Podcast Transcript: Christian Hille on Exponential Growth, Avoiding Low Returns, and Errors in Risk Management
By Bilal Hafeez
(45 min read)
By Bilal Hafeez
(45 min read)
This is an edited transcript of our podcast episode with Christian Hille, the General Manager and Head of Wealth Management at Fürstlich-Castell’sche Bank (FCB) in Germany. We discussed the dramatic changes in investment efficient frontiers, the bet way to think about risk management, how to access private equity, 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.
Christian’s Background & Career Path
Bilal Hafeez (00:02:16):
So welcome Christian to the podcast show, it's great to have you on.
Christian Hille (00:02:21):
Yeah. Thanks a lot, Bilal. I'm very pleased to be here and great opportunity to exchange ideas and provide my view as well.
Bilal Hafeez (00:02:27):
Great. And Christian normally before I start the more meaty part of a conversation I do like to ask my guests something about their background. So obviously now you're the general manager of a prestigious private bank in Germany, but you've had a windy route to where you are now. So maybe you could tell us a bit about how you got to where you are? Maybe you could start with what you did at university and then what happened afterwards?
Christian Hille (00:02:50):
Yeah, I did actually start in physics. I come from natural science, and that has some probably relation to what we're going to talk about in a minute, about COVID crisis. I studied physics and almost accidentally came into finance. I wanted to do a PhD but somebody told me about the famous auction house book. I read it, was interested in auctions, and I did one application to a consultancy at the time. It was Arthur Andersen, and they were looking for quantitative people and so I thought okay, might I send in an application? And it was to my surprise, actually taken, and then I spent four years at Arthur Andersen basically, together with a couple of other people, setting up their financial markets practice. We were doing auction pricing, implementing risk systems and risk models and so forth.
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This is an edited transcript of our podcast episode with Christian Hille, the General Manager and Head of Wealth Management at Fürstlich-Castell’sche Bank (FCB) in Germany. We discussed the dramatic changes in investment efficient frontiers, the best way to think about risk management, how to access private equity, 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.
Bilal Hafeez (00:02:16):
So welcome Christian to the podcast show, it’s great to have you on.
Christian Hille (00:02:21):
Yeah. Thanks a lot, Bilal. I’m very pleased to be here and great opportunity to exchange ideas and provide my view as well.
Bilal Hafeez (00:02:27):
Great. And Christian normally before I start the more meaty part of a conversation I do like to ask my guests something about their background. So obviously now you’re the general manager of a prestigious private bank in Germany, but you’ve had a windy route to where you are now. So maybe you could tell us a bit about how you got to where you are? Maybe you could start with what you did at university and then what happened afterwards?
Christian Hille (00:02:50):
Yeah, I did actually start in physics. I come from natural science, and that has some probably relation to what we’re going to talk about in a minute, about COVID crisis. I studied physics and almost accidentally came into finance. I wanted to do a PhD but somebody told me about the famous auction house book. I read it, was interested in auctions, and I did one application to a consultancy at the time. It was Arthur Andersen, and they were looking for quantitative people and so I thought okay, might I send in an application? And it was to my surprise, actually taken, and then I spent four years at Arthur Andersen basically, together with a couple of other people, setting up their financial markets practice. We were doing auction pricing, implementing risk systems and risk models and so forth.
And after four years, I was interested at the time in trading – I thought I really wanted to go into trading. And then I had an opportunity to go to London that coincided with an opportunity for my wife to go to London, working for Procter & Gamble. I started with Nomura then. At the time it seemed a little bit risky. My friend said, “Okay, 2001 is probably not the best time to go to London.” But it actually turned out to be the start of the credit derivative boom. And as it happened, I started in credit derivative, and I traded various different things over time. I spent six, seven years in London for Nomura and UBS, trading convertibles, hybrid securities, but mainly in the end CDOs, structured credit and so forth, so everything…
Bilal Hafeez (00:04:21):
All the fun stuff.
Christian Hille (00:04:22):
Yeah, all the fun stuff. But I’ve got a very different perspective to all the products now. At the time it was really an intellectual challenge at the end of the day. I can definitely say that I never, say, did anything bad. I mean all the products that we structured were properly developed, there was good collateral on it, and our counterparties were proper counterparties, so from that perspective it was fine.
But one thing if you look back at that time, there were very complicated products. Not all of them, not all securitised products because securitization as such, I think, is still one of the good things you can have, and it’s a good way to distribute or redistribute risk across markets. But there were certainly products like CPDOs or leveraged CPDOs, which you wonder if anyone actually needs them, to be honest. I spent seven years there, really interesting yeah.
And then for private reasons, just before the crisis but not in hindsight, we went back to Germany. I was looking for another job. There’s no real intelligent or let’s say challenging trading in Frankfort – there’s mainly sales, distribution and a little bit structuring, but I thought I might actually switch to the buy-side. So, I went from the sell-side to the buy-side, got an opportunity a DWS, which I’m very grateful for. And again, went right into the crisis and had the opportunity to prove myself because of my credit derivatives background. It was obviously a difficult time for asset managers, and I was able to help them to restructure some of their fixed income business. I worked with the now CIO Stefan Kreuzkamp and CEO Asoka Woehrmann, and had a couple of challenging weeks and months – let’s say that. But we turned the ship around and even made an opportunity out of a very challenging situation.
In the further course of my career, I was given the opportunity to lead the multi-asset business, which I’ve basically done since 2009, 2010. In the end, the multi-asset business had about €100 billion of AUM and AUAs as well as overlay business, employed around 60 people, and was one of the top three houses in Europe. It was a very good business, quite substantial, with the net revenue contributing to the overall bottom line.
At that point, you could say, “Okay, I’m through with my career.” But then I decided actually to take a little bit of a step back. I reflected on my career, took a little bit of time out also, and wanted to build up my own shop with a couple of people. And we were fully aligned, we had funding, everything was sorted. And in the summer of 2020 then suddenly somebody called me, the person that is now the head of the supervisory board of the bank that I’m working for now, so Castell bank, and he asked me to help to review the bank’s fortune and the bank’s plan into the future. As it developed, I made a proposal for a business plan, we had a lot of discussions, and in the end the owners, the lords (it’s owned by two lords) gave me the opportunity to play a substantial role in shaping the future of that bank.
