Gavyn Davies is an economist and investor. His career includes working for the UK Government, Chair of the BBC, Chief Economist at Goldman Sachs, venture capital investor and Co-Founder and Chairman of Fulcrum Asset Management. He is also a columnist for the Financial Times.
Gavyn shares his memories of the 1970s, a period of high inflation that few modern investors and economists had the experience of working through. We discuss the parallels and lessons that investors today can draw from this period. He also offers his thoughts on what the tell-tale signs of lasting (instead of transitory) inflation might be.
Gavyn describes his experiences working with Goldman Sachs, He describes what changed and what stayed the same after the firm converted from a partnership to a publicly listed company.
The discussion moves onto Fulcrum, its investment philosophy and some of the tools that it uses to invest. Gavyn explains what Global Macro investing is and what it isn’t. He takes us through its evolution and gives us an insight into some of Fulcrum’s latest areas of research.
We conclude the podcast by discussing some of the biggest potential macro risks: Geopolitics, Climate and Inflation.
This podcast is for informational purposes only. It does not constitute financial advice or take into account the particular investment objectives, financial situations or needs of individual listeners. Listeners should consider whether any opinions or recommendations in this document are suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice.
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markets, macro, big, economists, global macro, equities, inflation, trading, central bank, economics, Fulcrum, investors, clients, Goldman, wage, portfolio, risk, period, pandemic, good
Daniel Grioli, Gavyn Davies
Daniel Grioli 00:11
Welcome to the Foresight Active Advantage Podcast Series. My name is Daniel Grioli. And I'm your host. And joining me today is a very special guest, Gavyn Davies. He's the chairman of Fulcrum Asset Management. His latest in a string of very long and illustrious career moves, which includes being a chief economist at Goldman Sachs, and a chair of the BBC, as well as advising the government in a variety of different roles. Gavyn, we're very honoured to have you here on the podcast. Thanks for joining us.
Gavyn Davies 00:48
It's a pleasure, Daniel.
Daniel Grioli 00:51
I'd like to find out a little bit more about you. Before we get on to discussing Fulcrum and global macro investing. How did you start as an economist?
Gavyn Davies 01:03
My now grown-up children would say I was a nerd at a very young age, Daniel. So, at about 14 or 15, I really started to be very interested in economics, which I thought was numerically driven and statistically driven. And I'd always been a cricket statistics nerd, actually. And that kind of translated into economics. So, I studied economics at Cambridge, and at Oxford as a post-grad, and was very lucky I was in the middle of, or at the end of a post-grad degree, and the British government changed. Surprisingly, in February 1974, the election was won by Harold Wilson, out of the blue, very unexpected. And he hadn't really prepared a team of advisers to go into Downing Street. So, by a circuitous route, I was invited to join his team of advisors and spent the whole of the five years of that government working in number 10, as an economic adviser, and I missed my exams, as well. What a shame. But in the world.
Daniel Grioli 02:25
What a shame. So, I noticed the date you said, you started in the early 70s. And I couldn't help but think that's a period that some investors may remember as being typified by some very high inflation. Actually, I was. I was looking at that yesterday, and I was looking at a chart of US inflation during the 70s. And it began around 3%, and then got to double digits about the time you started your career in government and then fell back down to 3% and ended the decade above 10 again, so it was a wild ride during that decade. Yeah. What was it like, as an economist to government during that period fighting that inflation?
Gavyn Davies 03:10
Well, it was frightening, I have to say, because that level of inflation, and then the consequences for unemployment, for the exchange rate for Sterling, and for the stability of markets, were really drastic. So, we knew we had to bring inflation back down back under control. And we didn't know really how to do it, there was no kind of proven mechanism operating through monetary policy and the central bank. So, all of that had to be invented in different countries. At different times, the person who contributed most of that, in the end, was Paul Volcker, at the Federal Reserve. And we took tiny steps in Britain to try and do that. But we went down lots and lots of bad paths as well, including price controls, that's direct controls over the company's ability to set prices and wage controls, which lead to strikes and disruption before we settled on monetary policy as the means to do it, and I think we did make some contributions in the UK. We figured it out eventually, but with a heck of a lot of disruption.
Daniel Grioli 04:31
We were talking earlier that your experiences are not shared by economists of more recent generations. Now, I think that oversight could potentially be costly.
Gavyn Davies 04:46
I certainly hope I hope not. But it is actually interesting, both with colleagues here at Fulcrum and with our clients that the younger colleagues aged 40 and below, don't have any kind of memory of this very, very bad decade in the 1970s, which was all really driven by a high inflation episode, which was allowed to get out of control. So, I think they tend to be, they tend to make policy judgments and investment judgments, which assume inflation cannot really be a problem. Whereas economists in my age, including many of the central bankers, of course, today, know, it can be a problem and are very determined to try to prevent it from becoming embedded in the system.
Daniel Grioli 05:41
We'll have to ask you some more questions about inflation later on so that we can get that perspective that I know I'm lacking I was, the reason I was looking at that chart earlier was I was trying to find some good information on that period, to sort of study, study and see whether there are some lessons that can be drawn to our current situation because there's this open question about whether the inflation we have now is transitory or something more. We'll chat about that a little bit more later on in the podcast. I wanted to ask you during that period, who were the interesting people that you got to work with?
Gavyn Davies 06:23
Well, in the UK at the time, economic policy, including inflation policy was set by politicians, and not by central bankers. So, the key people I would say, in the British government were Jim Callaghan, who was prime minister, Labour Prime Minister, Dennis Haley, who was the Treasury Minister, the Chancellor of the Exchequer at the time. And then, of course, overwhelmingly important was Mrs Thatcher, whom I never worked directly for. But she was very much in the orbit that I was observing. And I would say globally, Paul Volcker was the key person. So, you know, what happened between the middle of the 1970s. And the middle of the 1980s was that we managed to design a method of setting monetary policies such that inflation could be brought under control. That was not widely believed in the middle of the 1970s, but it worked and laid the sort of groundwork for the centrepiece of economic policy of a sense, which is that the central bank should set interest rates. And now quantitative easing at a rate that is consistent with 2%, average inflation, and that remains even now, the number one thing that economic policymakers are trying to do.
Daniel Grioli 07:58
So, we discovered the power and importance of economic policy. So, roll forward monetary, monetary,
Gavyn Davies 08:06
Monetary policy, Daniel. Yeah. And there are people there that, you know, there are economic historians that point to this as a very big realization, which was true, I think, before the war, as well prior to the Second World War, but sort of reawakening to the power of monetary policy and controlling inflation. And let's hope it's still true.
Daniel Grioli 08:28
Have we had too much of a good thing there?
Gavyn Davies 08:31
Well, I mean, maybe we have, because the central banks, at the moment are saying to two things about inflation really. One is that it is high but transitory. And the second is that if they're wrong about the transitory part, then monetary policy can be relatively easily deployed, to bring inflation back down again. So, the combination of those two things that they're saying sounds a little bit complacent to a person who lived through the 1970s. Because inflation than did not prove transitory. And it was very painful to bring it back down again. We're beginning to see some economists now argue that the central bankers are making exactly this mistake. So, for example, Larry Summers, who's one of my favourite economists, former Treasury secretary in the US, is vehemently arguing now that the central banks are making a big mistake, and that they should be acting now, to head off this transitory rise in inflation. Other Keynesian economists like Paul Krugman, another of the ones I most admire, think the exact opposite. So, there's a debate going on among economists who normally agree actually from the same school about the nature of this inflation episode. And I think the next six months or more will be the story of how this plays out. And that's what will determine the way markets behave.
Daniel Grioli 10:12
Are you looking for any particular signposts along the way over the next six months that would sort of tip your view more towards transitory or something more, there are the themes you're looking for?
