Thriving Amid Change

Thriving Amid Change
Excerpt from Milken Institute Asia Summit 2023

Are Investor piling on risk in search of returns?

I reflect back over my 40 years in this business, and I think the key thing that is absolutely stunning to me is the fact that with rates having been so low for so long, that investors have taken five times the amount of risk to get the same amount of return they did thirty years ago, which most of you know. And so, what we've all done as an industry, asset owners, asset managers, allocators, we have been really focused on diversification, so diversification at the high level of asset classes, and equities, and fixed income, and real estate. And so, from the asset class level, we've also pushed ourselves the past 30 plus years to diversify in investment approach. So, bulk beta, passive, liquid alpha, traditional active and illiquid alpha, privates and alts. And what I would say in managing all this risk, we've then built into our system the intensity of having to measure the risk, and so, and to hold all of ourselves accountable for managing that risk. Unfortunately, what's happened though, is that we've gotten a false sense of comfort of the micro measurement that we've built into the system at every single level. And actually, our measurement systems are not long term. They're very short term. And it is one of the biggest things that we have a bigger opportunity to change in the system. And we have to. Because if you add one more layer — again as you just heard playing a bigger game or playing a new playbook — but add and layer on sustainability and environmental and social and governance issues, and recognize how important it is to extend our time horizons to really understand that this needs a longer time frame and that we need to build new accountabilities and new ways to measure success. We’ll celebrate a hundred years of commitment to active management next year, but my biggest fear is that we've built a system to beat benchmarks over shorter and shorter periods of time. And there is no way we're going to allocate capital responsibly that way. So, I think the good news is there's a huge opportunity to step into the change. 

What are the dangers of short-term investing, especially in the current market environment?

You know, going back early in early in my career, the one thing that I . . . had been pounded into me, was the idea that the best way to manage risk, the best way to control risk is to extend your time horizons. And it sounds very simple, but I always call it, not just risk management, but it's time management. It's not just risk tolerance it’s actually time tolerance. And I think we've gotten away from understanding how important it is when we've dialed up so much risk in time, and I look more specifically at this idea that the industry is anchored around one-, three- and five-year returns as the marker and the end of the destination versus having markers to the longer-term destination. A full market cycle, if you look back even a hundred years, is seven to ten years and yet we are so anchored as an industry on three and five as the destination now. That has to change. Because again, with everything that we just talked about, in terms of really allocating capital, really capturing the economic opportunity of the transition of sustainability, it is all about extending our time horizons and being able to capture returns over the long haul. And yes, I couldn't agree more how important liquidity is. And I think today people underestimate — and I think back to the global financial crisis and how quickly our memories fade — but I do think time is that power of actually even pricing liquidity in a way into your portfolio that gets underestimated. I think the last thing I would just say about measurements is that there's this evolution we're going through where in the old days, the early 60s, 70s as an industry, we realized we needed to create measurements, accountability for taking risks. Then we've moved into, for decades now, in the alpha era. And then we've moved, extended the alpha era into the ESG era, and we're in this really messy middle of that today. But I do think there's this enormous opportunity to create a new era, a stakeholder era. The era of us as fiduciaries really recognizing that, “Yes, our job is to ensure that we run good pensions in a livable world,” and I'm quoting one of the largest public plans in the US. These systemic risks are investment risks and it's not a separate ESG thing over on the side that we're going to measure separately. It applies to every single business all of us own, and we do have to get more active and we need to be more engaged to understand what we own with other people's money. So, that's why it's important. Short term is trading, it's speculation. It's not managing risk.

How should investors adapt in this polycrisis era?

I don't think I've been more excited about the future, even though we're smack in the middle of polycrisis. And that's because I actually think everything we’ve talked about on the panel, whether it's sustainability in ESG and alternatives, is that the system is telling us that we need to change — customers, regulators. So, the pressure's on and I think there's this opportunity for really us to step into a more human-centric purpose as an industry, where we've been so focused on measurement, “you can't manage what you can't measure.” And that's right because that’s the quantitative side of the investment world, but it's actually taken over to, I think, the value creation of the future. I was talking to the head of one of the largest banks in America and we were talking about ESG with this idea that that ESG as a term needs to go away. It needs to go away because it needs to be built into everything that we do and everything that we invest in. And he said, “just think about it, Carol, this is the biggest economic opportunity since the industrial revolution.” It truly is. And so, again, I said it earlier, it's this idea of extending our time horizons to really capture the economic value of this massive transition coming off of the great acceleration we've lived in the past 50 years. And so, as an industry, we have this opportunity to change the middle between the end investor and the public or the private companies, whether it's alone or ownership. We've got this opportunity. We can't just keep changing companies. We've got to change ourselves in terms of the incentives and the measurements that are actually going to capture the economic opportunity.

 

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