Investment Strategies amid Uncertainty

CFA Institute Alpha and Gender Diversity Conference
18 September 2017
Toronto

SUSAN SCHMIDT: I’m going to let the ladies introduce themselves. And Jen S., if you would please start.

JENNIFER STEVENSON: Sure, so I’m happy to be here. I’m from Calgary, where we turned off the summer switch three days ago and it did snow briefly at my house. Everything was white. I was horrified. It went from 30 degrees to 3 overnight.

My background is oil and gas. I started out working in the oil and gas industry. And then I went and did an MBA because CFAs were not really hip then. So I just did an MBA. I went into investment banking, property acquisition, divestiture, and I did that for about 12 years.

Then I went to the buy side, still focused on global energy pipelines and chemicals. I just like things that are goopy. It’s what I like to invest and research.

KIM SHANNON: Kim Shannon, founder and co-CIO of Sionna Investment Managers. I started in the industry way back in 1983, a perfect time for an equity manager to get started at the bottom of the market cycle. And it’s been an interesting run overall. But we specialize largely in Canadian equities.

JENNIFER LIPPIN REXINIS: I’m Jen Lippin Rexinis, Catholic girl with a Jewish dad married to [INAUDIBLE] Spartan Greek. Try faking it, awesome.

Anyway, I probably spent the first 18 to 19 years of my career on the global and international equities side, and then switched to the dark side of bonds and fixed income which has been actually more illuminating than I thought it could be.

I’ve worked at MSS for almost a dozen years. And quite honestly, working on both sides, you become a dangerous individual which I like to not talk about so much because I like to keep people guessing.

But in general, I would say that when you’re thinking about background experience — I mean, I was an equity analyst for a lot of years. But I’ve had a lot more fun — because of the intricacies on the fixed income side — I find it’s more cerebral. And I dig it. It’s been almost 23 years that I’ve been doing it, so thanks.

SUSAN SCHMIDT: Great. All right, and I’m Susan Schmidt. I’m from Westwood. We’re based in Dallas. And I am a portfolio manager for them focused on small and mid-sized companies.

So ladies, one of the big things that everyone talks about — we just spent some time talking about it already — is what do you do in today’s market? Given all that’s going on — and Kim, I’m going to throw this to you to start — what do you worry about the most in today’s market?

KIM SHANNON: Well, this market is a challenging market for all equity investors because valuations overall are quite high. If you look at valuations at expected returns going forward, for equities in aggregate, most markets around the world, it looks like it’s approximately a 6% return. Historical long-term averages are more like 9.5%, so it’s a more subdued return. And the price you pay when you enter an investment has a significant impact on your long-term results.

Because we’re entering a rich market — a lot of markets are trading close to a 20 P/E multiple — history suggests that the future return is going to be more modest and bumpy. We’ve been in a very bouncy, bumpy, sideways market for 17 years. Volatility is the norm. And we’ve had a straight upward market since ’09.

So we’re a bit long in the tooth and vulnerable for a bit of a correction. So, that’s the big issue I think facing equities today.

But the positive side is that a 6% expected return in equities sure beats the heck out of the bond market.

JENNIFER LIPPIN REXINIS: Keep them coming. Keep them coming.

KIM SHANNON: So we talk about TINA, there’s no alternative but equities.

JENNIFER LIPPIN REXINIS: You love that one?

KIM SHANNON: I’m hanging on to that one.

JENNIFER LIPPIN REXINIS: Tiny equals TINA. There is no yield. There is an alternative. Let’s play.

SUSAN SCHMIDT: Jen, tell us about what’s going on in fixed income and how you’re handling that right now.

JENNIFER LIPPIN REXINIS: So fixed income, everybody needs it, OPM (other people’s money). It’s what makes the world go round. Everybody focuses on equity because it’s sexy. It’s great, except the size of the equity market compared to the fixed income is like you little, bitty munchkin. You know?

And fixed income, when you start looking and peeling back the onion layers of the asset classes — now the problem is, fixed income is not necessarily less expensive. It’s a relative world. I mean in Kim and Jen S. world — they’re in equities — it’s not that terribly positive in terms of valuations. But the quality of companies has improved in a lot of ways, and there are arguments to be made on fixed income.

I mean, we were talking this morning for hours about where are the spreads. And if you wanted to buy emerging markets debt, which is great, you’re paying about 321 basis points just on average. You’ve got some outliers, like Venezuela, which is about to default if you’ve been paying attention, so that’s going to throw off that average. The really good companies, and the good countries, and even quasi-sovereign debt is tight.

But a 321 compared to high yield. . .

Now, let’s just look at credit quality for two seconds. In emerging markets, it’s at like a double B, double B plus-ish. High yield’s about a B, maybe at best, like a double B minus. And you’re at 327. You’re six basis points away from a much higher credit quality asset class. And you’re getting six basis points. So I would argue that’s a priced-to-perfection fixed income asset class.

But compare and contrast that with your investment grade. And your investment grade, if you an A-rated bond, you’re broken through 90 basis points. That’s not compelling.

What I argue to a lot of folks is, what’s your defense like? We’re talking about volatility. We’re talking about markets. Market volatility right now is relatively muted. And I argue if you’re going to think about investing next dollars and asset classes that are favorable, have you set up your defense?

