#29 - Karen Karniol-Tambour: Market Outlook, Portfolio Construction

Summary

In this episode, Karen Karniol, Co-CIO at Bridgewater Associates, discusses her journey into investing and the culture at one of the world's largest hedge funds. She shares insights on portfolio construction, the importance of understanding human decision-making flaws, and the challenges of adapting to a new investment paradigm. Karniol emphasizes the need for a balanced portfolio that can withstand various economic scenarios, highlighting the significance of diversification and the role of cash in the current investment climate.

Takeaways

• 😀 Karen Carnevale, Co-CIO at Bridgewater Associates, was not initially drawn to investing but found the industry's appeal in understanding the world and making decisions based on that understanding.
• 🧠 Bridgewater Associates is built around understanding the flaws in human decision-making, emphasizing systematic thinking and addressing cognitive biases in a structured manner.
• 🏆 Karen's experience at Bridgewater exceeded her expectations due to the culture of deep understanding and the meritocratic environment that encourages open dialogue and challenges, regardless of seniority.
• 💡 Bridgewater's culture of mentorship and challenge has enabled Karen to advance quickly, highlighting the importance of identifying and nurturing talent at the firm.
• 🔑 Karen's 'superpowers' include curiosity, energy, the ability to synthesize information quickly, and effective communication to make complex ideas understandable.
• 🌟 Bridgewater's vision for the next decade focuses on investment excellence, deep understanding, and being a valuable partner to institutional investors, with an emphasis on innovation and adaptability.
• 💼 Bridgewater's strengths lie in its culture of continuous improvement, fundamental understanding of markets, and portfolio engineering, while acknowledging the difficulty of integrating new talent due to high bars and the demanding culture.
• 🚀 The firm sees AI as a potential catalyst for significant economic change, possibly exceeding the impact of past technological revolutions, with both short-term inflationary pressures and long-term workforce implications.
• 🌐 The shift from private to public sector debt accumulation is a major trend, with governments taking a larger role in economic activity, leading to potential long-term implications for fiscal policy and market behavior.
• 📉 Current market conditions have led to an over-concentration in US corporates within portfolios, which may not be resilient to certain risks and does not reflect a diversified investment strategy.
• 🛡️ Karen emphasizes the importance of portfolio construction that aims to avoid catastrophic losses, narrow the range of outcomes, and avoid sustained underperformance to ensure long-term wealth accumulation.

Q & A

What initially sparked Karen's interest in investing?

Karen was not initially interested in investing and did not grow up with a clear career path in mind. It was only after being exposed to the world of investing that she found it appealing, as it allowed her to think about the world and predict future events based on her understanding and decision-making abilities.

How did Karen's academic background influence her career choice?

Karen's academic background involved writing a thesis with Danny Kahneman, the author of 'Thinking, Fast and Slow', which fascinated her with human decision-making and its flaws. This interest aligned well with Bridgewater Associates' approach to understanding and improving decision-making processes, which attracted her to the firm.

What does Karen attribute her career advancement at Bridgewater to?

Karen attributes her advancement to Bridgewater's meritocratic culture, which encourages speaking one's mind regardless of seniority, and a culture of challenging people quickly and pushing them to the next level, along with strong mentorship from the firm's leaders.

What is Karen's view on the importance of mentorship in career development?

Karen believes mentorship is crucial, as it helps individuals grow and take on bigger leadership roles at a younger age. She cites her own experience with mentors at Bridgewater, who helped her identify and build on her strengths, pushing her to achieve more than she initially thought possible.

How does Karen describe her 'superpowers' in the context of her work?

Karen describes her 'superpowers' as her curiosity, energy, and the ability to quickly synthesize information to get to the heart of an issue. She also mentions her effectiveness in communication, making complex ideas understandable to others.

What changes has Ray Dalio's transition of leadership brought to Bridgewater, according to Karen?

Karen suggests that Bridgewater aims to maintain continuity while also being open to changes and adapting to the shifting world. The firm's vision is to continue delivering on its investment promise with excellence and to be the best partner to its institutional investors, focusing on investment excellence and having a significant impact on investor portfolios.

How does Karen perceive the current investment paradigm shift?

Karen sees a significant shift from an investment paradigm that lasted for about 40 years, characterized by low interest rates and disinflation, to a new era where interest rates are becoming the main policy tool again, with a focus on balancing growth and inflation. This new environment echoes the 1970s but also has its unique challenges and opportunities.

What is Karen's perspective on the role of AI in the future economy?

Karen believes AI could have a transformative impact on the economy, potentially being as significant as the changes in manufacturing. AI could take out a larger portion of the workforce and happen faster than previous technological shifts, with both deflationary and inflationary implications depending on the time frame considered.

What are some of the major risks Karen identifies in the current investment landscape?

Karen identifies several risks, including the over-concentration in US corporates, the potential for a surprise recession, sustained periods of underperformance, and the challenges of managing inflation expectations. She also mentions the importance of considering geopolitical shifts and the role of government spending.

How does Karen approach portfolio construction to build a resilient portfolio?

Karen emphasizes the importance of reassessing asset allocation, ensuring each part of the portfolio aligns with the investor's goals, and directly mitigating remaining vulnerabilities. She suggests considering cash as a significant source of return, being skeptical about the repeat of past risk premiums, and focusing on alpha opportunities that may arise from market divergences.

What advice does Karen give for investors to avoid catastrophic losses in their portfolios?

Karen advises investors to be clear about their goals and constraints, reassess their asset allocation to ensure it is appropriate for current conditions, make sure each part of the portfolio is working towards their goals, and to take practical steps to mitigate vulnerabilities, such as diversification and considering assets that may perform well during inflationary periods.

Outlines

00:00

😀 Introduction to Karen Karnal and Bridgewater Associates

Karen Karnal, the co-CIO at Bridgewater Associates, one of the world's largest hedge funds, joins the discussion. She shares her background, explaining that she was not initially drawn to investing but was captivated by the industry's intellectual challenge and its focus on understanding and predicting global events. Karen joined Bridgewater in 2006 after college and has found the firm's culture of deep understanding and meritocracy appealing. The conversation delves into her career trajectory and the unique approach Bridgewater takes in understanding human decision-making flaws and systematizing thought processes.

05:01

🚀 Karen's Career Progression and Bridgewater's Mentorship Culture

Karen discusses her career progression at Bridgewater, highlighting the firm's meritocratic culture that encourages open dialogue and challenges, regardless of seniority. She credits the firm's investment in mentorship and its culture of pushing employees to take on challenges early in their careers as key factors in her advancement. The conversation also touches on her personal strengths, such as curiosity, energy, and the ability to synthesize complex information quickly, which have been crucial in her role.

10:02

🌐 Bridgewater's Vision and Approach to Investment

The discussion shifts to Bridgewater's vision for the next decade, focusing on maintaining investment excellence and deepening their understanding of markets. Karen emphasizes the firm's commitment to being a valuable partner to institutional investors by leveraging their capabilities to deliver the most value. She also touches on Bridgewater's strengths, such as their fundamental understanding of markets and portfolio engineering, and acknowledges the firm's challenges in integrating new talent due to their high standards.

15:04

📈 Market Outlook and the Changing Investment Paradigm

Karen provides an in-depth analysis of the current market landscape, noting a shift from a 40-year investment paradigm characterized by low interest rates and disinflation to a new era marked by higher interest rates and a focus on balancing growth and inflation. She discusses the potential impact of AI, comparing its transformative potential to past technological innovations like the internet and electricity, and suggests that AI could be a significant economic event in the coming decades.

