you could take three hours, right? But one thing that happens is, when we look at sporting teams who merge, it's not that common, but the Waratahs just went through it. And rugby as an example, no, no, go for it. You take a bunch of people somewhere else, you bring them together, and so basically, together. And so basically, with the Waratahs this year, they're a merger, a team that just faltered, which is Melbourne rebels. They bring a bunch of kids in right now, one of the things you want to create in any system is you want people coming through the system together, from the university graduates through, well, let's call it your academy, or, you know, the floor where guys are working together, and they become the senior guys and and all of that knowledge and time helps to protect the business from whatever market. So the problem is, when you have a merge, is everyone who's coming up through your system will have never been with any of those people before. So it doesn't just hit you when you have that merge, because you have those people come in with shared experience together, but none of them have worked with anyone else. So over the next couple of years, what will tend to happen is the people who come in together from somewhere else will tend to stick together and then leave together. So one of them goes, they all go, right, yep, yep. Because why would they be loyal? You know, if you, if you join an organisation, and let's say you've been there for 25 years, and they say, we've just hit COVID. Could you take a pay cut? Your wife's going to say to you, they've looked after us. Let's look after them, right? Yeah, if you've been at one for six months, and you come in and they say you need to take a pay cut, your wife's going to say to you, why are we being loyal to this organisation? Because we don't know if they're going to be loyal to us. We it's not that you don't trust them. It's just you don't know them. Yeah, there's no pattern of previous behaviour, so you're going to act quite differently. And that's not, that's just loyalty to family. That's not. There's no good loyalty available. There's just different types of it. So that's the first that's the first component. The next component is you're merging different systems upon each other, right? So there's different types of mergers. If you're buying a technology, if you're buying a business for a technology, that's just the system you're bringing in, but you're not bringing in the people who administer that system. And so it's when you merge people together and systems together with those people at the same time that tends to become a problem. If you're a if you own a mine, and you're just buying a hole in the ground, have at it, right? So there's different types of mergers that we look at, and then there's things like vertical acquisitions. But you know, all of the research that I found so far is telling me that that economies of scale is a vastly overrated issue. Just leave things as they were, for the love of God. And when people do that, that tends to be more successful over time. Yeah, and, and, but how you how you do it, how you go about that process, and, of course, size. So I'm not saying mergers and acquisitions are going to be successful or unsuccessful, but there are certain times, certain ones that we look at and go, this is not going to work at all. Now there's another, there's another form of merger which can take place sometimes, which is like, if you import a CEO from one of your competitors and he brings a whole bunch of people with him, you're fundamentally, fundamentally merging the company. If you look at borghetti, when he came to went to Virgin Airlines. He basically brought Qantas with him, and it was a merger, but not in name, yeah. And so that has its own components of outcome, so to speak. Wouter Klijn 53:32 Yeah, for sure. One concept that I find quite intriguing as well that is related to this is the idea of knowledge management within an organisation. And so there's been studies done into this, whether you can sort of retain a form of institutional memory so that you don't have to reinvent the wheel every time teams change, or, you know, senior management changes, but whether you can sort of codify this for new people to quickly access, see how things are done, what the history is of certain, perhaps transactions or certain techniques that they use, and get up to speed really, really quickly. Do you think that that is possible to then also help improve the cohesion that you have sort of this knowledge base that you can tap into and very quickly understand how an organisation functions. Ben Darwin 54:29 I think I was looking at a study the other day, and I'm not going to quote it directly, but it was talking about most knowledge acquisitions done with 80 before 80% of the time it's done on an informal level. You know, it's the the conversations at the water cooler, so to speak. So I think that, I think that you can optimise that structurally. I'm really interested in German companies, the way the German boards are built in that you have to have people who are on the floor. And I was, you know, looking at Mercedes and Ben. And you look at the CVs of their of their board members, and they're like, you know, Gert. Gert began as a 15 year old intern with BMW, right? And you think about when a decision is thrust upon an organisation like, we're going to switch to this type of tool set. And Gert can say, I remember we did that in 78 9107, and 14, and it only worked once, because of these were the circumstances. We did it slowly, whatever it might be, yeah. So I think that that creating structures that retain institutional knowledge is the most important component of that. And then I think that the way that Australian companies are generally built is this kind of, I'm not going to call it a plague, this kind of scenario of non executive