If anybody’s a football fan or soccer, you have strikers. You have sweepers. But if you have no defenders and no goaltender, game over. You need a defense.

One of the things about fixed income that plays off of what these ladies do on the equity side is correlations. If they’re going to yin, I have to yang. And if you don’t have your fixed income dialed into play “mad D” for you, considering that you’re in a relatively modest volatility type of environment, I think you need to make sure you’ve dialed in that risk and you’ve dialed in your defense.

And there are asset classes to do it. Investment grade is one. Just understand, you have to think about the types of exposures. And in this kind of marketplace, the fundamentals make a difference. So just like we’re talking about active management on the equities side, you really need to do that on the fixed income side. You need to be nimble. You need to be selective. Ladies, we know about being selective. Be selective in your bonds as well. Very important.

SUSAN SCHMIDT: OK. And Jen, you particularly have seen a little bit more volatility recently.

JENNIFER STEVENSON: Oh, we thrive on volatility.

SUSAN SCHMIDT: Energy and commodities is one of the areas of expertise. So tell us a bit about how you’re viewing risk in the market, what you’re watching out for right now.

JENNIFER STEVENSON: It’s interesting when I listen to Kim talk about how equity investors broadly are concerned about valuation and PE multiples and things are expensive, and I go, well, not in my sector. We are value.

If you have a fundamental understanding of where commodities are going, where energy is going, how fundamentals look for supply versus demand inventories, that sort of thing, and you’ve seen what’s happened in the market as commodity prices have fallen and then recovered somewhat, we’ve had a lot of equity sector rotation. You’ve seen the energies get hammered and tech go up. Energy gets hammered, and from time to time, financials go up or health care goes up.

So when you look at energy with a view on fundamentals, which matters in commodities from time to time, and all the time to an analyst, I would say we’re getting toward one of those times.

When you look at that, and you think about what a reasonable commodity outlook is and you look at the valuation of the stocks the energy sector — even some of the pipeline sector globally — represents in my view, some good value. It is a bit of a portfolio offset to some of the valuation concerns that Kim was mentioning.

SUSAN SCHMIDT: As you think about the market today and you worry about positioning, there are some new factors that have introduced themselves: high-frequency trading and you hear a lot of conversation about artificial intelligence right now. How are those impacting your decisions as you manage your portfolios?

KIM SHANNON: I wouldn’t mind jumping in on the artificial intelligence in particular. I just debated it last week. And . . .

SUSAN SCHMIDT: And you won.

JENNIFER LIPPIN REXINIS: And you won.

SUSAN SCHMIDT: Let’s not forget that.

KIM SHANNON: Of course. I was asked to defend active against artificial intelligence at an alternative investor conference. And I thought, I don’t know what I’m going to say, but I do want to know the answer. And fortunately, I found the killer app, which was a delight.

But if you look at artificial intelligence, it is basically categorization at this stage of development. It needs a lot of data of a very repeatable, science-like phenomena. And then you can teach an algorithm. The algorithm can learn how to deal with the issues that it’s facing.

And unfortunately, or fortunately for the markets right now, there’s just not enough financial market data history out there. I’ve always been interested in financial market history. You need, in many cases, millions and billions of examples to teach these algorithms.

I looked for data on bank services. You can get closing prices from services going back to the 1970s, but you don’t get a lot of detailed data in the past. And also, if you think about the 1970s, that was very close to 1981 when interest rates peaked. So you really have very little data about a — falling, an interest rate environment overall.

So, Bernstein went out there and said — a databank house — and said basically, you can not. There’s not enough information to predict stock prices over a week, or even a day. So it’s not going to happen in our lifetime. And I think that ultimately, for decades, at least.

I think ultimately it will end up being a tool in the toolkit of active managers. There will be a blurring. And of course, we, as active managers, are going to try to use every single tool we can to try and beat the market. So if that helps us with efficiency and costs and getting to the answer faster, we’re going to be out there attempting to do it.

In our current examples of artificial intelligence, currently, there are 21 funds with a five-year track record. One billion of AUM under management. And over the last five years, they’ve underperformed the S&P 500 by 30%. So they’re not there yet. And we’re not convinced they’ll get there anytime soon.

But the market is full of physics envy. We are wishing that there was a perfect formula — e = MC² — to help us determine valuation in the market. We’re constantly looking for the golden chalice.

And it’s like philosophers over human history. We’ve consistently looked for the answer to explain humanity. But humans are essentially irrational. We always have to start off with the assumption that humans are rational to explain humans.

That’s exactly what’s happening in markets. Because markets themselves — individual stocks and the idea of a corporate entity — are human constructs. They reflect our humanity and our excesses. So for the time being, we’ll have to use emotional human beings to try and win this complicated social science game of valuation.

SUSAN SCHMIDT: Maybe some comments from either Jen on the proliferation of ETFs. And you mentioned active managers fighting for survival and its battle versus passive. What impact is that having on your portfolios and how you view the market? What do you think is going on?

JENNIFER STEVENSON: I think ETFs are really, well, let’s use the word interesting. It means nothing. So my concern about ETFs is, I think from time to time, they will have a dramatically negative effect on market volatility.

Because when something happens — and we saw this two Augusts ago, we had the flash 1,000 point crash. Well, that was when all the index ETF guys have to make (and I use guys in the generic sense). I’m in the oil business. Got to be politically correct.

