Podcast Transcript: David Riley On US Debt Sustainability, the Reflation Trade and Corporate Defaults

This is an edited transcript of our podcast episode with David Riley, Partner and Chief Investment Strategist of BlueBay Asset management. We talked debt sustainability, the reflation trade, the USD, which EMs look attractive and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

David’s Background and Career Path

Bilal Hafeez (01:21):

Now onto this episode’s guest. I have David Riley. David is Partner and Chief Investment Strategist of BlueBay Asset Management, a $70 billion fixed income fund. Before BlueBay, David was Global Head of Fitch’s Sovereign and Supranational Group, responsible for more than 130 ratings of the world’s largest fixed income issuers. And before Fitch, David was at the UK Treasury where he advised on international economic and debt issues, including representing the UK at international debt restructuring negotiations at the Paris Club of Official Creditors. Now, onto my conversation with David.

Bilal Hafeez (01:57):

Welcome, David, to the podcast show. It’s great to have you on.

David Riley (02:01):

Well, thanks very much indeed, Bilal, for the invitation. I’m really looking forward to it.

Bilal Hafeez (02:05):

What I always like to ask my guest first is their origin story. So what did you study at university? And then how did you end up where you are now as CIO of BlueBay Asset Management firm?

David Riley (02:17):

Yeah, it’s been a long and winding road. I actually spent the first 10 years of my working life in the public sector, in different parts of the public sector, including in the civil service as an economic policy advisor. I was working at Her Majesty’s Treasury. That was great because I had learned a lot in terms of working with other teams within a team of economists and working with policymakers. I was much more of a bag carrier but did get to sit in on meetings with ministers with UK and G7 ministers at the Paris Club of Official Creditors when there was a restructuring of Russia’s Soviet-era debts.

As I say, I spent my first 10 years working in public policy, and that reflected the interests that I had and still have from my student days, distant as they are now, in what I would describe as political economy. I’ve trained as an economist, but it’s political economy that I like. I’m interested in politics and economics as a way of understanding the constraints policymakers and how policymaking works.

David Riley (03:37):

And then, I went from the Treasury to ultimately become the Head of Global Sovereign Credit Ratings at Fitch, a ratings agency. That included managing the global team through the Eurozone Crisis. That was an extraordinarily interesting and challenging time. You sort of get a greater appreciation and understanding of how you can get this multiple equilibrium. During that Eurozone Sovereign Debt Crisis, countries and governments were solvent and liquid, but only solvent and liquid if markets believed they were solvent and liquid. If they didn’t, then they were going to go bust. Interacting with policymakers through that time, including less positively, being pursued by prosecutors in a particular European country because they didn’t like the fact that their credit rating had been downgraded.

Bilal Hafeez (04:30):

Okay. It gets very personal.

David Riley (04:31):

It can get personal, yes, however much we try to avoid that. And then BlueBay Asset Management asked whether I’d be interested in this role as the Chief Investment Strategist and I thought, “What could be better than continue to look at the issues and topics around credit, around debt, around macroeconomics, and get paid for it – get paid to think about these big issues?”

Of course, when you’re on the investment side you also have to come up with some actionable and successful investment ideas, which is the tough part of the job. But my journey is really from being interested in political economy, public policy, and really that, just by a kind of process of natural progression, brought me into the financial industry and to where I am now at BlueBay.

Bilal Hafeez (05:23):

Yeah, that’s a really quite good and nice varied background. Just for our audience, what does BlueBay focus on? What’s its investment focus?

David Riley (05:32):

Sure. BlueBay is a specialist active manager of fixed income and credit, including emerging markets. We manage about $72 billion of fixed income and credit. So, that would be from high yield bonds, leveraged loans, collectivized loan obligations through to investment grade corporate credit, core fixed income, sovereigns, and the various blends of emerging market debt (emerging market and local currency debt, sovereign and corporate, so-called hard currency debt), as well as strategies like convertible bonds and multi-asset credit strategies where the end asset owner gives us discretion, not only as an active manager in terms of security selection, but also in terms of tactical asset allocation around the strategic allocation to credit, which I’m more actively involved in – so, the relative value between, say, high yield bonds and leverage loans at different parts of the cycle, or whether we should be increasing exposure to emerging market debt relative to developed market credit etc.

