- Can you run a big business when most staff work from home?
- Debt finance is being heavily favoured in recent years. How can we possibly shift that?
- Is there a pension ticking time-bomb? Are we as society saving enough and what’s the answer if not?
- Longer term, will there be inflation or will we continue on the low-inflation path? What has better value; the tech stocks or the kind left behind, cyclicals?
- Debt longer term. Will it continue to rise unabated or will there be a natural break, plateau or reversal? If so, how?
- Rise of importance of ESG. Where is ESG investing going?
- Brexit. Can the asset management business in the UK maintain its lead over France and Germany? If not, where will the growth area be in AUM? Or does London have insurmountable advantages?
- Consolidation in Asset Management. Is there still much more to go? Why is scale so important?
- Can active management and higher fees come through due to the shock of the pandemic?
- What is the steady state future of the AM industry?
Chief Executive Officer
- Joined investment industry: 1992
- Joined Aviva Investors: 2014
- Euan is CEO of Aviva Investors and a member of the Aviva PLC Leadership Team.
- Euan sits on the board of The Investment Association, the trade body that represents UK investment managers.
- He is also a member of the CEO Advisory board for The Diversity Project a cross-company initiative championing a more inclusive culture within the Savings and Investment profession
- Euan holds a Bachelor of Engineering degree in Physics and Electronics from the University of Edinburgh and a postgraduate diploma in Actuarial Sciences from Heriot-Watt University. He is also a Fellow of the Institute of Actuaries.
00:00:15 Hi, I'm Jim Reid, Global Head of fundamental credit strategy and thematic Research here at Deutsche Bank. Welcome to the latest in the series behind the headlines where we talk to a senior business leader and discuss the world as they see it for their business and wider markets. Today I'm delighted to be joined by Euan Munro who is CEO Aviva Investors, and hopefully Euan can give us a feel for how Aviva manage through the pandemic and also how Euan sees markets and life in general as we get closer to 2021. So Euan and welcome. Thank you very much for joining us.
Firstly I want to ask you a bit about the pandemic. So how have you found running a big business during this pandemic, especially when pretty much all of your staff have been working from home?
00:01:12 One of the things that we had to do before the pandemic was do an awful lot of work on resilience. Planning a regulator is pretty hot on businesses. Being able to operate if the disrupted for any reason, and I think helpfully that meant most of our staff were, you know, had laptops that could take home and so on, so I think like many an industry were able to move to working from home without missing a beat. Really, I think it's more at the human level in the idea sharing element that is the problem. I think our industry has clustered for a reason and it's because people like coming together, sharing ideas, collaborating, and I do worry that that aspect might degrade the longer this goes on.
00:01:57 Do you see there being any tension longer term between staff wanting to work from home and maybe your idea that collaboration is better in a central office space?
00:02:12 I definitely think that some people have found that some aspects of work are better done from home, and I don't dispute that that when you just want to get your head down and do work maybe write a report or whatever. Maybe it is more conducive to do that at home, and so I do think working practices longer term both change as a result of this. However, I do feel that you know, for the creative aspects of investment management where you have this mixture of specialists and generalists coming together to decide on portfolio construction and so on, I believe it is a collaborative process and requires us to cluster, so I think we'll probably spend less time clustering in offices, but we will have to spend some time and I can't really see any way to avoid that.
00:03:07 OK, let's move on to look at themes impacting your business and wider markets. Look both the businesses. We're in banking and asset management have been grappling with negative rates and yields for a while now. I just want to ask you, do you understand the reasons for negative rates and subsequently negative bond yields? Or do you think that they were a policy mistake that are now difficult to unravel?
