How Will Mega Trends Shape the Economy? ft. Casey Clark

[00:00:07] Casey

These four forces will, over the long term, create an environment that could potentially lead to (again you asked me to talk long-term) higher levels of income inequality, which could be a challenge. There will need to be leadership underway to ensure, with technological advancements, with healthcare advancements, with the demographic shift, and the instability of climate change, that we’re able to balance these forces in a way that allows for stable economic growth, and there are some risks to that if those dynamics aren’t thought through.

[00:00:48] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions.

Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:38] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary investors from all around the world. In this series, I have invited one of them, namely, Alan Dunne to host a series of in-depth conversations on the topic of what it takes to be a world-class allocator.

In today’s world, portfolio construction is fast moving to the top of the agenda of many investors as they try to analyze and understand the riskiness of their portfolios. With ever-increasing uncertainty around the globe, being well-diversified across many different strategies and themes in your portfolio can mean the difference between ruin and survival when the next crises emerge.

The aim of these conversations is to try and understand the experiences that have influenced these highly specialized allocators and the processes they follow to harness the best returns for their clients so that we can all become better-informed investors. With that, please welcome Alan Dunne.

[00:02:46] Alan

Thanks very much, Niels, for that introduction. Today, I’m delighted to be joined by Casey Clark. Casey is President and Chief Investment Officer at Rockefeller Asset Management. He is also a member of Rockefeller Capital Management Committee.

Prior to joining Rockefeller in 2019, Casey was Managing Director and Director of Sustainable and Impact Investing at Glenmede where he helped launch and build Glenmede’s sustainable impact investing business. Casey, good to have you on. How are you doing?

[00:03:14] Casey

Likewise. I’m doing well, thank you. I’m looking forward to the conversation.

[00:03:17] Alan

Great. Well, thanks very much for joining us today. As ever, before we get into the meat of the conversation, we like to get a bit of a sense on our guest’s background, where they started off in markets and how they get involved in markets in the first place. So maybe if you could just give us a brief intro to your own background.

[00:03:35] Casey

Yes, happy to. I’ll break my experience down into maybe four phases: one was just as a bond trader and portfolio manager, two was as a macroeconomic research analyst, three was where I launched and managed an ESG investing business within a business, and then four, where I am currently, as deputy CIO and then my current role as CIO and overseeing Rockefeller Asset Management.

I’ll just give a few comments on each of those phases. As a bond trader and portfolio manager, you’re learning the interest rates credit and really the forces driving the economic machine which are vast. That led to a real interest, for me, in understanding the economic machine, which took me to a passion of macroeconomic researching and in that role, I was think about setting strategic and tactical asset allocations. There the appreciation of complexities and forces driving economies and markets just continued to grow. But you need a better understanding of the influences behind rates, spreads, equity, multiples, commodities and geopolitics.

Now, maybe we’ll circle back to it later, but what I underestimated at the time about that experience is, I also sat on a manager selection committee and through that I heard hundreds of portfolio managers pitch from equities to alternatives and fixed income. What struck me is many of them sell the same. It just reinforced how hard it is to outperform. You need a differentiated edge, you need unconventional thinking, and you need a consistent repeatable process. That was an important lesson that maybe we’ll try to circle back to later. Then I’ll go to just the third part of launching and managing an ESG investing practice.

Here, the focus was on assessing the risk and return ramifications of ESG information. Now, much of the data in this industry is overanalyzed. It’s hard to find undiscovered data or data that’s not fully formed. I was enthralled with the idea of the environmental and social implications and how that drove prices in multiples over decades.

I would speak to people like George Serafeim, Harvard professor, leading ESG academic, he was one of the first to write the applications of materiality momentum, which is focusing on improvement and creating alpha enhancing signals, and it just led me down an enormous rabbit hole of how you can use that information in the pursuit of performance.

Then as deputy CIO and in my current role, two areas I focus on just for you and the audience, one is just process, process, process. How do we continually advance and improve the investment process in pursuit of excellence? Excellence is something that if you’ve worked here, you would hear a lot about from our CEO on down. The other is hiring portfolio managers and growing any new asset classes.

We focus on differentiated strategies, within a niche or asset class, where we believe we can capitalize on market efficiency. Right now my job isn’t necessarily to be the world’s premier portfolio manager. It’s to identify and hire 10 world class portfolio managers and analysts and grow the overall business.

[00:07:02] Alan

Good stuff. Maybe just to delve into that a little bit more. Rockefeller Asset Management, I believe, have about 13 billion in assets under management. Maybe just give us a sense on the types of strategies. You mentioned a focus on niche and differentiated strategies. But how would that 13 billion be split across the different asset classes?