How Sustainable are US and Developed Market Debt?

Bilal Hafeez (06:40):

Okay, yeah, yeah. Understood. One thing I wanted to pick up on is you obviously worked at the Treasury and then also at Fitch. You sort of mentioned the point about debt sustainability, and this is a big issue today where countries are issuing huge amounts of debt and yet, interest rates are quite low. You kind of hear the bond vigilantes or the fiscal hawks saying, “It’s unsustainable.” If you look at a chart of debt-to-GDP of any country in the world these days, and it goes back 10, 50, 100 years, it lines off the chart. But yields are low. There’s no crisis. How do you look at debt sustainability for a rich developed country?

David Riley (07:17):

Yeah, I think it’s been a really interesting evolution. I have to say, it’s one which I’ve also undergone to some degree. I remember one of my experiences, as an aside, when I was at the Treasury. I was attending a meeting with more senior people than myself from other departments and they asked this question about whether they could go ahead with this particular project. I said, “No.” And then I kind of went back to the Treasury offices and went to my boss and said, “I said no. I’m not sure whether I should have done or not.” He said to me, “Well, that’s absolutely fine. If ever in doubt, say no.”

That’s the traditional sort of Treasury and Ministry of Finance ethos. It’s one which I also carried into from the credit rating perspective. Look, I still do think there is ultimately some intertemporal budget constraint on governments – that there is some kind of limit to how long one can continue to borrow and the level of debt that is being built up. But I think the transformation or the transition has become much more nuanced and it’s been reflected, more importantly, in the way that central banks are thinking.

It’s an interesting contrast. You look at what the ECB was saying not only during but also in the aftermath of the Eurozone Debt Crisis – almost every monetary policy press statement started with the importance of governments meeting their deficit targets and putting debt-to-GDP on a sustainable downward path. If you look at the recent ECB statements, they usually kick off with something along the lines of how important it is for coordinated fiscal support for the recovery, and obviously we’re seeing that play out as well in the US.

I think part of that transformation or transition in thinking has also come from the fact that debt servicing costs are so low. Despite debt-to-GDP ratios being at or approaching historically record highs, debt servicing costs have actually been declining. I think what we’ve kind of learned two things. One is that for credible borrowers (typically tend to be advanced countries), the budget constraint, if you like, is much higher than Reinhart and Rogoff’s 90% of GDP. I don’t know where it is, but it’s further away than that. Debt servicing costs are such that I think it probably should be given a greater weight in assessing overall levels of debt sustainability.

Low rates may not stay with us forever. Paradoxically, a lot of people view quantitative easing as bailing out governments, etc. But actually, really what has been going on is that governments have been borrowing short essentially because the central bank has been buying long-dated government bonds and the liability they’ve created to fund that is a short-dated floating rate liability, which are reserves that are held by banks at the central bank.

So, QE has actually, if anything, made government finances in many countries somewhat more sensitive to a higher rate. I think a potential policy tension at some point in the future, which is if we get to the point where central banks think they should be normalizing interest rates, will they come under pressure from governments who will be concerned about the impact it will have in terms of budgeting?

Bilal Hafeez (10:53):

I guess that interest rate mismatch, so to speak, would sit with the central bank, wouldn’t it? I guess. They would be the ones that would bear that cost.

David Riley (11:01):

Effectively, it’s fiscal because if the Fed has been making payments into the federal budget because it’s essentially been generating a positive carry on its asset portfolio.

Bilal Hafeez (11:13):

Okay, so through the PNL of the central bank, sometimes it’s positive, sometimes it’s negative. It will end up going back to the Treasury.