00:03:38 I understand why we've got here, but essentially mean my view is you have to make a choice between allowing companies that have over borrowed or households. Back in 2008, it was households that had borrowed too much and it was a political decision made to allow them to live with the stalker debt that they've created rather than go through bankruptcy and so on. And so there's a trade off between loss of wealth immediately through bankruptcy or a slower transfer of wealth from savers to borrowers overtime through a reduction in the cost of borrowing. And so I understand the dynamic what I worry about is we've gone too much for the sustained borrowers through low interest rates. Rather than take some of the pain of businesses that simply do need to restructure and change and going out of business, so I think the risk of a zombie economy of your like is a real one and one that we need to face into.
00:04:49 So do you think there is a justification for some element of creative destruction and free market forces in debt markets?
00:04:59 I do, I think that you know maintaining businesses that have you know, excessive level of borrowing may just be a long term. A long term issue. I think one of the things we're seeing actually is what the you know what was saved of your light by the central bank says now maybe being destroyed by the coronavirus pandemic and even very low levels of debt service they're unaffordable if your income stops altogether and so we're seeing a number of companies now, particularly in the retail sector. You know, facing bankruptcy and I think that we do need to see a re-equitatation of our economy because I think we leaned too heavily towards debt. And maybe this is the way the process starts.
00:05:50 Yeah, I mean that's an interesting point because you know, debt finance is being heavily favoured in recent years. How can we possibly shift that? Because we've gone down this massive path and we've created this massive Goliath debt market. How can we now re equitize, do you think?
00:06:09 Well, I think people maybe need to adjust their expectations of equity. I think one of the things that's happened is, you know, interest rates have gone from, you know, depending how far back you go certainly gone from something five 6% to in the case of Europe negative another case in the UK very low. And during that whole time the expectation is that the return on equity should be 10% plus you know ten 12/13% return on equity. And of course that's been achieved by two things. One is by the taking on of cheap debt and levering up and the other. The other thing that's happened is as you move towards a low interest rate environment as you go through that transition asset prices tend to get inflated so people assume that ten 12/13% return on equity is sustainable. My view is that as we look forward and time people are going to have to adjust their expectations for the return on equity and lower returns will be you know deliverable with less levels of debt and so I think it's reducing expectations. Less debt. But I think we are going to have to turn to the equity market for income needs. For example in designing retirement product in the future.
00:07:35 That's definitely something I'm going to touch on a bit later, especially in your position before we kind of move on a bit more to the kind of retirement and return expectations just one last thing on negative rates. What do you think about UK and negative rates? Do you think the UK will eventually follow? Obviously the UK Chancellor looks like they are going to start the journey towards fiscal retrenchment to some degree and that puts extra pressure on the Bank of England or do you think the Bank of England is looking at this and realizing that negative rates has downsides? What are your thoughts on UK and negative rates?
00:08:15Yeah, I mean I think you know they'll be tempted to move in the same direction as Europe. I am not convinced that negative rates are particularly helpful and I do think it will lead to you know kind of stockpiling of cash and so on. We still have quite a bit of cash usage in our economy and certainly if negative interest rates are imposed on individuals as opposed to the you know the corporate sector or the banking sector I do think that people will start resorting to using cash more and so I think there's obviously a limit to how negative interest rates can go because eventually people will stop using the banking the banking system. But I it's got to be a temptation hasn't it for politicians that have a big fiscal bill to try and encourage a world where debt is cheap and maybe even pays them.
00:09:16 Yeah, that's fair. Moving on to, you know some of you talked a little bit about returns etc. How would you answer the question if I said aren’t all assets expensive now and aren't returns just going to have to be or expectations returns going to have to be adjusted down for years to come and in your position in the asset management business how do you kind of educate for that?