20:05

💼 The Impact of AI and Debt Accumulation on the Economy

Continuing the discussion on AI, Karen explores its potential to disrupt the workforce, drawing parallels with the manufacturing industry's transformation. She also addresses the long-term implications of debt accumulation, noting the shift from private sector to government debt and the potential limits of government spending. Karen suggests that while there are structural reasons for increased government borrowing, the ultimate limits and consequences remain uncertain.

25:05

🌳 Portfolio Construction and Diversification Strategies

Karen delves into portfolio construction, emphasizing the importance of diversification and the risks associated with over-concentration in U.S. corporates. She discusses the challenges of managing portfolios in a market where U.S. tech firms dominate and the need for investors to reassess their asset allocation. Karen also highlights the importance of considering cash as a significant component of returns and the potential for leveraging to achieve desired returns.

30:06

💡 The Importance of Alpha and the Role of Cash in Portfolios

The conversation turns to the role of alpha in portfolio returns, with Karen noting that alpha opportunities may become more significant in a market environment where beta is challenged. She discusses the importance of not taking past performance for granted and the need to reassess strategies in light of changing market conditions. Karen also underscores the role of cash in portfolios, suggesting that investors should consider the potential returns from cash as part of their overall return strategy.

35:06

🔍 Avoiding Catastrophic Loss and the Psychology of Investing

Karen discusses the critical goal of avoiding catastrophic loss in portfolios, comparing it to the importance of health. She emphasizes the need for investors to consider the pattern of returns and the importance of maintaining a consistent compounding of wealth. Karen also touches on the psychological challenges of investing, such as the tendency to root for hedges and the difficulty of living with investments that are intended to perform well when the rest of the portfolio does poorly.

40:07

🌟 Practical Steps for Building a Resilient Portfolio

Karen offers practical advice for investors looking to build a more resilient portfolio. She suggests starting with a clear understanding of one's goals and constraints, reassessing asset allocation, ensuring each part of the portfolio works towards set goals, and mitigating remaining vulnerabilities. Karen also highlights the importance of diversification and the need for investors to step back and reassess their portfolios periodically to align with future expectations rather than past experiences.

45:09

🏁 Conclusion and Final Thoughts on Portfolio Construction

In the final segment, Karen wraps up the discussion by reiterating the importance of portfolio construction in balancing confidence in one's views with the need for diversification. She emphasizes the need for investors to regularly reassess their portfolios and make adjustments based on a clear understanding of their goals and the potential future scenarios they may face. Karen also acknowledges the challenges of investing, noting that even the best decision-makers can be wrong and that portfolio construction is about managing these uncertainties.

Keywords

💡Investing

Investing refers to the act of allocating resources, such as money, with the expectation of generating an income or profit. In the video, Karen Carnevale discusses her journey into investing, highlighting how she was initially unaware of her interest in the field until she was exposed to it during her college years. The theme of investing is central to the conversation, as it shapes her career path and her role at Bridgewater Associates, one of the world's largest hedge funds.

💡Bridgewater Associates

Bridgewater Associates is a prominent hedge fund known for its unique approach to investing. Karen Carnevale joined Bridgewater in 2006 and has since become a co-CIO. The company is highlighted in the script as a place that values deep understanding and meritocracy, which aligns with Karen's interests and career progression. Bridgewater's culture and approach to investing are central to the discussion in the video.

💡Market Outlook

Market Outlook refers to a perspective or forecast on the future direction of financial markets. In the video, Karen shares her insights on the current and future state of the investment paradigm, discussing the shift from a period of low interest rates to a new era characterized by higher costs of capital. This outlook is crucial for understanding how investors might adjust their strategies in response to changing economic conditions.

💡Portfolio Construction

Portfolio Construction is the process of building a collection of investments to meet specific financial goals, risk tolerance, and investment strategy. Karen discusses her thoughts on portfolio construction, emphasizing the importance of diversification and the challenges of aligning portfolios with long-term goals rather than recent market trends. This concept is integral to the video as it provides a framework for investors to manage risk and pursue returns.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. Karen mentions inflation as a significant factor in the current investment environment, contrasting the recent past where inflation was low with the potential for higher inflation in the future. Understanding inflation's impact is essential for investors as it affects the real return on investments.

💡Interest Rates

Interest Rates are the cost of borrowing money and are a critical tool used by central banks to manage economic growth and inflation. In the video, Karen discusses the role of interest rates in the new investment paradigm, noting that they are returning as a primary policy tool. The discussion on interest rates is relevant as they influence the cost of capital and the overall investment landscape.

💡AI (Artificial Intelligence)

Artificial Intelligence refers to the simulation of human intelligence in machines that can perform tasks usually requiring human intelligence. Karen explores the potential impact of AI on the workforce and the economy, comparing its transformative potential to previous technological innovations like the internet and electricity. AI is presented as a double-edged sword, potentially leading to both significant productivity gains and inflationary pressures in the short term.

💡Risk Premium

Risk Premium is the additional return or profit sought by investors to compensate for the higher risk of an investment compared to a risk-free asset. Karen discusses skepticism about the future of risk premiums, especially given the high returns relative to cash seen in the past decade. This concept is key to understanding how investors might adjust their expectations and strategies in a changing market environment.

💡Diversification

Diversification is a risk management strategy that involves spreading investments across various financial instruments, industries, and other categories to reduce exposure to any one risk. Karen emphasizes the importance of diversification in portfolio construction, suggesting that investors reassess their asset allocation to ensure a balanced approach that can withstand different market conditions.

💡Alpha

Alpha in finance refers to the excess return of an investment relative to the return expected from a benchmark index. Karen discusses the role of alpha in portfolio construction, noting that while alpha opportunities were less noticeable in a rising market, they will become more significant in a more volatile environment. Understanding alpha is crucial for investors seeking to outperform the market and achieve superior returns.

💡Meritocracy

Meritocracy is a system where the talented are chosen and moved ahead into positions of power on the basis of their ability. Karen describes Bridgewater's culture as meritocratic, where people are encouraged to express their opinions and ideas regardless of their tenure at the firm. This concept is highlighted as a key factor in her success and the firm's ability to foster a culture of continuous improvement and innovation.

Highlights

Karen Carnevale discusses her journey from not having a clear path in finance to becoming a Co-CIO at Bridgewater Associates, one of the world's largest hedge funds.

Carnevale's interest in investing was sparked by the intellectual challenge and the allure of understanding and predicting global events.

Bridgewater Associates' culture of meritocracy and challenging the status quo has been instrumental in Carnevale's career advancement.

The importance of mentorship and pushing boundaries at Bridgewater is highlighted as a key factor in fostering talent and leadership.

Carnevale's 'superpowers' include curiosity, energy, and the ability to synthesize complex information quickly and effectively.

Ray Dalio's departure and the new generation's vision for Bridgewater involves continuity, adaptation to a shifting world, and a relentless pursuit of investment excellence.

Bridgewater's strengths lie in its culture of improvement, deep market understanding, and portfolio engineering capabilities.

Carnevale identifies the firm's culture as both a strength and a potential weakness, as it requires a high level of personal humility and openness to feedback.

The shift from a 40-year investment paradigm defined by low-interest rates and disinflation to a new era with different economic drivers is examined.