David Riley (11:20):

Yeah, because I do think in that respect, ultimately it does make some sense to, if you like, consolidate. Actually, some countries do. If you looked at, for example, the UK and their public sector debt, they actually do net off the Bank of England holdings of Gilts, but they also then include the reserve liabilities that’s been on the other side of that. It’s why when some suggest writing off government debt, which is held by central banks, it doesn’t really reduce the public sector liabilities. They would still have the liabilities. It would create a huge hole in the central bank balance sheet, which ultimately has to be covered by the sovereign, but it wouldn’t actually change the net liability position of the public sector versus the private sector.

Will the Reflation Trade Continue for 2021?

Bilal Hafeez (12:08):

Yeah. If we step back and just look at the bigger picture for a moment, we’ve obviously had the onset of the COVID pandemic almost a year ago, just over a year ago now. We had the initial shock. Now we’re kind of in the recovery phase of sorts. There’s obviously second, third waves going on, but we have a lot of fiscal support, especially in the US. There’s a vaccine coming through in many, many countries. How are you looking at the global growth inflation, the business cycle sort of picture at the moment?

David Riley (12:35):

Yeah, my views and the way that we are, broadly speaking, positioned is a pro-growth, is pro-reflation outlook. That is based on all of the things which I’m sure would be very familiar to everybody listening into this podcast.

I think the evidence today, not just in terms of the forecast, but if we actually look at some of the hard data, broadly speaking, I think it’s consistent with that narrative. There’s certainly lots of uncertainties that still exist. But yeah, I am a believer, if you like, in the global recovery, global reflation theme.

Bilal Hafeez (13:17):

Yeah. Do you have a different view regionally? Obviously, there’s this global story, but then you have Eurozone. At the moment the vaccine rollout has been smaller, there’s talk of lockdowns. China seems to be less aggressive on the policy side, especially compared to what they did after the Global Financial Crisis. And then there’s the US zooming ahead with more and more fiscal stimuli packages. Every week there seems to be another one. Are you differentiating across regions? Or do you think that you don’t really need to, it’s kind of a global and widespread them?

David Riley (13:47):

Yeah, I think that’s a really good observation. If we look at, for example, consensus growth forecast back in November, then the consensus growth forecast (which often is a bit of a lacking indicator, but nonetheless) for 2021 for the US has moved higher by about 3%, 3.5%. That’s a big move in growth expectations.

For the Eurozone it’s actually dropped. We’ve seen revisions downward in the 2021 growth forecast by about 1%, 1.5%. Part of that is because actually 2020 wasn’t quite as terribly, terribly bad from an economic perspective as originally feared and forecasted. But also a part of that is, precisely as you suggest, which is the ongoing monetary and fiscal response is less decisive than in the US and the vaccine rollout and persistent restrictions on social activity have been extended through time.

I think that’s important because when you get those divergences, a weaker dollar, which is I think one part of that global reflation narrative hasn’t, really played out so far this year. I think one of the reasons why that hasn’t really played out is because we’ve seen this divergence around growth expectations and we’re back into a little bit of a US growth exceptionalism, higher US rates story. And that’s supporting US assets including the US dollar. That’s also spilled over in terms of not only the EUR-USD exchange rate, but also in terms of emerging market assets, or in particular, emerging market currencies and local debt.

Peak Pessimism on Euro-area

David Riley (15:26):

Divergences across countries or regions does meaningfully impact on how you, as an investor, try to position for the recovery. But I actually think we’re probably quite close to peak pessimism on the European outlook. I do actually think it’s probably being a little bit overdone. The efficiency of the vaccine distribution in Europe is actually not so different from that of the US and the UK – it’s that they’ve not really had sufficient supply. I think that’s going to change pretty significantly over the coming weeks and months. In the grand scheme of things, if they’re sort of six weeks behind or eight weeks behind the UK and the US, I don’t think that’s ultimately going to make a huge difference. On the fiscal side, I think it’s less of a headline fiscal support, but we’re still getting the Short-Time Work (STW) and furlough supporting households, and the EU Recovery Fund, which I think is important, will start to kick in towards the end of the year and into the next year. So, I think one can get a little too bearish on the European outlook, but it’s certainly the case that right now I would have a bias to a stronger dollar, I would have a bias to being short US rates while pretty much be neutral in terms of the European rates outlook.