And that was very much in line with my intention to build, what was planned to be, a redefined investment platform with a couple of people. So essentially, going back to the roots of investing – in the sense of fair alignment – alignment of interest in terms of investing like we would do for our own money – with a very long-term investment strategy rather than short-term trading. If there’s arbitrage opportunities or distressed opportunities, you try to get as much out as you can.
The biggest thing I’ve learned throughout my career is that timing the market is a fool’s game, and timing the market is your best friend. And that’s certainly something that I’ve wanted to sort of employ and leverage as well, with all the know-how, all the knowledge that I’ve gained over the years, in combination also with a substantial part on sustainability. So that’s something that I would say is independent of the trend that we now see in the market, but nevertheless is something that’s driving me. I think given where we are in the financial sector, we have a huge responsibility because we have the leverage by investing into corporates, and we can then tell corporates, “Okay, this is good or bad.” And obviously that makes them move at the end of the day.
Bilal Hafeez (00:08:33):
Yeah, great. And we’ll talk a bit more about the industry and sustainability a bit later perhaps. But maybe in terms of where we start, I do know that you like to think very big picture in the true sense of the word rather than when people in markets talk about big picture, they mean the next week. You actually think in years and decades even. But maybe we can start with the COVID pandemic. So obviously that’s been the biggest events from last year, and it’s carrying over to this year. And so how are you interpreting the pandemic event in terms of some of the bigger themes that you’re looking at? Both economically and for markets, how are you looking at these things?
Christian Hille (00:09:07):
I mean first of all I have to say, it’s almost a life changing event. It has profound impacts on the economy, and then obviously on financial market, but it also has profound impacts from a personal perspective. I’ve seen this phrase just in interview accidentally half a year ago – somebody who was a basketball coach in the NBA actually use this word, “Ubuntu,” which means “I am because you are.” And I think that sort of sums 2020 up for myself and for the planet in a way. Because it reminds you that we are not lone alpha tigers. The financial market, at least the one that I’ve experienced, is super competitive and you always try to be the best. But at the end of the day, we are humans and people that need one another. And I think this is a very important aspect. We’re here as a team on this planet, and we live together. The other profound change is that Donald Trump is gone now and succeeded by Biden as the US president. And in a way that’s a nice coincidence, because it shows that you’ve got a bad situation but something good can actually happen and we’ve got a better future.
If you look at it from an economic and market perspective, I think there’s two things. One is the COVID crisis, the first time where people have experienced exponential growth, okay? And this is what I mean by exponential growth: I’ve thought about this in the context of a very simple thought experiment, take a piece of paper, it’s one millimetre thick, you fold it one times it’s two millimetres, okay? How often do you have to fold it for it to be one metre in height, or one kilometre in height? And it’s exactly 10 times and 20 times. You can calculate it because it’s 2 to the power of 10 and 20, which is one metre and one kilometre. It’s easy to calculate for any mathematicians, even my 17-year old son was able to calculate it, but it’s very hard for the brain to comprehend.
So even if I think about it conceptually, it’s almost as if I’m able to calculate it but not really able to comprehend it. And in the same way, I think this COVID or this crisis has hit us in a way that is very hard to comprehend. And sometimes even to an extent that people are… If they don’t experience the pain right next to themselves, they almost think it’s not really there, even though it is there, and the next day it’s still there. And that makes it very hard also for politicians to manage the situation, and I have to say I’m pretty proud to be in Germany where a lot of people actually complain, but if you look at how we’ve managed the situation it’s actually pretty well. I don’t want to underestimate the, let’s say psychological impact and the social impact this will have, and we will feel that in the years to come, but I think the way we’ve managed it is at the right, let’s say trade off, between what you should do and not doing too much. I think that’s important.
The other thing is bringing that into context, I was just reading about, because I’m a physicist, on two things, and then that reminded me of this exponential growth has already been there for the last 70 years. And I’ll do that with two examples basically. One is if you look at Moore’s law, so the IBM scientist who developed the first chips and transistors. He said that in two years the number of transistors on the chip actually doubles. And I’m a physicist so I should know how many transistors they are on, but I didn’t actually know so I had to look it up, and it’s actually two billion transistors at the moment. And if it continues like this, I think in one or two years, it will be 20 billion transistors on a fingernail size chip. And you can see this line. So if you draw it semi-logarithmic plot, you actually see a line.
And it’s something that very hard to comprehend because we’ve seen this development. Even your iPhone now has 100,000 times more computing power than the computer that was used for the Apollo flight. So, people have taken this for granted, and all these things have developed in the background. But now this event actually shows us and makes us look back, “What has happened in the last 70 years?” And this has profound implications, it has profound implications for growth and the way growth has developed over the last couple of years. This has profound implications also on how globalization has continued to develop, but I think now has come to almost a limit. And we’ll probably have time to discuss in how we think and how I think the world is going to continue in the future.
Now looking at the positive thing is we’ve talked about this exponential pandemic growth, but beyond tech for example, a German company which just sits about I think 30, 40 kilometres from here in Frankfurt (BioNTech in Mainz), has shown that humans are able to stop exponential growth. Okay? That’s quite an amazing and very positive takeaway. 2020 and the COVID Crisis has, on the one hand side, shown very harsh realities and negative realities, but on the other side it’s also shown what humans are able to do in a way that has never been imagined before. I think previous vaccines was developed over the course of five to seven years, and then it had to be tested. But this (COVID) vaccine was much faster – either they started developing it or they identified the structure in January or February, and by the end of the year we’ve got the vaccine. So, this is almost like a miracle.
Bilal Hafeez (00:14:45):
Yeah. No, that’s very good point. You’re right, psychologically it’s very hard to think about exponential growth or decay. It’s very hard to think about that, but the pandemic does show how it can visibly hit whole health systems and so on. And you’re right, it would be easy to become very pessimistic, but with the vaccine has shown that there is something in humanity that can kind of respond to that. One of the kind of thing I often think about in terms of the pandemic is how in some ways what it’s done is it’s accelerated the adoption of huge amounts of technology. Something that may have taken 5 or 10 years has now taking 5 months, just like how the vaccine turned out much quicker than everyone thought. Is that something you’re thinking about when you think about exponential times that we’re in?