AI's potential to be a transformative economic event, possibly eclipsing the impact of manufacturing automation, is discussed.

The short-term inflationary pressures of investing in AI and technology are contrasted with the long-term potential for significant workforce and economic change.

Investors are challenged to reassess their exposure to AI and consider what a 'neutral' position entails in light of market cap weightings.

The long-term implications of government debt and the shift from private to public sector borrowing are analyzed.

Carnevale outlines the major risks facing investors, including overexposure to US corporates and the potential for a surprise recession or sustained inflation.

Portfolio construction principles are explored, emphasizing the need to avoid concentration in any one asset class and to build resilience.

The importance of considering cash as an asset class and the potential for it to contribute significant returns in the current environment is highlighted.

Carnevale suggests practical steps for investors to build a more resilient portfolio, including reassessing asset allocation and ensuring diversification.

The interview concludes with a discussion on the importance of setting clear investment goals and being honest with oneself about risk tolerance and financial needs.

Transcripts

[Music]

joining me today is Karen carneal

Tambour Karen is the coci at Bridgewater

Associates which is one of the largest

hedge funds in the world um and Karen

joined Bridgewater back in 2006 after

graduating from college Karen welcome

great to be here thanks for having me

Karen before we discuss your Market

Outlook and uh thoughts about portfolio

construction I'd love to share some of

your background with our audience why

don't we go back to the beginning uh

what would you say originally sparked

your interest in investing well I

definitely was not one of those people

that sort of grew up knowing this is

what I was going to do even through most

of college it's uh not what I expected

to do I don't think I could have really

explained what a stock or a bond was

until very close to graduating from

college but my parents are both

professors growing up I somewhat assumed

that that would be the path I would take

um and as soon as I got exposed to

investing though it spoke to me right

away that it's kind of an industry where

you just get to sort of think about

what's happening in the world and

predict what's going to happen and you

kind of live off of your ability to

understand and make your own decisions

which is very appealing for someone who

wants to think about and understand the

world so I was drawn to it right away as

something potentially uh interesting but

I don't think without kind of meeting

Bridgewater on campus and uh running

into the firm I would have ever uh

likely ended up in this industry so I

guess there's certain aspects of the

industry that just seem to be very good

fit for the way you think and the type

of career you'd like to pursue yeah I

mean um when I was an undergrad I um I

wrote my thesis with uh Danny Conan um

the author of a thinking fast and slow

and I was fascinated by human decision-

making and its

flaws and when I ran into Bridgewater

sort of occurred to me like they built a

whole firm around the understanding of

the flaws in human decision- making

built a whole firm around the idea that

humans are going to be really good in

sort of you know system to slowly

thinking through cause effect

relationships trying to reason what's

happening in the world but that doesn't

mean they're going to be good at

day-to-day making decisions remembering

everything they thought about in the

past monitoring their emotions avoiding

kind of all the biases and what it's

like when all the data comes at you and

the firm was really built to bring

together that fundamental thinking with

being able to take a more systematic

approach to than putting together all of

your thoughts um so that spoke to me

right away as a really interesting way

to think about decision-making so uh

you've been at Bridgewater for uh 18

years now would you talk about how your

experience relates to what you had

expected when you first joined the firm

honestly I don't think I had very uh

many expectations

and I think it was a little bit to my

advantage because a lot of people came

in with this feeling of you know I

finally made it I'm at the biggest hedge

Fone in the world now I got a lot to

prove um and I didn't feel like I had a

lot to prove because I didn't know if I

even wanted to be there I was sort of

exploring and uh figuring it out and so

I think it made me less hesitant to ask

questions and say things that maybe even

sounded you know sacrilegious to the

firm and it's a really helpful thing in

your career to be able to kind of

question things and not feel like um

you're too nervous to ask because you

sort of have something to prove I think

that was very helpful the thing that

definitely met my expectations that soon

I started meeting people from

Bridgewater what really spoke to me

about those people relative to everyone

else I had met kind of on the job market

was how much people were really truly

motivated by deeply understanding how

things worked and why rather than you

know kind of sounding smart proving

things out but really wanting to

understand and everything goes from

there um and that the firm is definitely

lived up to that that's definitely our

culture well you've steadily Advanced

that Bridgewater and are now one of the

co-cio at relatively young age what is

it about the culture there that has

enabled you to thrive so far I think it

is a um very meritocratic culture we

encourage people to speak their minds

and express their opinions regardless of

how long they've been at the firm you

know when you look at kind of our key

investment meeting of the week we kick

off every Monday morning with an

investment meeting there is um research

that people read over the weekend before

that meeting and anyone can comment on

it and a lot of people at a lot of

different levels of seniority write

comments and sometimes people that you

know you've never heard of and are way

more Junior actually write some of the

most insightful comments so there's

really a culture that encourages people

to kind of speak up at any level and to

draw out ideas and not to kind of build

meetings hierarchically but really seek

what the disagreements are and where you

could get views from different people

and the same time there's a very strong

culture of challenging people so there

isn't a sense of you know you sort of

have to get really good at your job um

and be a little bit bored in it before

somebody's willing to give you the next

challenge but much more challenging

people quickly and pushing them um to do

the next thing and a really strong

culture of mentorship and so uh you know

the three Chief investment officers uh

when I started Rey H doio Bob Prince

Greg Jensen all were incredible mentors

to me as were others of the firm and

often Bob Prince Right I think was my

closest Mentor honestly saw things in me

before I saw them myself and pushed me

to do things before I sort of thought I

was capable of them so I think those

three parts of the culture really help

um us bring a lot of people up the curve

and into big leadership positions

relatively young relatively early when

we see Talent we have a bunch of people

that you know you'd be surprised maybe

are in the role they're in because we

kind of saw that Talent early spotted it

and were able to kind of challenge them

um and encourage that really quickly um

and I think it's lot of with made a

successful let me dig into that a little

bit uh you're in a unique situation

because you're surrounded by some of the

smartest hardest working people on Earth

and when you look around you know

thinking objectively and you see what

you're really good at relative to the

others that you're constantly

interacting with uh what would you

conclude are some of your

superpowers superpowers I like I like

that phrasing I mean I think I have um a

lot of curiosity and energy um I

sometimes say that I'm like water I flow

to where I kind of get a sense of the

biggest impact so I really kind of like

will be drawn to where I see the biggest

potential for impact and I think I um

get to a cut through synthesis heart of

the issue quickly um so I think um my

ability to kind of look at you know a

deep set of analysis and a lot of

information about what's happening in

the world and kind of get to the heart

um of the issue quickly has let me kind

of do a wide range of things but at the

end of the day I think that almost

anybody in this business you kind of

have to have um curiosity um and like

deep interest and understanding um

what's happening in the world and what's

going to happen next that has to be part

of your uh superpower Suite if you will

because that that's what we do at the

end of the day that's what investing

really is there's one other that uh I'd

like to share just knowing you for for a

long time it's one thing to learn

quickly and be able to synthesize things

in your mind it's another to be able to

effectively communicate that to the

audience and to the rest of the world

and that to me is a very distinct skill

and and I've just noticed the way you

explain things is just you hear it and

you say oh that's obvious but but but

synthesizing it to that degree and

making it sound simple is not an easy

thing to do well thank you from you you

talk to a lot of people and see a lot of

things I really appreciate

it uh let's talk about Bridgewater a

little bit uh you mentioned Ray doio the

founder uh he recently handed the Reigns

over to the next Generation uh what

would you uh describe as the vision of

the firm over the next decade or so you

know I think that we're trying to both