Gavyn Davies 10:24
Yeah, so there, there are two, and let's focus on the US because obviously, the story is probably at its most heightened in the US already. One would be where inflation goes, in the near term, it's, it's over 6%. That's a big shock, by the way to the US consumer already. If that goes much higher, then I think the chances that it will trigger wage inflation and become embedded in the system get bigger. So just simply the path for inflation itself is going to be something that everyone is watching and is going to become really focused upon, I think even more. But the other thing that the central bankers are always emphasizing is inflation expectations. Because if 6% plus actual inflation turns into 5% expected inflation, then it will become extremely difficult to get that back down again. So, from the point of view of the current chairman of the Fed, or the governor of the Bank of England, or the ECB, it's expected inflation that they're watching most if that starts to rise further, and it has risen already, then they're much more likely to act, I think.
Daniel Grioli 11:48
And that mechanism that you described earlier, where inflation starts to show up in wages. Based on your experience, how long does that take? Is that something that's quick? Or does it take time before it flows through?
Gavyn Davies 12:04
Well, so I would say there's the experience of the 70s and 80s. And then there's the rest of the period since. So, in the 70s, early 80s, the impact on wages happened quite suddenly, actually. And it was when the labour market and in particular, in those days, the trade unions suddenly woke up to the fact that there was inflation, and that it would persist and that it was eating into living standards. And then pretty rapidly over a matter of a couple of quarters wage settlements jumped considerably and were a very, very difficult thing to bring back down. Even with statutory wage limits set by the government, it was very, very difficult, impossible to bring back down easily. Since however, let's say the mid-1980s, It's taken a very long time and hardly fed into wages at all. And I think the reason has been that when prices start to creep up and inflation starts to rise, the labour market doesn't see it as a permanent thing. So, you know, for example, the three or four oil shocks we've seen over the last few decades, never really fed into wages. So, it can happen without a problem. And at the moment, I have to say that the wage increases that we're seeing are not that big, actually. So, on balance, I would say that the central banks are justified in being cautious about tightening monetary policy. But it's beginning to push a bit at the limits, I have to say, and certainly, in the UK, the Bank of England was extremely close to raising interest rates last month could well do it next month. Probably not in the United States, they're probably still 6 to 12 months away. But the debate is moving now. Daniel, the debate is moving towards earlier, bigger action by several of the major central banks, not including the ECB. But the more inflation prone governments, not governments central banks are beginning to consider this a lot more seriously than they were. And they're under more pressure. From what I count as really admirable right-minded economists. Correct thinking I don't mean right-wing economists, yes, Correct-thinking economists to consider action on the grounds that if they delay too long, it will become a lot more difficult.
Daniel Grioli 14:56
Yeah, we're seeing that tension between the Central Bank and markets here in Australia, because the central bank is saying it's not going to raise rates until 2024. And the market has a rate rise priced in for the middle of next year. So yeah, there's a different opinion there.
Gavyn Davies 15:15
Actually, Australia is an example of where the central bank can kind of lose control over the market a bit in terms of market expectations. And I think, once you've done that, especially if you're the Federal Reserve because you're the central bank of the world, really, you have to worry then because you have to surprise the markets with your actions in order to, you know, bring them back to the path that you want them to believe in. And it's not easy to do that once the central bank has lost its power have control over expectations for interest rates, that's a bad place for the central bank to be. They're not there yet in the big central banks, but they could get there.
Daniel Grioli 16:06
One thing I've been hearing a lot about, and I'm not sure if it's the case in the UK. And I'm just wondering whether or not it fits in with this possibility of wage driven inflation is the great resignation. I've heard it called Yeah, where people just quitting their jobs. And to me, after having had various lockdowns and economic disruptions for two years, you'd think people would be quitting because they, they like their chances of finding a better job, perhaps a better paying job? And does that mean that there is going to be some of that wage pressure that you were talking about is that a tip of the deck could be coming or that two things are totally unrelated?
Gavyn Davies 16:55
Yeah, I think this is a really, this is a big issue, which I don't think is yet really fully understood. And an interesting, you know, development in the UK is that what was called the furlough scheme in the UK, which supported employers in the pandemic, to hold on to their labour force has stopped now. So, what we're about to see is the consequences of that. Are those people going to become unemployed and search for jobs? Or are they going to become unemployed and choose to remain unemployed? Or are they going to stay in their original jobs? And we don't know the answer yet to all of those things. So, we're, and in the US is true, too. So, we're a little bit in a quandary about whether the great resignation, which is happening, by the way, is going to lead to a permanent shrinkage of the labour force. And if it does do that, then the chances have a bigger impact on wages. And actually, a lower level of potential output in the economy, those worries would get more significant. In the US, it's interesting to look at the makeup of the labour market, a lot of people seem to be leaving the labour market. So, the great resigners tend to be 55 years old and above, they appear to be opting for retirement. And I don't know that they're going to come back, you know, it could take a long time to persuade them and a lot of higher wages to persuade them to re-enter the labour market. And if they don't, then the economy has shrunk in terms of its potential output because more people have essentially stopped working. And that could be one of the long-term bad consequences of the pandemic. And it could also be inflationary as well.
Daniel Grioli 19:06
And I'm guessing too, that the disruption to travel because this is something that we've seen here in Australia because we've largely had our borders closed for two years to the rest of the world that disrupt the disruption to travel means you can't bring new workers in either.
Gavyn Davies 19:22
Well, and also in some countries, obviously, there is increased regulatory control over migration. Most countries are kind of moving in that direction, I would say in the developed countries. So, the safety valve that has been the case in the major European economies of being able to bring in workers from emerging countries at lower wages than the indigenous workers are willing to work. That safety valve is looking more problematic as well. I would say in the UK, that's a big deal because, in the UK, Brexit has caused a lot of EU workers to return home and has closed the door on incoming EU workers at the same time. And that is causing wage pressure and labour market shortages, employment shortages, especially in service industries, we’re failing that very, vary significantly. So there do seem to be a number of inflationary issues developing at the same time as they developed in the 1970s. They're not all connected. In the 1970s, oil prices were not directly connected to wages. I mean, indirectly yes, but not directly. But they all happened at the same time. And we are beginning to see that happening now to a lesser extent, but this is still early. And as I said, what I'm hoping is that we know more about how to just stop it than we knew then. we had our learner plates on in driver terminology on the car in the 1970s. And maybe we are with that memory a little bit better than controlling it this time, we'll see.
Daniel Grioli 21:23
Let’s hope so let's hope so. So, at the end of your period, working with the government, which I believe was the late 70s, you finished up with the government and went on to join Goldman Sachs and work your way up there to become Chief Global Economists. Yeah. So, what was it like working for Goldman Sachs would have been a culture shift? I'm guessing from Government.
Gavyn Davies 21:50
Yeah, a good one, by the way, was a good cultural shift. Goldman in those days was still a small investment bank outside of the US, it was big in the US and big by then in the bond market in the US. But I was still really trading international instruments, mainly for American indigenous clients who wanted to trade those instruments. And as I more or less when I joined, as I was joining Goldman, Goldman decided to really internationalize properly and become an indigenous player in all the major markets in the world. And in all the asset classes as well in bonds, obviously, in currencies in equities, investment banking, asset management. So, it was a fascinating time where I watched, in my mind, the best investment bank coming to markets that I was somewhat expert in. And that was, again, a very lucky thing for me, I think it enabled me to make a contribution to the firm quicker than otherwise, I would have been able to do. It was a very intense place, is still, by the way, has that hasn't lost that. It had and has, I think a culture all of its own culture of excellence, and hard work and focus on the bottom line of Goldman Sachs. So, you know, it's one of its secrets is that it's able to bring people doing different things in very different markets together to focus on the good of the firm. Even now, the firm is gigantic. I think Goldman has done that. And so, I have nothing but admiration. For the time I spent there. It was it probably is, you know, the formative part of my professional life and will remain so. And I'm very proud to have been part of Goldman.
Daniel Grioli 24:11
It sounds like a great experience. I'd love to ask you as an insider if your perspective on this. So, I read a great book called I think it was called “The Partnership” by Charlie Ellis. And it's the history of Goldman Sachs. And one of the things that I came away with after reading that book was this very strong impression that Goldman changed from there was a partnership period and a publicly listed company period. And the business was quite different and I believe, correct me if I'm wrong, you your career spanned both periods.