Christian Hille (00:15:26):
Yeah, it certainly has. And it’s a very weird situation, because I was talking to a friend of mine who is in the venture capital area and he said to me, “Look Christian, it’s almost as if you’re in this state of sleep. Because you’re in this lockdown and so forth, and everybody thinks okay, nothing’s really progressing. But actually, once we wake up, we will realize how much this crisis has accelerated and will accelerate change in every aspect.” And it will also transform a couple of industries, at the end of the day, for the better or for the worse. There will not be only winners to come out of this big change, as always.
I always go in a very positive sense with Darwin who was always misinterpreted as people think that the strongest survives. And what he really said was it’s the ones that are most adaptable to change that will survive. And I think this is now true more than ever. You have to be adaptable; you have to see which direction things are going.
And it’s very hard from here also, and we’ll go and talk about financial markets, to predict the next couple of years, because actually you have to do a bit more scenario analysis for things that could happen, it’s not that clear (the future is much more uncertain). I mean obviously, again, in hindsight, but much clearer after the global financial crisis because there were not so many options. It was a little bit of digital, now we’ve got much more options in the way things could go.
And you were alluding to the trend of digitisation. I also think about a different trend which is a shift towards more wealth dispersion (greater inequality). I think wealth dispersion has accelerated to an extent that is, I think, actually unsustainable already now. And if we don’t do anything about it (and there is a responsibility on the financial industry, a quite big one) it will create social unrest. And I think part of the situation that we’ve seen in the US where Trump was able to mobilize so many people so easily. It’s too easy to explain with the social media. I think it’s also got to do with the implicit feeling of those people that they’ve been left out of this globalization, on the wrong side of this huge wealth dispersion. And that creates aggression, that creates fear. And I always tend to say that if you’re under fear for the wrong reasons, you always do the wrong things. And you’re easily to be manipulated. So, this is something that we definitely carefully have to watch.
Bilal Hafeez (00:17:54):
Yeah. And in terms of regimes changing and you talk about scenarios, you have to think through types of scenarios for the next few years, do you think the market regime, economic regime has changed from last year? Is this like a big regime shift that we’ve been hit by?
Christian Hille (00:18:08):
I think we will realize once we come out that this is a regime. And then let’s first look a little bit back. The way I tend to think, as you said, is from a top-down perspective, but that doesn’t mean that I don’t look at balance sheet or corporate. I’m, in a way, an engineer, and I’m really much interested in business models and so forth. But let’s start with the other picture. If you look at the efficient frontier the last 20, 30 years, you’ll see you have two or three major takeaways. The first one is if you look, let’s say, I think it’s about 20 to 25 years back, okay? And you plot the efficient frontier. It is the most surprising picture that you could imagine. Why? Because if you had a portfolio consisting of 10% of fixed income and 90% equities or 90% fixed income and 10% equities, you almost generated, over the whole lifetime, the same annualized return, okay? It didn’t matter if you were almost entirely in fixed income or in equity, which is really surprising.
I had a conversation with a very wealthy person who asked me for advice. And he said, “You know Christian, I’ve only traded in corporate bonds the last 20 years. And this has been hugely successful and everything’s fine. And I’m a bit of a stomach trader.” He doesn’t really go into the details and, “Oh it feels right, it’s good, but now I don’t know what to do anymore.” And I said to him, “You know what? You’ve done exactly the right thing over the last 20 to 25 years. Okay? There’s nothing that I could have done better in a way.” Okay? Which is really strange, but now obviously it’s much more complicated and it’s much more challenging to generate return. This is the first thing.
Second thing is, if you look at the efficient frontier over the past 12 years since the global financial crisis, you’ll see that on every point of the efficient frontier, the Sharpe ratio is at or above one. Every hedge fund would give you a billion if you would be able to generate that return, or that Sharpe ratio.
If you take an example of let’s say a typical let’s say, 60/40 portfolio, so the famous 60/40 which is about 8% of average volatility. You generate eight, or you have generated 8% of return, which compounded, and compounding as we know by Einstein is the eighth wonder of the world, it gives you two and a half times. Which means if you’ve invested one million in 2008, it’s become two and a half a million in 2020. I think very few people have actually seen that return, even though it was very easy to generate with just two ETFs. But also, a lot of people haven’t realized how good these returns were, because they just took them for granted.
Christian Hille (00:20:52):
Now, if you look at long term capital market assumptions – an exercise that we do, that I’ve done in the past a lot, based on more fundamentally based models because you know that markets remain irrational for longer times, but they mean revert to fundamental value – and these estimates are pretty good over the 7 to 10 year horizon – then the efficient frontier is probably going to halve. That means for the same risk I use, 6% of my equity or 8% volatility for the 60/40 portfolio, to generate 4% of return. This is a big, big change. Okay?
And if you think that on top we’re going to move into a more volatile environment, then this efficient frontier is not only going to come down but shift to the right as well. Someone this morning told me that the best phrase he’s seen in the last year is basically, “The transformation of risk-free interest into interest-free risk.” And this is exactly what’s happening. you have to take risk, and that’s a big change. I see a lot of pension funds, a lot of even foundations and so forth who are very risk averse and typically have a 20/80, 30/70 sort of risk profile. They will have a very hard time generating the returns they are expecting in the future. And on top, they have typically risk limits. These risk-overlay techniques are typically very momentum style, it doesn’t matter if they’re CPPI, VAR-based or so forth. The cost of that overlay will become infinite at the end of the day, because my view of the world in the future is that we’ll see lower growth. So, growth will probably halve over the next 10 years – not immediately, but on average over the next 10 years.
It’s not only volatility – drawdowns will become much more severe and disruptive. So, two things actually. One is we’ve been in a regime which was below 10% of volatility for very long time, a regime which is positive for risk. And that in combination with this efficient frontier has also meant that a lot of people have leveraged… They felt so comfortable that they’ve leveraged their strategies and they take more and more risk. I think this time is over. You have to take more risk, but you can’t… There’s a limit to how much you can take. The other thing is that you will have many more – not to the extent of that we’ve seen in March, April last year – large drawdowns. So, you’ll have stable periods followed by sharp drawdowns and recovery, and that will make it much more difficult to trade the markets in the future than it used to be in the last couple of years.