So when everybody needs to make the same trade at the same time, there is no liquidity. And things gap down hard. I think ETFs are at risk of that. And everybody that’s buying an index or an ETF does not understand that until it happens. Then they’ll phone their broker and go, oh my gosh, what happened? I thought I was out. I thought I could get out. I had liquidity. And it doesn’t work that way.

The other thing that is concerning about ETFs is if ETFs, for example in the resource sector, took over the world, there would be no way to externally finance through equity the resource sector because ETFs don’t do that. Active managers do that.

So that’s something. If you want a holistic view of the market you say, well, we need to be around to fund these companies. Well, only if they deserve it, which is why active management is great because if you don’t have ROCE you’re not getting any money from me. But ETFs cannot provide that. And energy, at this point, is still something that is really hard to live without. So it does need some financing.

JENNIFER LIPPIN REXINIS: It gets a little more exotic on my end because you’re talking about bonds. I mean, these are . . . you have to go to the dealer, negotiate. You need to get the bonds.

But when you go and do an ETF, you say, well, gosh, especially for the emerging markets, do I really want that much exposure to Venezuela, which is about ready to default? Or do I really want to have 3+% in the Philippines because Duterte is going with genocide and I’m thinking that might be a political risk? Call me nuts.

Is that something that the average investor even understands what they’re buying? They’re just like, oh, I’m going to get emerging markets stat. Well, have you thought about the ability and willingness to pay? Have you thought about the political implications, the geopolitical implications, and the volatility of some of these exposures that you may have embedded, and the fact that ETFs can stop trading? And your liquidity can immediately dissipate? Question mark. I mean, do you know this? Do you understand this?

And the fact is, on the bond side, it just gets a little bit more complicated. People don’t understand the concept of short duration, intermediate, long. What do we do when rates are up, rates are down? There are ladders. I don’t get it. And people get really, in a lot of ways, flummoxed by fixed income because they think it is just a big beast, and therefore, they forget that to eat an elephant, it’s one bite at a time.

It’s the same concept with fixed income. Gather your arms around individual asset classes. Get a better appreciation for them. But ETFs are different in investment grade versus high yield or emerging market set, or whatever asset class you want to talk about.

On the fixed income side, there are embedded biases in these ETFs, or in the indices themselves. And I don’t think that the average investor fully appreciates some of the exoticism that’s embedded in those strategies and the fact that they can have liquidity just yanked out from under them. And they may not play defense because bonds can go down. Everybody thinks bonds are your defense. I get it. And I even talked about it, today even.

But bonds have a level of volatility. And as Kim was saying, they know the market. Historically, we’ve been dealing with a rate declining world. Well now, we’re starting to see a change.

So is your ETF positioned appropriately? Is there flexibility? What sort of tracking are they doing? Because they’re probably going for new tracking, right? They’re going for that index exposure. So wouldn’t you like to be prepared for the future?

I mean, Wayne Gretzky says, you miss every shot you never take. If you’re an investor, don’t you want to be prepared for that volatility we all know is coming? I can’t put my finger on what it’s going to be. I can give you a guesstimate. But don’t you want to be prepared? For me, an ETF and fixed income is like, oh, “survey says no.”

KIM SHANNON: If I could jump in. Passive investing started in the mid ’70s. It came out of the development of the efficient market hypothesis in the ’60s. And so, passive investing is reliant on the market being efficient because back in the ’60s there were so many institutional managers pricing securities efficiently.

The challenge now for this phenomenal growth that’s happened over 42 years, and especially with the advent of the ETFs in the last decade, this huge growth of passive that is becoming a bigger and bigger player in the market. We don’t know when the turning point is that this group of money that’s just out there buying basic indices and moving in tandem. But what we are seeing, in active markets everywhere, is that correlation coefficient, you’re starting to see more and more securities moving together in tandem. And so that can add to, ultimately, volatility.

Fortunately, in the last year, in the equity markets we’ve seen a little bit of normalcy of correlations that has created this opportunity for some active managers to get a little bit of crawl back, a little bit of out-performance and return in the last year. But there seems, there is a concern that there will be a big test.

We know that the people who create ETFs know how to make them really fast because they’ve been making them really fast over the last 20 years. What we don’t know is in a panic market when people want to exit, and I lived through October 19, 1987 — it was quite a painful period. The markets had difficulty opening. And then when they opened, they went limit down, and you couldn’t trade as the market was moving.

We’ve only tested people trying to draw money out of ETFs in any kind of size twice. And they flunked both times. That was the flash crash, as well as August of 2015.

It’s a big question mark out there. And I think they’re — the future is — ultimately, I think there’s a place for both, active and passive. And we, as humans, are going to learn what the ideal balance between the two is. But humans tend to test everything to their limits. That’s what we’re about to do now. We’ll find out the limit of this new asset category in the marketplace.

SUSAN SCHMIDT: One of the things that I thought was a great story that I want to have you share again for our audience is that there seems to be a movement toward a barbell effect. So we have a lot of money going into the higher fee alternative asset areas, and then you have a drift toward passive. That active manager in the middle is getting left out. I think you had a story about the Tampa Bay account and a multi-year record. Why don’t you share that?

KIM SHANNON: Yes, the FT did this article about a week ago and they called him the Oracle of Omaha. And there’s a chap down there who has been running the Tampa Bay, the Tampa Fire and Pension Fund, for 43 years. His father originally ran the firm and he’s taken it over.