00:09:48 Yes, I mean I think I think the answer is yes. If you move the fundamental you know the base level of the risk free rate of return, which we've seen with, you know sovereign bond yields coming down. It does have an effect on everything else and we see the effect becomes looser the further you move away from the risk free asset. And so I think obviously the price of sovereign debt has a fairly direct mathematical link to corporate credit for example. But I think there's lots of examples of well run, you know, kind of ordinary equity companies that have attractive yields and the equity market at the moment. So once you get into the equity market I think you can find sustainable levels of dividend and income at attractive prices. I think in terms of returns yes the thing that's going to go is that extra kick that you got from the return as we move from a higher interest rate regime to a lower interest rate regime so that's accelerated asset prices over the last couple of decades, and that has gone. There's a serious risk as well that governments will be incentivized to monetize some of the huge debt pile that they have, which ultimately could lead to inflation in the medium term and so even though nominal returns might stay. Reasonable or acceptable in the eyes of most people the real return could be much less appealing in the future. So in terms of educating people, I think it's we're going to have to educate people to look maybe towards the equity market for income rather than fixed income. Fixed income isn't really offering a level of income that's attractive. Institutional type clients that have previously relied on corporate bonds and sometimes even sovereigns to meet. Long term liabilities with increasingly seeing their moving towards real assets and you know, infrastructure debt than real estate debt and things like that to try and get some extra spread. So I think we are in a world of smaller numbers and lower returns and I think that probably the thing to think to worry about is has an asset been put into bubble territory by excess demand from official channels. So I think you know the further away you are from that the closer to sensible asset pricing might be.
00:12:32 It does seem from what you're saying, you know you believe the fixed income market is going to really struggle for returns going forward. If everybody felt like that who would buy bonds in the end? Do you worry at some point now that everybody will think like that and suddenly we have a huge debt pile that nobody wants to finance apart from central banks?
00:13:00 I think there's a fair amount of financial repression going on in the world at the moment. In the if you were unfortunate enough historically to have made some long term commitment whether that's an insurance guarantee or a final salary pension promise, and then through the actions of Central bank monetary policy, your risk free rate of interest has been lower than that's right through the curve now right out to the long end. Effectively you're obliged to follow that. In order to map your liability or manage to your liabilities, and so there's a large amount of I would call it kind of legacy or kind of older fashioned propositions and got with embedded guarantees that simply are obliged to buy fixed income, including, you know real asset type investments. My council would be that if you are in the position where you have defined contribution type of pension and you don't need to be buying bonds then personally I wouldn't. I would be trying to draw income and trying to take a slightly more risky but in real terms in other words will my wealth be eroded by inflation probably less risky strategy of investing in real asset economies with links to the growth of the economy and potentially some protection against inflation.
00:14:35 And looking a bit more at the equity market, obviously with the vaccine news in the last few weeks we've seen a big rebound in cyclicals. But the tech stocks in the US particular that did so well during the pandemic, they've held their own so far. Where do you think that trade goes going forward in Cyclicals versus those mega cap tech stocks. Which has the better value the tech stocks or the kind of left behind cyclicals?
00:15:05 I am nervous about the tech stocks. It is not that I don't think they've got fantastic business models and it's not that you know I can fully accept that they are great businesses, but I'm old and grizzled enough to remember the the.com bubble in 1999 where effectively the whole thesis of the stock price rally that we had then was accurate that we were going to be doing a lot more on the Internet. We were going to be you know, kind of trading more there buying things getting experience in customer service. There it was accurate, but the market just got a bit ahead of itself and it wasn't the discerning enough in terms of which of the companies would be the winners. As we look at the tech stocks, I think they've got growing business models, but they are priced for perfection and I do also see that some of the traits that we saw in the Internet bubble, which is. You know, stockbroking firms that are set up specifically to give access to these stocks or ETF's that are structured specifically to give access to these stocks I think that the part of the savings increase it was seen through the coronavirus crisis has been rotated into those hot sectors, and I do think there's something of a bubble there, less so with the more cyclical normal stocks real economy stocks. If we do get back to normal and we do start spending money those stocks have got you know legs and they're not expensive.
00:16:47 Yeah, great. Coming back to you briefly touched on pensions, etc. Do you think the pension industry are kind of a ticking time bomb? You know are we saving enough society? Are we saving in the right products? So give me a kind of an insider's view on where you think the state of the pension market industry is.
