How to Invest for A Hundred Years | Inigo Fraser Jenkins

23:13But what you care about much more is what is the probability that this asset will deliver a real return over an extended period of elevated and potentially volatile inflation? And that's not necessarily the same kind of asset. It could be equities. It could be farmland that has no correlation short term with inflation, et cetera.

23:29Demetri Kofinas:So you argue in the paper that with the increased share of invested assets managed by family offices and wealthy individuals, and also by sovereign wealth funds, more assets will be invested with a view toward genuinely long horizons spanning more than a single generation. What share of global investable assets sit in vehicles with ultra long multi-generational structural horizons, and how has that share changed over time and over the course of your career? Yeah, it's very hard to get really good numbers in this, but it's a small minority of assets at the moment. So on numbers we've looked at, it's sort of high single digits percentage of assets at best.

24:08I mean, it depends a lot on how you count it. But I think also that's reinforced somewhat by shifts that are happening elsewhere. So for example, there's a much larger pool of assets that underpin the global pension system, and that's undergoing its own slow change over time away from being dominated by defined benefits, shifting towards defined contribution, which happens in parallel to be shifting investors' concern away from normal assets out to real assets. So there's some other pools of assets that are operating on still long, but shorter horizons that happen to be moving the same way. And that perhaps amplifies even more some of the issues raised in the snow.

24:45Demetri Kofinas:Well, it seems that the percentage of each marginal dollar is increasing. And it's really, I don't have a number to put on this. I've read different reports, but it feels to be very true. I mean, there feels that there's been really an accelerated growth in the concentration of wealth at the very highest levels of society. And I'm curious, we're somewhat deviating a bit here from the portfolio discussion, and we'll come back to it. But how do you think about how this impacts the structure of economies in terms of where demand goes and price signals and market prices, and how does it impact the democratic process, so to speak?

25:26Demetri Kofinas:And one area where we see this, I think, right now is in the AI debate and concerns about concentration risk, et cetera. Yeah, these are great questions. So, I mean, I guess a lot of this goes back to the seminal work that Piketty did and published in, I think it was 2015, Capital and 21st Century, and his exhaustive documentation of the shift in wealth inequality over time. And of course, it's interesting that a few things can come out from that. So one is that, I guess, there's always some degree of wealth inequality, but if there are strong increase in asset prices, then that tends to increase inequality because it's the rich that own the mother's assets.

26:03But then the strange thing that happened is that you also got this shift in income inequality driven by a shift in wage structure across societies. And so you've had these two forces which have driven inequality. And then as you say, it's front and center of the AI debate where often this question is raised, does the path of AI which we happen to be going on, which is a choice, this hasn't got to be this way, one whereby there is a risk for jobs for many people, but a small group of people end up being much richer as a result. Now, again, I don't think is anything inherent in AI that means it has to be that way.

26:38But that seems to be the social and political path that we're on as a result. So you see this in equality, but you also see it in willingness of voters to have systems whereby corporates take an increasingly large part of the pie. That's certainly happening in the US. And so there's a separate podcast story, really, but there's a whole story around US exceptionalism, why that exists and why I'd want to defend it. But one part of that is the profit share of firms in the US is as high as it's been in decades, and it seems to be higher in the near term. And rather remarkably, perhaps, so far, these kind of voters haven't kind of pushed back on that.

27:19Now, I do think there has to be some kind of limit both to profit share and to inequality. There's this very interesting large work done by Luke Kemp in recent years called Goliath's Curse, where in the book, he goes back through the long sweep of human history and shows that one key predictor to societal collapse is an increase in inequality and with not too subtle references to, I guess, the issue that we face today. So, you know, I do think it does prompt really quite important questions about, you know, the level of social acceptedness. But that's something which I guess we're beginning to see perhaps in some of the backlash against AI at the moment.

28:00Demetri Kofinas:So you're based out of the United Kingdom. I don't know what the laws are there or in other European countries, but over the last 30 or 40 years, a majority of US states have either abolished or effectively gutted the rule against perpetuities, which is essentially a common law doctrine that for centuries forced dynastic wealth back into individual hands within roughly 100 years where it would be subject to estate taxes and the normal entropy of generational wealth transfer. The result is the dynasty trust, which allows wealth to compound inside a tax sheltered structure essentially in perpetuity.

28:38Demetri Kofinas:When you think about this shift toward longer investment horizons and more concentrated pools of capital, how much of what we're seeing is a structural change in the legal architecture that now makes dynastic wealth preservation more possible in a way that it maybe wouldn't have been even for the wealthiest families like the Rockefellers. I see this as mainly driven by just the shifts in wealth creation rather than necessarily legal choices. Now, obviously, legal choices can come along and disrupt this, accelerate it, counteract it in some ways. And as I said, I think that there will be some political pressure and social pressure against big increases in inequality.