They have one fund manager. And that fund manager, because they’ve done concentrated growth equity investing and a really conservative bond portfolio, has managed to perform the S&P quite handily in all their benchmarks. It is about 95% funded in an era when the average pension fund is funded about 70%.

And that fund is being criticized. It’s being criticized because it’s not diversified enough. Are they asleep at the switch? Are they even working? Are they thinking about it?

I think it speaks to a lot of issues that are going on out there.

I think that returns are modest in all asset categories. Most pension funds have a 7.5% implied expected return. Now if equities are only giving you 6%, and in the last 17 years since we entered this sideways market, Canada has given an average return of 6%, the US in Canadian dollars terms similar. And the US dollar terms has given roughly 4.5% and global equities have given you 3.5%. If equity is your best performing asset class, historically is giving you low returns, then are you likely to reach that 7.5%?

People are stretching for excess returns. And there’s this enormous splintering that’s going on in marketplaces and going into all kinds of things like hedge funds and private equity and all these brand new, unproven asset categories. And so, we’re demanding more and more complexity. And we’ve heard about how difficult it is to get good returns with low risk. I think we’re trading off — to get those returns — we’re trading off illiquidity. We’ve never tested enormous buckets of illiquidity in the marketplace before. So that’s one of the issues that I think we might face, or bump up against in the market overall.

SUSAN SCHMIDT: So Jen.

JENNIFER STEVENSON: I there’s a myth, too, for people — and I’m an active manager so I’m 100% biased, let’s be clear. But I think there’s a myth that you get diversification by a passive investment.

Yeah, there’s a lot of names in the index ETF that you buy, but if you were actually going to go construct that portfolio — I draw a little Venn diagram. I have the index Venn diagram. And then I have my portfolio Venn diagram. The overlaps are really small.

My joke is that I voted all those other guys off my island, like “Survivor,” and they didn’t make it because they don’t fit any of my return or quality thresholds.

You get diversification with an index, yeah, but you have to buy the bottom of the bucket too versus active management. Whether it’s bought equity, sector equities, fixed income, you have an active manager that is picking what we think is the best part of the bucket. So you’re still diversified. I think your quality is enhanced and a lot of people don’t think about that part of an ETF portfolio.

KIM SHANNON: And that’s, I think, what makes boring sexy.

SUSAN SCHMIDT: So there is a huge advantage to that. We talked about that. Boring companies can be the most profitable companies out there. We don’t always hear about them because they’re boring. But it can . . .

KIM SHANNON: But they’re low stress. They’re great.

SUSAN SCHMIDT: So they’re not nearly as exciting to talk about because they might involve a very basic industry, but they can be very profitable. So I’m always excited when we talk about cash.

We did get a question from the audience, and I think this is for the two Jens. In Canada, ETFs can be actively managed. And there has been large growth in fixed income ETFs with active management. So any thoughts or comments on that?

JENNIFER LIPPIN REXINIS: I’m still underwhelmed by the level of active management on the fixed income side. I have to say. When you start looking at tracking errors, and you start looking at up captures, down captures, and you start data mining it and trying to figure out compared to an active manager the risk profiles over time, because you also don’t have those long-term track records.

I have a muni portfolio that goes back to 1984 which, by the way, a lot of international companies want in on munis because if you’re a Japanese company, do you really want a Japanese government bond or like a bond that’s still negative? That’s not favorable. And even though as an individual you don’t get that tax-favored treatment or tax advantage, the level of default exposure is pretty minimal.

You have to start thinking differently about asset classes even on an international basis. But the ETFs, just don’t have that track record. They don’t necessarily have the same level of ups, downs, your standard deviations, your betas. I mean, all of the things that you want to see.

True active is like Jen S. was saying. I want the best of the best at whichever fixed income asset class I’m going to buy. I don’t want to buy the other 25%, 45% of the dogs that just happen to be in the portfolio.

And on an ETF side, I don’t necessarily think you always get what you pay for. I think active managers over time, I think that’s the key element is over time. I’m not saying we’re going to kill it every quarter, but if you’re thinking in terms of cycles, market cycles, we’re eight-plus years into a cycle. If you’re looking over three years, you’re wasting your time.

You should be looking now over 10-year periods. Why? Because on a rolling 10, you’re now encapsulating the current cycle. If you’re looking shorter than that, if there have been manager turnovers, I get it. But you need to look at valid information. And the ETFs, a lot of them, don’t even have a decade.

SUSAN SCHMIDT: I think that time is an interesting aspect of this. Because how have — the perception is we haven’t found returns in the market. My sense is people have become impatient. You see more rotation from sector to sector. You’re seeing growing impatience in “why aren’t we seeing the returns that I saw previously?” There’s perhaps a rush to switch. How are you dealing with that when you look at your portfolios and working with your clients? What sort of time frame are you looking at when you go in and take a position now and look toward return on your investment?

JENNIFER LIPPIN REXINIS: I would just say not only that, but also it’s a Goldilocks world. When you look at growth, it’s not too hot, it’s not too cold, it’s sort of modest is probably a fair estimate. I would say it was a lot more ups and downs. I think you had a lot more heated times and a lot cooler times. I think it was a little bit different.