Gavyn Davies 24:55
Yeah. I left about four years after we did our IPO. So I was a little bit in the public company, period. But I was a lot more in the partnership period. And Charlie Ellis, whom you mentioned, there was a big fan of Goldman throughout. But I think especially during the partnership, so I think he may have got the impression from that book, that things changed, fundamentally. I mean, they did, but slowly, and I would say the main thing that changed was scale, actually, because we did the IPO, in part to enable us to expand more rapidly to grow our capital base, which until then had been done by us the partners directly. We thought we needed more permanent capital in the company, we may, we thought we may need to acquire companies as well, which was easier with the ammunition given by the share price. So that's why we did it. The scale did change very, very significantly, the firm is, you know, very significantly bigger now in all aspects than it was 20 years ago. Some people think it is less client-oriented than it used to be. Some people think it is less risk-averse. Although we did, we took some pretty big risks as a partnership to, I must say, in markets, I think legitimate risks, but we definitely took them.
Daniel Grioli 26:41
It seemed to be a firm that was always run by somebody who'd spent time on a trading desk. Well, I always seem to be a risk-taker at the top.
Gavyn Davies 26:51
Yes, of course, Goldman has another unique feature, which is generally speaking to leaders in every business, if not three. Somehow, people outside look at that and think you're crazy, you can't have two CEOs but we did, we had two senior partners frequently. And on the whole, they were gone from the trading division and one from the banking division is the corporate part of the business, the corporate finance part of the business. And they coalesced to run both sides of the firm. After we went public, for a long time, I would say the trading side of the business grew quickly. And we became more of a trading dominated firm. And then after 2008, it went back in towards balance again, as the trading divisions found it harder to maintain their previous growth because the market had changed. But I would say the What the I was going say the thing that I still notice about Goldman above all else the culture didn't change. So even though the firm became bigger, that culture of in my mind excellence and hard work, and one firm, was sustained. Now other people on the outside think we're kind of greedy. You know, we throw our weight around stuff.
Daniel Grioli 28:29
I’m thinking of some of the quotes like ‘Vampire Squid’ and ‘call your clients muppets’ and some of the things like that.
Gavyn Davies 28:35
I don't recognize any of those things. That's not my Goldman Sachs. But yes, some people do see that aspect, I must admit.
Daniel Grioli 28:46
Very good. So, I have to ask, you have to put yourself on the spot here. What were some of your better and worse calls as an economist at Goldman Sachs? Any stick out?
Gavyn Davies 29:00
The some of you I mean, some of ƒthe miss reads that I've made in markets are just embarrassing. Daniel. Let me pick a couple of policy things because it's kind of one old - one for me and one for the one against. And they're both about exchange rates and the Exchange Rate Mechanism. In the late 80s, and the beginning of the 90s, a very big issue in the United Kingdom was ‘should we join the Exchange Rate Mechanism of the EU?’ as a prelude to the single currency and I was in favour and argued in favour. And it ended in absolute disaster. We joined at the wrong level. We tried to protect our membership when there was a run on the pound that could not be you know handled. Interest rates briefly went to 15% to try to protect Sterling. And system, we had to leave the system in a very painful devaluation, which the government didn't recover from. So, I felt definitely bruised by that, that was a big call in the wrong direction in terms of policy with some consequences for markets too. But I feel slightly redeemed because a decade later when we had to decide - the UK had to decide - whether to join the single currency by that stage, and the single central bank, the ECB. I was not in favour of that. And I think that was the right judgment because I think if we had joined the single currency before the UK economy was ready to do so meaning before it had integrated and converged, more with the European Union economy, that would have that really would have created a catastrophic problem, where there probably would have been the need to break up Sterling from central currency. But the process of doing that would have been much, much greater than it was for the ERM, and much more painful. So, I think that was the right decision. A lot of pro Europeans, pro-EU British people don't agree with me. But I, I think we had learned, I anyway, feel I had learned from the IRM mistake in the 90s, not to join the single currency until Britain was ready to join properly. And we never, as it turned out, became ready to join.
Daniel Grioli 31:54
It's interesting to hear describe that sort of evolution in your thinking over time. And I guess that's really what we all try to do as investors are trying to learn and evolve. Take your thinking forward. So as interesting to hear a personal example from you.
Gavyn Davies 32:14
The first part, the first part, I have to say, was bruising because in terms of a very major policy initiative that I was on the wrong side of that was one of the ones I feel bad about. And I hope I learned from it.
Daniel Grioli 32:34
That's a very famous George Soros, Stan Druckenmiller trade, isn't it?
Gavyn Davies 32:38
Exactly. They learned the right lesson, which was it was not going to last. Although you know, you, you've got to admire them for taking that risk. But I thought the way they described it was too political, personally, but anyway.
Daniel Grioli 32:57
So, I want to ask you a little bit about the differences now from Goldman Sachs to Fulcrum because of being an economist, in a large firm, you're offering an opinion of view on markets, asset classes, to then becoming an asset manager where you're responsible for a P&L. So, there's, there's a very different focus in what you do. What was it like shifting from Goldman Sachs economists to global macro investors?
Gavyn Davies 33:34
Well, obviously, I mean, you can't compare the two firms. Right. So, I mean, I wish we could. Maybe one day, yeah, you know, maybe not in my lifetime, Daniel. But now I suppose my role has changed somewhat, but I, I don't see it quite in the way that you described it there. I've always been, clearly an economist, not a trader, or, or a, or an investment manager, and invest a pillar of the trigger on investments. And I did that at Goldman and I've done that at Fulcrum to I see the role of the economics group, both in Goldman in those days and now at Fulcrum to be providing the research and thinking that supports the trading decisions and the asset management decisions. And I didn't try to shift from being a professional economist to being a trader or a risk-taker. I did not try that. And I don't believe that I would have I would be very good at that. I think it's a different skill. But what I do think works best in my observation over a long period of time in different markets, is when the research and the trading decisions combine to form a judgment. I think it's more likely to be right when both of those skill sets come together. And the traders are more likely to take bigger and more convinced positions in the market when that's true. And that's the role. I think for the economics group. It's not to tell our senior risk-taker that they should be selling equities. I don't think that's our role.
Daniel Grioli 35:45
So, if I understand you correctly, you've never stopped being an economist, you've just switched your clients, your client is now an internal group of team members.
Gavyn Davies 35:57
Yeah, I mean, that's one way of looking at it. Of course, our ultimate clients are the people who invest in our funds. And those are the people to whom we owe our responsibility. But internally within Fulcrum, and within Goldman, we took decisions with the economics group thinking somewhat separately from the trading and risk-taking groups. And then the two came together not to take a joint decision because I think that's that is a bad idea. I think it should be clear who is making the investment decision, but then, in my opinion, need to be informed as well as possible by research. This isn't just economics, by the way, this is Company Research and on research as well. And, I've always believed that the research function is somewhat different and requires a different skillset from the trading function and the risk-taking function. And that's best understood. And if you do understand that, and both sides believe that then things can work. A lot of economists have always hankered after being traitors and taking risks in markets. Not always successfully, sometimes, but not always successfully. I don't think many traders want to be economists. But I don't know why.
Daniel Grioli 37:30
You reminded me of a very famous economist, Lord Keynes, whom he started out trying to be an investor didn't do so well, at first, but in the end, he got there.
Gavyn Davies 37:45
Well, you know, Lord Keynes, of course, believe different things throughout his career, both about macroeconomic policy and about investing. He, he was early on a few things. I mean, getting the kings in diamond into equities, was actually pretty early in the 1920s. Out of real estate into equities, big success. But he didn't get out before the great crash, and concluded from that, that you shouldn't try to time markets, economists can't. He said, time markets. And then he became a stock selector. And he was very successful at doing that. And took big risks in individual stocks. I couldn't, by the way, do that. But that's what Lord Keynes turns out he could do. And of course, by trying at least three different approaches. He found what worked for him.