[00:07:24] Casey

It may be helpful just to start from the top of just how we fit into Rockefeller Capital Management too. I’ll be brief. We were the original family office for John D. Rockefeller. Fast forward to today to Rockefeller Capital Management, we have three divisions. One global family office, two strategic advisory, and three asset management.

With global family office, think sophisticated, multi-generational wealth strategies built on a world class technology platform. Think high-touch client service, unique investment opportunities, open architecture, and access to the unique ecosystem of intellectual capital available at Rockefeller.

With the second division strategic advisory, think investment banking and strategic advice for corporate clients but also for business owners, many of which could be family office clients. And then asset management. You mentioned about 13 billion of assets. We manage money for individuals and institutions across equities, alternatives, and fixed income. Let me just go into those briefly.

Think of equities, I’m just going to use round numbers in each instance, think around 8 billion of assets across multiple strategies, high conviction, long-term focus with an emphasis on high-quality companies. We’re the fortunate beneficiaries of the Rockefeller family who were early in many aspects. As an example, we have a 34-year US small-cap investing track record. That’s phenomenal, 34-year.

We have an over 30-year global equity investing track record. For many folks in the US, global investing still, to this day, is not as widespread as when you’re investing outside of the US. The Rockefellers were very early there with not only global investing, but ESG investing 30 years ago. We have an over 10-year track record of thematic or megatrend investing.

In those strategies from global to small cap, the thematic think, 40/60 stock portfolios that are high conviction. In our alternatives, think around close to 1billion, 900 million of assets, a long-short equity strategy that seeks to deliver uncorrelated alpha and a FinTech strategy focused on venture capital within the private markets. Fixed income, we have a burgeoning non-taxable, tax-exempt preferred and tax management business and will likely be growing into high-yield.

Does that give you a good idea of Rockefeller Capital Management and Rockefeller Asset Management?

[00:09:38] Alan

Sure, absolutely. You mentioned, I suppose, that history being the original Rockefeller family office. Would it be fair to say if you were to take what you’ve touched on there in terms of some of the points around a focus on ESG and interest in thematics, is there an overriding investment philosophy that encapsulates all of that? Is it equity focused, value focused, thematic focused? How would you describe the investment philosophy of the firm, if there was one?

[00:10:37] Casey

When I think of investment philosophy, there’s a lot of different styles of investors. You can have great growth investors, great value investors, great macro investors, great high-quality investors. When we’re thinking about the investment philosophy, it’s finding that niche, narrowing in on that and honing and differentiating that skill.

Now, many of our long-only strategies are high quality in nature. We believe, over the long term, that’s just going to generate outperformance. How do you define that? Think high return on capital, low net debt to EBITDA, solid operating margin, strong free cash flow.

We talk a lot about the six key characteristics of an outperforming firm: one – strong management team, tw -, clear competitive advantages, three – end market growth, four – balance sheet strength, five – ESG improvements, and six – valuation. Now, it’s easy to say and communicate, it’s harder to identify those stocks.

Not many people are going to argue with me if you say, “What’s an outperforming stock?” You can say, well, if you can find a stock in a growing end market, or a company in a growing end market, with a clear competitive advantage. So, one who is capturing more market share in a growing market, with a strong management team, who can allocate capital and manage their balance sheet with ESG improvement and a decent valuation, that’s a nice company. It’s just about identifying those is where we spend a lot of our time.

[00:12:04] Alan

In terms of the kind of clients you serve, obviously, 13 billion, sizable, but still probably regarded as boutique relative to the mega-cap BlackRocks of the world, etc. From that business perspective, which types of clients do you focus on serving would you say?

[00:12:27] Casey

Vague but ranges from institutions to individuals. On the institutional side, you have large, well-known consultants, through to large intermediaries or strategic accounts, as we call them, and then down to ultra-high-net-worth individuals.

[00:12:44] Alan

Maybe just thinking about the kind of strategies that you’re running and what you’re trying to achieve with those portfolios, what would you say when you’re thinking of launching a new offering? How do you think about what to add into the mix and, I guess, what are you trying to achieve with those portfolios?

[00:]13:05 Casey

The focus is on differentiated strategies, niche asset classes or themes where we can capitalize on a market inefficiency. We talk a lot about, we joke, that we don’t want to compete with the trillion-dollar managers. I once was in a meeting with one of the CEOs of those firms who would talk about how select strategies don’t move the needle for them anymore.

These firms are becoming so large that some of these either niche themes or differentiated strategies or asset classes will increasingly, I think, become overlooked. There’s inefficiency there and that’s the opportunity to generate alpha. So first and foremost, we think about an asset class where you can deliver that; where we have an ability to capitalize on that market inefficiency through there.