29:18But no, I see this mainly as a function of the process we've gone through for a long time, which is this huge generation of wealth and the obvious desire to set up structures that allow that to exist in perpetuity. But it does go beyond that as well, though. So again, if you think about the role of sovereign wealth funds as well, and the sort of gray area between a sovereign wealth fund and a national pension system that is funded in some way. And I think there is a kind of gray area there. Then there is a sort of recognition of the idea that there are sort of savings needs and that are truly long-term and critically are inflation linked in nature that have to be met through our bigger structures.

29:58Demetri Kofinas:So as I mentioned probably a number of times already, the subtitle of your paper is a state of mind rather than an allocation. What is the mindset that someone needs to have to create the conditions under which a portfolio will be successfully managed for 100 years? And how does this mindset relate to governance? Yeah. So I guess the first obvious point to make is that people are allowed to rebalance their portfolios in a 100-year horizon. But there isn't one allocation that we end up with at the end of the note and say, buy this and hold it for 100 years. Clearly not. Does that also imply that governance is more important than allocation?

30:34I think it implies that if one's thinking of long horizons, then governance has a a primacy which i guess probably always the case but it has a really important role to play if you want to think in truly of long-term ways about your portfolio i mean for example it so it affects the kind of target return that one wants to achieve so presumably it pushes one towards a target phrased something in the terms of needing to preserve purchasing power far into the future Maybe that's a real return target. Maybe it's phrased in terms of a percentage probability of not losing money in real terms over D &R X years in the future.

31:15I think it all comes down to other definitions of risk as well. So, for example, it's quite common to think of risk in a shorthand way as a volatility of returns in a certain year, but that might not be the right way to go and think about it. There's a section of paper where we show that if you think of the volatility of multi-year holding periods, then the relative volatility of equities and bonds actually looks very different once you extend the time horizon out. And if you look at the volatility of 20-year holding periods, then essentially the vol of stocks and bonds are equal. Or phrased another way, the probability of a real loss on bonds becomes greater than the probability of a real loss on equities once you extend out beyond a few business cycles.

31:55So that implies there's a governance need there in thinking about particular kinds of definitions of risk. I think it comes out also in attitudes towards illiquidity. I mean, unsurprisingly, if you're having a very long horizon, then putting a huge weight on a need for liquidity at a certain point in time is probably less likely. I mean, beyond a certain set of considerations of spending needs phrased in a particular way. And also, if some element of the returns are delegated out, it implies that the time horizon of which you assess the success or otherwise of the delegated returns should be made a timescale that's appropriate to kind of return and generating process involved.

32:40So to extremes, you can imagine a kind of cross-asset momentum investing process where the success or failure and measured over short horizons and a cross asset value driven process where it should probably be years.

32:54Demetri Kofinas:So I'd like to stay with this part of the discussion a little bit, because I feel like this is the most wicked problem related to this entire problem set, which is essentially... Now, first of all, how many of the folks that come to you are... Who are your typical clients? Maybe we'll start with that. Who are the people that typically come to you and seek your advice to solve this particular problem. Yeah. So I guess quite lucky, I speak to a very broad range of clients. So I mean, the clients who are asking these kinds of questions tend to be family offices, sovereign wealth funds, et cetera.

33:27Whereas I guess the broad super clients I speak to involves pension systems, insurance companies, et cetera.

33:33Demetri Kofinas:So for me, as I said, this is a problem that I've been trying to solve for several years slowly. And it seems that one of the central problems here is control. If you're in charge of managing your family's portfolio and you're the one that's created the wealth and et cetera, et cetera, and you want to set the conditions such that your heirs and their heirs will be able to successfully manage the responsibilities associated with the gains that they will accumulate as a result of the fortune that that will be bequeathed onto them, you can only do so much to sort of control it from the grave. You have to increasingly create the conditions by which they will be able to manage it over time.

34:17Demetri Kofinas:And so essentially my question is, what does that conversation look like when you're speaking with, let's say, a patriarch or a family office where this is the problem that they have, and again, they won't live forever? So what are the key mechanisms that can be put in place to increase the probability that wealth will be handed down successfully. And let's put aside for a moment the important things that need to be done within the family to prepare the children and their children to be responsible, to have the right values, et cetera. Yeah. So my colleagues who spend time working in individual families spend a huge amount of time on these kinds of questions and helping to tell them with that.