Bilal Hafeez (00:23:50):
Yeah. I mean why do you think we’re going to move to that type of environment of kind of stable returns, but then these very large drawdown shocks? I mean what is it about the world today that makes us more liable to have those?
Christian Hille (00:24:01):
Because in the process of transitioning and investors adapting to lower growth, they will neglect, at the beginning, the reality. They will say, “Okay no, this is wrong.” They will still play momentum. But with all this fast computer trading and risk overlay models, with the Sharpe reverted, with the liquidity capacity not being there anymore on the dealer side, you’ll have much more disruption over the course of the transition. I think we’ll be able to manage it, but it will feel weirder and will happen much more often. And I think the tails will get bigger. I think we’ll have probably larger upside tails too. So why tails? You’ll have the black swans and we have the green swans as well.
Bilal Hafeez (00:24:48):
Yeah. And why do you think growth is going to be much lower?
Christian Hille (00:24:50):
I mean look at global growth was driven a lot by China, and China has moved from an economy that in the beginning was basically the labour market of the world who was able to produce anything from basic consumer items to chips in a very efficient way. They’ve developed now into a consumer-led industry at the end of the day. And because of that transition, I think growth will be smaller, because they will become like a developed market. And we will go from double digit, or we already have gone from double digit to lower growth.
The other thing is I think we’ll also see a bit of deglobalization, even though I’m very positive on Biden’s arrival and I don’t think that this trade war is going to hurt us that much anymore and we’ll be able to reverse a lot of things – I think the way the Chinese think at the moment is a little bit different. Because they’ve looked and said, “Okay, Europe is politically fragmented – they’re not really clear what they want to do. They don’t really work together. The US needs to sort itself out. We want to develop our own economy, and we’ve agreed this Asian trade deal.” They are trying to create, from my perspective, their own sort of economy which will be renminbi-based, and that’s also why I think that the renminbi will appreciate. And they’re not so much dependent on a weaker renminbi anymore because they will be much more self-contained and self-dependent over the next couple of years. So, I think one of the strongest trends in the next couple of years is definitely the appreciation of the renminbi, which will be reinforced by the fact that Chinese will probably be the first to start with a digital currency.
Bilal Hafeez (00:26:35):
Okay. Yeah, that makes sense. And in this kind of context, how do you think about risk management then?
Christian Hille (00:26:40):
That’s a good question. I would say a couple of things. First of all, I think there’s a big misunderstanding generally in the market that risk management is always thought of a way of market timing, or as an outperformance strategy. And if you think like that, you haven’t understood it. From my perspective, risk management is like an insurance strategy, and whichever way you’re going to do it, with options or with overlay techniques like CPPI, VAR-based sort of techniques, it’s going to cost you something. I mean obviously you always want to have a strategy that is risk managed, because you want to, to a certain extent, get some asymmetric behaviour in your strategy. If you do that too much it will cost you an enormous amount.
I mean I know people that have been stopped out last year, and they didn’t find any way back to re-enter the market at the end of the day. And by cost, I mean in normal years, risk management may cost you on average maybe 80 to 100 basis points, depending on where your risk level and where your leverage is in the strategy. I think in years like last year it could easily cost three, four, eight, even 20%. So, if you cut that in one year, you’re totally out for the rest of your life. You won’t be able to re-enter the market. You need to be very careful in the way you do it. I don’t want to, let’s say provide too many secrets, but I would say don’t use any sort of CPPI or VAR-based techniques, use something that is more akin to, let’s say, not vol-targeting but vol-capping in order to get out of the market. But to re-enter the market you need a different mechanism because it’s too slow to react on the other side. And you can’t go fully systematic I would say as well. I think it’s good to have a systematic way to get out, but going back into the market is not a purely systematic game, let’s put it that way.
Taking advantage of extreme market moves
Christian Hille (00:28:34):
I mean the way I also tend to think a little bit about markets, if you’re at the extremes it offers you the best opportunities. I mean obviously you’re under fear or under pressure, performance pressure of course. But one of the best trades I’ve ever done was during the global financial crisis. Because if you’ve got the long-term view and if you’re not forced by your management or your CIO to just look at mark-to-market every second and then be stopped out, but rather follow a very strong fundamental approach (obviously you need to look for liquidity – liquidity can kill you at the end of the day), you don’t need actually complicated models. You just need to do your homework and look at what is money good for. For example, I bought some ABSs in 2008, 2009, and those ABSs actually paid coupon on the full notional until 2015 and redeemed at 100, and I bought them at 10 cents on the dollar. That is one of the best trades I’ve ever done. It wasn’t a huge amount, but it was something where I said, “Okay, I can write it off if the market really goes bad, but I’ve done proper due diligence on the underlying collateral.” And it tells you that in times of crisis people don’t distinguish or differentiate between things that are good or bad, they just sell it.
And the same was true, by the way, if you look at the loan market or high yield market, credit markets in general, or even investment grade last year, I think it was totally disproportionate. I mean obviously without the Fed we would have had a severe liquidity crunch, and maybe it could have gone really, really bad. So obviously it was thanks to them that they turned it around, but it’s really weird to see some of those things trade at those levels. Look at AT1s for example, I mean they traded down to levels last seen probably in the global financial crisis, and then bounce back to 80, 90, 100 again. We actually made a 50% return just in a year in some of those names at the end of day.
Christian Hille (00:30:38):
And the same is true also on the upside. Where we are now, think of interest rates. Interest rates are super low, and nobody thinks or believes that we’ll ever see inflation again or ever see higher rates. But if you think very long term, 10, 15 years out, there is a risk scenario. And I would call it a risk scenario that rates are substantially higher, that we will see inflation induced mainly by the shift that we’ve seen from monetary to fiscal policy and fiscal policy actually entering the real economy. Then, we could see some inflation. That will take a long time, but it makes sense if you see 10 to 15 years out. So, think about swaps and trade into the future, and there’s interesting, let’s say, optionality that you could buy relatively cheap to give you the opportunity in 10 to 15 years’ time, to refinance your house or whatever at a very low rate.