Dollar Trend

Bilal Hafeez (16:42):

Yeah. And on the dollar strength, do you think it could continue for the rest of the year? Is this more of a short-term phenomenon? Or do you think for the next 12 months, you could see continued dollar strength?

David Riley (16:54):

Yeah, I mean, I’m an investment strategist but I do find making calls on the dollar (in particular, G10 currencies) a particularly difficult part of the financial astrology. Yeah, I think in the near-term, I’m reasonably confident that the direction of travel is for a stronger dollar because I think we are going to see more evidence more quickly (in the US) in terms of recovery and reflation, so that will include some pick-up in inflation. I suspect that we’ll see a renewed drift higher in terms of US rates as well. I do think, yeah, for the near-term, you have that bias towards the stronger dollar.

I think longer-term, there is case for a weaker dollar is. This is not just a US recovery story. The rest of the world is recovering. Obviously, China has already experienced a V-shaped recovery. That is going to spill over in terms of broader recovery in terms of economic activity across emerging markets, and obviously within Europe. And maybe, to your earlier question, at some point along the line, there will be a price to pay for what is going to be widening between fiscal and current account deficits, so that longer term we might get into the sort of early or mid-2000s period, when you had big twin deficits in the US. And that was associated with a dollar bear market.

The Outlook for Growth Assets

Bilal Hafeez (18:25):

Yeah, yeah. Understood. One of the things that’s been a bit tricky on the investment side is we’ve seen this rise in US yields, as you’ve mentioned. The question keeps coming back, is that good for risk markets or not? Is it good for equity? Is it good for credit? How do you think about that?

David Riley (18:42):

Yeah, well look, bear steeping of the US yield curve has been very much part of our playbook from the third quarter of last year and coming into this year. So, while being pro-growth, pro-spread risk – and what I mean by that, we have a bias towards a more cyclical, lower-rated credit – we had the notion that actually we would also see some bear steepening of the curve.

We think higher rates isn’t something which is inconsistent with nor should derail a rally in more growth sensitive risk assets more generally. Historically, where we’ve had situations where higher rates, particularly Treasury yields, have really derailed broader financial markets, has been when the shift in rates reflected shifts in perceptions around central banks, particularly the Fed. In those cases, market positions have become more hawkish, or that they’re too hawkish relative to the economic outlook. Obviously, the Taper Tantrum in May 2013 is a spectacular example of that. Even the Great Bond Rout of 1994. Even the end of 2018, early 2019, when Jay Powell was saying, “Effectively, the balance sheet reduction was on autopilot and the rates had further to go,” etc.

So that’s not been the driver this time around. What’s been the driver is this re-rating, as we’ve discussed, is changes in growth expectations. I think that’s why, broadly speaking, risk assets have held up pretty well. I mean, credit certainly has been pretty resilient to higher rates. We’ve actually had spread tightening so far this year. Since rates started moving up more quickly it’s been a little bit more volatile, but not massively by any stretch of the imagination.

Will Corporates Start Defaulting?

Bilal Hafeez (20:34):

Actually, on the credit question, that surprises many people. After the pandemic, the economy shut down. Yet credit in general has actually held up remarkably well. Has that surprised you or not?

David Riley (20:45):

Yeah, I know. If I’d had the foresight or you’d said to me at the beginning of 2020, “We’re going to have the most severe economic recession and global recession in modern history,” then I would have said, “Credit’s going to be cremated because we’re going to have double digit default rates.” And we haven’t.

In fact, in Europe, the default rate in the European high yield market has been running at less than 3%. In the US it’s been meaningfully higher, sort of peaking at around 8%, 9%. But if you actually strip out energy (mostly high yield shale producers), then actually, in the US, the default rate has only been running at 5 or 6%. This is really extraordinarily low given the severity of the recession.

Bilal Hafeez (21:34):

Just for context, where were the default rates after the Global Financial Crisis in 2008?

David Riley (21:40):

For example, the US high yield peaked at around about 15%, 16%.

Bilal Hafeez (21:46):

Okay, so we’re much lower than what we saw in the last crisis.