Now you have a global re-synchronization in a lot of ways, in terms of where growth is and expectations, inflation is muted. I mean, you’ve had the Bank of Japan. You’ve had Aussies, they’ve reduced their inflation expectations for the next two years. This environment, over time . . .

You also have to look at what environment are we in? I mean, Kim highlighted it. We had historically, what is our history? Declining rates. We’re now looking at Bank of England potentially raising rates. We’re looking at a market bifurcation of developed market growth versus emerging market growth.

Let me tell you something. Emerging market growth is faster than DM, which means that certain asset classes become more favorable. More volatile? Yes. If you’re going to buy local emerging markets stat, absolutely. If you’re going to buy currencies, absolutely, because the US dollar is taking it on the chin. Might be a Trump thing. I’m not saying.

But as the story goes, when you think about that over time, what’s the context? Because there are two questions in fixed income you always have to be asking yourself: One is what is my expected pace of change of the rates? Number two is, what’s a realistic terminal value of where rates might go and why?

And of course, they’re hard questions to answer. But if that answer is not the same as it was three, five, seven years ago, then you’re thinking incorrectly about how you need to be positioned going forward.

SUSAN SCHMIDT: All right, so we have another question from the audience asking about ETFs and smart beta and faster products and using those as a tool within your portfolios. Anyone want to comment on that?

KIM SHANNON: Do any of us do that?

JENNIFER LIPPIN REXINIS: No.

JENNIFER STEVENSON: No.

SUSAN SCHMIDT: No, no.

KIM SHANNON: No, I mean I’ll write options on some of the stocks in my portfolios just to either write puts to get — to buy the assets or to buy the equities at a lower valuation. I don’t generally write calls because I’m in it for the upside. But yeah, I don’t use factor stuff.

JENNIFER LIPPIN REXINIS: If I don’t like the company it’s not in the portfolio. And if I love it, it’s in there. If I love it a lot, it’s there bigger.

SUSAN SCHMIDT: So, all right, so more granular–

JENNIFER LIPPIN REXINIS: It’s kind of simple.

SUSAN SCHMIDT: A more granular approach and it’s company by company. I think the audience member who wrote this question, wherever you may be, I think made a good point. Aren’t ETFs an indexation, especially with the smart beta and factor products? Another tool to express your investment beliefs or outlook for the market? And I think that that can be a way to do it, but I think we all take a much more granular approach building block by block from the bottom up on our portfolios.

So, one of the things I wanted to talk about was global risk, because we are so interconnected in the world right now and the central banks are all taking a well-known stance on their position and what they’re doing. So, what does that do and what overall impact does it have? I know Jen, Kim, you’re focused on Canada. Jen L. more on the US. I’m focused more on the US, but it doesn’t seem that we can just be focused on our domestic product. You have to be aware. So how do you think about that?

KIM SHANNON: You want to start with energy?

JENNIFER STEVENSON: Well, energy is global. And energy, I would argue, oil is priced for everybody holding hands and singing “Kumbaya.” There’s no geopolitical risk priced in at all. And there is a smidge going on in the world. Some of it is just oil related and some of it is broader implications, like North Korea, but nobody seems too stressed about Venezuela. If they default, then they have no money, which means they can’t pay the oil workers. They produce 1.9 million barrels a day. And the last time the oil workers went on strike, we lost about a million barrels. That would hurt.

The Gulf Cooperation Council — the middle “C” is kind of missing because everybody is fighting with Qatar. And Saudi Arabia is doing a great job — no kidding — holding together the group for high compliance levels on their cuts.

But we will probably have a change in leadership there. Mohammed bin Salman, who is the crown prince — he was the deputy crown prince, so he’s gone from the number two in line to be the next guy to be the King. His dad is the King. And he’s — let’s pick a number — 32. Nobody really knows for sure.

He’s got a big vision for Saudi — Vision 2030. It’s going to be more diversified, broader economic growth, less reliance on energy. And they’re going to sell part of their national oil company, Saudi Aramco, in an IPO late next year, early the year after, to fund this big Vision 2030 initiative.

But that is to keep the people happy and gainfully employed so they don’t protest and that there’s not an Arab Spring in Saudi. So there’s nothing bad happening there, it’s all fine.

There are lots of these things that are just all fine, sort of. I mean, nobody talks about Nigeria anymore because every two weeks it’s back to the way it wasn’t. So production is off. Production is on. Production is off. Production is on. And the people, unfortunately, have to live through that, but that’s what’s going on with the unrest there. Nobody worries about that. They produce over a million barrels a day, too.

We are consuming more oil than we supply, but it’s fine. There’s no geopolitical risk priced into oil. So it will be interesting. If something that actually disrupts supply enough that the market cares happens, you will see that reflected in the price of oil because oil is a super liquid financial instrument. We burn up about 98 million barrels a day. You can trade financially on the top six exchanges in the world about 31 times that amount financially every day.

So if you want to express an opinion about oil prices, have at the market. What you see in the paper as the oil price sometimes hasn’t anything to do with fundamentals. It’s got something to do with what headline just crossed Reuters. It’s kind of interesting to think about geopolitics as it pertains to energy, energy prices, and then how that factors into economies enough to buy it.

SUSAN SCHMIDT: What about the central banks? How do you think about the central banks taking action and potentially all going in the same direction at the same time?

