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This material is provided as a courtesy and for educational purposes only from Olde Raleigh Financial Group, A member of Advisory Services Network and should not be construed as investment advice. All information contained in this video is derived from sources deemed to be reliable but cannot be guaranteed.  All economic and performance data is historical and not indicative of future results.  All views/opinions expressed in this video are solely those of the presenter and do not reflect the views/opinions held by Advisory Services Network, LLC. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

Meet the Masters – Joachim Klement, CFA, is a trustee of the CFA Institute Research Foundation and offers regular commentary at Klement on Investing.

 

Trevor Chambers:

Hey Everybody, this is Trevor Chambers from Olde Raleigh Financial. I want to welcome you to another one of our series of blog and podcasts called “Meet the Masters,” and I’m very excited today. I’ve got a really interesting gentleman with us. Joachim Klement is somebody I started following. He’s got a great newsletter out, and we’ll include all the contact information on Joachim when we get done.

His observations on markets, finance culture and politics are rooted in what I would called a unique vantage point. Joachim is German born and raised but lives in London with his American wife. I want to hear that story. He’s an investment strategist with a long career in asset allocation economics, equities, and alternative investment. And he looks at the lens. He looks at life and everything, but particularly in markets, through the lens… He’s a trained physicist, but he loves the human side of financial markets.

Olde Raleigh Financial welcomes Joachim Klement. How you doing, buddy?

Joachim Klement:

I’m very good. How are you guys?

Trevor Chambers:

Good, I’m great. I’m sorry for the long-winded introduction, but you got a lot going on there. How’s things in London? Are we foggy, overcast or what’s going on over there?

Joachim Klement:

No, for once, we’ve had two terrible weeks of rain and gray, which is obviously, a typical British summer, but now we actually have sunshine which is quite a nice change.

Trevor Chambers:

That’s fabulous. Well, I’m glad to hear that, and I do want to hear about how you got this Yankee wife. We’ll get to that in a minute. I want to jump right into it, all right? What’s the stupidest argument in the world of economics, in your opinion, currently?

Joachim Klement:

Oh, that’s easy to answer, because I hear from time to time that people are afraid that China has so many treasuries that they could basically pull a nuclear option and dump all their treasuries on the market and as a result, tank the prices of treasuries globally. That is, bar none, the stupidest argument in economics at the moment in my view, because it just completely ignores the numbers and what has happened over the last six months, in particular.

If I just go for the numbers, China has about $1 trillion in U.S. treasuries. Sounds like an awful lot, but then again, this is 2020. What’s a trillion dollars amongst friends? You might think, “Okay, that is a lot,” but the federal reserve alone has $4 trillion dollars on its balance sheets. So the Fed is four times as big as a holder of treasuries than China. And to think about it, during the reaction to the COVID crisis this spring, the Fed easily pushed into the market and placed into market way more than a trillion dollars. I bet you will all have a very, very hard time figuring out where the spike in treasury yields was this spring, because there was none.

There’s actually new economic research evidence coming out or has come out that looked at the impact if a foreign central bank—or any foreign investor, really, but foreign central banks obviously are the biggest ones—if foreign central banks starts to buy or sell treasuries in large amounts. And essentially, even in a calm market like 2019 or 2018, dumping $1 trillion of treasuries into the market would raise the treasury yields for two year yields by about 80 bids. That is really a normal three to six month move anyway.

Trevor Chambers:

Wow. All right, so we’re going to put that one to bed. Hey, by the way, are we going to have EU bonds to cover this COVID stuff and all these expenses? What’s going on over there [crosstalk 00:04:24]?

Joachim Klement:

See, that’s when you’re talking to a German, we’re culturally inclined to say, “No.” [crosstalk 00:04:31].

Trevor Chambers:

Yeah, I know. That’s why I asked it. You guys are the banker… You try to keep things straight over there. Oh my god. We’re not going to open up any wounds with [crosstalk 00:04:41].

Joachim Klement:

No, no, no, no, no. That’s totally fine. We’re all about solid fiscal policy and not making any debt and all that stuff. But the German government is one of the biggest obstacles to overcome in launching what is usually called “Euro bonds” where you issue bonds, and all the nations in the European Union are debtors, and if they default, then the last man standing has to basically carry all the debt, which obviously explains why Germany is not too keen on that construct. However, if you want to have my personal opinion, my honest opinion, if the Euro is going to survive over the next 10 to 15 years, we will have to have Euro bonds come what may, because otherwise, the Euro is too unstable. Basically, the differences between the North and the South in Europe are just too big to deal without Euro bonds. And you can actually, see that a little bit. There’s a little bit of softening now with the COVID crisis where Germany si actually willing to invest more, take on more debt than they used to and also invest in these recovery funds that Merkel and Macron have proposed, which are awfully close to Euro bonds.