Daniel Grioli 38:45
Well, it's good that he didn't give up. I remember reading a letter he wrote because he had a few different positions. He had the King's College, which you mentioned, but he also served as an advisor, a board member, I forget which to a couple of insurance companies. And in these letters, he was lamenting that insurance companies wouldn't leave him alone to do what he did at King's College and he couldn't get the same results.
Gavyn Davies 39:15
Yeah, no actually as King's Bursar. Well, he wasn't I don't think he was but he was working for the king’s college bursar. He was given free rein to run the endowment as he chose. And over the 20 years, he did it roughly from 1920 to 1940. It was a big success. So, to be fair to the great man, as usual.
Daniel Grioli 39:37
He came back in the second half.
Gavyn Davies 39:40
He thinks he figured it out. He figured it out.
Daniel Grioli 39:44
Yeah. I think even his own personal account because if I remember correctly, he got wiped out personally and had to loan money for friends. Yeah, but made it all back.
Gavyn Davies 39:53
Think you when into 1929 31. Crash, long equities probably levered as well. But I'm not sure that's true. But I think it may have been, and got and got dented. But he was a man who was hard to dent, actually. So, he rebounded very, very, very well. Good for him.
Daniel Grioli 40:16
So, I want to get your perspective on a couple of quotes about economics as a discipline, because I think it's interesting to reflect on what economics is good for, and what it might not be good for, and how it can help. And I'm hoping these quotes might help us explore that idea. So, the first quote comes from a book that I found very interesting, written by Humphrey Neil, and it's called “The Art of Contrary Thinking”. And he was one of the first American investors to popularize the idea of contrarian analysis. And this is the quote, it's he says, it's not that many proven wrong in their analysis, but that they may or may be proven wrong because of their influence. They may so affect operations and plans of businesses, and the public, that their forecasts fail to prove out. Collective action from United predictions often pushes the pendulum too far in one direction, thus, upsetting the timing and momentum previously expected.
Gavyn Davies 41:36
So, I think that's a warning against groupthink. And I think in markets, it's a, it is actually a very accurate warning, because piling into stuff that everyone else believes, almost can't work in markets, you know, you've got to be aware that, that you need to watch out for a trade that everybody's already in and about to change their mind on and you mustn't be late, you shouldn't be trying, you should really try not to be late into those trades. So, I guess that's what he had in mind. For me, the sort of contrary conclusion that you should always be contrarian is also not right, though. Because contrarian traders have a different pattern of P&L, though, they tend to make a long run of losses, followed by some very big gains, a much shorter period of very big gains. Whereas momentum traders, and this, this is most macro people really make a long run of gains. And then if they overstay their welcome, a large loss at the end. So, you've got to try to avoid both those pitfalls. And of course, that is market timing. And that is extremely difficult. But we have to kind of try that. Because if we don't tie markets, we might as well just don't passive exposure to the world asset markets and, you know, live like that. We are not trying to do that, although we do realize markets are hard to beat that is for sure.
Daniel Grioli 43:24
Yes, yes, you make a very good point that the market as a whole is right most of the time. So, you being a contrarian, for the sake of being contrarian is just going to get you in trouble. It's only those few points when things get to an extreme where it can work in your favour.
Gavyn Davies 43:45
Yeah, I mean, I'd rather it. If you talk to the really great macro traders, you know, the last three decades, we've made a huge amount of money trading macro, for themselves and their clients, and they tend to have somewhat similar trading styles. I mean, Stan Druckenmiller has, has, has repeatedly said, what his trading style is, which is to hold a strong opinion but hold it likely, likely meaning. I believe I'm quite convinced now but if the market tells me I'm wrong, I lose I you know, I begin to lose confidence in my own ability to beat the market. But if the market agrees with me over the next few months, then increase the size of the position probably through the options market. So, you're controlling your downside risk, and building a big position in things where you are convinced and where the market is still supporting you. And I think that is how many not all by any means of the great macro. investors tend to invest in’s that order of play, firmly convinced opinion. But watch the market carefully too because it will really punish you if you ignore it. That's for sure.
Daniel Grioli 45:12
I always chuckle watching Stan interviewed on outlets like CNBC because they'll ask him how he's positioned. And he'll describe his portfolio and then straightaway follow with, but don't listen to me because I'm probably going to change my mind next week.
Gavyn Davies 45:32
Yeah, I mean, it's alarming. Actually, the very great macro traders will persuade you on Tuesday, that something is clearly true. And then on Wednesday, they're selling it, they do the exact opposite because they've realized something else is clearly true. And I don't really literally mean change their minds overnight. But I think economists probably should spend longer holding the same view, if possible. Some of the great macro traders, do they definitely change their minds frequently.
Daniel Grioli 46:10
So, on this theme of macro, tell us a little bit about what led you to cofound Fulcrum?
Gavyn Davies 46:18
Well, we, two of us were leaving Goldman, at the same time, myself and Andrew Stephens, co-founder of Fulcrum. And we wanted to build a firm that we hoped would be excellent managing assets with a macro theme, not always macro-economics or macro, global macro strategies, but with a kind of macro-overview. And Andrew had been a very successful money manager at Goldman, and I had been Goldman chief economist, we thought we could work together well, and that is what has happened. And we've done many different types of things at Fulcrum. But we've arrived at a point where we think our sort of key strength is to build investment approaches, based loosely around a macro kind of understanding of the world. And that's unusual, actually, most, most asset managers don't have that we think we can attract very good people to work with that vision in mind. And I suppose if we have a USP, that is it. We've built a business that is growing, so far, so good.
Daniel Grioli 47:56
Yes, it's, it's grown very well. And you have some, some excellent strategies in, in multi-asset and climate. Now other areas, which we'll talk a little bit about later in the podcast. How would you describe the firm's philosophy, your approach to markets and how they work?
Gavyn Davies 48:18
Well, I mean, the number one, we're actually I, I would use that I hope all the people that are working at Fulcrum would recognize is humility in the face of markets. And, you know, we are not people who think it's easy to manage money in markets. There are very large numbers of other extremely able people doing this. The market price is a kind of referee, that sorts out all of those opinions. And you've got to be able, therefore to do better than the amalgamation of all that talent. And that is not easy. And I think the moment you think it's easy, and the moment you think it's like golf the moment you think you've got you finally found the secret of golf, and you can wack it 320 hours down the middle, you're about to do a triple-bogey honestly. So, humility in the face of markets, I think is one I do hope excellence is a feature of what we do. Our economics group now is far more excellent than I ever was in, in many, many, many ways of being an economist in the academic work they do in the econometric work they do.
Daniel Grioli 49:53
Do you put that down to anything in particular?
Gavyn Davies 49:57
We when we started to When we started to build our, our economics group, I suppose that was 15 years ago, really. We initially started with some Goldman people whom we had worked with at Goldman. And they came proven because we knew exactly how they would function. And there's still with us, actually, many of those, the ones that have joined us have tended to join us from central banks, on the whole, interestingly, so not from competitors in the markets, economics group that is, and therefore, they are people who are trained in what they would think of, and I would think of as really, you know, proper economics, economics that can, that can influence other economists as well as understand markets. And we have outstanding people that have wanted to work in the financial markets, but want to apply their skills as pretty serious economists to those markets. And I think if we have a particular sort of USP, that might be one of the ways of defining it.
Daniel Grioli 51:22
Can you give us a feel for some of the things that the economics team is working on - some of the ideas you're researching, some of the tools you may have built? I know you use ‘now casting’ in some of your work.