34:58I mean, that's one of the reasons, I guess, why we have the focus on governance in the note and instilling structure around governance, which is going to focus on an appropriate time horizon. I think it comes matched with questions around education and thinking around the role that housing setting that up. And also, it can also stretch to, and think about these longer horizons, thinking about other needs or spending requirements that are going to be set up on a long horizon, which could be issues that matter to the family or matter to a sovereign wealth entity, for example, in some way.

35:33Demetri Kofinas:So if you're investing for 100 years, by definition, you're making a conscious choice to forego the consumption of products, services, and resources today. Is it important, therefore, to have a clearly articulated reason for why you're doing that other than just, I want to invest for 100 years? Yeah. I think being articulate about the reason why investing is always important. But that's true, frankly, over one year horizon and over 100 years. But perhaps it becomes even more important over longer horizons since you have a greater freedom of choices made - And a greater fortune that you could spend.

36:11Demetri Kofinas:So do certain reasons matter more than others? Are certain reasons better or more aligned with wealth preservation and success over long horizons than others in your experience? I'm not sure. I think that people can set their reasons upfront and should be as explicit about them as they possibly can, and then one can try and respond to that in the best way possible. And if people have particular, for example, payout needs or particular requirements in mind, those guys can set up front. I mean, the same way that's similar, not quite the same, but it's similar to other asset allocation decisions that we help people with over more normal horizons, which often come down to set your liquidity requirement at first, and then other requirements to fit around that.

36:53It's just in this case, but that liquidity requirement is presumably very small.

36:57Demetri Kofinas:I'm really glad you mentioned liquidity because presumably for the strategy to work, the portfolio manager must avoid becoming a forced seller at any point for any reason. What are the optimal liquidity needs of such a portfolio? Yes. I think avoid being a forced seller is obviously key in this. There is an interesting question mark about how much liquidity backstop is needed. So I guess number one, obviously any needed payout has to be set outside of this structure. So that's a set sort of ex ante, if you like. Can you elaborate on what that means? Well, I mean, in the case of either some national entities or families, there'll be some suspending requirement that is required each year.

37:38And the key thing is to be overt about that and not let that drift upwards in good times, for example, and be more kind of focused on it as being really a hard, long-term kind of set number. And if it is going to be changed, that requires some due deliberation. Again, not just because it happens to be a run of five years or 10 years of good numbers. But then beyond that, there's a question of, is there a need for holding liquidity back to be opportunistic at certain points in time? Now, there are two sides to this. One is making sure there's enough liquidity to not be a foreseller. And that comes front and center.

38:13But the value of having liquidity that's held back kind of depends on are you actually going to use it? And are you going to use it to invest in broad asset class decisions or single assets that might be trading at very dislocated prices? Now, if you are going to be the kind of investor who is willing to jump into those kind of opportunities, then the value of that extra liquidity held back will be greater. If you're less certain about it, or if the opportunities you're looking for are only at the asset class level, then that can be an opportunity cost and drag on the portfolio, in which case you end up with a portfolio that's closer to being fully invested.

38:52Demetri Kofinas:So I have a section in my outline labeled risks of wealth destruction. So we might end up actually touching on that later, but are there certain periods where having discipline around liquidity management is especially important. When I say periods, I mean regimes, for example, high tax regimes, where you have highly punitive capital gains taxes, where selling assets from the portfolio will devastate your long-term returns. How do you think about the fact that these cycles themselves can be generational? And so one generation may have to be very different in how it manages its liquidity needs than a different generation.

39:31Yes. I mean, that I think is a point to questions of both liquidity, but also tax arrangements in general. I mean, sort of slightly separate from this and running through the whole paper, I have this view that at least for foreseeable decades, we probably face somewhat a lower return future. And it's evident that government debt to GDP is a very high level. So whatever the current crop of politicians say across many countries, my view is tax rates are going up you know at some horizon and so the combination of those of the two views imply that the value to a taxable investor of the tax planning actually becomes a larger share of the take home returns than they've had for many years now again that applies over shorter horizons as well but that's certainly a consideration that runs through the note you know I think, though, that in the section of the note where we do talk about damages, wealth in the long run, just to bring that in, because I think it's relevant at this stage, inflation is a key one.

40:37I mean, yes, at certain points, impunity of taxes can be a problem, or social dislocation can be in a very acute problem. It's very hard to diversify against, but making sure that you are generating those real returns over long periods of time, that is the critical long-run theme that runs through constructing portfolios, these kind of horizons.