Trevor Chambers:

Yeah. Well, it’s going to be interesting to watch that play out for sure. Along those lines, actually, we don’t talk about block chain or bit coin around here at all too much, but I want to explore it intellectually. What’s your thoughts on these block chain’s technologies, as it relates to China and the U.S.? I know that China’s pushing some sort of a digital currency. They clearly want that. So with the Fed, do you think the Fed would counteract? We’re going got se central banks doing crypto at some point, wouldn’t you think?

Joachim Klement:

Oh, I think so, too. The Swedish Central Bank, the Riksbank, is already working on a trial program since February this year, to launch digital currency and cryptocurrency by the Swedish National Bank. That makes a lot of sense because Sweden is, I think as far as I can tell the country in the developed world that is farthest ahead when it comes to abolishing cash anyway, because if you go to Sweden, everything is done by electronic cash already. They would probably also be the first one to launch a proper cryptocurrency that is managed by the Central Bank.

Trevor Chambers:

Hmm. Interesting. Do you think, though… Let’s say China launches one, do you think it’s any threat to the dollar dominance? Then, I want to talk about trade and all that.

Joachim Klement:

I don’t think it’s necessarily a threat to the dollar dominance immediately, because in the end, what makes the dollar special is that it is the world’s trading currency, as you rightfully pointed out. Every commodity in the world is predominantly traded in U.S. dollars, which gives the dollar a very unique place in the world of currencies. Now, obviously, nothing lasts forever, so there is a tendency for China to become bigger economically, and as it becomes bigger economically, of course, its global influence in trade will become bigger as well.

If we look back in time to the 19th century and then into the 20th century, in the 19th century the world’s reserve currency wasn’t the dollar. It was British pounds or sterling, because the British Empire was the world’s mightiest economy. Even when the British Empire declined, it still took essentially two world wars and about 30 to 40 years for the British pounds to be superseded by the U.S. dollar, because the U.S. was a bigger economy than the UK economy in the late 19th century. But the U.S. dollar became a global reserve currency only after the Second World War, so I would say, yes, China’s renminbi and any cryptocurrency that the Chinese might launch will become more important. And here I would say, particularly that the transmission mechanism is the so-called Belt and Road Initiative, where China is building a lot of infrastructure to trade with countries in Asia, Africa and the Middle East. They will obviously use that to increase their influence, also in terms of spreading their currency. But my guess is it will still take decades before the dollar will be seriously threatened by the renminbi.

Trevor Chambers:

Yeah, I concur. But the U.S., we have this populist rise of populism rising, especially in the U.S. but in other areas, and it seems like the [inaudible 00:10:02] in particular, because of the dollar dominance and other things… We have a large standing army, and we’re the hegemony. It seems like we’re pulling back from that, and that’s what the politics is telling us. We don’t want to be engaged in the [inaudible 00:10:19] and Middle East, for example. And it seems like there’s two potentially roads… There’s roads forward and there’s the China and then the U.S way. Do you have any thoughts on that, because this to me… If you’re… Time horizon is the next decade or two, this is an important kind of point. Maybe, it’s going to take longer than that, but I don’t know, because the 20, 30-year time horizon is definitely for me, so any thoughts on that, the hegemonic role of the U.S. going back?

Joachim Klement:

Oh, the U.S, I think is making a big mistake in pulling back from the global scene [crosstalk 00:10:58]-

Trevor Chambers:

Ah, this is why I like you, because… Guy’s this is why I like this guy, because he’s not afraid to say stuff like this, and that’s what attracted me. I just know [inaudible 00:11:06] that he is… very interesting.

Joachim Klement:

Yeah, no, I mean, I can understand the motivation. If you look at how much the Iraq War and the Afghanistan War, etc., cost the U.S., it’s ridiculous amounts of money. And you wonder whether you’re better off just kind of saving that money and spending it on Medicare, on social security and all your pension systems that are obviously slowly going bankrupt just like they do here in the UK, just like they do all over Europe. So I think the motivation is clear and it kind of is… intuitively it makes sense. However, if you retrench, if the US retrenches, it effectively leaves the playing field to China, because China is expanding and it’s expanding aggressively. I’ve mentioned the Belt and Road initiative, which is a multi-trillion dollar initiative to essentially… Well, I mean, it’s kind of building an economic block that can where you can cut off developing countries and middle income countries from the West by just basically linking them with your infrastructure to China.