Gavyn Davies 51:38
So ‘now casting’ is a kind of specific term about an econometric approach, which has come out of new developments in the last 20 years in econometrics, which enable us to make very large amounts of data with different durations and different endpoints, and produce an S single estimate of whatever it is that you're seeking to estimate. So, for example, global economic activity, obviously, there's a zillion different series that can help you do that. What these systems do is actually daily, believe it or not, they give you a, what we think is the single best judgment of where economic activity is, today, measured as a, as a growth rate over a month, say, and we couldn't really do that some years ago. So, one of the issues that we always had some years ago, was to try to understand what the starting point was for the forecast. So, you know, even before we made the forecast, we had to argue for weeks on ‘what is today's state of play?’ and then the forecast will just reflect that really, actually. So now we've tried to get that part better, insofar as we can, I think we've moved away from the sort of big macro modelling that is done by the IMF and, you know, the Fed with very large econometric models because we haven't found that very useful. I think that kind of forecasting is very good in the middle of the economic cycle when you don't need it, right. So, you know, when you don't need to be told that in the middle of an expansion, the growth rate will be 3% next year. That's when that type of model will tell you exactly that. But it isn't so good at picking a big turning point. And the probably other ways that we're trying to develop a way of doing that and understanding that quicker in the pandemic that came really to the fore. Because there was a sudden, massive change in economic activity imposed by lockdowns. And we couldn't pick that up very easily or at all from official data of any kind because the official data was lagging a month or two behind and in a very big dislocation like that. That is too long. So, we started to use daily information from alternative sources, credit card information, for example. Google searches very big new sources of information at that stage, and other items of daily information we could find. So actually, the Nowcast became very short term because the really big issue was, is the US economy has the US economy shrunk by 25% or 15%. Now, you wouldn't believe, would you that you didn't know, where the level of US GDP was within 10 percentage points at any given time. But we did a huge margin. Yeah, I know, honestly, it was like alarming, right. So, things of that nature, we've tried to develop since the pandemic, since we settled down again, we're still using those things. The state of, you know, consumer sentiment on a very, very frequent basis, etc. Bill, we hope, with as much econometric skill as we can. My team has published in very, you know, the leading economic journals in the world, the American Economic Review, and, and many others. We have a leader for the team Juan Antonin Diaz, who is absolutely outstanding by any standards, and are among the best people I've ever worked with throughout my life. So, you know, we've got good people doing this. They're serious about it. And I think that's another thing I would say if you're not willing to do this 100% off with 100% of your effort, and ability, you won't succeed because there's some other guy out there or girl out there, women out there, who will do it with 100%. And you've really got to be you've got to be willing to love it. You know, otherwise, you won't be the best at it.
Daniel Grioli 56:48
It sounds like you do give that to you. You started your journey with statistics back as a 14-year-old.
Gavyn Davies 56:55
Yeah, I still love cricket more, mind you. But there you go.
Daniel Grioli 56:59
Well, Australia won the World Cup last night.
Gavyn Davies 57:02
So, there's only the T20 World Cup. Come on?
Daniel Grioli 57:07
We'll take we'll take this. I know it's pajama. It's pajama cricket.
Gavyn Davies 57:12
It is not. It's not the proper stuff. On the other hand, I'm not going to be around you for the ashes this winter. I'm not going to watch that. Because that is the proper stuff. And I've got a nasty feeling. It's, or you guys could play that as well, by the way, I've worried about it.
Daniel Grioli 57:31
It's good that maybe we can use some cricket analogies, because usually when you hear American investors, so baseball and fat pitchers and hitting over the plate
Gavyn Davies 57:41
I have no idea what they're talking about. No idea.
Daniel Grioli 57:44
We can talk cricket. Yeah, very good. So coming back to Fulcrum. I was thinking when you were talking about the nowcasting and some of the things that you're working on. They're obviously very data-intensive, they probably have like a machine learning angle to them. Does that mean that the proverbial Three Men and a Bloomberg just can't make money anymore? Is it now at a point where you need to have this industrial-scale tech machinery behind you?
Gavyn Davies 58:20
You know, I think you need the tech, there was a period where the PC on your desk was really pretty good, actually. And there definitely was a period where you could build a macro model, have quite a big economy like the US on your desk, he relatively easily. I think the data intensity of it has gone up now. So, it's harder to do that. And my, my econometricians think that I see, you know, a weapon in their favour, is the IT department that enables them to estimate things more quickly. Because you know, believe it or not, it can take a day or two to estimate the results of some of these models where you can't tell the market to freeze. While you're deciding whether the Non-Farm Payroll was good or bad, right? The market is not going to listen. If you say please stop while my model chanters in the background. So, they do think that it's important and it's becoming more important and I certainly think for systematic methods of managing money, the IT backing, and the computer backing, you've gotten the ability to, to work in the cloud has become a lot more significant. So, it is tending, I think to favour bigger entities that can afford that degree of technology. But in terms of human beings, I'm not sure you need I've never thought you need a massive team of human beings, in macro style investing. I think anything more than I'm going to say one to two dozen people actually doing it can be very confusing. And you can start arguing with each other instead of arguing with the market, which is what you should be doing.
Daniel Grioli 1:00:23
Do you think there needs to be a human element or? Do you think there needs to be a human element? Not purely systematic?
Gavyn Davies 1:00:33
Yes, I do. So this is the fashion of these changes all the time, right? I mean, go back to the 90s. It was nearly all not quite a discretionary human. Then models were built that seemed to be doing well, systematic models. Momentum based a lot of them CTA models were doing well. And there was a new fashion, which was I want the model, and I don't want human judgment on top of it, because the human will panic at exactly the wrong moment.
Daniel Grioli 1:01:10
It's like the joke about the portfolio manager, the dog and the computer. Have you heard that one?. So, you need the computer around the portfolio, the portfolio manager to feed the dog and the dog to bite the portfolio manager if he tries to touch the computer.
Gavyn Davies 1:01:30
There you go. So that was believed very widely, I think, I think now, so here's my view. At the moment, I think that the dichotomy between systematic and human discretion is less than it was actually, I think many, and we certainly are trying to really diminish that gap. So, we're trying to have models that inform human decisions and have humans that can see things that models are not necessarily seeing, and can judge when the model just hasn't been able in its past life, to see stuff. So, one example of that, actually, at the moment, we're trying to build systems that enable us to hedge inflation risk. And the team has come back to us and said, you know, one of the problems here is that there hasn't really been a period in the last 30 years where the markets have had to react to a serious risk of inflation. So, we don't have the same datasets that we normally would have. Now, they've still built the models. But when we use those models, we are aware that they're not necessarily as reliable and may need more human judgment than some of the other stuff we do where there are 30 years of daily data. So, we're trying our best to make our systems or not our systems our process, an amalgamation of the best of both of these things. Now, we've said that before, it's hard to do. But I think we're making some progress actually, on this.
Daniel Grioli 1:03:21
It's, it's interesting to hear your perspective of the importance of the two and in your answer, I couldn't help but notice you describing CTAs. And a lot of investors think of CTA is in some ways, is a close cousin of global macro. Yeah. How would you describe the similarities and the differences between the two strategies?
Gavyn Davies 1:03:44
Well, we've run CTA type strategies, and we've run discretionary macro type strategies. So, there are some similarities, Daniel, and I would say that one is that they trade the same instruments. I mean, basically, you know, those, the CTA, and the discretionary macro person, that trading about 200 kinds of instruments, futures, and cash instruments, and those are the instrument and commodities and currencies, and those are the instruments that CTAs trade as well. But and another similarity is that most discretionary macro traders, whether they will admit it or not, do have some element of momentum built into their process. Right. And the reason is, that's worked over a long period of time. So, and that is exactly what the CTAs do. them, you know, for a living themselves. But that's, those are the two similarities, the big, the big difference is that the CTAs don't try to have any kind of fundamental view of what's happening in the world or the markets or their economies? They are solely in general; this is price-driven. Right? So, they don't know that the Fed is meeting next week. And they don't know that there have been tariffs imposed on US-China trade, they don't know any of that. They say, who cares? I get all my information from the price. And that is different from discretionary macro, it is almost completely the polar opposite. So yes, there are some similarities, but I think it's completely wrong, actually, to see them as alternatives. Where you have to have one or the other, because they're going to give you a very different return stream and risk stream, I believe, from each other.