00:17:11 Well, I think we're not saving enough because the price of income in retirement has just you know ballooned with the reduction in long term interest rates and therefore, you know, you know if people didn't anticipate the extent to which the price of a pension was going to go up and very few did, then they highly unlikely through their lifetime to have been saving sufficient. So I think in the long term you know the key thing is, do we ever see you know our interest rates low forever or will they will eventually go up? And that's maybe an issue for those with a couple of decades to go before retirement for people that are closer to retirement is a more pressing issue. So we have seen saving rates go up during the COVID-19 crisis. I suspect a bit of that is in voluntary as people just haven't got the outlets to spend money, but some of it will be genuine savings as the arm commuting and things like that. And we've had the furlough money coming through and helping a number of people out, and I would be interested to see where that where that goes. At the minute, I think it's going into short-term savings. It would be wise if a number of people saw that as a windfall to put into long-term savings, but in terms of simple answer to your question, are people saving enough? No, they're not. And part of the solution is, I think, going to have to be people utilizing things like the wealth in their homes through equity release products and so on to generate income in retirement because they simply haven't got enough money.
00:19:06 And I mean, obviously you argued before that you think a better vehicle for peoples longer term savings is equities rather than fixed income. Going back to fixed income, obviously it's propping up a huge ballooning debt situation. What do you think of that? Here is the easiest question I am going to ask you all day. Where is debt going longer term? Will it continue to rise unabated? Or do you think there's a natural breaker? Sometime in the future, inflation or even the worst case scenario, default, where do you kind of see the debt outlook over the next decade or so? Easy question.
00:19:48 Yeah. Well I think I said that the debt market is supported by a whole load of legacy liabilities defined benefit pension plans, and I suppose all their fashioned insurance propositions that have embedded guarantees. They are almost forced buyers of debt, and I think one of the things we'll see over the next ten years or so as we'll see that defined contribution type savings or savings on platforms that don't have embedded guarantees overtake become bigger than the maybe the older fashioned legacy type of saving product, and I think that's where asset allocation shifts will change dramatically away from fixed income towards more equity. Now what I hope I hope we can make a fairly smooth transition by people reassessing the level of return expect to get from equity and equity market becoming less leveraged. So lower return on equity, less leveraged, safer equity market, which will allow people to tap into the income, and I think what that probably means is that some of the high growth, more risky type opportunities might not be in the publicly listed equity market they might move more to the private markets.
00:21:16 But do you think when that natural asset allocation shift out, there will be enough buyers for debt products to keep bills at a sensible level? Or do you see there being a kind of a day of reckoning ahead?
00:21:33 I think, well, I mean when you talk about these transitions generally as you know we all sort of talk about smooth transition from one regime to another and very rarely does it happen that way. So very often what you do have is you have a tectonic plate moves at some point and it's very difficult to judge when that when that is. But I do expect that at some point as we make the transition into a future which has more less leveraged debt that there's less natural buyers for credit that we will have some scares. There's been quite a bit of retail money flowing into credit funds on the assumption that is perhaps just like just like a bank account no matter how we try to try to educate around new generation and spread and what it can do. The number of people will have drifted then just because they're fed up in Europe getting negative returns on their bank deposit or very low rates of interest in the bank. So they see that is safe. And of course it's safe as long as you have this higher level of support, particularly from central banks, as the underpin, I think the thing that might challenge it would be if governments decide to effectively monetize their debt and you start getting inflation coming through. I think that's when I would personally worry about them being able to hold on to the long end of yield curves you might get quite rapid steepening. And there could be retail losses at that point, which leads to money leaving the fixed income market. I don't think so near term risk by some point in the next 5/10 years, definitely.
00:23:23 And do you think? I mean, we're having a huge debate at Deutsche Bank about weather inflation or disinflation is the most likely outcome to be honest, even before the pandemic. But the pandemic is arguably intensified that debate. Which side do you lean on? If you go out? Let's say maybe 3 to 7 years are you inflationary or you disinflationary in your outlook and why?