You’re going to think about things like private equity, private credit, small cap, long-short, and both with high yield; both corporate high yield and municipal high yield. Now, we don’t offer all of those today, but those are the areas that one would consider, and within their niche and differentiated thought process unconventional thinkers where we believe that we can, hand over heart, have a competitive edge.

[00:14:26] Alan

We’re starting to see the asset management industry evolve in terms of on a number of axes, I think it’s fair to say. I’m just curious to hear your thoughts on a couple of those maybe before we go more into specifics of some of the strategies, but, things like AI, greater use of active ETFs. You mentioned privates. I guess this ongoing growth of the private versus public markets. Which of those, would you say, are the key mega trends that you’re trying to position the firm to capitalize on a multiyear basis?

[00:15:07] Casey

When we think about strategies that could become mature scale, we think about three things. One is the strategy, two is the end market and three is the vehicle. We need alignment there. With strategy it’s people, process, performance. With the end market, it’s distributing that into a growing end market with, three, the right vehicle – whether that’s an ETF, mutual fund, in a roll fund, things of that nature.

If all three of those align, you can get strategies at scale. But first and foremost comes the people, the process, and the performance. Those are the three areas that we think about that hits a little on privates within market growth. I know it’s been a tough time, this year, with private equity firms raising some down rounds and large institutions lowering their allocations to private markets.

But there’s a secular trend for an increase in alternative weightings for many investors that aren’t considered institutional, that will continue for many, many years. That’s an example where, if you can find the right people, process, and performance, you have long-term end market growth in private market investing and then you have that in the right view.

As you know, there are not a lot of daily, liquid private market vehicles, so ETFs don’t necessarily apply. Just to touch on ETFs since you mentioned that, yeah, there’s a noticeable trend from mutual funds to ETFs. Rockefeller Asset Management, along with others, are just going to continue to deliver vehicles that are in demand which include ETFs more and more.

[00:16:54] Alan

Sorry, just on that ETF one, it’s something that we do see in my own background, more in the managed futures trend following space. Even in that space, we’re increasingly seeing firms go into the ETF space. From your perspective, is it just convenience or is it the intraday dealing capability? What do you think is driving that secular trend, as you say, of ETF growth?

[00:17:23] Casey

It’s convenience, intraday trading, tax efficiency.

[00:17:32] Alan

You talked about, in terms of thinking about what makes a successful, scalable product, three things, obviously, in terms of people, process, and performance. That’s probably a good segue into, as you mentioned, a key part of your role nowadays is appraising investment managers, appraising portfolio managers, and trying to determine which ones can truly deliver alpha over time.

Obviously, performance is a natural thing people look at, but what else? What are the key drivers when you’re appraising any strategy or investment managers that you think about to try and determine consistency of performance?

[00:18:14] Casey

As I mentioned, my role here too, it’s hiring and building out a world-class portfolio management and analyst team. It’s also ensuring that we maintain, adhere to and run a disciplined process. That requires full-time focus. You mentioned performance, that tends to be something that everyone thinks about. But what’s underappreciated is process and style, so consistent, repeatable process.

Underperformance can happen over near-term cycles. It’s okay if it’s a result of process. For example, if you have a high-quality process and high-quality stocks are underperforming, you can manage through some underperformance as long as the long-term trend is higher. There’s a big focus on process there.

I do want to add though, if you want me to get more specific, we have a benefit here, at Rockefeller, of just having a well-known brand. So, when you’re speaking about hiring people that are world-class talent, it’s sourcing that world-class talent and then it’s assessing them. We have seven-point criteria to do that.

When I think of world-class talent, I’ve been pretty amazed. We posted an analyst role, it was in 2022, and we got 1,450 resumes for that role pretty quickly. Our intern program at Rockefeller Capital Management has 22 slots, and these are for interns coming in. This coming summer, we have 8,600 resumes. That’s a 0.2% to 0.25% acceptance rate.

For analysts, especially, coming in, we look at seven things: one is analytical capabilities, two is investment judgment, three is idea generation potential, four is culture, five is work ethic, six is passion and seven is content expertise. I would just add, there are a lot of very intelligent, collegial, passionate individuals. But does that flow through to investment judgment and alpha? That’s the objective. Can we flow that through to investment judgment and alpha?

[00:20:22] Alan

I guess nobody would disagree with any of that. Probably the million-dollar one of those is probably investment judgment more than anything else. For people coming in, early stage in their career, obviously, you don’t have a track record to assess people on, is there qualitative pointers to people that would suggest that they would have an ability to have good investment judgment do you think?

[00:20:52] Casey

For people early in their career, let’s just simplify it and say maybe undergrads or MBAs coming out of school, it’s passion and intellectual curiosity. Those are the two main things. You need to be excited about this role. It’s challenging and it’s a lot of hard work, and you need to wake up every day excited to take that on.