have a significant amount of continuity

but also open ourselves to changes and

understanding kind of how the world is

shifting most importantly um our goal is

to

really overd deliver on our investment

promise be able to you know kind of um

set out how we want our performance to

look hold the highest possible standards

of excellence keep growing our

understanding and capabilities to manage

money in markets and um you know be

really be able to deliver the thing I

would add to that is we really want to

be the best partner to the institutional

investors we work with we've always been

a firm that has a small number of

Partners um rather than you know a huge

number of partners because we saw

ourselves as being able to kind of be in

there with them understanding their full

set of

circumstances um and we want to keep

those Origins and keep thinking about

what are the ways that we can deliver

the most value into investor portfolios

with the set of capabilities that we

have and so we've kind of set up to say

the vision of the firm over um you know

next 10 years is number one investment

Excellence deep understanding overd

delivering and everything that we're

doing um and really having excellence in

markets but number two and equally

important using that to really be able

to have the biggest impact that we can

in investor portfolios which doesn't

always mean a setup that's a traditional

hedge fund setup being you know Broad

and open-minded and creative to what is

the way that we can bring the most value

to our partners and make the biggest

difference in how they're managing money

what would you say are some of

Bridgewater's strength and you probably

just shared some of those now but also

some of its weaknesses and areas of

improvement uh for the firm over the

next five to 10 years so I think our big

strengths are you know kind of above a

literal strength just the culture of

constantly raising the standards focus

on Excellence calling out problems

continuous Improvement kind of underlies

everything and then in terms of what we

literally do I think we have incredible

fundamental understanding deeply

understanding how markets work paired

with the ability to kind of process that

data write down that thinking and then

be able to build on it so all the

thoughts we've had about how markets

work over the last 40 years have really

been written down codified can be you

know used and built upon rather than

starting from scratch back to this idea

about decision- making this is what

enables good decision- making not just

having any new person's thinking but

also being able to really build on that

um and then lastly I take portfolio

engineering like knowing what to do with

that insight to actually have the

biggest impact on a

portfolio um I think our weaknesses look

I'll be the first to admit that our cult

is certainly not for everyone it can be

it requires you to kind of be able to

separate yourself from your ego in a way

that can be difficult because we

prioritize being able to give

unadulterated feedback and it's hard

especially when you're an experienced

person you think you know what you're

doing and you got to be able to just

sort of open yourself up but I think it

makes us great it's part of that

Relentless pursuit of improvement and so

on um I think it takes us time to build

new expertise because we have that high

bar and we want it kind of codified and

stress tested and so on and I think it's

been difficult for us to integrate new

talent and that's something that um we

were really working hard at improving

and changing because it kind of limits

the growth of the firm if you can

integrate new talent but we've been

weaker relatively speaking at that let's

transition into the Market Outlook I

think everyone's always interested in

what Bridgewater thinks the future holds

and let's start at a very very high

level if we zoom out and and we look at

let's say 100-year charts how did things

generally look at this point I think we

were in a specific investment Paradigm

for something like 40 years that hit its

limits when covid hit with consistently

lower and lower interest

rates disinflation integration across

the world and almost like a

gravitational pull towards maybe like if

you did all else equal inflation would

have been something like zero um

consistently lower and lower interest

rates and something really broke with

covid and we kind of propelled us out of

that Paradigm into a different

investment Paradigm um we're now

entering I'd say kind of the height of

that old investment Paradigm over 50

years um the 40 years before it was

probably really like kind of the height

of it was probably in the 2010s where

you really had you know zero rates

quantitative easing extremely easy money

and a traditional portfolio kind of

invested in just like a market cap 60 40

7030 just did incredibly well because

there was just such a desire to keep

rates at zero and have risk PRS

continuously fall we've now kind of been

catapulted into a very different

environment that has a lot of Echoes of

what occurred I don't know 70s is you

know before this kind of big

disinflationary period but is also

different in its own right um it's an

era where interest rates are back to

being the main tool of policy rather

than quantitative easing but interest

rates are not just one-sided because the

kind of gravitational pole of inflation

is no longer to zero so there's actually

tension between you know kind of how you

use the interest rate and how you're

balancing between growth and inflation

um at the same time where inflation is a

factor you know one of the interesting

things in that 40-year period before is

you could understand a lot of markets

and break them down if you showed up

from like uh you know another planet and

never have heard of inflation and

understand what happened that's not

normal that was not true in kind of 50

years before inflation is a big factor

again governments are back to playing a

much bigger structural role part of the

role of interest rates is I want to

compensate for this you know very easy

fiscal policy and uh debt taking that's

that's happening um on the government

side um and at the same time there are

things that look very unprecedented they

don't we don't know where they're going

to play out I'm sure we'll talk more

about AI but while we've had a lot of

technological Transformations then this

one might be somewhat different um

what's happening in climate is going to

change somewhat what the nature of risks

are what a tail risk you know really

means so it's an interesting environment

but it had to well down to one thing

where're definitely out of this kind of

consistently falling interest rate

environment or very very low interest

rates to just needing a higher cost

capital structurally and the transition

there it's been gradual there are

reasons that it's more gradual than in a

day but I think that's just the new

paradigm that we're in and and you

mentioned AI uh when we if we zoom out a

little bit do you feel that AI is going

to meaningfully change the trajectory

anymore than all the previous

technological innovations like the

internet Railroad electricity Etc look

the comparison I would make is to what

happened in manufacturing in the

previous few decades basically what

happened in manufacturing if you had to

kind of sum it up even though it wasn't

all Tech Innovation something like 10%

of the workforce in the rich countries

was taken out partly because there were

machines that were put into

manufacturing sites but partly because

you just outsourced to cheaper places

but the bottom line is we took about 10%

of the workforce and we took him out and

if you look at who works in

manufacturing today they're very

productive relative to what they used to

be but there are way fewer of them and

lower value Ad work is happening abroad

or happening via machines that was about

10% of the workforce and there was no

like one day where that was the event

but over a long period of time you could

say this was really you know a very

significant if not the most significant

event that took place over that

preceding couple of decades and it

didn't only have Market implications the

biggest Market implication was really

the fact that inflation kind of tended

towards you know zero or so because

Goods got so cheap and were constantly

deflating it also had big social and

political implications and a lot of what

we're seeing in the rise of populism and

what not would have looked very

different if none of that occurred now

you look at Ai and you basically say

could we get an event as big as that it

could easily be bigger AI could easily

take out more than 10% of the workforce

you could look at a lot of estimates

that would say you could end up with

more than 10% of the workforce being out

could it happen faster than

manufacturing could you could imagine

that it takes time to literally rebuild

your physical manufacturing it also

takes time to you know kind of redo your

services and use AI but it may be faster

than that we don't know so if you say

that what happened with manufacturing is

a little bit of a downside case almost

for AI and there's a lot of upside

beyond that there's a decent chance it's

going to be the economic event of the

next at least 10 years maybe 20 depends

on exactly the pace that it goes now the

big issue is that that's kind of the

medium to longer term picture I don't

think that's the short-term picture on

AI I think the short-term picture on AI

is it's extremely inflationary it's

almost the opposite of everything I said

it's not deflationary at all it's a

reason for people to spend large amounts

of money actually not being tied to

productivity gains to lowering costs

because they see this future coming and

kind of want to be prepared for and

don't want to miss out so you have this