directors on the board, the adults in the room, so to speak, who, and there's different forms of them, absolutely, and they provide a fantastic service. But I think there's always a danger if you have a CEO who is the main font of that knowledge and memory, right? Is you need that memory on your board. I think it's extremely important. Because when the big decisions come, and I remember talking to a board and the AFL and we presented to them, and they said, this was so good, you should have been here five years ago. And I said I was, but none of you were in the room, right? And now we're still having the same conversation, right? Five years later, yeah, which can be, you know, we never name we don't, we don't, some some companies we work with name us, but we don't tend to name who we work with, except if, if I'm sort of presenting to a room up, but I won't, we won't put it up publicly for a whole bunch of reasons, because sometimes they just don't listen at all. Yeah, and one of the questions I actually have for board members is, why are you on the board? Are you on the board so you can tell your mates, are you on the board, and would you be comfortable for this company or team to fail, you know, while you're here, but be successful later, and you not to get any of the responsibility for that. Like, what's the most important thing out of this? You know, if, if you're not winning today, but you're winning in five years time, permanently. And I'm, I've actually got this idea about coaches, which is that coaches should be rewarded, but only for the wins they have five years after they retire. Yeah, because they, you want them to be thinking about that, about how they set up the team for success further down the track, and that needs to be their kind of be all and end all in a way, because otherwise you're just self interest, right? You know, the nature of our work is, is trying to understand self interest. And I've, I've had scenarios where we've talked to coaches and they've said, one, I don't have any permission to do what you think we should do. That's fine. So maybe we need to have a different conversation about this, about how we have success. But also is that that sometimes people want organisations to fail after they leave. Yeah, they don't want to set up for long term success for a whole range of reasons. Right? Revenge is pretty sweet sometimes. So it's, it's needs to be about who is the person who's looking after the long term success and isn't thinking about self interest. I think a lot of self interest is inadvertent. The other part is, and I'll say this, and you know, put this to other other It can't just be about sport. Is that we, we've been presenting to coaches who are performing extraordinarily well, and we actually saying you need to understand you are not necessarily the coach you believe yourself to be . Wouter Klijn 58:29 Or the reason for success. Ben Darwin 58:30 Yeah. And so they're like, Get out of my office, right? Because they're, they're renegotiating their their lease. In fact, there's a great study I just saw from the University of California. I'm going to get this wrong. They did on monopoly. And what they did is they they flipped a coin at the start of the of the game, and the person who landed on heads, they got two dice and got 200 every time they passed. Go, yeah. And the person who who had tails got $100 and they got one dice. So they weren't going around as fast, and so inevitably, the person who had heads would win, yeah. And they did it 180 to 80 something times, and the person with the heads, I think, won all of them. And they would start talking down to the other person, right? Yeah. It starts sort of cheating. Did I present this at the conference? Wouter Klijn 59:18 Yeah, you did. There were some videos where you can see them just becoming more and more rude, but Ben Darwin 59:24 yeah, and they asked the person at the end, why did you win? And none of them pointed to the coin flip. Okay, that's coaching. Yeah. No one wants to know when the when the The coins are stacked in their favour. So it's like their favour. Wouter Klijn 59:37 That's a big discussion, also in investment industry, right? When you have successful fund managers, are they just lucky, or are they actually doing something that is better and repeatable, or is it just how the markets played out? Because often you see that investment decisions are made and implemented for entirely different reasons than what it's. Played out to be, even if it's a successful trade. And I think there's a sort of a famous example that we've heard is where a fund basically took a position based on the idea that Hillary Clinton was going to win the US elections over Trump. And of course, Trump won, but the rationale behind the trade was, well, if Hillary wins, is great for markets, and we're going to make money out of this. Well, Trump won, and the market still went up, so they still made money, but for completely their own reason. Yeah. So is that like, is that skill? Ben Darwin 1:00:30 Well, the thing is, too, is that then what happens is, because you've you've theoretically now good at what you do, then you get the good trades, right? You get the good information comes to you, particularly in startup investment. The other thing. And I might be wrong about this, but I believe there was a report out of a company that had, you know, like online trading, and they found the best investors were people who either died or lost their login because they hadn't they they weren't making any changes, right? Wouter Klijn 1:00:57 Well, there's definitely correlation to super funds there, because some super funds offer their members self directed options where they have a certain percentage, and it can be quite high. It's up to 60 to 70% of their portfolio that they can invest themselves, and they can invest it in single names, also within bandwidth. And