I mostly try to convince people not to join the industry. What you want is people who understand that but are so passionate about it and have such intellectual curiosity and ability to connect dots and you have to think they are unconventional thinker. You just want to see this relentless pursuit of excellence in investing. Folks in that level of experience, that’s mostly what you can look for.

[00:21:52] Alan

Say, for people who are even more experienced, obviously, you can look at all these factors. You can have the tailwind of a bull market. So, if you had a bias towards mega stock investing, or large-cap investing in the US, for a decade you would have looked pretty good for most of that period. How do you allow for the particular environment that a strategy has been running?

[00:22:19] Casey

One of the things I talk about with one of my colleagues, outperforming is very challenging. Especially in an area like large cap, the majority of people don’t outperform. Every resume you get says the individual outperforms. That doesn’t mean they’re lying or misleading. It’s just what’s the benchmark, and maybe my ideas weren’t included in the portfolio and were they included, we’d see strong outperformance.

That is one of the most challenging things. The only thing you can do is put them through a rigorous interview process. We have three stages. You can try to attribute their performance by removing the contribution from factors. So, large cap, tech, growth investors will clearly look better in certain environments than others. It’s just about having the right benchmark, but it also goes back to when you’re building a team, the right skill set and the right personalities.

We talk a lot about the goal was not to be right, it’s to get to the right answer. In fact, one thing that I look for is for someone to say, I don’t know the answer to that question. That’s important. We need people to say that because analysts have three jobs: one is collaborating in the team (and let’s just put that to the side), two is selecting stocks, and three is advocating to get those stocks in a portfolio.

All too common in our industry, you can have someone in that third area who maybe has some unfounded confidence and can convince people to put a stock in a portfolio. You need to guard against that. Conversely, you could have people who are excellent stock pickers but have a hard time communicating and advocating for ideas.

These are things that you just need to identify, constantly adapt, learn from, and try to get to those answers through an interview process which includes stock pitches and which includes some intensive debates. Does that answer the question?

[00:27:37] Alan

Absolutely. The second part is process, people process. You look at any slide deck from any asset manager, any fund, will talk about the rigorous investment process. From your perspective, what differentiates a good process from an inferior process?

[00:24:57] Casey

Consistency. That means if you’re speaking to a portfolio manager and then individually speaking to an analyst, you should hear a pretty consistent message. There should be no style drift. A lot of people know what to say. They’re convincing marketers. But it’s do they believe it, and does that flow through?

If you say you are high-quality investor, look through a portfolio. Does every company have on balance, there’s no perfect companies out there like there’s no perfect people, but the on balance portfolio, high returns on invested capital? On balance, is it low net debt to EBITDA? What are those quality metrics and do you see that flow through? It’s trying to identify those issues.

At Rockefeller, we think about, one – is our idea generation, two – is our research effort and three – we have a stock pitch, and then four – once the stock is owned, we have a few select strategies, shareholder engagement efforts. We’re increasingly trying to increase idea generation from our quantitative work, from our shareholder engagement team, from our Rockefeller network.

[00:26:08] Alan

That’s an interesting point. You mentioned the dual part of your role in terms of this domain of partly hiring PMs but also putting the right environment in place to enhance the investment process. You touched on some of those things in terms of idea generation in different areas.

Have you looked at anything a little bit outside the box or do you look at academic studies for ideas? You mentioned the quant work. Can you talk a little bit about that in a bit more detail?

[00:26:52] Casey

Yeah, happy to. These are areas that we’re trying to grow out for differentiated sources of ideas. Within our quantitative work for example, we spent the last year building a pretty unique, long-short model that right now is just a model running in the background with no assets in it. That was a 12 to16 month exercise that has shed light on how we quantify those six key characteristics.

For example, how do you quantify management quality? You can do that through capital deployment. In fact, Empirical Research Partners is excellent at this. What are management teams? What should they do? Well, they should deploy capital. How do you deploy capital? Through the use of leverage, through the use of buybacks, through the use of paying dividends, through M&A. Those things can be quantified.

High-quality stocks can be quantified. Earnings quality can be quantified. It’s just a matter of, from a quantitative perspective, finding unique alpha sources that help quantify your process and then challenging analysts and portfolio managers to say, “Why wouldn’t you pitch this stock or why wouldn’t you pitch that stock?”

Other areas that we’re trying to generate greater connectivity is our shareholder engagement team and select strategies after we own a stock. We have a phenomenal shareholder engagement team that works with companies in order to help create shareholder value. They are closer to companies than many analysts in the industry. The insights that they glean from those conversations should lead to greater ideas.

Lastly, we have the Rockefeller network. That’s harder to quantify. But while there is no, just as an example, formal connectivity between Rockefeller University, between Rockefeller Foundation, there is informal connectivity and there’s informal connectivity to academic networks.