40:56Demetri Kofinas:So again, I'm glad you brought up inflation because in the paper, you advocate abandoning market-based cross-asset benchmarking and other institutional financial frameworks in favor of purchasing power preservation. Can you elaborate on this? What do you mean by that, purchasing power preservation? Yeah. But I really mean that the reason why most people invest and hasn't got to be even for long horizons is to meet some need in the real world. I mean, I guess it was obviously retirement, but it could be educational needs or - Potential healthcare needs. Exactly. Starting a business. But these are things that are clearly real spending requirements and they have an inflation number attached to them.

41:29So investing, for most people, has to involve achieving an ability to at least preserve and ideally kind of grow your ability to spend on real terms. So hence, inflation, I think, is a more natural long run benchmark for many people. Now, it happens to be the case, we've been through, at least in the 20 years prior to COVID anyway, a period where inflation had been very benign, asset class returns were very strong in real terms. People kind of perhaps were lulled into false senses of security, their ability to outperform inflation while taking a relatively low level of risk. And I think that is pretty different in future.

42:12Again, it's not a bearish message, it's just a more complicated message. So I guess that's the second reason why I think inflation matters. And the third is, I think in the finance industry, we have become a bit over-obsessed by benchmarks and this whole kind of cottage industry of just kind of growth and benchmarks in all kinds of ways. I mean, we showed in a paper a while ago that the number of equity indices in the world was already measured in the millions, whereas there only are about 45 ,000 stocks all in in the world, including small caps. But the idea there being at least 60 or 70 times as many buckets to put things in as there are individual assets seems a bit ridiculous.

42:49Yes. And so that raised some questions around the in about the risk of, you know, being overly focused on benchmarks, even within an asset class. And then if you think cross asset and the problem becomes much worse. Now, I would argue that there is no such thing as a default natural cross asset benchmark. mark. I mean, some people would say, oh, well, surely it's 60-40. Well, yes, 60-40 is often the default allocation people use, but it happens to have done well in the last 40 or 50 years. But there's no theoretical basis for it, really. It just empirically happened to work well in this kind of time period.

43:24And I'd argue that there isn't a natural way to weight assets across asset classes. You have to think about it in a more risk-based approach, or think about targeting inflation. So that becomes the thing that is an exogenous level over which you have to achieve a return.

43:43Demetri Kofinas:What does that look like in practice? I mean, even targeting inflation is hard to quantify. You could target CPI, but even that doesn't necessarily capture what we're talking about. And it's also arbitrary. It can be adjusted by the government depending on the regime. So how would you describe the most sort of prudent way of approaching this in practice? I mean, I guess it just means, especially over long horizons, that the assets you're buying are going to be biased much more towards real assets. Assets that either by the legal nature underpinning the return stream or empirically through the return for distribution that they generate, that these are assets that deliver a return in excess of inflation.

44:23And that ends up being there's a dominant sort of asset that one has exposure to. One thinks about the risk metrics that you use, probably more geared towards the risk of a real loss over time horizon, but that's appropriate. So if you have those two things that I would point to, there's always a question mark about what level of inflation to go and use because everyone actually in practice faces a different level of inflation, but it becomes very cumbersome to go and think about that for many, many people. So I guess for a shorthand approach, you'd say, well, I want to outperform an X-year forward view on inflation in the domicile that one's based in, obviously, one can come up with something much more specific than that if people have conveyed particular needs.

45:08What are some examples of assets that aren't real? I guess nominal bonds is the obvious. So obviously, you can guarantee a return stream set in nominal terms. Also, I'd argue there are elements of the equity market that are not real. Overall, I say in the note that the equity market is the biggest real asset out there, And the basis for that is the ability of corporates to pass through inflation by increasing prices and passing it through dividends. But there are other elements of the equity market, such as issuance versus buyback activity and levering up of corporates, which are financial activities rather than real activities.

45:44Demetri Kofinas:Are growth stocks less real than value stocks or value stocks that issue a healthy dividend, even though they're both real companies? Is there something? That depends, I guess, on the nature of the return streaming generator. So for example, there are growth stocks, say in the healthcare sector, where there's a good long run ability or a good long run evidence that one can raise prices in line with or in excess of broader inflation. So they count as delivering a real growth in the long term. Likewise, if there are you know, upward shocks in discount rates, then perhaps it moves one more towards short duration stocks.

46:28And by that, I mean, and value companies. But then even with them, there are differences between them. So for example, one can think about companies linked to the commodity complex. So I mean, energy being the most obvious example, where the dividend streams are linked to some kind of exogenous real asset, I mean, albeit indirectly, the link is there, of those still.