world where people have a desire to do a

lot of spending they feel is existential

and it's not tied to like taking cost

base out it's not tied to getting more

productive they feel it's exist IAL

spending and that means in the near term

that's incredibly inflationary spending

it's inflation you're going to do

regardless of what demand you face

regardless of kind of how the cycle goes

and so in the near- term I think it's a

very inflationary pressure but when I

look out you know even a little bit

beyond that I think there's a decent

chance we're looking at a very very big

event and I guess it's one of those

things where you can easily overestimate

or underestimate its impact and its

timing yeah I think that one of the

things happening with investor

portfolios is that investors almost have

to ask themselves what is neutal

exposure to AI because the big companies

that are in the AI movie are just such

dominant parts of people's portfolios

whether they expect it to or not they're

just such a big part of market cap and

you get this Divergence where what

they're doing doesn't look like what the

rest of the stock market is doing

because they're not reflecting what's

currently happening in the economy right

they're pricing off of this thing into

the future that as you say you could

underestimate you could overestimate you

could also get the players wrong you

could think it's these players and it's

different players that'll reap the

benefits so you can kind of say that's

one thing causing Market moves and then

there's what's actually going on in the

economy today that's also causing Market

moves so you almost have to ask yourself

like what is my neutral position with

regards to that and how do I want to be

positioned related to this knowing that

I don't know and I think anyone who

tells you they confidently know you

shouldn't trust and I guess the default

answer is market cap weight but I guess

you could also view it differently from

that exactly I think market cap weight

is too easy than a default of a default

for too many things another big Trend

that we've observed over the last three

four decades is as a country living far

beyond our means uh you know you have

these massive deficits that just seem to

grow and growing debt uh what would you

say is the long-term impact of the uh

debt accumulation that we've experienced

you know it's interesting because with

like longer term perspective the big

thing that happened is that we shifted

from the people taking on the debt being

the private sector to it being the

government and so we were taking on

massive debt before the great financial

crisis right just it wasn't the

government it was businesses it was

households that's who was getting

massively indebted and we understand how

you run into limitations like what

happens that a household suddenly can't

pays mortgage we sort of understand how

you run into like when are you at your

limits and can't take on more debts it's

a harder question how does the

government run into limits so I think

where we're at now is one there are

really good structural reasons why the

government will be the structural

borrower in the next 10 years biggest

thing geopolitical competition right we

moved from this environment in the Years

prior where there was constant

integration and that was a deflationary

pressure to one where everybody but the

United States probably most prominently

is kind of

reassessing what does it mean to feel

that China is now a competitor are we

energy independent are we manufacturing

independent where is our Reliance and so

while the private sector feels this

energy too and they also feel a great

need to be spending on this issue the

government's clearly taking a lead role

in creating the incentives and saying is

the kind of spending I want to see and

the shift between thinking that uh

what's typically called industrial

policy where government kind of directs

where capital is going to go is kind of

ideologically not in our wheelhouse has

changed to say well if China's gonna

spend so much money basically going in

and you know having um different sets of

incentives and whatnot and saying I want

to be a solar Powerhouse and then

winning why are we not doing the same

thing and so you have a lot of

government spending that's going towards

whether it's

remilitarization let's build our own

semiconductors there's a lot of money

that's going towards building our own

industrial base up so I think

government's going to stay a bigger

spender than they had been structurally

for some time and then the question you

get to is like what's the limit of that

when are we going to be told that that's

not going to work anymore um there's a

lot of things that are delaying that you

know kind of Reckoning we don't know

exactly what Reckoning is going to look

like the only developed country I think

that's really had it is if you look at

the UK kind of How It's like Liz trust

moment where we're sort of told by the

markets like wait a minute

this is too much this is not going to

work um and you can look at that market

action and say what would it look like

if it happened to the US I think a lot

of the reason it's not happening to the

US is there's not a lot of competitive

places for the capital to go right and

so um you have a you need a structurally

higher cost Capital to deal with the

fact that there's such a desire to spend

on things like AI like geopolitical

remixes you need a structurally higher

cost of capital to deal with the fact

that fiscal policy is so easy but then

at these higher level of rates there

isn't any borrow

happening from the private sector people

are just you know using their incomes

using their balance sheets they have

lots of cash and so it's not like

there's a lot of competition for Capital

so we're not actually asking people to

fund that much borrowing overall uh so I

think we're far from knowing what that

Reckoning is really going to look like

but you play forward such a reckoning

some version of it will occur when we

look at some of the risks out there

there's obviously a lot of uncertainty

uh what are some of the major ones that

you're thinking about uh is it a

surprise recession that you know most

expected a couple years ago and have

kind of forgotten the risk of or is it

inflation staying higher for longer or

there other big risks you're thinking

about well I think I often start with

what is the positioning that people are

in that a risk will actually really hurt

them um so for example you could have

great or terrible performance in China

it's not going to affect almost anybody

because most people don't have any

Chinese assets anymore that's you know a

weakness in the sense that they're less

Diversified but it's a reality versus if

you look at what people have there's a

couple of major exposures that people

have that are kind of the primary

question to be asking the most obvious

one of them is everybody is massively

allocated to us corporates um what used

to be standard as more of a 6040 is now

more of a standard

7030 um people got rid of their bond

allocations in this period where there

were negative real rates and so it just

didn't feel like it made sense to hold

any bonds they couldn't really meet any

of your return goals and got really

concentrated equities and then with what

we've had happen in um US tech

firms us equities became such a big part

of any global market cap though a lot of

people kind of you know being anchored

on market cap you end up with an insane

concentration I mean typical portfolio I

look at is somewhere between 80 and 90

sometimes 95% of the risk I'd say is in

some version of us corporates you also

had um a lot more correlation get higher

between us and count the main markets

people do hold like Europe like Canada

so the main RIS people face is a bad

environment for us corporates and then

you have to ask what would cause that

and so you have a surprise recession and

for that you actually have a really good

hedge that exists today that didn't

exist for a while which is if you had a

really surprise us recession the FED

could ease rates are such of the feds

could actually ease that's a traditional

role bonds used to play in portfolios

they can actually play them again you

also have sort of higher longer stickier

inflation you actually need to tighten a

lot more than discounted where bonds

obviously don't help you with that and

then your best bet is to sort of be

somewhere else um go to places where

you're not invested go to places that

are kind of be maybe on a different

cycle of growth and inflation like for

example a Japan Which is less likely to

have a sticky inflation problem you need

to you know tighten much more

aggressively into so let's talk about

portfolio construction uh obviously

asset allocation is the major driver of

returns and you just talked about your

observation about how most portfolios

that you've seen are currently

positioned but one of the first rules we

learn as advisors and uh allocators in

in managing a portfolios don't put all

your eggs in one basket yet when you say

80 or 90% is in us corporates that sort

of sounds like it's all in one basket uh

how do we get to that point well I think

the biggest thing that's going on is

that there's still a lot of hesitancy to

use leverage so one of the the clearest

arbitrages that exists is that if you're

not comfortable with leverage then

people just look at return levels even

if something is less risky um the

perfect example is is in the equity

markets I think there's a lot of you

know academic papers and whatnot to say

this is still true and a lot of evidence

of this that if you look at companies

that are just less volatile they just

have you know less going on they sell

something that people just buy every

every year no matter what even when