For example, if you’re researching future food companies, and I spoke, maybe I’ll give a shout out to Dr. Roy Steiner who oversees the food initiative at the Rockefeller Foundation, who grants significant money away to future food companies, understand what he’s seeing and what he’s looking at and what maybe is nowhere near hitting the public markets, what could be disrupting this industry.

I’m an advisor to NYU Center for Sustainable Business. They have a pretty innovative engineering and future of solar lab. So, what kind of technologies are in the lab that could reach mainstream that could disrupt the solar industry? These are things that the Rockefeller network can provide.

It opens doors that are often closed by others. When you call or email someone and say, hey, I work at Rockefeller Capital Management, you tend to get a call back or an email back more often than others. So it’s trying to use and get more intentional using specific tools like that for differentiated idea generation.

[00:30:14] Alan

It makes sense. I know a big focus of your own, in your career as well as Rockefeller, has been ESG and sustainable investing and I suppose linked to the whole area of thematic investing. Maybe it’s good to touch on that for a little bit. Obviously, ESG as an element of the process in the first place, and also it would be good to get your perspective on where ESG will go in the next few years.

I think it’s fair to say maybe it’s been a little bit maligned in the last while with some skeptics in the market even though it’s maybe well intentioned. I think it’s fair to say ESG is here to stay. But how do you see ESG evolving as a style or as an element of the investment process for most asset managers?

[00:31:07] Casey

We talk and write a lot about, we’ve been writing about this for years, that the world will differentiate between ESG leaders and ESG improvers. Leaders is best in class and worst in class and improvers is focusing on your trajectory. Are you improving or declining? To us, that’s just part of good investing. Are you improving margins? Are you improving profitability? Is management quality improving? Is your ESG footprint improving?

That’s where our work suggests you can generate uncorrelated alpha. The objective with ESG information is to generate alpha. I guess that’s point one that I would bring up. Point two, as far as where is the industry going, 85% of assets are in Europe. They get the vast majority of flow, the vast majority of assets.

It’s probably no surprise that that’s where we spend a lot of our time and that’s where a lot of the clients are asking us questions about how we use ESG information in pursuit of alpha and how we use shareholder engagement to both create shareholder value and change.

One other comment I would touch on, as it relates to the US, because I think ESG is just so incredibly misunderstood. Everyone just associates it with divesting, or they think Tesla is ESG or not ESG. To us, ESG investing is not the panacea. You can’t make a bad investor good through ESG investing. We just want to try to make a good investor and good investment process better. We’re trying to inch out additional alpha in what is very tough industry, and that’s how we approached it.

In fact, I’m writing, just finishing our annual letter, which goes in our sustainable report. In the last two years, in 2021 and 2022, even before this sentiment arose in the US, I wrote that one of the top five trends was the drawback of divesting which will receive increased media attention. That’s worth reinforcing because divestment may generate unintended consequences that could lead to worse outcomes for society’s investors.

I mentioned George Serafeim before. He has a lot of great research, one of which was a 2021 paper called “Hyperboles and Reality”. He wrote, which I agree with, that markets have a correction mechanism for when a company’s valuation falls significantly below its cash flow generating capacity. At some point, a buyer steps in, and often from the private markets. That hurts transparency, that limits investors’ ability to affect change and it also results in near-term deviations of performance compared to traditional benchmarks.

I think in the US, it’s just widely misunderstood. Most people are using this information to try to eke out additional sources of excess returns, and as I’ve mentioned, there is a growing divergence between the US and Europe. If I can remember the stats, through Q3 of last year, you saw 68 billion of inflows into European sustainable funds. In the US through Q3, you saw 8.5 billion of outflows.

[00:34:31] Alan

You touched on that differentiation between leaders and improvers. As you say, the focus has shifted away from ESG maybe initially been thought of as the exclusions, don’t invest in tobacco stocks, etc., or maybe don’t invest in energy, and increasingly the conversation seems to be about who’s going to be part of this solution and who are the improvers.

Do you just see that as a lens by which to find opportunities or is it also a constraint in terms of portfolios, that they’re able to be classified as a level eight ESG fund in Europe, etc.? Because I think a lot of people view that the accusation of greenwashing tends to come from that perspective that that funds are just being constructed so that they can be jammed into a particular category as opposed to being constructed with the most optimal portfolio in mind.

[00:35:43] Casey

We’re using ESG information with the goal of trying to enhance alpha. I mentioned this notion of improvers. Where did this come about years ago? You have your ”ESG leaders” which increasingly captured a valuation premium. If you can find companies that maybe are average or even below average from what the average person or the media thinks is an ESG company, but yet you think they’re going to improve, you could generate alpha in excess, or alpha and positive change if you identify those companies, see that improvement, help them improve, and in fact, when they become a leader, sell them when that valuation premium happens.