JENNIFER LIPPIN REXINIS: Globally, on the fixed income side, you worry about policy errors or mistakes. Are they going to raise too soon? Are they going to raise too much? And over what time period? Because I keep thinking what’s that rate change? What’s that pace like? Where are they going to get to?

You have political issues with leadership. You’ve got elections in Brazil next year. You’ve got elections in Germany coming up. And everybody thinks that’s going to be a no-brainer. Merkel will continue to be where she is, but Brazil has been interesting. That’s a big country, particularly in Latin America. That’s had its own headline risk for two years now. I mean, Lula’s in jail, and Dilma’s guilty, and Temer’s guilty, but we’re just going to let him stay.

It’s very interesting, that volatility, but on the fixed income side, what happens with central banks? I mean, if ECB stops with their QE, what happens if the Fed starts continuing to raise rates? And are we expecting inflation?

There are a lot of factors. We’re looking at wage inflation. We’re looking at pricing power, producers, consumers, everything. All of that is baked into the expectation for fixed income markets because we look at investment grade on a global basis. We look at high yield on a global basis. Compare and contrast that with domestically the muni world, which has no exposure to any of that. What’s that insulated asset class looking like versus emerging markets debt, which is going to compare and contrast with all the global as well?

So, you really look at bank policy, political issues, geopolitical — like you said, North Korea, but don’t forget China has potential for bubbles in real estate, which could be an issue. They call it their social financing, public social financing, which is really like mortgages, if you will, housing.

We look at China. We look at — I mean, it’s a list: Russia, North Korea. No question. There’s really a litany of things that you’re concerned about. But on the central banking side, policy errors. Are the countries that have IMF assistance — we always joke it’s “It’s Mostly Fiscal” help — generally speaking, are they going to continue to meet those metrics?

The average investor — and I’m just going to throw this out there — loves CNBC. I’ve forever called it the “Constantly Negative Business Channel.” So if you’re looking for happiness and “Kumbaya,” especially on the fixed income side, because they tend to focus on stock jocks and Cramer’s like that little hyena just going back and forth making me mad. I can’t even watch it. The yellow is offensive, but anyway . . .

You look at this and you say, “well, if equities are going to continue to bounce around and they’re going to be expensive on a valuation basis,” and you want your fixed income to play yin to the yang, “where do I go, what do I do?” And if I’m thinking about all the inputs. It is a lot more inputs on the fixed income side with the public banks, the interest rates, the monetary policy, the fiscal policy of individual nations. What’s going on with Theresa May, the great shoes, and the Brexit discussion.

All of a sudden, now they’re looking at some inflation pressure. Are they getting wage inflation? No, they’re not. Are they getting prices? Is that going to be a sticky level of inflation? Or is it going to be short-lived? Are they going to have a stagflation? I don’t know.

But isn’t it fun to think about? And what does that do to the European Monetary Union versus the Eurozone? One’s trading. One’s literally related to the currency.

These are all the inputs you have to be thinking about on the fixed income side. And so, errors in judgment, pacing too quickly, raising too quickly, all of that stuff comes into what we’re going to expect, or where do you position. Because everybody thinks if rates are going to go up, I want to be short. And I’m thinking to myself, no, you don’t unless you’re taking on some monster leverage.

Because if you’re high quality and short duration, what’s your cushion these days? Remember I was mentioning how tight the spreads are? You’re taking it right on the chin because when central banks change their rates, it hits the front end of the curve. Oh, all you short people with high quality and no spread cushion, you just reduced your returns. And likely because you’re short duration, you don’t actually have the yield to offset that.

So what’s odd for a lot of folks is I say to them, if you’re in a rising rate environment, you need spread cushion. You need to rethink your duration and your exposures, which gets you back to being selective in what do you want to own for a longer period of time and that duration in that potential rising rate environment. Because both Kim and Jen have already said, if you’re thinking about being a long-term investor, and you want to have those returns, and you don’t want that risk profile.

Everyone’s sensitive. We all want something for nothing. Free lunch is free. Phenomenal, but you can’t get that in this environment. You’re paying real prices and real difficult valuations for next dollars in at the current asset levels. And you’re not sure about volatility. So you have to really think about that context. You have to think about, do I want to be more intermediate? Do I want to have some spread cushion to absorb some of the potential volatility with the rate change happening?

It means that you might want to barbell. Maybe you have some shorter duration, but you have some longer duration. You have to rethink that. That’s the expectation setting with clients because they don’t all think about this all the time. I mean, we do this; this is fun.

But for the average investor, they’re not always understanding that because they think rates are going up, must be short. And my argument is, be careful where you position. Because being short with your whole fixed income portfolio is not diversified. Again, you’re not diversified. You’re about to take it on the chin depending on where you may be positioned, depending upon what could be happening with central banks and rate changes, et cetera.

SUSAN SCHMIDT: All right, Kim I’m going to throw this one to you from the audience. As we talk about returns to investors, explaining returns to investors — and this goes back to the debate between active and passive — if active managers are picking higher quality stocks, how do you explain the poor performance history of active management on average?

KIM SHANNON: I know a lot of people are looking at the last 10 years and they’re seeing that active managers have not done well against the indices. But that is a really short-term time horizon. We know that it’s been a very challenging environment, because of this wall of money going into passive. So, you’re pushing a lot of the same stocks up.