there's a recession they tend to kind of

have the same returns even though

they're a lot less volatile so it feels

like something is off and the reason is

if you wanted to make the same return

and have a less vle thing you'd have to

leverage it so people actually demand

the same kind of nominal level of return

regardless you see it in what happens

with attraction to there's a lot of

Alpha and private assets but there's

also a lot of attraction to private

assets because the Leverage is sort of

embedded and so it's just the nominal

level of return can just be higher than

what you can accomplish by yourself so a

lot of what ends up is if you kind of

start and say I need 7% return I need 9%

return I want some number return but I

don't really feel comfortable kind of

dealing with leverage myself you have to

end up where you think that's the

nominal return level even if there are

good risk PRS in other places and that's

sort of how you end up where you are the

second thing is that I think that um

market cap is a natural thing to look at

right there's fish Mark hypothesis of

this for a reason Etc um but it has

gotten more concentrated and so that

becomes your starting point and tracking

air is hard for people to live with if

you constantly have to justify uh

yourself relative to what any index is

you're drawn to be more like the index

or to kind of add something un

correlated on top of the index so if you

have an index that kind of goes up or

down what you want is a straight line

you have to be able to live with the

fact sometimes when you have a straight

line you feel like an idiot because what

everyone else is doing is going a lot

better and other times you feel like a

genius it can be a lot easier to live

with I'll take that not straight line

I'll take that up and down and I'll just

add something uncorrelated on top so

always Beed by a couple percent much

easier to live with and so that's how

you end up that market cap is

concentrated and other people are

concentrated and you can't take leverage

you're in us corporates what you just

described as a framework that uh many

investors take is they back into the

allocation based on the uh expected

return and the tools in their toolkit to

build that portfolio uh Would You Walk

us through uh the way you think about

constructing portfolios if you're

starting from a blank slate and if your

goal is to build a resilient portfolio

as close to a straight line as possible

uh walk us through your thought process

for how you construct that portfolio so

first I'd remember there's basically

three sources of return you can have

there's the cash rates there is beta or

risk creams that you're earning holding

riskier assets than cash and then

there's alpha or your skill and

timing cash was an irrelevant thing for

a pretty long time and so I think a lot

of investors almost forgot to think

about it which made sense when cash was

at zero but cash is no longer at zero

and if you look at what cash is sort of

price to be over time you can make a

bunch of the returns you need just

sitting in cash and that's a big deal de

and that means that for example you know

if you're buying a bond a lot of what

you're doing is not really trying to

make a risk pram you're just trying to

lock in that cash rate and say I'm

pretty sure I'm at least going to make

this nominal return which is primarily

just what the FED is going to do with

the cash rate is going to be so it kind

of deserves new consideration then

there's what risk BRS are you earning or

your beta and there I think that you

don't have to be confident that the

world is going to turn to at least be

skeptical that it'll be as good of an

environment for earning risk premiums as

it was because the 2010s were like a

runaway success right like the returns

relative to cash were the highest we've

ever seen in the decade and that's mean

the decade with the highest returns

relative to cash um primarily driven by

us equities doing so well and so you

don't have to really have a strong view

to at least say I'm skeptical that

repeat I know that in the start of the

2010s valuations were terrible I just

came out of the great financial crisis

before that I had you know 1999 and that

stock market blow up I started with good

valuations and now I'm you know

10 plus years into an amazing bull run a

lot of success is already priced in I at

least would be skeptical that's going to

repeat itself and so I think you can

look at what risk premiums you're kind

of sitting and earning at least with

some more neutral view of saying I know

I'm positioned for what just happened

what's the best way of position going

forward where do I think there are our

risk premiums and I think when you look

around the world in a lot of places it

doesn't look like Risk premiums look

great there's already a lot of optimism

priced in there's a lot of easing that's

already baked in so it doesn't take take

a lot to imagine tightening more than is

already priced being difficult for all

risk premiums Etc it's just probably not

going to be a great place to make

returns where it was incredible kind of

the last period and then you get to

Alpha and the biggest thing I say about

Alpha is that in the environment we just

had Alpha was almost people almost

didn't notice it because everything went

up right and so you didn't really suffer

if you had slightly worse or slightly

better private Equity or public Equity

managers because everything went up the

difference is felt small we're probably

moving to an environment where it will

matter and where differentiation gets a

lot bigger and you actually have big

opportunities just look at in the public

Equity markets how lowly correlated

single stocks are to each other that's

telling you it's a it's a time of big

opportunities um the last thing I'll say

in kind of building the portfolio is

don't take anything for granted for

example for a long time people didn't

even ask themselves what am I holding in

terms of currencies it just kind of

happened so you've gotten into these

habits where for example most people

hold their bonds hedged and their

equities unhedged does that really make

sense no just kind of what expertise has

grown up like um it Felts for a long

time in equities that it didn't really

matter what currency your Equity was in

and in bonds it was easier to see the

impact so you got more skill set on the

bond side to deal with currency than in

equities that doesn't actually make a

lot of sense you're in a different

environment now and back to the alpha

opportunities when you start getting

divergences divergences also exist

across countries so you can actually get

exchange rates moving so in the last few

months

the Japanese Equity Market is like the

best in the world if you hedge the

currency and not that good if you're

exposed to the Yen and probably whoever

was making that decision for you didn't

even ask that question but the N or has

no expertise in that space that decision

becomes more important starting to split

out decision and asking where do I have

Alpha where do I have expertise and

where are the opportunities going to be

and it's interesting when you use that

framework of where the the Returns come

from Cash Plus risk premiums or beta

plus you know excess returns or Alpha

and You Look Backwards cash was zero and

beta was high particularly in equities

and Alpha was more challenged and let's

say over the next 10 years it could be

almost the opposite where where beta

could be more challenged uh cash is a

lot better than it's been for a long

time and there may be more Alpha

opportunities as you get divergences

across the globe and across asset

classes yet most portfolios are backward

looking and have a lot of beta exposure

and probably Less in the other

categories I totally agree this is the

fundamental flaw that um probably the

biggest flaw in investing and big FL on

how markets price and why opportunities

get created which is whatever just

occurred there's just a bias to be

expecting the same thing is gonna happen

and it's natural it's a natural human

flaw and decision-making whatever just

occurred it just feels to you like

that's likely to happen again what ends

up happening is that that then gets into

the price because everyone expects it's

going to happen again so by definition

what just happened can't occur again

because now it's in the price and

markets you know basically price

relative to what how things transpire

relative to the starting price and so

people naturally get positioned for a

repeat of what happened in the past even

though the future really can't look like

the past precisely because market prices

have Incorporated that information and

now already have that outcome um in its

pricing and investors have been too late

to build a portfolio that's appropriate

for what's coming ahead versus what

worked for them in the past to me that's

one of the most fascinating things about

investing in that we can only see

historical prices we can't see future

prices so so it's natural to to

extrapolate the recent past into the

distant future because that's that's I

think our minds have that blind spot and

what ends up happening in at least in my

experience is oftentimes the near future

looks like the recent past and so it can

reinforce that belief and keep it going

for an extented period because you have

psychology actually plays into markets

and and I think that's part of why you

get these cycles that go longer in both

directions than they may otherwise well

said very well said and I guess this all

kind of circles back to what you said in

the beginning which is what attracted

you to Bridgewater is is being able to

separate out how the economic Machine

Works how fundamentally markets price

the cause effect linkages and then

overlaying on top of that human

psychology and its impact on prices and