00:23:50 I probably lean towards inflation rate towards the, you know, three years plus range just simply because I think that there's a whole lot of easier policy options which would create inflation. Also think that the sort of deglobalization theme that we've seen in recent times is going to break up supply chains and will likely make things just that little bit more expensive. I just don't believe that you can print money and not face the consequences at some stage and and so I have to believe it's going to come. I'm also a bit more optimistic about the bounce back once we're all allowed to get out and spend money. So I think the deflationary argument is to some extent linked to how you think the world from a sort of economic functioning point of view is going to land after we've got a vaccine, then start maybe behaving a bit more like normal.
00:25:01 Yeah, and I you know these are some of the debates that are ringing round our virtual offices at the moment I'm on the inflationary camp, but there's plenty of people that I've got a great deal of respectful within our research department who think the opposite. So I think it will be a debate that rumbles on.
00:25:19 Let's move on a little bit, now I suppose before the pandemic hit in January, February ESG was one of the hottest topics around. It probably still is one of the hottest topics around, but it's obviously got slightly swamped by the pandemic. Very broad question. What do you think of the future of ESG and how is Aviva dealing with that topic?
00:25:45 I mean, I think we've been concerned about ESG from, you know, a risk point of view for quite a number of years, and I'm delighted to say that share action recognized as one of the top five managers globally in terms of how engaged we are in voting on environmental issues and so on. So we've been voting since the 1970s in anger on to try and encourage corporates to improve their behaviour. To a large extent because we felt that companies that were taking risks with the environment or social risks in terms of cheap and unfair labour practices were likely to end up in difficulty at some point. So these were risks that we felt needed to be managed. Going forward that's only going to become more important. I think the crisis is just showing how lacking in resilience a number of our industries and societies are and so the ESG agenda I think is just going to become greater. The big debate over the next little while is going to be between engagement and exclusion. I think the number is right. Sort of rush to sign up to ever more aggressive, net zero by XY Z date type targets. You know we are part of that and I support that is an ambition. But how you get there is quite important and I think that personally I believe that exclusion is ducking the issue if I tip my rubbish over my garden wall into the neighbours yard I might be making by environment look a bit cleaner but I'm not saving the world by any stretch of the imagination and I think that if you want to save the world rather than just make yourself look good frankly you have to get involved in engagement and that's the direction that we will be heading in or we have had it in for some time but we will continue with that direction.
00:27:46 Great, we just had a few extra topics now before we wrap up. Brexit another topical issue especially with asset management, which obviously the UK is a world leader in really and I think in Europe I think 37% of the asset management business in Europe is in the UK and that's quite a big lead over France. I think it's got about 18% Germany 10%. How do you think asset management will in London will survive Brexit? Is there going to be a growth area elsewhere or does London have kind of insurmountable advantages that other centres can't hear?
00:28:30 I do, I mean I'm optimistic about London's chances. I do feel the UK has, you know it's got the world's second largest asset management industry. And I mentioned at the start of this podcast that industries cluster for a reason I think the UK does have a very diverse, talented set of people in the industry. There's talent here and we've got the opportunity to build on that so when I look at the opportunity that we have not caused necessarily by Brexit, I don't think Brexit has been particularly helpful, but I think it has focused perhaps the minds of some over government ministers on where we are competitive as a nation and through my one of the hats I wear as I sit on the board of the Investment Association, the group that looks after or speaks for Asset management as an industry we've never had such engagement as we've had with government ministers, so I think there is a recognition. This is an area where the UK is a leader and we should try and win the arguments. I think the big wins that the US has had over the rest of the world is obviously the massive increase in passive managers. So huge Vanguard and Blackrock's and so on. And undoubtedly there's been that switch from active to passive that's favoured them. If I'm right, we're going to see a switch from passive to engaged, not necessarily passive to active, but passive to engaged. And I do think that the European market in general to be fair, but the UK as well have got leadership potential in that area.
