Shoulders of Giants – CFA Sociaty Chicago Annual Dinner 2015 Interview with Mohamed El-Erian

Mohamed El-Erian attended the CFA Society Chicago annual dinner yesterday as Keynote speaker. Following are some highlights of the interview which interested me and got me thinking the most.

– About Fed and rate hike: Investors shouldn’t worry about the 25 bps Fed rate hike. We have lived in this exceptional low interest rate world for too long and Fed also did a bad job communicating to the street. We should understand that the rate hike will be mild to begin with, and will gradually move to a target rate which is still much more stimulating than historical average. To talk more broadly about Fed’s role, Mohamed pointed out that for the past 10 years, central banks have been use finance as a growth engine, (e. g. US housing’s driving US economy, European countries like Ireland, Iceland, Portugal and Greece thought they could solve problems by financial engineering their balance sheets and leveraging). But end of the day, finance is a service industry and cannot be a driver of the economy! Now we are just trying to reverse that. It will be a tricky transition because 1) it needs political system which reacts quickly which we don’t have; 2) flexible financial system 3) the whole system is susceptible to disruption from new technology (same as hotel being disrupted by Airbnb and urban transportation being disrupted by Uber). Therefore he predicts this transition period is going to be very “volatile”, and will have a lot “hiccups”.

– About student debt, he thinks it’s a bubble, same as back 10 years ago all people are incentivized to own real estate, and more recently China tried to convince all retail investors to own public equity. The return of education has been down, thus not all people should pursue college degree with debt.

– About emerging markets, when asked about how to get prepared, he joked “learn Chinese”. You have to realize that central bank there is not a only a referee but also a player, so providing solutions is more important than providing just products.

– About active vs passive: Back in late 90s, Argentina bonds consisted 20% of an index. In the year of the Argentina debt crisis, the index returned 3%, but 15% without Argentina exposure. PIMCO held 0% Argentina bonds, having a big tracking error, but which way is better? So the question is really about how much risk you are willing to take with what level of liquidity. Remember there were days that there was no liquidity for TIPS, the “risk free” asset! With buy side growing and sell side shrinking, one cannot assume there will be always liquidity. This is what he called “illusion of liquidity”. Note these statements are very similar to what Carl Icahn has been advocating recently about the ETF pumped high yield bond market!

– Where is your daughter’s college fund allocated? “Very bar belled”, meaning one end of a lot of cash which offers the optionality to deployment when assets prices are overly corrected and the other end of illiquid assets which are immune to central banks influence. He would avoid public markets, because he thinks the current public assets price level is elevated by the central banks’ prolonged stimulus to well above their fundamental value, the outcome would be either 1) elevated assets price creates illusion of wealth, cultivates consumption growth and eventually drives assets intrinsic value up to price level, or 2) price collapses back to the fundamental value. The bar bell strategy may sound well, however I personally think it’s easy said than done for ordinary investors. When you look at “illiquid assets immune to Fed policy”, there is really not a lot options. Real Estate, Currency, Commodity are all closely tie to the monetary policies in this more correlated world. The only alternative is private equity, but how can ordinary investors access that? I don’t have $500 million to buy a piece the next Uber. Mohamed did reveal that he owns stake of an credit FinTech start-up, that explains his strategy of cash + PE.

– What’s the next big innovation? Don’t know what, but know characteristics. They are optionality, agility and resilience. They are important characteristics not only for individuals, companies but also governments.

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