David Riley (21:50):

Yeah, it was pretty much double. Again, much higher also within Europe as well. Emerging market corporates default – I mean, we’ve seen some sovereign defaults, but EM corporate defaults have also been extraordinarily low.

And that’s the thing. Part of it is the policy response, which has actually been more on the fiscal side, I would argue, rather than on the monetary policy side. Businesses have been supported. A huge amount of operational expenses has been taken onto governments’ balance sheet through short-time working and furlough schemes. We’ve seen tax and rent holidays. Also, we’ve seen direct bailouts as well. We’ve seen governments directly come in and provide the rent, financial support.

Another big difference about this crisis, compared to the Global Financial Crisis, is that obviously, banks were very much at the center of that particular crisis. In this crisis, they’ve been much more resilient and they’ve been used by policy authorities to provide support to the broader economy. Things like guarantees on bank lending to small and medium sized business has been very important. And then you’ve had things like the ECB and also the Fed’s intervention in credit markets, which in terms of money spent was tiny (well, it wasn’t tiny but it was really very little) but what it did was to ensure that credit markets stayed open.

Again, if you look at typical economic downturns, even setting aside the Global Financial Crisis, access to credit generally gets much tighter and only really the best, the higher-rated companies, the bigger companies, can continue to access public credit markets and get new financing from banks. This time, in 2020, we actually had a record volume of issuance in the US investment grade and the US high yield markets. Public credit markets were very much open, willing, and able to provide the liquidity to support the economy and the businesses through this downturn. That’s kept default rates low. Ultimately you restructure or you default because you run out of cash. We didn’t have that liquidity squeeze or catalyst.

Bilal Hafeez (23:52):

Do you think when the government support runs out … Presumably it will end at some point over 2021 … that will be the sensitive point for the default cycle? Do you think at that point, it’ll suddenly be revealed that a whole bunch of companies can’t survive?

David Riley (24:05):

Yeah. I mean, that’s been very much the debate we’ve been having within our investment forum in BlueBay. I think they’re [at-risk companies] pretty well flagged within the market right now. I don’t think there’s going to be any big surprises.

I think where you could get a bigger pick-up in defaults going into the end of this year and into next is if we don’t actually get a full return to normality. The expectation that we will get a full re-opening is what’s allowing airlines, cruise liners, car rental companies and travel companies to continue to get funds – whether it be from private equity, public equity markets, and obviously public credit markets. Because we, as investors are saying, “Yeah, I can see the other side and I’m willing to bridge you to that other side. Okay, you’re going to be much more leveraged, hence why you’re paying much higher yields, but hey, we can work together through this and see the other end.”

If that other side shifts by 6 months or 12 months, or actually, if whenever the other side is, if it doesn’t include getting on a plane on a regular basis, whether for business or for pleasure, then actually, we’re going to see a big pick-up in restructuring and defaults and business failures in those sectors.

I do also think that there is perhaps some underlying distressed credit that’s being disguised, if you like, particularly in private markets. There’s a lot of private capital around. I think a lot of that has been put in as additional money to support businesses. That gives companies the optionality, if you like. They don’t need to restructure, or they have done some restructuring in terms of extending the liabilities and payment profile and changing business plans. While it’s not counted as a default, it’s actually kind of in distress.

Impact of Higher Rates on Credit

Bilal Hafeez (25:49):

Yeah, and you do have that uncertainty about that hand-off or that bridge to the other side, so to speak. Is there a way you hedge your portfolio for that possibility, or do you kind of keep your portfolio tilted towards the reflation risk trade and you’ll adjust the risk as you get more clarity on the scenario?

David Riley (26:09):

Yeah, it’s one of those real downside risks. It could either could come about, heaven forbid, if there’s a variant of COVID-19 that renders existing vaccines much less effective or for whatever reason the vaccine rollout is not complete, or there are changes in behavior. There’s various things that could happen.