46:49Demetri Kofinas:So I have a couple more questions before we move to the second hour, Inigo. Let's go back to diversification. So you argue in the paper that investors need to reconsider, and you did so in this interview as well, reconsider their definition of diversification, moving away from cross-asset correlation within the Markowitz framework toward one informed by different global conditions. So here we're really talking about risk versus uncertainty. What are those different conditions and how should the portfolio adjust accordingly? Yeah, so I guess a few things to unpick here. So firstly, we're putting less weight on simply diversification, we generate this correlation, partly because there's a risk that the last 20, 30 years has been this period that's been very special.

47:31And that is correlations we've observed over that period don't necessarily apply in the future. I think one particular thing from that that I would pick out above all others is the observation that up until 2022, the correlation of stock returns and bond returns was negative. And that's been somehow embedded into people's kind of thinking. I would argue that that shift since 22 to the correlation of asset classes being positive is firstly, a return to normality. So if you go back over the 200 years prior to the last 30 years, that correlation was positive most of the time. And secondly, that's more consistent with a world where we face inflation shocks, be it from climate or from deglobalization or from risk of debt monetization, which are not growth linked.

48:16And so I think there are reasons why those correlations which have been super helpful for investors and across asset class sense in recent years aren't there anymore. So I need to do something different. And the second aspect, which pulls us towards a slightly different process, is this idea of the uncertainty about the future. And again, I really want to stress, I don't want to just take the view that the future is always uncertain. There are a few things we can point to now, particularly AI, climate, geopolitics, and the breakdown of the rules-based order that mean we have some extreme divergence in future forecasts or where paths could take us.

48:52So one wants to build a portfolio that is robust across some different examples of those paths, and especially when we have a very poor ability to model what policy and growth looks like across them.

49:04Demetri Kofinas:Is this what you mean in the paper when you talk about the need to adopt a total portfolio approach that looks across public and private risks? It's linked to that. I mean, the total portfolio approach is a specific approach to constructing portfolios. It's become much more popular and talked about much more in recent years, although it's by no means new, certainly something we're talking to clients about, say a decade ago, but it's become much more popular recently. In essence, a total portfolio approach is thinking about risk in a holistic sense across the portfolio. So what that means is kind of denying the primacy of asset classes in the way you partition and allocate to risk in a portfolio and think more freely about that.

49:47So think in terms of the more fundamental factors that drive portfolios. And it leads to, you know, perhaps a more efficient way of allocating risk that I would argue is helpful in an environment where diversification is hard to achieve. Now, it's not for everyone because it requires a big shift in governance. And these kind of shifts in governance are things that should be done very humbly and slowly over time, particularly for large organizations. And some organizations have moved in this direction, but for organizations, it can be difficult to implement that kind of governance change. But this is an example of where a response to a slightly different kind of regime is helped by a total portfolio approach.

50:31Because you could think of, well, I want to build a portfolio that has return streams that can survive in a world where temperature increases, say, more than two degrees, and there's geopolitical change, and there's an unexpected shift in the way AI changes job creation, say.

50:49Demetri Kofinas:So, Indigo, I'm going to move us to the second hour. There are three categories of conversation that I would like to dissect. One is allocation, looking at equity, real estate gold, bond allocation. Also, what constitutes a risk-free asset or how does one manage risk in a world where bonds do not play that role consistently? I also want to discuss risks of wealth destruction, as I mentioned earlier in the conversation. What are the primary drivers of wealth destruction over time? How important is tax planning? What role do war and confiscation play in changing legal regimes? Also climate change, which you mentioned.

51:23Demetri Kofinas:And then I want to get into a broader macro discussion really about the current climate. And we can have a chance there to discuss equity, US equity versus US dollar exceptionalism, the effect of the fiscal picture on equities, the Fed and treasury credibility, and a number of other timely topics. For anyone new to the program, Hidden Forces is listener supported. We don't accept advertisers or commercial sponsors. The entire show is funded from top to bottom by listeners like you. If you want access to the second hour of today's conversation with Indigo, head over to hiddenforces.io slash subscribe and sign up to one of our three content tiers.

52:02Demetri Kofinas:All subscribers gain access to our premium feed so you can listen to the rest of today's conversation on your mobile device using your favorite podcast app, just like you're listening to this episode right now. In it go. Stick around. We're going to move the second hour of our conversation onto the premium feed. If you want to listen in on the rest of today's conversation, head over to hiddenforces.io slash subscribe and join our premium feed. If you want to join in on the conversation and become a member of the Hidden Forces Genius Community, you can also do that through our subscriber page. Today's episode was produced by me and edited by Castilianos Nicolaou.

52:40Demetri Kofinas:For more episodes, you can check out our website at hiddenforces.io. You can follow me on Twitter at Kofinas, and you can email me at info at hiddenforces.io. As always, thanks for listening. We'll see you next time.