invariably, they do way worse than their just default option, because they just chop and change and incur fees and get out of trade at the wrong time, or get into trade at the wrong time. And usually it is driven by trying to change return, and you're always too late when you do that. So there's definitely a correlation there as well. Maybe to sort of finish up, what are you working on towards future research? Any new areas that you're looking at? Ben Darwin 1:01:46 I'm a really big believer in the turn of phrase. I think it's the stonemasons creed. You know, you keep hitting the same spot, and if you want to break the stone, it's the 100th hit that breaks the stone. So and everyone forgets the first 99 they go, Wow, what a great blow. And it's like, it doesn't work like that. You have to keep going at it. So what I'm finding is, the more we look at the work, the more we keep focusing on the same thing, the more we discover. So it's more of an iteration. And I think about guys, you know, who make the samurai swords. Yeah, you know, they do it for 30 years, and they can understand, Okay, well, if I do this many folds of the metal, it creates this brain, and if I stoke the fire in this way, and so you make mistakes and you improve it, and you make mistakes and you improve it. What we're trying to do at the moment is, in all of the systems we have, we're trying to break it, keep trying to break it and find Okay, so what does the Auckland Football Club, for example, doing well in their first year? What does that tell us? So what's the truth of performance? That's always keeps coming back to for us? What is the truth of performance? And I think one of the great challenges has been, is to keep on questioning the way things are done, particularly in trying to prove things out. And I think through conversations with my mom and that experience with the Peter Drucker experience, yeah, it tells me that just because something is studied and done doesn't necessarily mean they're getting it right, and that applies for us too, and and we need to look at things again and again in the most objective way we can say and begin with, okay, what do we actually know? And everything else is on the outer until we really feel like we can prove this out. What I would say is that we're slowly but surely expanding the different things in which we're looking from and learning, but the for me, you know, there are accountancy firms who are the Canterbury crusaders of accountancy firms, and there are accountancy firms who are the West Tigers of accountancy firms, and they have more in common with each other, yeah, right, than they do the other accountancy firm, right? And I think one thing that is quite interesting is, is how all of this comes from governance, and where it begins from. And I think a structure of governance is where I'm kind of looking at a lot. At the moment, you create conditions. There's a there's a great example of this in rugby league. So the Paramount eels had a lot of success in the 80s and 90s, not perfect by any stretch, but I think they won 58% of the gains, and they decided, because of fundamentally, the dominance of one person in the club, to kind of limit the limits the the tenure on their board. And by simply limiting the tenure of their board, they then went through like 11 CEOs and nine different coaches in 25 years, and went from 58% winning record to 36% winning record because everyone wanted that success inside of that tenure, right? Yeah, so for me, it's what the structures do through good decisions, and what are the long term ramifications of those structures. And then. How can we create structures? And the other part that I think I'm really learning is that, you know, we go to this notion of good and bad culture and good and bad people. I kind of everyone fundamentally, I think, believes they're doing the right thing. Most of the time, they just have a different version of what a good thing looks like. And so, you know, we've had so many different conversations with organisations. We've just been like, my god, you people are you look incompetent, but they're not incompetent. They're just dealing with a really difficult structure. It's making them appear to be incompetent, or also maybe, maybe they're making them appear to be extremely confident, competent. Okay, and let's not over believe that they are necessarily fantastic at what they do. Maybe it's the scenario of that. So with kind of there's an evolving view for us that cohesion is an outcome as well of of other components, and it has obviously a set of ramifications, but everyone's doing their best. Wouter Klijn 1:05:59 Yeah, so it's not simply a matter of sending somebody, a team, away, if we can to do some team building exercises, play ultimate frisbee and they come back as star investors. Ben Darwin 1:06:11 Well, unless your job is to play ultimate frisbee, that would work. But, but literally having this conversation right now internally, you know about what that stuff does. I think, I think developing interpersonal trust is great. I think developing clarity is better. I think doing the thing you're supposed to be doing is best, right? It better to just get that process right first, then the fun comes later. If I walk into an office, I see a table tennis table, I walk straight back out the door, no interest. People just put stuff on it, right and it's noisy. Get rid of it. Wouter Klijn 1:06:43 Yeah, fair enough. Well, Ben, we could talk about this for another few hours, but you've been very generous with your time, so I'll let you go. But thanks very much for this conversation. It was fascinating. Ben Darwin 1:06:55 It's absolute pleasure. Thank you. Wouter Klijn 1:07:12 Thank you for listening to the [i3] podcast. For more information, please visit our website at www.i3-invest.com and don't forget to like, subscribe and review. Thank you very much.