Our objective from this standpoint is how do we use this information to generate outperformance? I think focusing on those improvers, again, is part of good investing and then focusing on some potential mega trends, that we could get into or not, gives us the highest probability of doing that. This is not about divesting from energy companies. This is about understanding environmental and social implications and trying to use that as an edge to generate performance.

[00:36:58] Alan

Well, you touched a little bit on mega trends there. We’ve talked mega trends maybe a little bit from the perspective of the asset management industry, but maybe thinking more broadly about what the investing world might look like over the next number of years. For a decade, we had a period of low inflation, moderate economic growth, but it was very favorable for equities, for beta, and as we’ve come into this decade, things have changed a little bit.

Obviously, 2022 was a tough year for traditional assets, stocks and bonds both struggling. But 2023 has snapped back and was a good year for equities. Do you see any big picture changes in the landscape this decade? Do you think 2022 was an outlier or do you think we’re into a different type of investing environment than we were in going back four or five years?

[00:37:54] Casey

I could touch on the dynamics this year, but longer term, I see four mega trends that are going to continue to shape economies and markets, and that’s: one – tech, two – healthcare, three – demographics, and four – climate change. From a technology perspective, that probably requires no explanation for your audience.

Healthcare, I think there’s going to be dramatic advancements relative to decades past in healthcare technology. Demographics, it’s more than just populations getting older and how that impacts the economic machine and also changing consumer buying preferences for younger generations. And then you have climate change.

Climate change, I believe will transform economies and markets. We are just at the tip of the iceberg of seeing some of the ramifications of that. It goes back to what I was saying before about returns, just understanding the potential implications of these things and using that information in order to try to develop unconventional and differentiated insights.

I could also just go with this year because, more near term, I do think, broadly speaking, we’re just in decades, decades of unprecedented quantitative easing. We are going through a long and slow period of unwinding. That will not happen overnight. There will be more sideways markets. There will be more volatility. I envision that you will have, and again with such a rise of growth investing, that you could have a resurgence of value investing where things like free cash flow matters.

Now, it’s not going to go back to the Benjamin Graham days of value investing given how much the world has changed and the technological advancements. But there will continue to be, in my view, a focus on free cash flow generation in this high-quality bias. What was interesting is, if you read a Reuters article in 2022, December of 2022, it would have said that 60-plus percent of economists were predicting a recession. And then it said 75% of economists said that their GDP forecast was skewed to the downside.

Now, you come into this year, and that’s already below 50%. Last year was too negative. This year, it seems the market is just too convinced on a soft landing. You have S&P 500 earnings that are expected to grow at about 11%, yet the Fed is supposed to cut rates six times. It’s just hard to square those scenarios, an economic environment that is supportive of above average earnings growth and an economic environment needing six rate cuts.

The truth, in the near term, is probably somewhere in the middle; more robust or more modest earnings growth coupled with fewer rate cuts. Even if you reduce earnings growth, next year, to 7%, you’re still at around a 20 times multiple. It feels a little rich, but it is in an environment where you have 4% treasury yield. So the market could muddle through much of 2024. It could consolidate last year’s gains.

I think some of the laggards from 2023 could perform better. But I also think this is just emblematic of a world where we are trying to slowly wean off of quantitative easing.

[00:41:57] Alan

Taking those mega trends, you touched on in terms of technology, healthcare, demographics and climate change, it’s hard to disagree with any of those. Obviously, there will be a winners and losers within those and obviously, I guess your equity focused portfolios are going to be looking at those opportunities.

But putting them together from a macro perspective, does that point to stronger economic growth do you think? Does it point to the potential for a higher inflationary environment? Does it point to an environment of higher yields, do you think, over time? Can you draw any macro inferences from those mega trends?

[00:42:40] Casey

Well, yeah. First, you brought up a good point. It’s easy to say those things are mega trends. It’s easy to talk about mega trends. It’s harder to identify companies within those mega trends that are priced attractively, that have the high-quality characteristics that we talked about. It’s very easy to talk about these things. It is a little harder to execute on those. That’s just worth reinforcing.

That’s a big question. The greatest challenge for policymakers, and I believe I’m paraphrasing Ray Dalio, but this just stuck with me, is to engineer. You’re talking long-term. You wanted me to talk long-term. So, engineering a capitalist system that raises productivity and living standards for consumers without worsening inequities and instability. When you think about it, that’s the greatest challenge, and the Fed is driving the market. Stock and bond correlations are at a 26-year high.

There’s another good research piece saying that 60% of stock price returns last year were predicted buy rates. We’re having correlations and bonds moving the equity market unlike any time we seen here in modern history. If you think about that comment of policymakers designing or engineering a capitalist system that raises productivity (which technology can do), and living standards (which technology and healthcare can do, for consumers without worsening inequities, that’ll likely worsen inequities and create instability.

