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Erika van der Merwe (Erika): What does it take to run an investment team in 2022? Very little of what we see today in financial markets, in central bank policy and fiscal action is business as usual. Well, we invited Victor Verberk and Mark van der Kroft to tell us how they are positioning their investments right now. Victor is Robeco’s CIO Fixed Income and Sustainability, and Mark is CEO Fundamental and Quant Equity. Welcome, gentlemen. Really good to have you on the podcast.
Mark, as you look to the year ahead, do markets and the outlook seem more uncertain than usual, with so much that's changed fundamentally in recent years? Does it at times feel especially challenging to make firm decisions?
Mark van der Kroft (Mark): It's almost every year the same. I've never had a year in which you start thinking: oh, this is an easy one. And I notice almost everyone is saying this year is going to be very difficult. And I think the only thing what might be different this time is that we are talking about a few things coming together at year end. And maybe that makes this year a bit more challenging or more people looking it into, oh, there's a lot of uncertainty. It's, you know, it's still Covid, but it's also the change, a bit of a paradigm shift in central bank thinking, high inflation. These are things that are all coming together in the last two, three months of last year and that is now the key thing going into ‘22. And I think because it's such a big topic, it makes it feel as if it's much more uncertain than in other years. And at the same time, you can also argue that maybe it's less uncertain for the simple reason that we now, for example, have clarity on central banks, what they will do going forward in 2022. So, it's the balanced answer, I would say.
Erika: Victor, your last Credit Quarterly Outlook was entitled ‘Imperfect information and imperfect foresight’. And I believe that was a title that you selected. So how do you invest under these circumstances or is it, as Mark implied, this idea of perfect information and perfect foresight is merely an illusion.
Victor Verberk (Victor): Well, indeed, we have noticed that policymakers, politicians and central banks have intervened massively in the economy, of course, and the Covid fallout was huge and the intervention was huge. And then we have new phenomena like ‘the great resignation’, as we call it in the US, that are discouraged workers that do not come back to the labor force. That’s a new phenomenon. So indeed, it was a little bit more blurry than normal to make forecasts for economy and credit flows and inflation and stuff like that. So, yeah, imperfect information and imperfect foresight. It was a little bit more cloudy than normal.
Erika: Mark, given all of the movement that we see and the impression that we seem to be at various points of inflection right now, how do you cut through all of the noise? And how do you know indeed, what is structural or cyclical or simply something that needs to be ignored?
Mark: Yeah, I think that's the most difficult part when you talk about investing, right? To distinguish between structural trends and noise. I think the way we try to do it, or the way we do it, is within our different investment strategies, we clearly get away from the noise by sticking to long-term investment beliefs we have. And that is not easy. But that's the only way you can avoid getting caught by the noise and being led in your decisions by short-term behavior or short-term market movements. So for example, if you look to the way we are managing more of our fundamental strategies that are really based upon longer-term secular trends or longer-term views on where we think business models are changing. So by definition, that is a long-term view where you really cut through the noise and don't try to look at it on a day-to-day, week-to-week basis. And for example, if you look to our quant strategies, there it is much easier, because there you take out all the emotion by being 100% rule based. And there it's, I would say, easier to stay away from the noise because you stick to proven academic factors. And as I said, it's a 100% rule-based way of investing. So there it is pretty easy to do, but even there you can get a lot of noise in the way you are performing and the way people look at you. So it is a tough one to deal with. And certainly when markets are becoming much more volatile, you get huge swings. I think the trick is for most investors to stick to what they believe in, stick to the long-term plan and don't change course to what they have formulated as their investment philosophy.
Erika: I just want to stop at one point you made now. You said there could be noise in your performance and how people look to you or perhaps react to you. Are you talking about this idea of always needing to perform on a monthly basis, even? Like CEOs that publish results on a quarterly basis?
Mark: Well, yeah, that's always a risk in our business, right? People look at calendar years, people look even at quarterly results, clients demand us to outperform. Not always, of course, on a monthly or on a quarterly basis, but they still expect you to show an upward line and that's not always the case. No one has this perfect foresight and in that sense you really must be stable in the way you think and act, in particular act, and not get sideswiped by this noise.
