I met Phil Zecher in New York in 2000. He had built a risk metrics company and was consulting for an asset manager I was working for. He is now heading the Investment office of Michigan State University. I must warn you of two things about him. First, he is by far the smartest, and most powerful brain I have ever known. There isn’t one topic he takes more than 5 seconds to understand, even the most complex one. Do not try, you will fail miserably. The second important thing to know, especially for our French readers, is that I happen to spend a weekend skiing with him and his friends. To be nice to us and my French girlfriends, they brought bread for the weekend. Bread dough you take out raw from a can that miraculously takes the form of a “baguette”. But honor is safe, since then he claims to make his own stock from chicken bones !
We are in 2040, how do you see the world around us?
First, I would like to thank you for asking about 2040, because my guess for 10 years’ time is always that things will be basically the same, but definitely not in 20 years.
Also, it lets us move past all the noise of the present moment, which always seems more consequential than it likely is over the long run. I’m not saying that events today aren’t causing a lot of real suffering, they certainly are, but 20 years down the road, a lot of what concerns us today will be just distant memories.
I would also like to emphasize that since I am a US investor, working for a US institution, with US liabilities, so my vision here is naturally US centric.
I see two important things that might have changed in 2040.
First, I believe we are currently at an inflection point in terms of globalization. An inflection point doesn’t mean that globalization will necessarily reverse, rather it is a pause. We will either continue to chase the cheapest way to produce products while ignoring the risks the pandemic has exposed, or countries will repatriate production. I doubt we return to the indiscriminate globalization of the past few decades. Why? I believe the pandemic will shape the behavior of Millennial and Gen-Z generations much the way the Great Depression shaped the views and behavior of people who grew up during that period. The hardships brought on by the Great Depression and the world-wide conflict that followed created a generation that valued thrift and savings, that rebuilt institutions, and understood sacrifice for the common good.
The younger generations today have not only had their worlds irrevocably altered by the pandemic, but many of them also grew up in communities decimated by the loss of work to globalization. It is almost cliché to talk about how the younger generations value work-life balance more than older generations and they want to know where and how the products and food they consume are made (and disposed of). I believe their values will make it harder for us to return to the blind globalization of the past.
"I believe we are at an inflection point in terms of globalization.
It doesn't mean it will necessarily reverse, rather it is a pause "
Of course, we won’t be repatriating all manufacturing; for all its ills, globalization also had positives. Rather, I see a path of partial repatriation, where producers will consider the risks of globalization that have been largely underestimated so far. Pricing in those risks should realign manufacturing from globalization into ‘regionalization’ where risks are less, and geopolitical interests are more aligned between producer and consumer.
And wouldn’t it be great if countries started to compete for business in part based on the quality of their governance, not just the cheapness of their labor? For the developed countries who have been the major outsourcers of production, this should create opportunities for investing in the rebuilding of production infrastructure.
But we don’t need to just rebuild and update our aging physical infrastructure, we also need to rebuild our institutional infrastructure, which requires rebuilding trust and is far harder.
“Wouldn’t it be great if countries started to compete for business in part based on the quality of their governance, not just the cheapness of their labor?”
Unfortunately, a lot of the labor disruption that began with globalization has been replaced by jobs lost to technology, which brings me to my second big trend: the technological revolution in broadband1, artificial intelligence and machine learning. I believe we are only at the beginning of a technological revolution affecting how we live and work that is comparable to the scale of the Industrial Revolution in the 19th century.
The future of work is at stake for 2040. The acceleration of technologies leaves few jobs for under-qualified workers, including many information workers that make up the broad middle class. This is an example of where our current, unexpected labor shortages should not be confused with long-term trends. Countries need to figure out how to employee these people in jobs that have dignity. We are already witnessing the development of massive wealth gaps that will continue to widen in the future unless we think about the future of work and find remunerated occupations for displaced workers. This is an economic challenge but also a political issue that has already fed populism and anti-globalization across the globe.