Daniel Grioli 1:05:51
Okay, Thank you for bringing out that nuance. Because I, I've seen a lot of investors in terms of how they think about, say, a multi-asset portfolio allocation, they'll create an alternatives part of their portfolio. And they'll often think of having one or the other within that alternative, because they see them sort of, as both diversify against equity risk, which is the main risk in that portfolio.
Gavyn Davies 1:06:17
That's not a bad idea, right. So, I do think they can both diversify from equity risk, but they are also, I honestly, look, look at their track record, they are also different from each other to or certainly can be a key time. So, they can, they can give you the advantage, they can both give you the advantage of diversifying, diversifying your main risk in the portfolio, your equity risk, but they won't do it at the same moment by the same amount. So, they're not doing it the same way, by any means.
Daniel Grioli 1:06:56
Sure. Global macro strategies had this fantastic tailwind several decades ago of higher interest rates because you're default, your do-nothing position gave you a decent return. And that has obviously eroded over the time, to a point where you, you are next to nothing on your risk-free investments. How has that impacted global macro? And if rates rise in the future? What might that mean for the performance of global macro strategies?
Gavyn Davies 1:07:35
Well, I'd say I agree with you. I think high rates in the past did favour global macro strategies. And by the way, a lot of other hedge fund strategies, if we're talking about global macro here as a hedge fund strategy, yes, which I would say is only part of, and not a big part, actually a relatively small part of global macro. But if we're talking about the hedge funds, then I think you're definitely right there, Daniel Lydic did help. But it helped, especially and in particular, because rates were trending downwards. And many macro traders were always long, the front end. So, whenever the front-end rate, forward, rates spiked upwards, the global macro guy would say, well, look, the long-term trend here is downward. So I'm going to, I'm going to bet that the trend will reassert itself and rates will fall. So, I think all of that came together to give the global macro trader a good period for sure. What would happen if rates rose, I suppose, you know, if they rise to more than two, the equilibrium rate, so they're now above what we call our star, the same process may restart. What happens between now and then depends on whether you judge the rise in rates correctly, right? Because the dangerous period is between the current and the higher rate equilibrium, we might move to that’s a difficult period for all markets, not just for global macro, but you're definitely right that now, global macro has to work harder to earn alpha, that is, market returns, returns over what the market gives you from the asset classes than it probably did when interest rates were higher. So, I agree with that.
Daniel Grioli 1:09:41
Okay, another question that people often ask of global macro strategies is that back in history you had some fairly maybe this is a poor choice of words, but yet some fairly large obvious trades, for example, the converse against the trade for European currencies. And these trades were big, they're in liquid markets. Yeah, every macro manager could sort of getting on these trades and ride it all the way up to what was a fairly certain outcome. And the question that people have now is these sorts of big, obvious trades. They don't seem to be around as much now. And they're wondering, I guess whether that impacts the performance of global macro? Is that a fair question? No?
Gavyn Davies 1:10:33
We certainly did benefit from some of those trades. That is for sure. But one of my little rules in markets is things are a heck of a lot more obvious ex-post ex-ante, right? Yes. So all of the obvious things that didn't happen, we forgot all about, you know, you know, what to think about those? The things that did happen, we think are obvious. Yes. So there's this massive hindsight bias in determining what's obvious or not, I really do believe that those trades, having lived through those traits, had many periods of going in the wrong direction, and people not believing them. People hedging against the tail risk that the politicians would change their minds and that eating up a lot of the returns. So they were easier in retrospect than they are than they were actually when you were living through them. So yes, in part, I would say to that one, now, whether or not such things will reassert themselves, I mean, who knows, but I would expect they will, the pandemic was one of them, actually. And a lot of global macro players had a terrific time, during the initial period of recovery from the pandemic, because they read two things correctly, one, the pandemic drove everything, policy responses to it, a true macro event where one thing drove everything right. And secondly, that the output losses would not be sustained. And thirdly, actually, that the change in the Fed at the end of March last year, was so profound, that it would rescue the system. Now, those were three good perceptions by more macro people than others, I would argue, and a lot of money was made by a lot of people in picking those up. So yes, some of those old trades look more obvious now than they did at the time. That we can have huge macro dislocations, you know, in the future as well, and I'm absolutely sure we will, and with the global economy, still globalizing? Really, I mean, you know, okay, there's been a problem with global supply chains, but we're still really globalizing, you would think a lot more of the shocks are actually going to impact all markets, and therefore be more suited for macro thinking, than for other types of investment management.
Daniel Grioli 1:13:22
On this topic of macro thinking, would you describe that as, or how would you describe it? How would you explain what macro thinking really is for you?
Gavyn Davies 1:13:41
Okay, so I don't think it has to be economic thinking, right? I think macro means that one or a few major forces are moving a lot of things in the financial markets. That's what I count as a macro. Usually, that's economics. Because usually, you know, the big economic things like the Fed changing policy, or the pandemic or, or Trump's tariffs or a big fiscal change by Biden, those things are the things that are big enough, right, to change markets. But so is war, war, you know, war, conflict, politics. They can all change markets as well. It's just that I happen to know more about the economic ones. And therefore I tend to think that it's the economic ones that are the most important, but I think to be macro, they have to affect a lot of different markets, through one thing that you seek to understand. And in the old days, we used to think macro global macro is more about interest rates and currencies, really, that's what it's about. In the last decade, it's also become about equities. Now, you know, the great Stan Druckenmiller said the other day. That's a shame. Because as an expert in a trader in currencies and bonds is AAA. And as a trader in equities, he's only B minus, I think he's a bit better than B minus
Daniel Grioli 1:15:25
I think he's being modest
Gavyn Davies 1:15:28
are usually modest for Stan. But no, he's triple-A and everything. But you can see what he means Oh, can't you that it's taken us into fields that are not as familiar actually. And there's more complication because there are more parts are more companies with specific company's stories that can sort of make the macro signal more confused. But I do think the last decade has been to a large extent about Central Bank reducing rates, quantitative easing, boosting equities, right. And if you were going to ignore that you weren't picking up that big macro trend. And, that I do count as a macro. So it can be inequities. But usually, in the past, it's been more in currencies and bonds.
Daniel Grioli 1:16:23
Do you think that presents a challenge in terms of how your clients might use you in their portfolio? And by that what I mean is if they're looking at, if they're looking for a global macro to diversify their equity risk, which most multi-asset portfolios, they've got probably 60 to 70%, allocated to equities, but their risk allocations probably 90-95%. Yeah, so they're looking for you to give them something away from that. But then your kind of have to deal with that because that's where the central bank is effective too, it's the central bank's turning that into the only game in town through their policy in some ways. Does that then make it hard for your clients to how do they put you in your portfolio? How do they deal with those sorts of issues?
Gavyn Davies 1:17:13
Well, I think definitely, yes, Daniel, if you lose as much money as equities when they go down, I mean, that, you know, that is absolutely for sure. So, I think that clients, when clients look at diversifying out of equities into any form of macro activity, they don't want you to be fully exposed to equities. And that's it because they can get that usually cheaper in other places, and they can get in their minds, perhaps better stock selection as well, perhaps. So, they don't really want you to do that. They would like you to not participate in very big drawdowns for equities. And they would like you to participate to some extent in bull markets. And then how well you do both is how they judge you. But they're willing to allow you to have some equity risk, like I say, 20 or 30% of equity risk in your total risk. As long as you don't fall as much as the equity market in a bad environment. So, in April last year, and then, you know, whenever it was September 2008, they didn't want you to add to the pain that they were getting from their equity portfolios. And luckily, I would say, well, I hope not. Luckily, we didn't add to their pain. And most macro people did reasonably well in those environments. So, they're willing to forgive you for not matching equity gains in the ramp and bull market, as long as you don't match the losses in the bear market and net-net, reduce the volatility.
Daniel Grioli 1:19:13
I've noticed that a lot of multi-asset investors will typically invest, let's call it five or 10% of their portfolio into a macro strategy or a CTA hoping that will buffer the portfolio. Is that a big enough allocation? Is that going to move the needle?