It’s hard to construct a portfolio that gives you the upside to the full reopening and full recovery while at the same time maintaining a hedge against the downside. Really, the way that you try to manage that is the quantum of risk that you’re taking on that reopening and COVID recovery place within portfolios. So, we’ve done that. We do have that trade on in our portfolios, but it’s being skewed towards areas where we think we have more confidence that there will be a return. So gaming. We do think people are going to go back to casinos in Las Vegas. Short-haul flights in Europe, for example. But there may be some other sectors, cruise liners for example, that could still be a great trade, but it’s one where we don’t have as high a level of conviction.

It’s about the quantum of risk and, as ever, picking the spots where you want to have that exposure. I mean, the biggest headwind to credit so far has actually not been from concerns or worries around whether reopening and recovery will happen and prove durable. It’s actually been the headwind that’s coming from higher rates. It’s really been more about managing your DV01 risk, if you like, rather than getting over your SKIs in terms of credit risk.

Bilal Hafeez (27:55):

Yeah. You’ve mentioned a few sectors so far, but what about the energy sector?

David Riley (28:00):

Yeah, the energy sector was one of the hardest hit last year. Classically, it’s a cyclical sector. It has a high beta to global growth. Obviously, we’ve seen a meaningful recovery in commodity prices and in oil prices. A lot of that recovery and related credits has played out. It’s also been a difficult sector to invest. Part of the value added that we bring as active investors is going through the individual balance sheets, looking at the cashflows, looking at the capital structure of the business and the business model, and then you have this great big hard-to-predict macro factor, which is the oil price, lying over the top.

We’d had an overweight in energy exposure. We’re pretty flat now. We do have energy exposure meaningfully, for example, in some of our emerging market strategies. That’s often the big energy producers in emerging markets, many of which are basically parastatals – they’re quasi-sovereign. You’re kind of mixing some of the sovereign risk, if you’d like, with some of that commodity risk.

Which EM Markets Look Attractive?

Bilal Hafeez (29:10):

Yeah. And then on the emerging markets side, the story has been a bit mixed this year. Obviously recently we had the Turkey news around the change of the central bank governor. Then in Brazil, there are ongoing concerns about the fiscal picture there. The political side is also changing with Lula possibly returning to the political arena. How are you looking at the big EM regions?

David Riley (29:31):

Yeah, it is a mixed picture, undoubtedly. Broadly speaking, we’re generally positive on emerging markets as part of that global recovery theme. Manufacturing is doing well. Global trade is picking up. Commodity prices are higher.

Colleagues have described emerging market growth as being kind of set by policy in Beijing. Emerging market financial conditions are set by policy makers in Washington. So far, China growth has been very strong and seen a big pick-up in demand. Obviously, that’s been reflected in commodity prices. That, I think, as you alluded to earlier, is where we could get an inflection point. I think people don’t perhaps give enough attention to China and its cycles and how that impacts the global economy. At the moment, it’s still pretty strong.

What’s been impacting emerging markets has been policy being set in Washington and the rise in Treasury yields. Now, the extent of the dollar financing needs of emerging markets today are much, much lower, certainly, than 2013, when you had the so-called Fragile Five being exposed with big current account deficits. When you have an environment where US Treasury yields are moving higher and you’ve got some bid into the US dollar [USD rising], then that does start to expose some of the weak links. We’re seeing that kind of play out. We are seeing idiosyncratic stories where countries have been on that path, but are being exposed and brought to a head, if you like, by this macro shift that we’re seeing, this re-rating of US rates.

I still think most emerging market credit, particular corporate credit, has proved very resilient. I think the fundamentals are pretty good. I don’t think it’s going to meaningfully underperform developed market credit. It may not necessarily outperform, but I think it’s going to do reasonably well. I think on the sovereign credit side, there’s a lot more of a differentiated story, which gives you some opportunities on the short side in terms of playing distressed debt situations, as well as being long on the positive side.

Bilal Hafeez (31:54):

Are there certain markets or countries you’re looking at on that side, the long and the short side?