Eduard van Gelderen is Head of Research for Focusing Capital on the Long Term (FCLT), an organisation that was established in the wake of the Global Financial Crisis, or Great Recession as it is known in the US, to move away from a so-called "quarterly capitalism", which arguably contributed to the crisis, and towards a true long-term mind-set. Van Gelderen joined FCLT in 2024, after spending over six years as the Chief Investment Officer of pension fund PSP in Montreal, Canada. He is also well-known for his role as CEO of APG Asset Management, the investment arm of pension behemoth APG, in the Netherlands. In episode 113 of "Conversations with Institutional Investors", Van Gelderen discusses whether private equity can be a model for long term investing, dealing with concentration in portfolios, decarbonisation and the rise of A.I. Enjoy the Show! Overview of podcast with Eduard van Gelderen, FCLT 03:00 In 2026, FCLT celebrates its 10 year anniversary 04:00 When I was CEO of APG AM, we became one of the first members of FCLT 05:00 Three things are important to me: innovation, strategic thinking and having an impact 07:00 Dominic Barton of McKenzie and Keith Ambachtsheer and long term investing 08:00 If corporates are too short-term focused, then they will not invest enough in truly value generating projects 11:30 I do like the private equity model, but they still look to exit in about five years. Is that really long-term investing? 13:00 One of the nice things to see when I moved to Canada is the difference in board composition 17:00 Is passive investing leading to fragmented ownership and therefore less stakeholder engagement? 18:00 If you really understand the business models of the companies you invest in, then you can be much more concentrated and still be diversified 20:00 Diversification is possible, not with a small number [of assets], but definitely with a more limited number of names than the index 23:30 Sectors that are carbon intensive will need to do something or they will be punished, weather it is by governments, or regulators. For investors this means there is a financial reality here 24:00 But at this point the carbon price is too low for investors to make a decision 25:00 If I diversify over different sectors, then I need to use the less intensive sectors to hedge what I do in the carbon intensive sectors. That is a portfolio construction question 26:00 Stranded business models: It has happened before. The ones that reacted to all the opportunities that the internet offered became the winners, but there were certainly companies that completely missed the boat. I'm convinced that we are going through the same cycle again. 29:00 I don't think A.I. is just a toy; I think it is going to disrupt a lot of things that we take for granted 31:30 How will A.I. impact the business model of an investment manager? There will be operational efficiencies, but where managers are not yet very advanced is about 'How can we do advanced analytics?' And it is not just about alpha generation, it is also about portfolio construction, risk management and trading 35:30 I do think we need to rethink diversification in the current uncertain environment 39:00 Upcoming research projects: future fit boards and proxy voting 43:00 I truly believe that public and private markets will merge at some point; it is really a data issue Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights

In episode 111 of the [i3] Podcast, we speak with Michael Weaver, who is the Head of Global Real Assets with the Australian Retirement Trust. We discussed the role of real assets in the context of a multi-asset, pension portfolio, the ever-lurking threat of inflation, the return of office property and more. Please enjoy the show! Overview of Podcast with Michael Weaver, Head of Global Real Assets, ART 02:00 Role of real assets in a multi-asset portfolio 03:30 We don't call them mid-risk, but it is a similar philosophy 06:30 Inflation: what we are most worried about is unexpected inflation 08:00 We would expect to grow our infrastructure portfolio in Australia, but also internationally. 09:00 Benefits of larger scale, post merger 12:00 Massively expand the real asset team, no. But expand yes. 16:00 Retail and Office property: we are actively looking at new investments 20:00 Did Covid wobble your confidence in airports? Wobble is probably a good word. 25:00 Impact of data centres on power generators 27:30 Multi-family, build-to-rent property 33:00 Energy transition assets Follow the Investment Innovation Institute [i3] on Linkedin Subscribe to our Newsletter Explore our library of insights from leading institutional investors at [i3] Insights