Erika: Moving on to the inflation outlook, it seems that central banks are finally at the point of accepting that inflation could be higher for longer. And there have been some dramatic about-turns in their language, particularly if you, for instance, follow the language from the Fed from around about September last year till more recently. Quite a change in the messaging. And we could debate your views on inflation at length, and I'm sure you might have different views on the outlook. But the key question is, Victor, how are you positioning your portfolios right now, given what you expect from inflation?
Victor: In general, with respect to inflation, a little bit more is better, normally. But too much is not good. So if it is too much, you get capital flows, central banks that become nervous, you get the chance of policy mistakes, too much hikes, or too little hike hikes, or too late. So we do believe it will moderate a little bit. It is transitory, but we also see signs of spill-over effects into wages, and to come back on this ‘great resignation’, you see the labor force shrinking somehow or at least the part of the labor force that is offering their services. And we have seen the low point in inflation, we are convinced about that. Runaway inflation, like the 1970s, you need much better unionized labor forces and less globalization, and the internet technology is causing deflationary pressures also. So we are not afraid of runaway inflation, but we have seen the low point. And that's what we do in the good times, we do research. So also to come back on the former point: to combat short termism, as we call it, you do the research in the good times, so you can trust your research in the more difficult times. So we know when things, when the risk premia are there to take and when not. And that's the same for inflation. If it is moderate, it's fine. If it is too much, we know what to do, so we are prepared for then.
Erika: So Mark, what is your research, or the research of your various teams in your domain, what does that research show about the implications of inflation? So, for instance, high inflation, depending on how it rolls out, could be trickier for your growth-orientated portfolios and investors, but perhaps really positive for your more conservative quant strategies.
Mark: Well, that is true. That's normally what you see. I mean, I don't think that there’s a 100% relationship between inflation and the way our strategies perform, that depends a bit. But it's true that in general and certainly where we currently are in the cycle, that if inflation is really at the levels it is and it is not showing signs of coming off – and I think it will, as Victor is saying – but if it's not coming off, then you have a clear risk to the growth stocks, which have a long duration and therefore much more vulnerable to any action stemming from central banks due to higher inflation. So in that sense, and that's also what we've seen in the past couple of weeks, our strategies which have really this growth-oriented bias are clearly being hit by the fear of inflation and the consequences for central banks, indeed. You know, taking off liquidity and leading to higher interest rates. And that is certainly hurting that part of our business.
Erika: I'd like to tag onto this discussion around inflation on TINA: ‘there is no alternative’, sort of the search for yield. Mark, starting with you. How does that fear or this hunger for yield affect your strategies?
Mark: Well, I don't think it changes the demand to the several strategies we have. We have this TINA, I mean, TINA is positive for equities. I mean, that's what it is, right? There is no alternative. So even if valuations are high, you cannot park your money somewhere else. Govies are giving you a negative return. Cash is giving you a negative return almost, except in some countries. So people are easily enticed to go to equities. If inflation is running high, then also equities may be a better hedge because there you have companies who are able to pass through higher prices into their prices. So in terms of margins, that will certainly help some companies as well. So in that sense, equities in itself can be a good hedge against inflation. If you translate it to what's beneficial currently to our strategies, what we do see indeed is where growth stocks are being hurt at this stage and there is more nervousness in the market, that we clearly see that our value-based strategies and in particular our conservative equity strategies are doing very well and really are outperforming their respective benchmarks. So it is leading to a shift within equities. But it's not, per se, being a big negative or so within our strategies.
Erika: And TINA from a credit investing perspective, Victor? I recall that TINA also featured in one of your recent credit quarterly outlooks.