And if that doesn’t happen you just write the option premium off at the end of the day. I think we are at one extreme point in the cycle – that doesn’t mean that we’ll see a crisis again in the near future, but it means that it can’t just continue as it has. At extreme points in the cycle, there are opportunities and you just have to look at these opportunities. So, I think this in combination, yeah? Don’t just focus on risk management, don’t just focus on fear, but see the opportunities in an almost anti-cyclical way. I think that’s something that is relevant and that will differentiate a good from a bad investment.
Bilal Hafeez (00:32:16):
Yeah, absolutely. You talked about the risk that interest rates and inflation could be high further down the road. There was a big debate in the market at the moment about inflation, reflation, stagflation. How are you thinking about that say for the next 12 months or something? Or the next two years, say?
Christian Hille (00:32:33):
I actually think that it’s more something that is being priced by the markets than a real risk in the real economy. I think the market’s reality can remain lower for longer. The market has priced this huge fiscal stimulus. I mean, Biden again, coming with this $1.9 trillion fiscal programme and so forth, and we’ve seen huge amounts all over the world, money that needs to be put to work. And I wouldn’t be surprised even if Germany at some time down the line will issue a German bond for infrastructure and schools and digitalization and so forth. I mean I would actually do it, because if 30-year rates are below zero you actually get some money. Obviously exactly you get paid to spend, so why don’t you do it now? Especially where we need the money anyway. Normally I’m very rigorous (conservative). I’m not in the Schäuble camp, but I’m rigorous on the balance sheet. But I think there’s no better time than now actually to issue some debt and also some government debt.
But having said that, I think it’s only the market that plays the “inflation game.” Obviously, we’ve seen headline inflation, I think in the US, it’s 1.3% core, 1.6%. The surveys or the one-year expectation is 2.7%. I think that would be actually be met and we won’t see inflation completely going through the roof. I don’t really see that risk. I see it on a longer term, on the two, three, four-year horizon. Because we first need to, let’s say, salve the wound of the COVID crisis and we need to see how we’ll manage the situation once we come out, which hopefully will be in the third and fourth quarter of this year. But it’s too early to see inflation hitting reality, it’s more the market’s playing this at the moment. And only also really in the US, not really in Europe.
Bilal Hafeez (00:34:35):
Yeah, yeah. And then in that context and what you talked about earlier, in an environment where interest rates are very low and it’s hard to see how you can get huge returns from bonds now, does that then mean that we all go into equities, private equity alternatives? And if so, should we be worried about valuations which many people are kind of concerned about, especially with certain sectors?
Christian Hille (00:34:58):
That certainly is a big risk. I mean first of all, let’s say if you look at the portfolio, there’s two things. First, you don’t get the returns on the bonds side anymore, and even on the credit side you need to look very, very carefully and very deep. I’m actually a big fan of emerging markets (fixed income). There’s some value to be seen in high yield. There used to be very good value in some loans, in more illiquid segments, and I think that will come back. So, with a properly managed loan strategy I think you can generate good money over the next couple of years. But generally, you have to go into equities, okay? There’s almost no alternative or what I would call real assets. Probably not commercial real estate, more residential real estate. I think commercial real estate will have a hard time given that we’re all working from home. And just a little anecdote again, somebody told me this morning, “We don’t work from home anymore, we live at work.”
Christian Hille (00:35:56):
So, what are the alternatives? I think gold definitely is. And gold for two reasons. Because the opportunity cost is relatively low on the bonds side, and also that the effect of diversification is low. I think there’s some good diversification benefits of gold, it’s probably exaggerated in most of the research that’s been put forward, but I still think stress situation it’s got some diversification benefits. And I’m only interested in diversification and stress. I think in normal times diversification can go anywhere. And all this analysis about correlation, you could look at stress correlation, look at downside correlation and so forth, the normal correlation graphs – it’s a lot of math but it’s irrelevant in a way, from the portfolio context.
And the second thing is, I would say, defensive stocks. So fixed income-like stocks. I also believe, for that reason, that… Which is a bit strange because the digitalization trend and the tech trend will continue. But I think given where we are in terms of valuation, if we’re going to continue, not in the same way as we’ve recovered out of the crisis, but with a flatter slope, we have to see a shift into value stocks. And I think that trigger could be, once it’s clearer how we come out and if the vaccinations work, if we’ve got massive immunisation or above, I would say 66 to 70% in the countries. If you follow Good Judgment’s (Superforecasting’s platform) estimates for most of the countries, I would say the point would be reached in August, September, late October – and the market will anticipate that much earlier. I think probably in 12 to 18 months’ time, we will see a shift into value stocks. Surprisingly enough, tech won’t continue this stellar rise. It doesn’t mean that tech won’t continue to rise, but I think the gap that has been opened that is almost infinitely wide between growth and value stocks will be closed to a certain extent. So, value stocks, more defensive dividend type of stocks, inflation-linked bonds and obviously you’ve mentioned alternative strategies.
Christian Hille (00:38:13):
Now the thing with alternative strategies – I’m actually a big fan of private equity if it’s well managed. I’m a big fan of infrastructure debt, loans, and other alternative strategies. And there’s a lot to be discussed and told, but that’s probably part of another podcast series on private markets. Having said that, the differentiation between good and bad is quite big. I think the demand is so huge that a lot of people go into these asset classes and they don’t fully understand them. And part of the beauty actually comes from the effect, which in this case is good, that you don’t have a daily mark-to-market, and it saves you from jumping into behavioural finance traps. So that’s a good side. But the other side is, I would highly recommend doing proper due diligence on what one should actually invest in.
Bilal Hafeez (00:39:09):
I mean I guess one challenge with private equity is, as you said, there’s a big range in terms of performance and quality. But it seems like a lot of the good PE funds are closed to many people. Now is there the case that there are actually other PE funds that you can get access to? Or is it that these supposedly closed PE funds, there are ways to get access to them?
Christian Hille (00:39:30):
I think that the ways to access funds will change and will be disrupted as well. I mean we’re not there yet in terms of blockchain based tokenisation, fractional shares and so forth. But I’ve even seen platform for fractional shares for art for example. Normal art that you as a normal person wouldn’t be able to afford. I think that will also develop for more illiquid markets, and that will disrupt the market. But we’re not there yet.
If you look at firms like Partners Group, KKR, and so forth, they are also doing an excellent job from a management perspective to implement efficiencies to turn companies around and so forth, so you can get the extra leverage on management, alpha, and know-how.