Creating instability with climate change, there’s a real chance that does that, and demographics with an aging demographics is a counterbalancing force. These four forces will, over the long term, create an environment that could potentially lead to (again, you asked me to talk longer-term) higher levels of income inequality, which could be a challenge. There will need to be a leadership underway to ensure, with technological advancements, with healthcare advancements, with the demographic shift, and the instability of climate change, that we’re able to balance these forces in a way that allows for stable economic growth.

There are some risks to that if those dynamics aren’t thought through. I feel like I went on a tangent there that you weren’t looking for, but you may have asked for it.

[00:45:31] Alan

That is what I was getting at. Ultimately, the question is, will all of those factors lead to stronger productivity growth as you say? McKinsey had a report out last year around AI and how much of an impact it could have. One, they said the gains would probably to largely accrue maybe from 2030 onwards, but I think in terms of productivity growth, they had it at somewhere between an additional growth of 0.1% to 0.7%, so something fairly broad. Whereas I think Goldman’s then had a report subsequent to that which is more upbeat and maybe possibly 1% per annum for whatever it was, maybe 10 or 20 years. But when you’re thinking about that technology mega trend, are you largely thinking around AI or is it robotics, or is it just the innovative capacity of the US economy in many shapes or forms?

[00:46:44] Casey

I’ll go back to it’s the easy to talk about AI and how that’s going to change the world and how to identify companies that are good long-term investments. I think like most things, and it’s an overplayed analogy, where in the 1800s gold rush, you didn’t want to be out mining gold, you wanted to be selling jeans and picks and that’s where the money is. Here, you will have increase in productivity, whether it’s 0.1%, 0.7% or 1% annualized, there will likely be increases in productivity.

So what’s going to enable that behind the scenes? Yes, there are some consumer artificial intelligence implications of that, specifically like Microsoft tools. With Microsoft Office, the tools that they will roll out there will be real. But you also have engineering simulation where you can innovate faster than ever before as a result of that engineering simulation. You can map the physical world and test products easier than one could have before. The pace of innovation could just continue to grow.

What is the next new product that no one is thinking about that will result from that innovation? I don’t know. But going back to selling jeans and picks to gold mines, there are companies that are at the forefront of this type of engineering simulation software. Also, to your point, workforce automation is going to increase productivity, is going to be a slow mega trend as well. It shouldn’t scare people.

I think it’s going to displace as many jobs is one thing, I think it will create just as many if we can learn to work with and not fight that technology.

[00:48:53] Alan

Maybe before we leave it, just quickly on the healthcare point. What do you think of there? Is it longevity or is it the fact we’ll need more healthcare workers because of the aging population or enhancements in medicine, etc., being a boost for the economy? Anything specific around that?

[00:49:16] Casey

I’m not a healthcare expert, and that’s a deeply specialized asset class. But it’s easy to envision a world where higher quality healthcare and greater preventative medicines lead to longer lives, which have meaningful implications for a variety of reasons. In addition to that, you have the ability to similarly, before, the ability to innovate in when I talked about mapping simulating the virtual world.

There’s an ability to map and simulate the body through genes in order to have new and innovative solutions really unlike any other time in history. That will have an enormous impact, even on things more tangibly like weight loss and Alzheimer’s to the other area of just living longer. What do we do about that from a mental capacity perspective?

[00:50:37] Alan

One thing we touched on briefly but I’m curious to get your thoughts, more specifically, we touched on some of the 2022 tough year for bonds and equities and you talked about how analysts were wrong around the recession call. Another thing we heard a lot of in 2022 was around the end of the 60/40 portfolio. I didn’t hear so much about it last year obviously with equities bouncing back and a 60/40 doing well.

From your seat, running an asset management firm, is that a trend you think about that asset managers, wealth managers, asset allocators will shift away from that? Obviously, not many people use a simple 60/40. But many people use derivatives, that benchmark might shift over time, what might a new approach look like if it’s not 60/40?

[00:51:34] Casey

I don’t know if that concept will shift. If you look back to the late 1970s, and you just take a traditional 60/40, think S&P 500 and US AG, the average return is around 9.5% if you look at rolling three-year returns. I think the rolling three-year return of the most recent year end was a little south of 5%. So, it has been a challenging period, just recently, again, those are three year returns for a 60/40 portfolio.

I think the bigger question is around correlation. If you look at the three-year rolling correlation between the S&P 500, that’s in total return including dividends, relative to the Barclays AG, total return including coupons, it’s at a 26 year high. From 1998 through 2020, that correlation was zero to negative. It’s now 0.75.