David Riley (32:01):

One country where we’ve looked at the broad story and the current valuations is Mexico – it will clearly be a beneficiary of the US economic recovery. It’s relatively fiscally conservative and has a very credible central bank. It does have lots of issues and structural issues, but it’s a good backdrop. So we like Mexican sovereign and corporate credit. There are also other countries in Latin America like Peru and Colombia which we think will do reasonably well. Obviously Brazil and Argentina … Well, they’re very, very different so I shouldn’t really link the two together in that way, but there can be opportunities, as I say, even in a distressed credit like Argentina.

And other countries that we like from a long-term perspective: we do like China, government bonds, Tier-1 property developers. We like some of the sovereign and corporate credit, for example, in Indonesia. There are places where you can go and where I think the growth outlook is strong and the underlying macro fundamentals are such that they will benefit from catching some of this broader global recovery.

And on the other hand, as we saw with the announcement in Turkey, the change in the central bank governor, those who have idiosyncratic weaknesses will be exposed and there won’t be anywhere to hide.

The Impact of ESG on the Asset Management Industry

Bilal Hafeez (33:18):

Yeah. One of the things that I find when I speak to investors increasingly is the whole ESG agenda. It really does feel like it’s become really mainstream, such that it’s not just a side consideration now – it’s a central consideration for lots of asset managers. It really has changed even over the past year I’d say. Are you finding that as well? What do you think are just the implications for the industry with this?

David Riley (33:44):

Yeah, you’re absolutely right to say that’s sort of changed – the importance of ESG, environmental and social governance factors and sustainable investment more broadly. As an industry, we have to respond to what our end-investors are wanting. Particularly in Europe. The US investors, I think, have been lagging in terms of their understanding, appreciation, desire for having ESG-integrated investment strategies or any ESG-tilted strategies, and ultimately impact investing, et cetera.

I think even now, potentially with the change in the US administration, I think US investors will be catching up to that. And not just amongst investors, but attitudes are changing among regulators, central banks etc. There was a small thing in the UK budget announcement recently – there was an amendment to the supplementary objective of the Monetary Policy Committee of the Bank of England, to support the government’s efforts to transition the UK economy to a net zero carbon by 2050. It’s filtering through.

What’s interesting, I think, is that it’s moving to deeper integration of ESG. End-investors want to see that you are in a rigorous and proper manner, integrating ESG into your investment process. It’s not a separate or an add-on or a tick-the-box exercise. It’s properly fundamental integration, looking to go beyond negative screening (so okay, you don’t have tobacco companies or producers of weapons or whatever in your portfolios) to actually having a positive impact and being able to demonstrate that in terms of the investment allocation and outcomes.

Some of that is obviously through straight impact investing and supporting projects in clean energy, but it’s also about engaging with businesses, or engaging with policymakers if you’re a sovereign debt investor, and talking to those policymakers about deforestation etc. That is actually something which does impact the investment allocation and ultimately is going to have an impact on your access to and cost of financing.

It’s going to be huge. I think it is the big secular trend for the asset management industry over the next decade.

Bilal Hafeez (36:12):

Yeah, no, I agree as well. Yeah, I imagine there’s going to be lots and lots of changes that we haven’t even seen yet. It’s definitely a space to watch.

David’s Productivity Hacks and Book Picks

Bilal Hafeez (36:20):

That was great talking about markets, but I also do like to talk to my guests about personal questions. One, a topic close to my heart, is how do you manage your information and research inputs? It’s quite easy to be overwhelmed with emails and just Twitter and social media and just the reports that you may receive. How do you manage your information flow?

David Riley (36:44):

Yeah, probably not as well as I should do is the honest answer. That’s a good question – it is a challenge. The danger always is that you try to assimilate so much information that ultimately, as you say, you can’t process it into intelligent and ultimately, from my perspective, into actionable investment ideas.

In some respects (I don’t want to sound anti-expert, so don’t overanalyze), if you can’t reduce down your investment thesis to a narrative that you can explain to an intelligent but casual observer, then it’s probably too complex and it probably has too many moving parts from an investment perspective.