1: At this stage, Phil tries to explain to me the power of broadband. Using his nuclear physicist background to illustrate: “When I used to work in the Lab in Michigan, on nuclear detectors, the speed of our detectors (not really sure the speed of what to be honest) was 3 to 5 nano seconds. Now while we speak on Teams, the speed is 0.2 nano seconds. Do you imagine? The speed of light during that time it’s 30 cm. (At this point, he had totally lost me, and I am writing his example as I understood it, so very badly I am afraid). But we got the point.
How will the financial markets have evolved?
For public equities, I think we will continue to move away from active management to more passive and systematic strategies.
Market efficiency, the easy availability and flow of data, and insider trading rules have all made it impossible for fund managers to develop and validate the truly different views that have successfully driven active investing in the past.
It is the paradox of skill, as professional investors become more skillful, the more the outcome of stock picking depends on luck.
Conversely, private markets are, by definition, all about private information. In private markets, you can have unique information and knowledge that allows you to be better than others. But importantly, the game is played by invitation only, cutting out the small investors—who ironically are exactly the people the securities regulations are there to protect.
As long as those regulations continue to ratchet up the pain of being public, we will continue to see private markets flourish. I’m a physicist and understand that for every action there is an opposite and equal reaction. The corollary for public policy is for every regulation, there is opposite and unintended reactions. So, I would much rather see us revise or rollback regulations to incent firms to go public than pile on more regulations for the private market.
"It is the paradox of skill: as professional investors become more skillful, the more the outcome of stock picking depends on luck."
Another important, and I feel underappreciated, trend already happening is the move from tangible to intangible assets.
What matters now is the idea, the intellectual property, the brand. This idea has led us to weight more towards venture capital. The actual manufacturing of products has become a secondary factor thanks to technology and the ease of outsourcing.
This changes the relationship with capital. If you want to bring a new product to the market, you don’t necessarily need to invest a lot of capital in building a plant. And the technology that makes this viable today is also what is changing the future of work. Creating value with less demand for capital (physical or human) should keep rates lower in the long run. A short-term countervailing force would be efforts to repatriate manufacturing and modernizing the infrastructure, all of which will require significant capital. But the long-term trend is clearly towards the value residing in intellectual property.
What role will asset management professionals play in 2040?
A lot of what asset management professionals do today could easily fall prey to the trends I describe above for the future of work—particularly in the public markets. But investing other peoples’ money will always rely on trust, and trust is built by people interacting with people, even institutional trust. So, at the end of the day investing is still a people business despite all the algorithmic, big-data, high-frequency, passive index, etc., trading. And as I said before, the very lucrative private equity world is by invitation only, so building relationships is going to remain very important.
As with public companies themselves where the regulatory burdens and costs are high, public equity managers will trend more towards the biggest firms. When I first entered the hedge fund world 25 years ago, you could start a successful fund as the proverbial 2-men in a garage with Bloomberg terminals. Today, the cost of starting a new firm is much higher, particularly if you want to attract institutional investors. This will continue to favor the bigger firms and it is the big firms that will have the resources to develop and deploy the disruptive technology that could displace workers. Private equity, on the other hand, will continue to rely heavily on relationships, so those jobs will be less sensitive to automation. In 20-years’ time, I would expect big changes in the work force of large public managers, but little change in private equity shops.
Looking back, what is the biggest forecasting/anticipation mistake you have made?
In 2016, when I took this role, I really thought private equity was doomed. Coming from the public side, I believed they were too big, the fees were too high, raising too much money, and relied too much on leverage and financial engineering. I obviously was wrong. I didn’t appreciate the information advantage in private equity, nor did I appreciate how much the public market has shrunk in terms of the number of firms, which today is about half of its peak around the dot-com bubble.
But these concerns, and some of the ideas I mention before about the shift to intangible assets, did lead us at Michigan State University endowment, to refocus the private portfolio a little, focusing more on the smaller (read less public-like) markets and venture, which has served us well.