I don’t want to insult anyone’s intelligence, but what that means is when stocks go up, bonds go up, and when stocks go down, bonds go down. That is a little scary to me and that’s the point of the 60/40 portfolio, to provide that diversification benefit.

Now, if you go back that same chart, you can think about three year rolling correlations between the S&P 500 and the Barclays AG, if you go back from 1978 to say the mid 1990s, correlations were much higher, and three-year rolling correlations were in that 0.5-ish range. So it’s not uncommon for them to stay this high.

What we’ve noticed is that the periods where CPI or inflation is above historical averages, the correlation between stocks and bonds remains elevated. Now, why is that a little scary? What does that mean? It means now a 60/40 portfolio, if correlations remain what they are and you have a down market, you’re not going to see the benefits that one had.

So I do have a strong belief and I’m talking a lot about alternatives into a portfolio, broadly you can buck them as alternative investments, but they mainly provide uncorrelated sources of returns that are not correlated with stocks or bonds so that you can get that blast in your portfolio or that countermeasure in your portfolio to get that diversification benefit that we’re not seeing.

[00:54:19] Alan

I know you’ve touched on the alternative sleeve within your lineup I think being long-short equity. Are there other strategies you consider within that domain in terms of quant strategies, global macro, trend following, managed futures, that a whole gamut or is that something that just as a firm you don’t have a particular offering?

[00:54:43] Casey

Just as a firm, we don’t have a particular offering there given that we’re leaning into some of our core competencies, but there’s a place for those especially if they offer this uncorrelated, and again, easy to say and harder to ensure that there’s correlation benefits in the future. But that’s my point. There’s a real place for those now more than ever with stocks and bonds at such a high correlation.

I don’t know why it’s not talked about more when the fact that bonds and big tech are correlated. It did not used to be like that. Especially for large institutions who can capture illiquidity or illiquidity premium and capture the benefits of that illiquidity. That doesn’t necessarily have to be through alternatives.

You have things like interval funds now where you could have quarterly liquidity and use some leverage in order to better take advantage of market dislocations, and you’re not at the whim of a daily traded product. But there’s a real place in the portfolio especially for investors with size in those areas.

[00:56:02] Alan

Well, very good. I’m just conscious of time and we’re getting close to the hour. One thing we do like to ask our guests before we wrap up is advice for people starting off. We’ve heard a little bit. I think you’re uniquely placed, maybe, given what you said about the 8,600 interns that applied for the 22 positions.

All of those interns won’t get the benefit of speaking to you. So maybe if they’re listening in on this podcast, what advice would you have for people starting off in terms of things to do? I’m curious also, why would you discourage people from the industry in the first place? I think you said that. But for those who are resolute in staying in investment management, any pointers or advice?

[00:56:51] Casey

Yes, I’ll go back to passion and intellectual curiosity but then I’ll give you something more tangible. In fact, we’ve had a very successful program here, at Rockefeller Capital mentorship pods. There’s a lot of mentorship programs at companies that aren’t as effective. Here, we have a very effective mentorship pod program. Maybe I could just leave two pieces of advice that I give to that pod.

One is write a 10-year life plan. What that is, is take today’s day, 10 years from now, and write hour by hour what your ideal life looks like. I actually got that from Debbie Millman who talked about that on Tim Ferriss’s podcast. That’ll tell a lot about what you want to do and what drives you. The second exercise is from Jim Collins. Those are three conjoining circles of outlining, one, what you’re encoded to do, two what you’re passionate about, and three, what’s economic.

I bring that up to people want a new start in the industry because ultimately, those two exercises, if you do them in an intellectually honest manner, will guide you on what your true passion is. After doing those exercises, it takes passion. This is a challenging industry. It takes passion and intellectual curiosity. Those are the raw traits that you need refine.

After doing those exercises, if you think this industry is right for you, you have to commit with all of your heart. You asked why do I discourage people, I probably shouldn’t say this because now you know my trick, I want to try to convince people not to join the industry and then you want people who understand that and just relentlessly move forward and say, I hear what you’re saying, but there is nothing that will convince me not to be in this industry.

I want this so badly that I will do whatever it takes in order to be a good investor. Because it’s hard and there are a lot of people with just raw passion, raw intellectual curiosity who are team players. That’s what you’re going to need to refine those skills and turn those skill sets into investment judgment and alpha. It’s a whole different thing.

[00:59:33] Alan

Very good. Great and interesting advice. Well, very good Casey. Thanks very much for joining us. It’s been a tremendous conversation. Make sure to follow Casey’s work because as you can tell from today’s conversation, it’s an ever-changing and uncertain landscape and important as ever to be informed when allocating capital.

From all of us here at Top Traders Unplugged, thanks for tuning in. We’ll be back soon with more exciting episodes, so stay tuned.

[01:00:16] Ending

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