Victor: Yeah, for many quarters we have been writing about TINA, ‘there is no alternative’. We started writing about it about a year ago, I think. So what's happening is that already for years, you see central banks pushing down yields, especially real yields causing ‘there is no alternative’. So there is going on some kind of a stealth flow from risk-less assets into risky assets and in extremis, of course, into growth equities, internet stocks. But in general, every risky asset had benefited: credit, equity, art, antique, bitcoin. So it's all out of money markets, out of treasuries, into stuff like that. And to me, that is the biggest risk, which is underappreciated by markets. If we get a hump in inflation, which is bigger than we think and central banks might become scared, then more rate hikes than expected could cause this TINA to really stop singing. And in that case, you know, this stealth flow into risky assets could reverse. And normally markets are driven much more by flows than it is driven by fundamentals. So that would be one of my biggest concerns for risky assets.
Erika: Looking to climate. Climate has in the space of about two years become one of ‘the’ investment themes. Now, Victor, a year on from Robeco’s net zero pledge, what's your focus in this regard in 2022?
Victor: We can talk for half an hour about the climate without repeating ourselves. So it's about building tools, building databases, unlocking the data for all investment professionals and even the clients. So there's a technical element there, but the most important part of it, of course, is assessing which part of climate change is priced by markets. So it's a long-term, slow-moving thing. And if you look at the Green Deal from Timmermans in the EU, I think it's a ’24, ’25, '26 kind of plan for import tariffs, carbon policies, but markets look forward. So part of those policies are being priced in into markets, so it will cause winners and losers in the more short term. So that's the exciting part of climate and markets. It's not some kind of a theoretical exercise, it’s really about hardcore stock picking.
Erika: Mark, what about you? How difficult will it be for you as a business to move in this direction? Before you answer, here's Larry Fink talking to CNBC about his latest CEO letter.
Larry Fink: I had a great deal of frustration in 2021 about the means in which we’re moving forward. I wrote over the last few years about to move forward in a more sustainable, decarbonized world, it requires a combination of government and private sector. And that's just not happening. We are not seeing the totality of society moving forward together.
Erika: That's Larry talking about the global challenge, but perhaps you feel some of these challenges more to a local, business-specific level, Mark.
Mark: Yeah, I would say it's an anxiety and not a frustration. It can sometimes be a frustration for, let's say, portfolio managers who due to regulations feel that their universe is becoming a bit smaller, for example, due to exclusions or whatever. But I think we are in a period of, you know, big transition where everyone is seeing that we have to act. It's society, it is clients, and we as a company, we feel we have to act and we want to be a front runner in doing this. And as Victor said, I think it's all about here in, you know, collecting the data, getting consistency on data, doing your research. And we really have done a lot of investment in that area, but we’re still not there. It will be a very, very long road to get there, but we feel, and with me I think the whole company as well as the portfolio managers I'm working with, everyone feels excited about it. And again, it's not easy. The bar is really very high and it's not easy to get there. But I think we will, and we clearly have the ambition to continuously improve in that area. And I said, it's not an easy one, and sometimes, you know, it's a road where you don't know where it stops. But we feel we will take that road and we will succeed to get there.
Erika: Larry also responded to criticism that he's following a sort of a woke capitalism. Do you have views on this?
Victor: First of all, Larry writes great CEO letters. What I would advise him to change is his voting policy. Put your money where your mouth is, right? So there are a lot of asset managers that vote at shareholders’ meetings in favor of climate policies, for independent board advisors, for climate and greening the firm. And big investors like BlackRock are way behind there. So all respect for his letters, of course. For us, yeah, we set the bar high. We are very active in pushing companies and engaging with them. We vote, we support, I think, about 90% of the shareholder resolutions to speed up climate policies at all the companies we cover. Earth needs help. So we do not have that much time. 2030 is around the corner. So increase the bar and jump over it.
Erika: Time to switch gears and move on to our rapid-fire quiz. I'll be posting you short questions that require short answers, so no need for you to be too reflective on this. Are you ready? What's your biggest market-related surprise in 2021?
Mark: That yields were still so low.
Erika: Victor, Larry Fink says in his CEO letter that staff turnover and retention could be a major challenge for businesses in 2022. You also refer to that. Related to that, what for you are the top qualities for which you hire in your investment teams? What do you look for?
Victor: Contrarian people.
Erika: What does that mean?
Victor: People that lean against the wind. So if everybody is buying bitcoin, you question why they're doing that and if everybody is confirming yields are low forever, you question why.