Obviously, it’s very hard to get access to those funds. If you don’t get access there, there is a commoditised beta version. It has been written about actually, even in The Economist – you could run a strategy whereby you take a smaller mid-cap portfolio and you tilt it PE-like to certain industries and sectors and then, Warren-Buffett-style, take a leverage of 1.3 and so forth, which you could still do in a UCITS format. And you will be able to generate PE Beta, which is probably better than let’s say 70% of PE funds, not the good ones, but in a much more efficient way. And that’s something that will come, that people have started doing. I think also competition there will change and differentiate the market. Maybe later where I’ve got a bit of time to think about how the market changes and who will survive and will cease to exist, I think, again, COVID will accelerate the change in the market quite substantially.
Bilal Hafeez (00:41:31):
Yeah. And in terms of risks to lots of people’s portfolios, what types of things are you looking at?
Christian Hille (00:41:38):
I mean one of the risks we’ve actually spoken about. If we get an inflation shock, that definitely is a risk because you will see your whole diversification completely break down, and you’ll see bonds fall and equities fall. We’ve seen some of these scenarios in the past where the Fed started hiking rates in the US – we saw these sudden market dislocations. I think that’s definitely a severe scenario.
The other one risk is from the real economy. I’ve actually got a neighbour who’s a PE guy, and he’s in the real economy. He always tells me, “Christian, we are already starting to restructure. I see so many problems and challenges,” and so forth. He’s in automobiles, he’s in other industrials, he’s in the farming business. It’s pretty, pretty tough. So, I think the market is almost ignoring the risk of an economic recession. I hope very strongly that all this fiscal stimulus and monetary stimulus will help us through, but the reality is that we’ll definitely see a lot of defaults and people going out of business in certain industries. The question becomes, how will the economy as a whole manage that. So, it’s not a given that we’ll come out totally positive here.
Bilal Hafeez (00:43:04):
Yeah. And I wanted to ask you, you’ve got obviously a huge amount of experience in the financial industry and now you’re running a private bank or you’re the general manager at a private bank, how do you see the financial industry? Because it strikes me, at least in Europe at least and maybe to some extent the US, that you have very low interest rates, negative rates, very large costs, IT costs that are huge, personnel costs that are very large. It’s hard to kind of get much visibility on improving returns over time, especially with such a flat yield curve. So that’s kind of a very bearish kind of picture on the industry, and then you have all the FinTech guys you know chipping away at all the different parts of the pipeline so to speak, or the infrastructure. So it’s easy to paint quite a pessimistic picture. I mean, how do you see things?
Christian Hille (00:43:52):
That’s a very good point. And first of all, I would say if I’ve learned one thing in life and in my career, it’s that everything is relative. If the market turns 50 down and you only lose whatever, 10, I think you can be totally happy. And I had a recent conversation with a very wealthy person and he sees his benchmark as the wealth percentile he is in at the moment, relative to his peers. And he wants to maintain that. In order to do so, he has to take risk. Even if he’s got a billion, he needs to take whole chunk of equity at the end of the day. So, in that sense, everything is relative.
And you could argue everything becomes more competitive but that’s, in a way, the nature of the game. I mean, at the beginning of the interview we discussed exponential growth. I think everything in the value chain becomes more and more efficient. And you as a bank or as an asset manager, you have to very much differentiate where in the value chain you want to position yourself. Number one. And where your sweet spot really is and where your value add is.
And to give you one example, in a much more sort of broader scale, if you look at the asset management industry at the moment, I think it’s more than ripe for disruption. It’s very old style the way the incentive structure works and the way the technology works and the way service (in Germany, we say beratung, which how you service, how you advise clients) actually works. I actually feel better advised going into an Apple store and talking to a 25-year-old who’s totally passionate, very knowledgeable and tells me exactly about all the details of my Apple Watch, than going into a bank branch. So that model will totally change from my perspective. And it will either go to rubbish, or it will go to high quality excellent advisory.
In the same way you imagine a chart – on the Y axis you have the investment offering, a spectrum from beta (bottom) to alpha (top) and on the X axis, boutiques (left) and “Amazons” (right). On the far right, I would put a house like BlackRock, which would span everything from beta to pure alpha. BlackRock appears to have done a great job in understanding everything. If you want to go big, you have to build and leverage a big technology infrastructure, and you have to become a powerhouse across all asset classes. There’s probably only three or four worldwide who will win that game. They’re, for me, the Amazons of the world.
On the left-hand side, you won’t have a boutique focused on beta – you will only have boutiques focused on alpha. And there’s two parts of alpha. One is what I call service or advisory alpha, and the second part is extra performance alpha. In the latter group, you’d have the Brevan Howards of the world, and in the former group, you’d have the, let’s say, Pictets of the world, with very personal advice, high quality and extra service on top of normal standard. Everything in the middle I think would disappear over time. And somebody from Bain or McKinsey just recently told me that that’s called the Death Valley. I mean, that’s a pretty harsh description. The reason why it is… And at the moment you still have many asset managers and wealth boutiques in there because they live based on a captive distribution model. This captive distribution model will be disrupted over the next years.
In very traditional countries like Germany, that will probably take longer. In the UK, it’s already happened, in the US it has as well. I think that will be massively disrupted. And you have to decide yourself – do you want to be a boutique? If so, you have to be someone like Fundsmith, who is specialized in global equities, very dedicated, and a real alpha house. If you do a bit of alpha for average or high fee, you won’t survive. And if you don’t do beta on a large scale, or even smart beta on a large scale, (I’m talking about mandates of 500 million, 1 billion plus), then it’s very hard to survive. Because the fee pressure and the industrialization will drive the market towards that model at the end of the day. And if you look at the Porsche Taycan, how it’s being produced these days – the level of atomization and the level of efficiency there. If I compare that to the asset management industry, I think we’re in the 16th century, to be honest.
Bilal Hafeez (00:48:54):
Yeah. One question I do have about Germany is, I worked at Deutsche Bank for a long, long time as you know, and what struck me about the German system, both the buy-side and the sell-side and the retail-side, is just how over banked it is. You have the Landesbank banks, the Sparkasse banks – it’s very labour intensive as well. And then also if you look at the holdings of households, they don’t really hold much equities, it’s very kind of bond-centric. It just seems like it’s just structurally not positioned for the world that you’ve just described.