Gavyn Davies 1:19:39
It depends on the volatility of the 5%. Right. So, if you put five or 10% in a standard macro fund with relatively low vol. I mean, like an eight ball or something or a 10 ball. I mean, the arithmetic will tell you that in a big bear market, it isn't going to make that much difference, but it's better than nothing, by the way, because it probably will protect the portfolio to some extent. So, it's a matter of your risk aversion. You know, if you're more risk-averse, you'll have more of the asset that is negatively correlated with your main asset. And, you know, that’s up to you. The other thing I would say, though, is that people tend to look at this as if it's how much of a global macro hedge fund strategy or CTA hedge fund strategy do, you want to put into a portfolio of equities and bonds, and that it very, very much segmenting the value of macro into one corner of the portfolio, right? I think a different way of doing it is to allow macro thinking, macro modelling, to influence the whole of your asset allocation. So, you permeate through and particularly your tail hedging. And you then permeate macro type thinking, and I would hope, some of them the negative correlation benefits of macro more widely in your portfolio, but you don't do it necessarily through buying a macro fund. So, there are, there are different ways of doing it. For me, 5% isn't enough. But you know, I would think that, and I think people tend to believe that vehemently after a bear face, and less vehemently after a bull face. Not Yes, human beings respond.
Daniel Grioli 1:21:43
Yes, we all like to revise history. But as you brought out, an excellent point about using a macro. The fund is a way to bring macro thinking into your overall investment process. And we used to do that at the superannuation fund, where we worked, we had, we had several macros and multi-asset and CTA strategies. And by looking at how these managers who are all very different from each other, how they present position, their portfolio and how their allocation shifted, we brought that information into our own investment process. And that was a big part of the way we thought about that allocation is, you know, they weren't just giving us our for returns, they were teaching us as well.
Gavyn Davies 1:22:34
well, we would, you know, I think teaching is, for me is a bit of an arrogant way of putting it and I wouldn't use the word teaching, but we hope to help our clients, especially some of the biggest ones actually think about markets more broadly using some of our models, some of our trading experience. And then they are the ones who will implement some of those, you know, ways of thinking into their whole portfolio. The other thing that we are now doing as well is we are developing models that integrate economic variables and markets as well as we, you know, as well as we can do it. This is something we've tried to do multiple for multiple years. But we think we're making some progress. And I always tell my, my team. So, I always tell them, you know, actually guys, the most important thing in the world is to know what the equity weights should be. That's what clients are worried about? Yes. Then, you know, they would tend to say to me, well, Model X as it should be 30 model Y says it should be 20 to a model Z says it should be minus 10. I said, well, I don't want you to give me three numbers between minus 10 and 30. Gentlemen, and ladies, I want you to give me one number. Give me the equity weight the model, you know, says I should have we finally settled that they can do that now. But of course, it is different for people. So, for clients with different risk aversion, That's understandable. And I see age as well, which affects risk aversion. But within that, we've begun now to see a way of producing a preferred equity weight from our models, which we're excited about because now we can build asset allocation models more readily, from our econometric work.
Daniel Grioli 1:24:37
Yes, The way I always thought about it was there were four questions that I had to get right if I could, you know, Todd, one was the equity way. The second one as an Australian investor because of our tax laws and dividend franking was the split between Aussie shares and global. Yeah, especially when you're running a retirement portfolio. You The third one was the currency because the currency is our greatest risk mitigant as an Australian investor, when the Aussie dollar sells off, it does far more to buffer portfolio volatility than bonds could ever do. Conversely, for most of its history, it's given you positive carry. So there was always this trade-off between the diversification benefit and exactly the yield pick up. So that was an important one. And then the final one was the duration of your bond portfolio. And it was getting those four things, right, that kept me busy all the time or trying to get them right.
Gavyn Davies 1:25:37
Those are all still absolutely the key things. And you know, they will wait differently according to what's happening in the world and what's happening in the markets at any given time. And which country you're looking at too. But basically, you're right, I mean, those are the things that will determine most of us have a multi-asset portfolio. And then within that, there'll be lots of other stuff you need to do as well, if you can, like picking stocks, etc. But that's why I believe in macro. Daniel, it's because you've just named the big macro things.
Daniel Grioli 1:26:14
Yep. How do you? How do you bring politics into it now? Because I can't help but feel that politics is going to be a bigger part of this. And yeah, historically, fund managers have shied away from that. And they've kind of you know, they've, they've chalked the big political event almost up to red or black, or there's no way we could have forecast that. Yes, but it seems like you can't get away from it these days. So how do you bring it into your process?
Gavyn Davies 1:26:46
Well, there are forecasting it and reacting to it. Those I think are two different things. I mean, two of the very, very big political disruptions we've had in the last six or seven years, have not been forecasted. So, one Brexit until the very moment, at 10 pm. That night, I didn't think the Brexit vote was going to go in favour of Brexit. until halfway through the night on Donald Trump's election nights, I didn't think he'd win, right? So, there's forecasting which there are ways of trying to improve. But then there's reacting and, and getting the response, the right has to be quick, because a lot of the response to the Brexit vote happened, of course, through the pound, that night. And a lot of the response of the markets to Donald Trump happens pretty quickly within days. Now, the Trump one was really interesting, because most people said, oh, Trump has won, this is disastrous for equities.
Daniel Grioli 1:27:55
Sell everything and move to Canada
Gavyn Davies 1:28:01
Sell and move to Canada. Now I can claim I didn't take that. And one of the reasons that I didn't actually was I remembered Reagan winning. Took a lot longer in those days. But everyone thought Reagan, this guy, what is he? He's an actor who comes out of Hollywood does cowboy movies. This is a disaster. Right? And of course, it certainly was not. And I thought that about Trump, I thought some of the things he wants to do, like cut taxes on corporate America are going to be very favourably welcomed by equity investors. So it always seemed to me that nature was wrong about Trump. So it's trying to understand the politics. But if not, then at least react to them appropriately, I would say, but they are big-play look the that now, for example, how are President Biden and Xi Jinping going to rebuild the relationship between China and the United States? As hopefully they both have kind of seen they want, they would like to I'm hoping that's a heck of a big, that's a heck of a big question for markets. And look, the whole climate policy that this is the biggest it may well be the biggest question, not just for us as the human race, but definitely as investors, this could be the biggest question of all, and that's going to have a lot of politics wrapped into it. So, I've never taken the view that we must not take politics into account even though it's hard to predict it.
Daniel Grioli 1:29:43
You've touched on two topics that I'm particularly interested in. I'd like to get your thoughts on so one is this relationship with China? Are we already in a kind of a cold war with China? You've got Australia, purchasing nuclear submarines from Britain or the US? We're not sure who yet. And you've got obviously all the high jinks in the South China Sea and flyovers in Taiwan and cyber espionage and all of these things. Is there already a cold war with China? And what risk might that pose to markets?
Gavyn Davies 1:30:23
You know, I think there are some elements of it, I mean, the two nations have become competitors in technology, for sure. And that has become more pronounced, the competition element has become more pronounced, I would say, and the protection element has become more pronounced both in the United States and in and in China. And obviously, the two nations are now adopting tariffs against each other on the trading front. So uh, trying to build their economies a bit more separately from each other than in the past. So those things are just facts of life. I mean, that is happening to great powers that are nearly similar in size, economically, are kind of likely to have those competitions between them and, and concerns about each other. Whether that is going to turn into something a lot more sinister. You know, I'm hopeful the answer to that is no. Xi Jinping is very concerned about Taiwan. And it would be wrong to ignore that. But I assume that he will continue to build the pressure in a way that steps a little bit short of threatening to bring the United States directly into a conflict in the South China Sea. In his mind, he is always talking about 2049. That's a long, you know, that's quite a distance away. And at the moment, I think it's pressure building rather than anything more disruptive. But of course, accidents can happen. And therefore need to worry about it and watch it. But with the hope with a, I would say a strong hope that it doesn't turn into anything much worse than the current in terms of the economic Cold War. I mean, that was at its worst, I would say, in the middle period of Trump. It hasn't improved under Joe Biden, Joe Biden has not been very conducive, you know, he hasn't thought a in a very constructive way about reducing tariffs. But the last thing, I would say, maybe America is beginning to think that those tariffs should be unwound now because they are inflationary. And Joe Biden's biggest worry, for sure. Ahead of the midterms next year, is that the inflation rate will stay at six or seven, in which case, I think he's going to really suffer a big loss in Congress. So it's possible, I'm kind of hopeful that they'll start to unwind some of those tariffs, we'll see.
