Q: In that kind of environment, how should investors balance risks and rewards to meet their long-term goals?
A: People tend to get too optimistic about the broad level of economic growth. Then they don't adjust enough when actual growth turns out to be lower. If you think economic growth is going to be very high, you would invest in broad-based market indices. But we don’t expect high growth. Instead, we expect medium-term economic growth to continue to be in the 1.5% to 2.5% range on average. Not all businesses and assets will grow at the average rate, so you have to look for pockets of higher growth that will emerge. Then we think about volatility. When we're experiencing low growth, our sensitivity to shocks increases, the U.K. referendum being the latest example. So we have to think about the consistency of the returns that we get. How we allocate risk within a portfolio should not just be based on the highest expected return, which is probably equities, but the best combination of risk and return that we can get. Most of our work shows that investors can handle 8% to 10% volatility. Much more than that and they start to behave the wrong way, selling low and buying high. So we try to create portfolios that are much more stable and that have the correct balance between risk and reward so clients will stay with their investments for the long term.
Q: Brazil, a struggling emerging market country, is in the global spotlight this year as host of the summer Olympics. How do you view that market?
A: I think what's happening in Brazil is quite positive. Remember, this is a country rich in many resources, including its people. With the proper stewardship, there can be a tremendous future for the country. A country may have a rich store of human capital, but you have to find ways to help the people become healthy and well-educated. Beyond fiscal discipline, it’s going to be important for Brazil to spread wealth in its economy through the development of its people, infrastructure and private sector businesses. With better government, we should now be thinking much more brightly about Brazil than we were just one or two years ago.
Q: What about emerging markets more broadly?
A: Given the concern about low, slow growth structurally in the world, you have to look at where there are pockets of growth. One way to do that is to look at themes where there is growth around the world, such as the development of health care or infrastructure. Emerging markets are going to be at the center of both these developments.
It’s a mistake just to think about emerging markets geographically. We all got obsessed about BRICs (Brazil, Russia, India and China). When you create these acronyms or names like “emerging markets,” you're assuming a level of homogeneity about how they will act, and that's clearly not the case. So the trick will be to move beyond the country definition of emerging markets and take a more thematic approach.
Q: You've written about the trend of unbundling asset management products, separately offering the elements of beta, strategic beta and alpha to clients at different price points. What’s going on?
A: Consider the analogy of the cable TV industry. People don't necessarily buy the full package anymore. Perhaps my generation still does, but other people are now buying internet service and downloading the entertainment they want, instead of paying for a standard TV package. Similarly, in the investment marketplace, we will increasingly see investment products that are unbundled. You may want to buy the beta on its own and that's already a fast growing area — which investors may know as passive investing and which they should be able to buy at very, very low cost. Strategic or smart beta factors are harder to analyze and reproduce, particularly if you combine them together. They require more experience and more knowledge, and they're also slightly less common. Hence, while they are increasingly available unbundled from other sources of return, they will be priced higher than basic beta. Alpha is much rarer, but also more valuable because it has idiosyncratic return — meaning it is not explainable by reference to anything else, thereby offering better diversification benefits.
Q: Why is this trend of unbundling asset management products happening?