Christian Hille (00:49:24):
No, it’s absolutely right. And that’s a big challenge, and an even bigger challenge now. You’ve mentioned two things. One is overbanked, I think that can change. I don’t want to be too drastic, but I think that the COVID crisis will mean that we will see some consolidation in the banking sector, particularly in areas that are probably not the DB type of clients. I think that will definitely come. The normal sort of loan business that has been done in the last couple of years has been done by those sorts of banks, and that will be affected one way or the other as through COVID, and quite substantially so. We’ll see consolidation, banks coming together and so forth. I also see that on a European basis, we might see the start of consolidation in the banking sector. So, pan-European banks – I think there’s an opportunity from an investment perspective if you’re smart on that, so that’s on the positive side.
Christian Hille (00:50:15):
The other side you’ve mentioned is something that I feel bad about, because the best thing you can do for your kids is a savings plan. And I recently read an interesting article that there was a guy, he posted on LinkedIn and did an exercise with a 30 or 40 year savings plan, testing the returns if you invest every year on the worst possible moment or on the best possible moment. It turns out that it doesn’t actually doesn’t really matter that much. What matters is that you consistently invest over time. And actually, when you invest at the worst possible moment, if you’ve got the same amount and you buy more shares at that point in time, so the cost effect works for you as well.
We need an actual mind shift towards investment and financial knowledge. We’ve seen actually quite positive signs recently of increased engagement by the average saver. I’m not sure where it’s stemming from – it could be that people had more time at home and think about their finances. We’ve seen this rise of trading like Robinhood, Trade Republic and so forth, which I think is very controversial to be honest. It’s one thing to educate people to invest properly and another to nudge them into trading thoughtlessly. But that’s another topic. Widespread knowledge on long term investing is not very much developed here in Germany.
Christian Hille (00:51:58):
I’ve recently spoke to a guy named Daniel Young. He has a YouTube channel, is probably the most popular mathematics tutor in Germany. It’s immensely successful, and it’s all for free. And I had this idea that we were bouncing in terms of how does education of the future look? He thinks it’ll be a hybrid of online and in-person. So, it’s a combination of on and off (screen). You do need the human element and peer interaction and so forth, particularly if you’re young. The thing is that there’s almost no financial education in the school system. There’s relatively little need, or there used to be little need because we’ve got a relatively robust social pension system. But if you look at the wealth that could have been produced just by a very simple savings plan, then compare that to where people are now by having missed out, then it’s a pity. It’s really a pity.
And then going back to what I was saying earlier, I mean look at 2008. Between 2008 and 2020, okay? Let’s say you’ve just had 100,000. So, 100,000 invested as a 60/40 in 2008, that’s 2.5X return in 2020, so 250,000 in 2020. Otherwise, if you hold your savings in cash, you just stay where you are or actually, after negative rates, you’re actually in the negative space. That’s a big difference
Bilal Hafeez (00:53:31):
I’d also say even in the UK, when I look at my kids’ school and speak to other parents, the financial education at school over here in the UK is pretty terrible as well. I think that’s kind of a global phenomenon where, for some reason, basic things like that just aren’t taught for some reason. Which I think is a big issue.
Christian Hille (00:53:47):
It’s a big issue, but I think we have an opportunity to make progress in this area. Look at Germany, for example. We’ve got this Nuclear Decommissioning Fund, okay? It’s an endowment fund for managing assets to provide for waste storage sites. We should expand it to become like the Norges [Bank Investment Management] of Germany from my perspective. And then, if that model works, it can be a model for how people in Germany invest on a long-term basis. And I think this is a huge chance, that we’ve got this chance now and we need to take it. There’s a lot of political discussion on the issue, and things are not moving forward in the way I would have hoped. You need somebody that can articulate and communicate the vision in the media and so forth, and make this accessible to normal people so they really understand.
Bilal Hafeez (00:54:34):
Yeah. I mean one thing I had noticed in Germany is that real estate prices have been going up, residential property prices have been going up a lot. Now is that because the famous German renters are buying property now, so they’re starting to view property as an asset? What’s your take there? I mean is that like an investment decision, or…
Christian Hille (00:54:53):
You know what it is? It’s positive for the people who have profited from it and who are on the right side of the wealth distribution. It’s mainly the wealthy and the rich people buying second homes, third homes, family houses, and they tend to go much more into property than they would go into equity, even though they would have done much better with equity. I mean I’ve got a lot of friends, they’ve got second or third homes which, if you ask them 10, 15 years ago they would have never thought about purchasing. It’s sort of the rich getting richer in a way, which I see quite critically to be honest. Obviously, they’re doing the right thing for themselves, you can’t criticize them at the end of the day. And it is also because a lot of foreign money, which has never been in Germany because of a very boring property market, has entered over the last couple of years into the property market. In the big cities – even Berlin, which has been for many artists the cheaper alternative to New York, is now becoming too expensive for them to stay, so they go to Spain or Portugal now. The same thing is happening in Frankfurt, Munich and so forth. There’s huge demand.
And I don’t think it’s going to stop. It’s not going to rise as stellar as before. Most people don’t understand that a property investment is like a bond, and it’s also got a duration. But it’s much more complex to hedge the than a normal bond, which is a much more liquid investment. People will have a hard time, I think, if they haven’t done their liquidity calculation right, if rates in three four years go substantially up. They then have to refinance, the value of the collateral, IE the house goes down. I think you need to watch that. Yeah. I think not everybody has done this liquidity calculation properly.
Bilal Hafeez (00:57:04):
Okay. No, that’s great. I thought we could wrap up our conversation with some personal questions, which I ask all of my guests. One is… And I know you think a lot about these sorts of things. One is how do you manage your information and research flow? Because obviously you’ve got a lot of things to focus on, but you’re inundated with research and ideas and news information. How do you manage it all?
Christian Hille (00:57:28):
I tend to speak to people like you who are very, let’s say, focused and are able to condense information and filter information. And there’s a lot of people out there who just reproduce information or they just tell a story around information. I think what is super important is trying to identify… And I have a bit of different communities around myself for different topics even up to, let’s say, psychology or history and so forth. So people who are naturally interested, and I’ve learned a lot from Superforecasting by Phil Tetlock and the Good Judgment Project and so forth. And the way they think – they’re very open minded and they read and listen a lot, but they also filter. If something is not good quality, they take it out very rigorously, and then they are able to condense it.