Erika: Mark, going to you. The question is: how do you avoid blind spots when investing? Now, you did mention quant investors, and because it's model based, it takes out the emotion. But let's not talk about the quants right now. Let's look at your fundamental and your thematic investors. How do you avoid blind spots?
Mark: Continue to challenge, as Victor says, to continue to be finding people who lean against the wind. And that's the only way you can do that. Continuously be critical on your own choices.
Erika: Is that a mindset? Is that a culture? Do you have mechanisms in place?
Mark: It's both. I think it's a mindset. I think the people we would like to hire, and we hire, are having this. You looked for a diverse set of people who are able to challenge each other in that respect. And then it comes to culture. You must be able to criticize in a positive way the choices you make and to spend really time on that. And I think that's what we clearly try to do.
Erika: Victor, in recent weeks, what has been your best investment read, podcast or video that you could recommend? What do you enjoy listening to?
Victor: I almost eat research for breakfast. The ‘Great resignation’ from Morgan Stanley, a very new innovative kind of research. I like Lombard Street on inflation. There's too much to mention. The China real estate pieces from the local brokers, very interesting and market moving.
Erika: Certainly seems that breakfast time is an important time in your life. Well, on the sport note. So we know that you’re both very serious about sports, whether it's watching or playing. What's the biggest lesson that you've learned from sport that's applicable to the investment world, Mark?
Mark: I think what I learned from sports is that you really have to work hard every day to get to the best of your ability. At the same time, you should not always look upwards, because there will always be someone better than you are. And certainly in an individual sport. So at the same time, there are many other people who are not able to achieve it, but get the best out of you and then you can be satisfied with what you've done. If you for yourself have the feeling and I think that's the same with investment, if you checked everything around a company or a bond or whatever and really deep dived into what you think, this is the way I should invest, then you have done a good job. And whether the result is positive or negative, I mean, that's the nature of investment. That's the same with sports. You know, it's you can practice hard, the moment you go into the into a court like tennis, for example, you can lose. But it's the road to it, which I think determines your success and the way you can live with it, I think.
Erika: Let's move on to the performance in your domains in 2021. Victor, performance in fixed income, in your domain and in markets more broadly.
Victor: We had a good year, so Robeco’s assets under management outperform 80% of the time. That is one of the best years we had in a while. Drilling into fixed income, it was an uphill battle, so markets were very calm, so the beta choices were basically delivering very little. But under the surface, there was a lot of stock picking to do, so on equity value versus growth, but Mark will allude to that, I think. Within fixed income, you've got the Covid-recovery plays and the interest rate fears. Stock picking from cyclicals to non-cyclicals and Covid-recovery plays or more recently, recycling into financials because yields are rising. So it was an uphill battle in terms of there was no trend. And in those times, you try to harvest the research you do in the good times, and then sometimes you think, ‘oh why am I covering this company? It's boring, it's not moving’. But you have to be able to do that in the good times to benefit in the more volatile times and in the Covid period you monetize on that research you've done in the past. So it was a very hard work, stock-picking kind of year where we ended high in the peer group, but it was not the best year ever. You need market volatility for that. So that was about ‘21.
Erika: Mark, on the equity side, what did performance look like across fundamental thematic and quant investing in 2021?
Mark: Yes, I think if we look back to ‘21, we are pretty satisfied on what happened. I mean, of course, in absolute terms, equity markets had a stellar year with almost 31% return in euro terms. So that was great. I think there was a big dispersion between developed markets and emerging markets that clearly that was lagging extremely. In dollar terms, it was even a negative return. If you look to, try to slice and dice the market a bit, it's interesting to see that was a year with two faces, almost, where the first half was mainly driven by the reflation trade, with value and cyclicals picking up. And during summer, that took off again and value and growth almost ended at the same level in ‘21. So that was an interesting year to see. We have been able to really do that pretty well, I must say, in particular, if you look to the quant business, you mentioned it. Factors really came back in ‘21 and we benefit to a large extent within our strategies on the quant side, whether it's conservative, whether it's multi-factor, whether it's our value strategies. So we clearly outperformed our benchmark there. The same we could say in general for our fundamental equity strategies where the Asian and Chinese strategies did a perfect job and global remained roughly at benchmark. And thematics did a good job until the last 8-10 weeks of the year, where clearly the non-profitable growth stocks were really hit by this changing paradigm, almost, in central banks. So there we ended the year in relative negative terms. But overall, I think, as Victor said, with 80% of strategies outperforming, I think ‘21 can be a very good year, it was a very good year for equities in general.