00:30:22 And so I mean, so you think we might be past peak passive management because of the pandemic? Or is it too early to say that?
00:30:34 I think part of it. I've always said passive has a place in portfolios. If you want to get market exposure and that's fine. But you know, but passive is a reflection of the past, and so you're effectively your ossifying where we are, whether the passive allocation engagement is forward looking is looking to how we're going to change things in the future, and I think you know to coin a phrase you know we can't be passive in the face of the climate emergency for example, that's where if you just support thoughtlessly the market capitalization, this position that we have at the moment, you're not going to be affecting change. Some people are trying to do that with adjusting indices, but I think that can help the texture and colour of portfolios, but it's not actually addressing the fundamental problem, because it just maybe those assets are finding different owners that maybe don't care much about the sort of environmental damage or whatever that they're doing. So my expectation is that we will move towards more engaged thematic type investing over the next few years and the passive players will not know to adjust their offer to try and catch that trend. But so will the active managers, and I think we'll just have to see how it how it plays out.
00:32:07 Great staying within the kind of asset management area. I mean, I started as a bond salesman 25 years ago and then moved to research soon after and I suppose it ever since I started sales, there's been constant consolidation in the asset management business. There are some asset management businesses now which when I started were 4 four separate companies and they are all consolidated into one and we've forgotten about the previous ones. So why is asset management in constant consolidation? Is there further to go? Why is scale so important? What is the kind of steady state future? Are we still going to be talking in 25 years about constant M&A activity in the asset management business?
00:32:58 Possibly, yes. I mean, I think I think we touched on the fact that obviously returns are later to be lower in the future, and I think that's being reflected in the fact that we've seen a gradual decline in the level of fees that fund managers are able to take. The probably the most aggressive reduction of the last save 5 six years has been in passive fees that probably have gone down by 40% by active fees have gone down by about 20% and the amount of active money has reduced as it's kind of been moved into or something with the flow has moved towards passive, so I think you know when you've got pressure on fees consolidation makes some sense. Scale is important in our industry, so I'm not particularly surprised that we've seen that level of consolidation. So if you are a sort of fund manager that's trying to offer a broad based service, then scale is critical. Access to distribution is also critical. But I think at the other end it's actually quite encouraging to see there's a whole load of creative small startup boutique type for the managers being created all the time. Many with new types of approach to investing like artificial intelligence and so on. And I think that we will see both ends of the scale highly successful new starts that will come and threaten established players and you will see some of the bigger players consolidate just to get that scale.
00:34:38 So it seems like the consolidation isn't over in the asset management business according to you, but that seems to be the message. One final question. We touched on a lot of longer term themes here as we are in December now unless you're listening to this well in the future on the podcast provider, what are your thoughts into 2021 specifically?
00:35:08 We are relatively constructive. We've seen a big rise in household savings as we've gone through this year. I mentioned earlier, you know that's probably to some extent involuntary. We do think that once people are free to get out and take holidays and do all the things that they would normally like to do, they will absolutely do so. I guess the risk to that is that these savings are precautionary people are bracing for worst times to come and they don't come out and spend and I think that would be a problem to hold of businesses that are really needing the post inoculation world to be a kind of bounce back period for a while. I think we're kind of constructive and do expect that monetary conditions and fiscal positions will be supportive of markets into 2021. I think you then have some longer term risks emerging beyond that, but 2021. Be positive.
00:36:18 OK, well that sounds like a decent point to end it. I think we both agree that next year probably is not the year to worry about the longer term structural problems because of the bounce back, but we should always have in the back of the mind that the structural problems that we have so I think we agree on that. So many thanks Euan and that was a really interesting conversation and I appreciate your help in speaking to us today. So thank you very much Euan.
00:36:53 Thanks for having me.
*Minimally edited for clarity.*