trying to put it all together to come up

with forecast for the future yes and at

Bridgewater for me the two sides of the

equation have been really fun were both

one hand just truly trying to get my

best view of what's going to happen next

and that's really what kind of making

Alpha is all about right taking in

everything you see happening and trying

to call like what's coming next and

trying to stress test that thinking and

live through it but then the flip side

of that which is really fun from

Bridgewater's you know kind of perch

where we see whole portfolios and look

at every asset in the market is also

being able to come into big portfolios

and partner with them and say okay here

are probably the flaws in your thinking

that you're making and here are the

dials that you could potentially turn

that would make you better prepared for

you know what you kind of see coming

ahead speaking about portfolio

construction and its goals as you're

building a portfolio I'm curious to see

your thoughts about what I I always feel

that uh one of the primary goals and

actually probably the primary goal for

every portfolio should be to avoid a c

catastrophic loss and I and I think of

it as similar to one's Health uh it

tends to creep down the priority list

the longer you go without uh suffering

some pain um and until you have the next

Crisis and all of a sudden it's priority

number one again uh I'm curious how you

think about this Dynamic and and how do

you generally think about this risk I

agree I mean I would say that um the

right way to think about your goals in a

portfolio is that people really should

have four goals one is the most obvious

one everyone always wants which is they

want higher returns everyone wants

higher Returns the second is the one you

list which is easy to be aware of when

it seems like a big deal and not

otherwise which is avoid tail risk

outcomes and then the kind of less

thought of ones are narrow the range of

outcomes actually is a bigger deal than

people sort of think about especially

when you do use your cash along the way

right and so um if you lose a bunch of

money it's not good enough that it's

theoretically going to recover you need

to be able to potentially spend at that

point and not be able to just reinvest

it all and so it really is helpful to

have more of a a range of outcomes be

narrower and the second is avoiding

sustained periods of underperformance

which again over a very long period of

time you could say I can live with it

but sustained period you have to use

that money it matters it matters for the

pattern so in other words people think a

lot about the level they don't think a

lot about the pattern if they think

about the pattern they usually think

only about tail risk risk of Ruin which

is extremely important because you got

to stay in the game but you also want to

think about what am I doing for the

pattern and what can I do to basically

get from a lot of ups and downs to

something that feels more like a

consistent straight line which over time

is going to compound your wealth a lot

better especially if you're planning on

you know kind of using the money at

different times everyone thinks

themselves as a long-term investor but

the reality is we all have some time

frame on it it's never a forever and it

does matter how our wealth compounds

along the way and then markets long term

is a lot longer than it is in the

regular world yeah I mean you look at

what happens when you are in a place

like Japan and you go through just a

long period of equity

underperformance and it's not something

you can tolerate even if after many many

years it's going to recover you're much

better off saying what assets should I

be in that avoid that outcome um you

know we're seeing the same thing in

China now where stocks have been a

disaster but actually it's been a great

time to hold bonds because there is

consistent carry there and a consistent

need to stay easy and so you keep having

these cases where you basically say I

know that just being being concentrated

in the stock market has these outcomes

sometimes sometimes I can get very long

periods of underperformance I've seen it

it happens over and over different

places I know it hasn't happened

recently in the United States but I

certainly know it can happen I know it

can have you know a very wide range of

outcomes and very long periods of slow

underperformance and so you have to kind

of at the same time get yourself a

psychology of it's been such a good

investment and I have so much peer risk

if I move away from just being in the

stock market am I really willing to

sacrifice that for something that I

think is going be more resilient to a

wider range of outcomes even though I'm

not necessarily betting on what the

outcome is going to be and and there's

always a narrative that supports the

strategy so for example the S&P 500 has

been on fire it seems to never go down

anytime it has a little blip it bounces

uh straight back uh but people forget

that the prior decade before this 15E

16e bull market S&P was negative one of

the worst places in the world to be as

it was grossly overvalued after after

the uh the 99 you know the late 90s boom

um but that Narrative of these are the

you know greatest companies in the world

they're growing fast how can you lose by

investing in them that can be pretty

self-reinforcing totally and it can make

being you know more Diversified look

like a bad decision for an extended

period of time yeah you know I was

talking to someone recently that was

telling me how they had some things in

their portfolio they were really

intended to do well when the rest of

portfolio did badly that that was the

goal of those things and we're talking

about how hard it is to live with things

in your portfolio that that's their

literal goal and they were saying to me

I find myself sometimes rooting for the

hedges and I know it's illogical because

it's just a hedge so it means that my

overall p is doing badly so I can't

really want to root for this I have to

root for like the main horse but I just

wish I could prove better that the Hedge

matters and it's going to work and it's

a real you know it's a governance

problem it's a psychology problem it's

difficult to kind of live in those

periods where the at any point in time

one thing is going to be the best and

you could feel bad that you're not in

the single best thing it's the hardest

when other people are by definition just

harder at those times and it comes back

to I think when you kind of look at what

levers people can pull in some ways the

hardest lever to pull is to do the most

diversifying thing because it's

something that just doesn't stand on its

own you're adding something for the

purpose Pur of complimenting everything

else you do so that's kind of the most

difficult decision um easier decisions

are to you know more gradually shift

your pfolio um asset allocation or look

within assets and say how do I do them

better in a way that you can still kind

of be able to evaluate that outcome with

less of a sense of as extremity of you

know kind of just complimenting my

issues and one of the challenges that

I've seen with with investors and

clients is this tendency to zoom in to

more recent periods rather than zooming

out so you you mentioned that straight

if you had a choice between investing in

let's say the S&P 500 over 100 years and

you can get a straight line S&P that

gets you that nine or 10 perent a year

every year without fail or the volatile

S&P that swings up and down and ends up

in the same place if you're zoomed in

you may choose the more volatile one

because over that period it looks like

it's doing better but if you were to

zoom out it'd be very obvious what the

choice should be so oftentimes people

just get too zoomed in and it it's

really hard to get them to zoom out to

see the bigger picture and to remember

that that's what it's supposed to look

like that's actually what success looks

like like I had a couple conversations

recently with folks that had made

attempts to take their Equity allocation

and say my goal is a total like highest

ratio Equity allocation I want my

equities to be more consistent just like

you're saying I want to create an S&P

that's more consistent and you know that

the goal of that is literally like the

the meeting it would be making a

straight line and you don't think that

straight line is going to make 20% a

year or even 10% a year that's not

sensible but that's the goal and you

know that that means that if you really

succeeded sometimes it'll be under the

S&P sometimes you'll be over but over

time you'll have more of a straight line

and literally they do a thinking on

average I'll have the same return as the

S&P 50% of the time I'll be above 50% of

time under and they set that up but now

they're living through probably the

biggest period of Divergence ever

because today literally the biggest

thing that determines your quote unquote

tracking ER difference the S&P is how

much you hold of just a few companies

and

so living with that and saying I know

that goal as you're kind of saying Alex

if I zoom out I know that's what I want

I chose it proactively but it doesn't

feel good right now because right now

I'm under what would have been this

really cheap S&P 500 exactly the way it

is and I think part of the issue is the

reference point if the S&P was down 20

and you're down five you're you're doing

okay but if the S&P is up 20 then all of

a sudden you look like you're not doing

well and it's that reference point and

and the US Stock Market at least for

investors in the US maybe for investors

globally is the kind of DEA facto the

reference point because that's what's

talked about on TV when you ask somebody

how the Market's doing they're talking

about the US Stock Market and so I guess