And I think what’s also important is to bring things down to first principles. If somebody can’t explain something in a simple way, they most likely haven’t understood it themself at the end of the day. So, look for the right people. And also, in our research model, obviously you need to have one or two big information sources where you have a large platform and access to some of the markets, but I don’t need many of them. And then you have these small boutiques which are creative thinkers, people like you who are able to understand and connect the dots and see what really matters at the end of the day. And I think that’s really key, and that will become more key because all information is available.
Christian Hille (00:59:06):
During COVID, I was doing a Python course because I had a bit of time and one thing that shocked me is how easy it is to get the best teacher on Python. And you could choose between any on all of the platforms. And you pay $100, you do a one-month course, it takes you whatever, one and a half hours a day, and you can learn everything. And all the information is available. I mean if you’ve got one topic, it’s just a matter of it’s so much information that A, you have to decide okay, what do you really want to know? Because you can easily get distracted or there’s another thing here, there’s another thing here, another thing there. So, choose your topics. And then within the topics be very clear on what you want to achieve and who to talk to at the end of the day.
Bilal Hafeez (00:59:55):
Yeah. Yeah, make sense. And then the last question, is there any book or books that have really influenced you in kind of a work context, or even personally?
Christian Hille (01:00:05):
I would say two things. There’s almost an exponential growth in very good books, and I don’t know if it’s got to do with the fact that I’m now more looking at good books more than before, or if there really are. I’ve got almost a bookstore in my home now because of books that I bought or I got as presents. But if I would say three, let’s say, books that influenced me or that that had profound impact, one is actually Rumi Poems. So, Rumi is a 13th century Persian poet, it’s very much on philosophy, psychology and so forth. Something that sounds very different from what we’re doing here, but if you’re not, let’s say, mentally stable, mentally clear, and if you can’t set yourself away from, let’s say, the daily noise and all these financial markets, I think this is something that’s super important. I mean that’s certainly one thing.
Second thing is there has been a lot of research on why people are successful or not successful. I think one book is super good, and that’s called Growth Mindset from Carol Dweck, and she’s developed this growth mindset concept. And I can highly recommend everyone to read it, because it makes you understand why some people are successful. I don’t want to judge that, if successful is good or bad, but these are people who believe in themselves, they have got the grit and they get things done at the end of the day.
And the third one is, even though I have to say I’m sometimes a little bit critical about him, but he’s certainly got some great work done, and that is Ray Dalio and his book Principles. So those three like Rumi, Growth Mindset and Principles, those are the ones. And one book that I still have on my list is a must read, is Promised Land by Obama who was one of the, I would say, greatest leaders that we’ve seen in the last years.
Bilal Hafeez (01:01:54):
I have to say your range of books is probably one of the most eclectic we’ve had so far, and I don’t think anyone’s mentioned Rumi and Ray Dalio in the same breath. I’m a big fan of Rumi as well as it happens. What I find nice about Rumi is, well one is it’s timeless. So, although it was written hundreds and hundreds of years ago it’s still very relevant to today. And then also what Rumi does really well is he brings kind of very deep concepts into the mundane, into the day-to-day, so he kind of gives examples of cooking or something, or going to a tavern, and uses that as the way to express deeper ideas rather than going into very abstract concepts. And so, it’s really accessible at multiple layers.
Christian Hille (01:02:33):
Yeah, he’s got one which is one of my favourites. And I didn’t understand it for a long time, it took me actually a while, it’s called the Guest House.
Bilal Hafeez (01:02:41):
Oh yeah. Yeah, I know the one you’re talking about, yeah. Yeah, that’s very good. Yeah.
Okay, well with that I’d like to sort of thank you. It was an excellent conversation that we had, I learned a lot. And if anybody wanted to follow you somehow, what’s the best way for people to follow your thinking, if that’s possible, or track you in some way?
Christian Hille (01:03:01):
I’ve never been, let’s say, the greatest fan of social media to be honest. I have started on LinkedIn to publish both some private things and for Castell bank. I will do more thought leadership articles for Fürstlich Castell’sche Bank. I also work together with a few guys and do some advisory for Sempera as well. And probably a couple of articles on Medium (the platform) will be forthcoming.
The ambition is to give back what I’ve learned in a way to educate and provide transparency. I’m not there to have a great profile. Okay? We’ve got big ambitions with the private bank, with Fürstlich Castell’sche, it’s an exciting job and I will be in full demand there. But when I published in the private capacity, there’s the real intrinsic motivation to give back a lot of things and increase transparency (knowledge).
Because this is one of the industries that is intellectually challenging and super exciting. When I stepped out of DWS, I thought maybe I’d go into a completely different field, but I was almost dragged back into finance because it’s almost a gift to speak with so many gifted and intelligent people in the industry. Sometimes finance is misused, and there’s a lot of dark sides to it, but I think it will get whiter and whiter and better and better as we develop as an industry. But you rarely have any other industry where you have so many exciting, interesting and diverse people.
In that sense, it’s important for me to give back what you’ve learned, be transparent, and also try to make a case for long term investing to the public. As you said, maybe there’s even something we can do with the German education system – maybe even do some YouTube videos for free and some educational stuff for free. The tricky bit is to boil it down into what I call the KISS principle, so keep it simple and stupid. Okay? This industry, on one hand side is so exciting but on the other side it’s a bit like a drug. Everybody makes it so complex. And the more complex you make it, the more intelligent you seem to be, but the opposite is actually true. I mean let’s be honest, if you can’t explain it to your own kids, you probably failed in understanding it yourself.
Bilal Hafeez (01:05:37):
Yeah, exactly. Yeah, that’s very true. That’s really great insights there and good references. Well, I’ll add some of the links that you mentioned in the show notes, like your LinkedIn profile and then also the bank as well so people can go there to see that you’re doing. But with that, thank you very much. It’s great to have you on.
Christian Hille (01:05:54):
Thanks a lot, Bilal. It was a real pleasure, and good luck to all of us and stay healthy in 2021.
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