And also, it incorporates — if you go back to 2009 to now — a lot of that time period is a big upward move in the market. To me, there’s a lot of similarities that we’re feeling in the marketplace today as we felt in 2000 and 2007/2008, where you generally see when the market overall gets expensive and pricey. You get a narrowing of leadership and you get a handful of stocks that have phenomenal multiples.

We’re seeing that again today, particularly, and more extremely, in the US. For Canada, for a while there it was Valiant, which dominated our exchanges. And the market becomes much more of a growth orientated market. It’s very hard for active managers to beat the index because the index is taking on a lot of risk.

Typically, at the end of a cycle, like we may be in right now, you see that active managers, as a group, underperform in the overall benchmark. And people sit back and say, well, the better game is passive.

JENNIFER LIPPIN REXINIS: And then they’re also coming back to you.

KIM SHANNON: They hand it back to you.

JENNIFER LIPPIN REXINIS: So the passive, as one of our audience members pointed out, [INAUDIBLE] for a passive, why should I pay a 1% fee on actively managed? What is that trade-off doing for me?

KIM SHANNON: And in a low return environment, it’s a higher percentage. In the last 17 years — it’s an excellent point — the market return was 6% or less. And a 1% fee is a very high percentage of 6%, something like 20. Whereas, in the events leading up to 2000, we had double-digit equity returns. The fee level was very modest compared to the excess returns you could get.

But generally speaking, after you get that correction in the marketplace, active managers, who are ultimately by and large all risk managers to some degree, tend to outperform and get good relative out-performance and you normalize the market return. I think there will be a push back and forth between the two categories.

JENNIFER LIPPIN REXINIS: I would say especially if you’re looking at risk-adjusted. You’re checking your Sharps, you’re looking at other different metrics, not just what’s the pure number, because that doesn’t tell the whole story.

SUSAN SCHMIDT: One of the other questions from the audience — which I think is really interesting — putting some data out there. ETFs are $4 trillion in assets under management. Equity markets are $65 trillion in AUM. Bond markets value $100 trillion in AUM. How is it that ETFs would affect the markets that much and potentially be a threat? Are they more reflections of liquidity? What are your concerns there?

KIM SHANNON: I think one of the big issues is that ETFs and a lot of passive strategies are very actively traded. And they are a higher percentage of the daily volume of trades. So I think that is tipping the market in their favor, like they are having a bigger impact than their actual size. Does anyone else want to have a try?

JENNIFER LIPPIN REXINIS: No, I’d agree with that.

JENNIFER STEVENSON: I think you’re right.

SUSAN SCHMIDT: Here is one from our audience. So, all three of you are senior PMs and it’s been an interesting and varied road. I know some of your histories, so I know the past. But the audience would like to know, how did you get to the position you’re in now? And are there one or two things that you could point to that were valuable for you in your path to success?

KIM SHANNON: I’ll jump in then while you think.

JENNIFER LIPPIN REXINIS: I’ll go second.

JENNIFER STEVENSON: Go Kim.

KIM SHANNON: I think that what I always valued about being in the asset management industry is it’s a meritocracy. Back in 1983, even today, women portfolio managers are less than 9% globally. And so, to be in a level playing field that it is not qualitative, it’s quantitative. Clients really value someone who can get returns. And they really are indifferent to who you are in a sense.

So if you can outperform, you can win the game of investing. I found that really valuable in my career. I think that makes it a really cool career for women.

JENNIFER STEVENSON: Yeah, I mean, if you put up good numbers, it doesn’t matter what you are gender-wise: purple, red, green, yellow, pink. It doesn’t matter at all, which is pretty cool.

The other thing I found is, I spent 13 years in corporate finance and I decided that was no longer fun. I wanted to do the same thing — have the same client interaction, the same company interaction, do the same kind of analysis — but what other parts of the business could I do it in? And I thought, oh, the buy side.

I hadn’t thought about that before when you’re either focused on an industry, working in it, or being in corporate finance. It’s something that even if you’re a sector specialist you can still do. And I think it has value, especially these days.When I see a lot of the people coming in, everybody wants to be a generalist. And that’s great. But at our shop, at Scotiabank, which is 1832 Asset Management, our generalists will use the specialists to their advantage. I think being a specialist gives you an advantage of that specialized knowledge in an industry that is full of some really high-quality generalist investors.

JENNIFER LIPPIN REXINIS: I’m going to answer a little differently because I started on the equity side and I’m on the bond side these days. What I would say is, like Suni [Harford] said yesterday, which is be yourself. Be different. I’m probably the only chick I know who was raised on cars and hockey and I love F1. Like hot men, fast cars, it’s not illegal, and I watch this every other weekend for like 20 plus weeks? Amazing.

I used to be an auto equity analyst. I’d show up in the Dolce Gabbana suit with the driving shoes and they’d say, oh, look, an automatic. And I would be like, I didn’t drive here in one and you can keep yours. If you are yourself and you start by busting . . . I loved being the only woman at the auto show or the ride and drive for 100 miles showing men how to drive stick properly. No offense to men. They’re all F1 drivers. I get it.

But my point is, being a gal in this business, my mentor — and I’ve had one for so many years, since the 90s — has said to me, do not apologize. Women apologize. Oh, I’m so sorry I’m late. Oh, I’m so sorry I didn’t send that email five minutes after I got your email. I’m so sorry. No. Do not make hurdles for yourself. Do your thing. Study hard. Do well. Do your homework. Be amazing in stilettos and looking lovely. And quite honestly, shock the world. But don’t make your own hurdles. Don’t apologize for what you’re doing. Just go be amazing in whatever you’re doing.