Daniel Grioli 1:33:26
You also mentioned climate as being a risk. I'd be interested to get your thoughts on how that might affect asset buckets. And how do you bring that into your thinking about macro investing?
Gavyn Davies 1:33:45
Well, so you know, that there are lots of there's a great deal to say here. So just in brief, I mean, number one is most of our clients are demanding now not requesting strategies that are climate-friendly, from their investment teams. And maybe 10 years ago, you could say, well, the macro doesn't do a lot of, you know, investing in things that are related to climate, you can't say that now, the clients want you to have a strategy that helps the climate actively. And so, you know, we've been thinking a great deal about that. We've implemented some of that, both with an independent Climate Fund and in the implementation of macro strategies more generally. And I think that's great. And I think it's actually impacting I do think this is impacting the cost of capital for carbon companies, and that is affecting future production of carbon. So, there's that facet to it. And then the other facet is, yeah, okay. And what will those policies to control the climb prove the climate due to the economy, what will they you know, what were those strategies due to inflation? And what will there be a supply shock, like there was in the 70s? Because carbon prices rise as they did in the 70s. And I think this is we're seeing this actually happened now, you know, the natural gas phenomenon that we saw in 2021. To some extent, the oil price behaviour we're now seeing is wrong to coal costs? Yes. is raising the question. Is climate policy going to impose a supply shock? On the world economy? If so, how big when will that supply shock be mitigated by offsetting policy action elsewhere. And this is going to have a very big effect on the path for growth and inflation in the major economies. And therefore, clearly, I think, in the, in the financial asset markets as well. And it's a, we haven't really had to focus very much attention on that as global macro investors. For a long time now, there have been flare-ups. As they'll, you know, they're in the oil market on, let's say, six occasions, lasting a year at a time, inherently temporary. But this is different. And I think it requires better and deeper knowledge about climate policy. And about the way energy markets work. You know, for example, the pricing of emission permits, all of those types of things that we've not had to focus on. So it's working in both directions, we have to have strategies of our own, to help the climate. And we have to understand climate policy to understand markets. And I think this is undoubtedly going to be the biggie for the next, you know, period of time, for sure.
Daniel Grioli 1:37:14
I would agree. And I'd certainly agree with your point that clients are very, very focused on this. Particularly, some of the high net worth clients that I used to deal with in previous roles. A lot of them are looking for ways in which they can not only address climate in their portfolio but also have an impact on the environment, looking for strategies that do that.
Gavyn Davies 1:37:44
Yeah. exactly. I mean, the change there is palpable, you know, you can see it in every meeting with clients. And our former governor of the central bank in the UK, the Bank of England, Mark Carney has been really good on all of this, I mean, both as a central banker, and now as a climate policymaker, he's been great, actually, and has led the process of getting capital provision in the world financial markets, to be more climate-friendly. And as I say, I was reading a report by the IAEA the other day, which said that something like, because, you know, in part because of these changes to capital provision, and the willingness of banks and bond owners or holders to provide capital to, to carbon production, we're now investing about half in carbon production and exploration, as we were in the last recovery period in 2014. And they said that should sustain carbon output, about 30% below current levels by 2030. That's that was their conclusion. Because we are under-investing, you know, in carbon to maintain the current production rates. Now, we're not cutting demand, as far as I can see, by that amount, are anywhere near that amount. So we're running, we're going to run into a period of carbon shortage in markets, I think. And maybe that's a great thing for the climate problem almost certainly is it's going to potentially mean higher carbon prices. But it's not so great for the rest of the economy. We're going to have to live with that somehow and figure it out and figure out what the market consequences are. So, these are big changes that are not that far away and are already happening through our financial systems, correct attempts to help solve the carbon crisis.
Daniel Grioli 1:40:15
Looks like we've got a lot of big things to discover over the coming months and years. Just before we finish up, I'd like to change the pace a little bit. And I believe you are a long-term Southampton Football Club fan.
Gavyn Davies 1:40:36
Daniel Grioli 1:40:39
I'm hoping you can clear something up for me. So, I have fond memories of watching Matt Laetitia play ever Southampton and pretty much carrying the team in some ways. He was special, but for some reason, he could never translate that success onto the international stage.
Gavyn Davies 1:41:03
When he wasn't picked. Come on, Daniel.
Daniel Grioli 1:41:06
Why do you think that was?
Gavyn Davies 1:41:07
I would hesitate to point out that the manager of England at the time was Glenn Hoddle, who was the second greatest ballplayer, English ball player of my lifetime, right with Matthew being them, the best the number one. Me I have no idea why Glenn Hoddle didn't want to demonstrate that on the international stage, but he didn't know Look, it's ridiculous. I think Matt played six times for England, he should have played 60. He's got 209 top-level goals playing for a team that never finished above 15th. From the midfield, I mean, he was absolutely a different kettle of fish. I'm not sure he could play today, because he just didn't move much around the pitch.
Daniel Grioli 1:41:56
Well, that was always the criticism that he was lazy, didn't have the work, right?
Gavyn Davies 1:42:01
He did a lot of work between his ears in his mind, you know, that all the great players do that. He didn't he wasn't that mobile, I have to give you that. And his ability to crunch tackle an opposing midfield player wasn't the best either. But putting the ball in the net, you could do that. You know, that's part of the game too.
Daniel Grioli 1:42:27
It's funny you remind me a little bit because I was also a big Italian soccer fan. And I remember in the 90s, there was very much this fashion away from Italy that we'd call somebody like Leticia little literally in English would be a three-quarter man. So not quite a forward, not quite a midfielder. And in the 90s, there was this big move away from that style of play. I think it was maybe because Saqi had such success at Milan with a 442. And you know, very sort of formulaic system type play. And they had a lot of players like that in Italy, like Badger, for example, that didn't really fit and sort of bounced around from club to club, because the manager never really wanted to use them within that system. And I remember reading a story that Carla Ancelotti wrote when this is before he went on to become as successful as he was in around Madrid and in Italy when he was a new manager in Parma, he had the chance to acquire Badger. And he looked at him, he said, Look, it just doesn't fit my system. And he passed. And then he saw that he went to Bologna and scored 20 goals. Yeah, I had he realized it was probably the dumbest mistake. You've made a nice career because for the sake of being too rigid, he cost himself 20 goals.
Gavyn Davies 1:44:03
Yeah, well, I think there were some managers that thought the same about Matt. And that was perhaps why he stayed with us. But listen, he single-handedly kept us in the present in the Premiership for about a decade on his own. I mean, there's no debating it.
Daniel Grioli 1:44:19
Incredibly exciting to watch or remember.
Gavyn Davies 1:44:22
It’s incredible to watch. Anyway, it's no coincidence that my third child was called Matthew. So very good. I didn't tell sue my wife why I like to know Matthew.
Daniel Grioli 1:44:36
Well, it's a nice name anyway, if it was something a bit more esoteric, or strange. Maybe you wouldn't have been able to get away with it.
Gavyn Davies 1:44:45
I know. I think that too.
Daniel Grioli 1:44:48
Well, Gavyn, it's been a pleasure talking markets and macro and hearing your story from the government to Goldman to Fulcrum. Thank you for joining us on this podcast
Gavyn Davies 1:45:01
Thanks for your time, Daniel.
Daniel Grioli 1:45:03
It’s been great talking to you. Hopefully, we can do it again soon. And I do hope you get to see the ashes.
Gavyn Davies 1:45:10
Ah, you've blown it now. Bye.
Daniel Grioli 1:45:19
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