When it comes to maintenance research, I try to just narrow that down. There’s just one or two morning emails that I read. Keep it narrow in terms of where you think are a couple of key reliable sources of information on issues like, I don’t know, tracking vaccine rollouts. And on the macro analysis and forecast, there’s so much macro analysis out there. I tend to actually rely much on primary sources, so I’ll read working papers produced by the Fed – I’ll read them monthly. They’re kind of bulletined by the ECB. The speeches by monetary policy makers or finance ministers. Yeah, I think if you go to the source you can quiet a lot of the noise, and also get a more unfiltered view.

And finally, I’d just say talk to people. I spend a lot of time, probably more time than my colleagues would like, talking to my colleagues who are specialists in the European high yield market, who are investing in leverage loans or emerging market local rates. That’s a really efficient way for someone like me who’s looking from a broader cross asset perspective, it’s a really efficient way to kind of filter and focus on the key issues which are relevant from an investment perspective.

Bilal Hafeez (38:40):

Yeah, that certainly makes a lot of sense. Perhaps a related question is books. I’m a big fan of books, reading books. Are there any books that have really influenced you over your career? Or are there some books that you’ve read recently that have been really good?

David Riley (38:55):

Yeah. Reading and being eclectic in the way you think about the world, I think, is really important in our industry. Fooled by Randomness by Nassim Taleb was one of the books which I read which did make me think more carefully about the classic areas of induction around black swan events. Also, just about survivorship bias. I’m sure he would describe me as, at times, a talking head on financial TV where I’m always looking to put a narrative on a 1% move in EURO STOXX when that’s a random walk.

I think for rigorous thinking about how to think about thinking, Daniel Kahneman’s, Thinking, Fast and Slow, had a big impact in the way that I at least try to discipline myself, if you like. It’s really interesting from an economic perspective because it kind of challenges the economic textbook view of rational agents. It doesn’t mean people are behaving irrationally. It’s understanding the biases which we all have.

I guess more recently Trade Wars are Class Wars I’ve just finished reading by Michael Pettis and Matthew Klein which I really enjoyed. I didn’t wholly share all the views being expressed in there, but it was an interesting read.

Bilal Hafeez (40:23):

Yeah, I had Michael as a guest last year where we talked about the book. It was a really interesting thesis he had, definitely provocative.

David Riley (40:32):

Yeah. It’s one where it kind of chimes, to some extent, with some of the views which were even heard in the populist Trump Administration (they probably wouldn’t want me to say that perhaps – Michael Pettis, I don’t think that’s his leanings) … But it does chime somewhat with how the policies have been enacted and these big excess savings and big surpluses have been created in Germany. It was a policy starter of the way that they responded to the Eurozone Crisis; they then kind of imposed that business model or economic model across the whole of the eurozone. And of course, China, as well, with its big excess savings and surpluses, kind of created the sources of inequality and dysfunction in the global financial system which has, if you like, fueled some of the populism and the trade wars that we’re subsequently seeing.

As I said, I don’t actually share all the analysis, but it’s exactly the thing which I like reading because it kind of challenges some of my views and it gives an alternative perspective. And people like Richard Koo on Balance Sheet Recession, I thought has been really interesting. Always interesting to read stuff about Japan.

Bilal Hafeez (41:47):

Yeah, no, that’s true. Yeah, yeah. Japan is one where everything you think should happen doesn’t happen. It’s always the corner solution or the case that doesn’t ever kind of follow what you think should happen.

That’s great. Now, if people wanted to follow your thinking and your work, what’s the best way for them to do that?

David Riley (42:08):

I do a podcast every couple of weeks which is available from all good podcast platforms. Also, it’s also freely available from the BlueBay Asset Management website. I do put out occasional insight pieces. I’m not as prolific as I probably should be because I just spend a lot of time working with colleagues on our internal investment ideas and analysis. But probably the podcast is the best source of commentary from me at least.

Bilal Hafeez (42:37):

Yeah, no, that’s great. With that, thanks a lot. It was a great conversation. I learnt a lot and hopefully our listeners did as well. Yeah, good luck with trading these markets.

David Riley (42:46):

Yeah, no, thanks very much, I really enjoyed it. Thanks for the invitation and this opportunity to have this kind of discussion. It was fun.