part of the issue is that's the

reference point we all compare ourselves

to and and and so the question is is is

that the right reference point is that

just what it is or should investors

think about it differently it's hard to

commit to really assessing what you're

doing relative to Absolute returns but I

think that's actually the right answer

like the right answer is to commit to

assessing yourself relative to Absolute

returns or even better would be relative

to cash saying cash is really the thing

I don't control I'm G to just assess my

level of return over cash so I'm just

going to say my goal is to make Cash

Plus X let's pick Cash plus4 Cash Plus

five I'm just going to assess myself

relative to meeting that'd be kind of

the right intellectual answer very hard

to do very very hard to do and so I do

think there's steps you can take that

move you away from just purely looking

at market cap and let you kind of you

know go along towards that direction

even things like I'm going to create an

equity index that's more geographically

Diversified doesn't have limits how much

is in any one company does something

that kind of helps me get in the

direction of remembering that the right

perspective doesn't have to be the

random one that just happened to be set

by the market cap the other thing I've

seen people a little bit do is try to

build portfolios to do the two extremes

and then you can see the two extremes so

you can literally say okay here is where

I do the market cap in Alpha overlay so

I'm just trying to beat the market cap

I'm going to assess any manager there by

whether they beat the market cap that's

just what I'm going to do and over here

I'm just going to try to make cash plus

four Cash Plus five where you pick your

number and I'm G to be able to see the

extremes and I'm able to see what bias

I'm getting by being attached to market

cap but like again sticking with the

equity example one of the things you see

is if you tell a manager I want to make

sure that you beat the market cap I'm

going to assess you by whether or not

you kind of outperform the market cap

and let's say that manager for some

reason thinks that meta sucks they think

meta is bad company they have to put all

their efforts now and all their focus on

do I have Alpha and companies somewhat

similar to meta because that's the

biggest driver of my deviation I know

that's how you're going to assess me and

so there's a lot of downside to that

because whatever is that thing that

might not be their best source of Alpha

and returns and they might think oh yeah

I'm buying something for you very

similar so I'm minimizing my tracking

error or something but actually it's not

because that is just really

fundamentally different and

idiosyncratic so you're kind of messing

up your like what's the best way to use

your Insight but you're getting the

benefit of it making you comfortable to

be able to say I know I just want to

make the market cap I want to be able to

compare myself and I'm gonna just check

ability to do it relative to that so

it's almost sometimes nice to say I'm

just going to do the two extremes see

what that's like see what biases I'm

getting in both and be able to use that

to kind of assess where could I be what

could my portfolio do for me and I know

the my portfolio that's stuck with

market cap is stuck with that like its

base is 90% risk in us corporates that's

it that's its weakness and I guess

perhaps most practically somewhere in

between those two extremes is probably a

place to be in terms of being able to

hold on when your peers are performing

relative to that straight line and and

protect yourself during those periods of

extended underperformance yeah Karen

what would you say are some practical

steps that investors can take to uh

build a more resilient portfolio I'd say

first step is always step back and try

to be honest with yourself about your

goals and constraints what are you

really trying to achieve what would be a

big deal for you in your financial

situation what is an unacceptable loss

for you how much volatility are you

really willing to take second I'd say is

reassess your asset allocation you're

probably stuck in an asset allocation

that is not right for today and the most

obvious example I see in most portfolios

there is people hold no bonds because

bonds just had zero returns for so long

that they really couldn't achieve any

goals I talked about in that first step

with zero returns but now they can they

can actually achieve returns but there

could be other elements of your asset

allocation as well then the third I

would say is make sure each part of your

asset allocation is working for you to

meet the goals that you set in the first

kind of step and so as an example you

know a lot of the reason people are

inequities to a large extent is they

feel they have real uh Alpha they can

get out of that space make sure you

really believe in that Alpha and it's

not just kind of showing up as if you

had Alpha because you're in an

environment where everything went up in

the bond space a lot of people end up in

allocations where when they look at the

alpha the way that they get you know

kind of active decision- making added to

bonds is primarily through leaning into

credit spreads well that kind of negates

the reason you have Bonds in the first

place if what you're trying to do is you

know get away from concentration us

corporates and so think with each within

each ASA class what you're really doing

to kind of get the allocation you want

and then the last thing I would do is

basically step back and say Here's Where

I Am is there anything I can do that

would directly mitigate the

vulnerabilities I have left and how much

am I willing to take something you know

kind of mismatched and different to

remember that that's my hedge whether

that's an asset allocation that is much

more balanced to begin with and you want

to watch that and see how that does

something more like a risk parody

whether that's something like something

you feel is more negatively correlated

Alpha you have good reason to think it

tends to do better when things are bad

whether it's a geographic diversifier

you sort of say you know this let me be

in places like Japan and Korea that just

have a different cycle what are things I

can do that kind of directly mitigate

whatever vulnerabilities I have left and

I guess part of that is also looking at

assets that may do better during uh

inflationary periods uh because that's I

found that's missing in a lot of

portfolios because we haven't had

inflation issues for several decades I

agree almost no one has any almost any

inflation protection

um I think that as you kind of said It

felt unnecessary because there was no

inflation and then even the last few

years have given people I think some

sense of false Comfort because inflation

Rose to high levels and yet people's

expectations were that inflation would

come back down so you didn't get a

repricing of all assets to account for

inflation Staying High if you had said

to me you know kind of going into this

period before it happened you're going

to see the kind of inflation numbers we

saw but don't worry no one's going to

believe that's going to remain I never

would have believed it and it's actually

back the top talking about before with

all the government debt it's kind of

magic for the government right like you

run High inflation inflates away your

debt but no one believes it's going to

stay so you don't have to pay higher

interest rates kind of magical but it

has have people with a lot of um lack of

inflation protection and it means that

there isn't a lot of value being put on

those places where there is inflation to

be had one example we've talked about

recently is um infrastructure assets

some of them have a lot of inflation

protection some of them don't you don't

necessarily see a lot of differentiation

because a lot of investors aren't in

there again remembering the goal of why

they're in the asset class and trying to

kind of prioritize that and what they

pick to me it's amazing when you get a

massive disconnect between if you ask

somebody what their goals for their

portfolio were and you look at how

they're positioned um and I guess every

once in a while you just got to reset

take a step back ask yourself those very

obvious questions and reassess it not

relative to what you've experienced in

the recent past but what the future may

hold absolutely and that's really what

portfolio construction is all about it's

about um those tensions of you can't see

the future don't know what's going to

happen you're trying to build resilience

through whatever methods you have and

you've got to kind of trade off

confidence what are you really confident

in what do you have a strong view of how

it's going to transpire what Alpha do

you really believe is going to deliver

with diversification and realizing you

don't really know how the world's going

to play out you don't have to make a big

bold bet about the world and everything

that you do and you have to trade these

things off if you always buy just the

things you're most kind of confident in

you you will end up sometimes blowing up

because you're G to be wrong even the

best decision makers are wrong you know

40% of the time 45 at best but if you

over lean on just diversification you're

missing the chance to really take

advantage of where you do have

opportunities you can lean into whether

that's managers or you believe in their

Alpha whether it's an understanding of

where the world is going to go and

trading those things off well is really

what portfolio construction I think is

about

well Karen thank you for sharing your

insights with us um I greatly appreciate

it and I know our audience does as well

thanks a lot for having me Alex thanks

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