I backdoored into equity analysis in Boston. I then went to business school many years later. I didn’t do undergrad, then go straight to business school, and then try and get a job. I was working the whole time because I wanted to learn more about equities. I became a global international equity person for years, 19 actually. And I loved it.

But the opportunity to continue to learn, to continue to be me, to continue to travel. Not a lot of my portfolio managers like to speak, and I can do it in multiple languages. I enjoy this, surprise.

But not everybody does. And not everybody wants to do that. I’ve always felt financial services is about the service you provide clients. That you offer to prospects to bring them into your fold. To have the background, the experience, the analytics, the knowledge, the desire to communicate with others in whatever language that I speak, or whatever, that is a gift. So, I just think back to what Suni said yesterday, be yourself.

I’m going to be the girl who is unabashedly going to watch F1. I’m going to watch hockey absolutely every time. I’m going to be the girl who’s going to sit there on the plane and rip through the Economist, rip through the FT, rip through the French papers, Le Monde, et cetera. And then I’m going to open up Car and Driver, and Auto Week, and Round Out, which is BMW only. But my point is, that’s what I’m going to read. That’s not what every person is going to do. And that’s what makes it awesome.

SUSAN SCHMIDT: So bring your own personality.

JENNIFER LIPPIN REXINIS: 100%.

SUSAN SCHMIDT: Suni did make that point yesterday. And I think it’s very important. I do think — Jen and Kim, as you said — numbers matter. This is a nice area to be in because you can get away from the bias, any bias that may exist, because the numbers are the numbers. So performance is a way to show yourself regardless of what you’re wearing to work or your sex. I think that is unique.

I also think it’s a good thing to have perspective. Ours is one of the interesting industries where you can switch from corporate finance into the investment side. There are a lot of different ways to apply the skill set. Communication is very important in understanding that there are roles to bring forth your strengths. So is it still a good industry for young people just starting out wanting to get into this and looking at it as a career path?

KIM SHANNON: I think it’s a good industry because you get a broad understanding of how to look at a company. Doesn’t matter what sector it’s in. Doesn’t matter if it’s equity or fixed income.

You also get an understanding of how to deal with people, which is your point, because people are entirely different I found. When I was in high school I was a bank teller. I applied at McDonald’s and I didn’t get a call, so I worked at a bank. It was way more fun.

But people are totally different when you’re dealing with their money. Woah. And when you’re in client interaction, whether it’s with their investment adviser or the client directly, it’s still dealing with their money. So when you develop the skills to interact with people on their most touchy subject, you can transfer that. You can transfer industry analysis knowledge.

So being in this business, if you decide it’s not for you, that’s fine. You’ve got some hugely transferable skills. There are different facets of the business, too. I mean, you could go from the buy side to research.

JENNIFER STEVENSON: Given that our audience is largely women, this is a social science, as I mentioned earlier. And there is that physics envy. If we could get on top of the formulas and numbers. But women do tend to have really good social skills, and the markets are very much dictated by humans and human emotions. I think women understand that better. I think we tend to be fairly good communicators as a whole. And I think those advantages are what we can bring to the table and add diversity to what is still a largely male-dominated field.

JENNIFER LIPPIN REXINIS: The only thing I would add is the collaboration that you get. I mean, women when they go buy a car, most of them that I know they lift up the bonnet, they check out the engine, and then they start thinking about, OK, where was this built? I want to know more about it. Give me more information.

They want more context around just buying something, whether it’s a stock or a bond. They want to know what’s the interrelation, what’s the network? In Boston, we always say, how’s your mother? The first question is how are you doing? How’s your mother? It’s all about the family. It’s all about that networking, that relationship. And women are very good at that.

In this business, I think on the services side of financial services, I think women get it right. I think we’re leaders in that aspect quite honestly. I think we can continue to do as we’re doing, but I think we can do so much more.

SUSAN SCHMIDT: All right, the last question, and I’m going to guess clearly from a consultant who’s in the audience, how to overcome manager selection bias?

Women are more socially — can be more socially engaging. Men can be too, but women can be more communicative. So when people come to talk to potential clients and they’re curious, what advice do you have to them if they’re looking at managers? How do you overcome that bias of naturally liking someone, but wanting to make sure because it’s your money that it goes to the right spot?

KIM SHANNON: Yeah. I mean, I always think that honesty wins, and quality wins, and education wins, and experience wins. And the gender is — some people will come in and they just want a guy. That’s OK, it’s their money. They can do what they want.

But if they’re going to do legitimate due diligence, and they’re going to go and interview some managers, then they’re going to want to see education, experience, track record, numbers, and the ability to communicate fluently about what the strategy is, and how the money is managed, and how risk is perceived. I think just being able to look at those objective criteria is the way that people should go in and make that selection.

And then let the best candidate win. Whoever they turn out to be. And if they have a specific preference, whether it’s gender, race, whatever, fine. It’s their money. That’s totally cool.

SUSAN SCHMIDT: OK, that also is perfect timing. We are right at the end of our segment. So I will thank you. Thank you audience for your good questions.

[APPLAUSE]