Erika: Let's talk about China. How does the outlook for China affect your investment decision making in both your domains? We devoted much of the last two podcast episodes to China, when we spoke to Arnout van Rijn and Jie Lu, and also Morgan Stanley's Rushir Sharma quoted in the FT stating that China may have peaked as an engine of growth for the world economy, mainly because it's now become more inward focused with its new policies. China accounted for a quarter of global GDP growth in 2021, down from around a third before the pandemic.
Victor: Your former question was about sports. In sports, the biggest thing you learn there is losing graciously, so you lose and you think why and how can I improve. On China, I started warning about this debt bubble in China 10 years ago, so I was wrong ten years in a row and only now it plays out. And that is going to be a ‘22 story. China has way too much debt, 250-280% debt to GDP. It's a debt trap. It's a liquidity trap. It's all at the same time, so it will be a slow-growth period forward and demographics hurt also. So, they need to improve governance, transparency, see default cycles coming through, via the real estate sector, and that will transfer into the banking system and we know how that works since 2008. It will not impact capital markets directly because it's a closed-end system. But the impact on growth and inflation will be there, so a big part of global growth will fall away. While China was, of course, the locomotive of growth in the last couple of years. Maybe other locomotives emerge, but China is going into a slowdown for a while, that's my core belief.
Erika: Mark, any concerns from an equity perspective? You did refer to the good performance last year.
Mark: Well, I think there are a few burning questions indeed on China, as Victor is alluding to on the property side, for example. That's clear. The team in China is there somewhat more constructive maybe than Victor is saying here, in the sense that for the first half, we are seeing those kinds of problems. At the same time, we do think where the team is clearly more positive on how supportive policy will be going forward. Again, the first six months will be pretty volatile, but in the longer-term perspective they are more constructive. I think another risk which is clearly there in China is more on the Covid policy, the zero-tolerance policy. That is a bit of a wildcard because everyone is vaccinated or becomes immune around the world. But in China, that's clearly not the case, apparently, and that can still lead to some disruptions in supply chains. And that is something which can also be a problem going forward. The longer-term perspective, we do think that China still has quite enough potential for equity investors to be there.
Erika: In closing, gentlemen, with so much going on, we are looking at rising inflation, uncertainty about growth, surging debt levels and much more. What is it that you are hopeful about for 2022?
Victor: I hope bitcoin goes to zero and there is a reason for that. I think higher yields are necessary to get more realistic about behavior and saving behavior. There is a whole generation of young people trying to get rich as soon as possible. Betting on bitcoin and other stuff like that. And we just need higher yields, alternatives, so TINA needs to go. And so you get a little bit more volatility, better capital allocation and less bubbles of the future being built, for example, in real estate in the West. So a bit of a normalization of the whole thing. I think that would be very healthy for society. And maybe finally, I am looking forward to all people coming into office because I miss them and I've been here with 10 people in the office for the last year. It's time to go back.
Mark: Yeah, not so much to add to Victor saying on the last part, of course. I hope that on the Covid side, we really get rid of it in terms of, for everyone personally, but also for us as a company to be able to work again and be close together, and build your relationship within a company in particular for the younger people or the people who are not as long within our company.
Erika: Well, thank you, Mark and Victor. Really good to hear you, to hear your views and even to see you in person, albeit at a distance. Thanks for your contribution.
And thank you to listeners. Thanks for being part of this conversation. We'd love to hear from you. So please do send us your comments, feedback and suggestions to email@example.com. And you'll find all of our podcasts on your favorite podcast platform, as well as at Robeco.com.
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