This is particularly interesting if you look at the discussion about where… Well, Jesus, 5g and Huawei… I hope I pronounced this correctly

Trevor Chambers:

Yes, you did.

Joachim Klement:

Because what happens is when the U.S. basically says, “Okay, we don’t want any Huawei hardware to be used in our 5g network,” that is all fine. And that makes sense because we all know that Huawei is very close to the Chinese government and probably helping the Chinese government spying in the West. However, if you don’t have that technology in your 5g network, not only does it take longer for you in the West to build that 5g technology, because Nokia and Ericsson, which are the two Western dominant powers in that infrastructure, they’re far behind, while a little bit behind about 12 months behind Huawei, and it opens up the possibility that the 5g network used in China has a little bit of a different standard than the one in the West. And then you come up with the situation sooner or later where a country, say in the Middle East or in Africa or in Latin America, when they want to build out their 5g network, they have to decide whether they use the Chinese standard or the U.S. standard. And that already gives you basically a bifurcation and a situation where the Chinese can indirectly force an alignment to their standards and to their network, And the U.S together with Europe are left behind in that respect.

Yeah and that scenario, I think, is playing already. Already Iran is cozying up closer and closer to China. So I hear what you’re saying. But I think you know the U.S., we entered the situation, especially in the last 30 or 40 years, where we basically… We kind of made a deal. The deal is this: Asia, particularly China, you make all this stuff that we buy Target for relatively cheap and in exchange, unfortunately, manufacturing moves of all types out of the U.S…. And that’s just kind of where it is and I think that’s kind of where the body politic is. But yeah, for sure, but the other side of it is the economics. It’s tough. It’s really tough to sometimes justify to the voters why we’re spending all this money.

Trevor Chambers:

Thank you for that. I appreciate it. It was excellent on that topic. I want to switch gears a little bit. What’s your thoughts on this market and where we are today? Again today, we’re the 13th of July, S&P is up quite nicely. So what’s going on?

Joachim Klement:

Yeah, I actually spent my whole working day today figuring that out and trying to figure that out. And it is quite baffling.

Trevor Chambers:

Please tell me, because I don’t know what the hell is going on.

Joachim Klement:

I call it the “FOMO market.” It’s definitely a situation where you see… And I looked a little bit at the AAII sentiment indicators that are based on surveys of association of individual investors on a weekly basis, and what you see there is that in March, April, everybody was super bearish. Well, no surprise there, that was the peak of the market crash. And since then, sentiment has recovered really, really quickly. Now at the moment what we have is kind of slightly bearish sentiment again with a high, high percentage of people who don’t know, who are undecided and don’t know where the market is going. And that is essentially climbing a wall of worry now, where a lot of investors are sitting back, observing the market and then probably, especially if you’re older, think to themselves, “Wait a minute. In 2009, I missed the March recovery.” And at the end of 2009… Let’s remember that at the end of 2009, nine months after the recovery started, the S&P 500 was up like 35% or so. And so everybody is trying to getting in on to that market at this point in time, and that’s why I think this rally still has legs because it’s still… Our people who are thinking, “I don’t want to make the same mistake as in 2009. I want to get into that rally.”

Having said that, what I find super interesting is that normally, a sustainable rally at the end of a crisis or a bear market starts with value stocks outperforming growth stocks, because usually at the peak of a bear market, the value stocks are so beaten down that they’re dirt cheap. And this recovery that we’ve seen now, actually has no value [inaudible 00:17:38]. In fact, we continue to see the tech names outperform all the value names. So it’s hard for me to say what to make of that, because it could either be that this is the one exception in the last 20 or 30 years, where value doesn’t lead the recovery after a bear market, or this is just a rally in an overall longer bear market. We have to have another down leg before we see a final leg up and out of this bear market.

Trevor Chambers:

Interesting, interesting. All right. Well, that kind of dovetails Under this: big tech. You talk about, you’ve written, you’ve done some research… Definitely, I mean… I think most people… The consensus is there’s going to be some legislation coming out of U.S. Certainly, in the EU obviously, it’s already gone on against these companies, but there’s some other factors. Talk about big tech and then let’s talk about how the pandemic accelerated trends that play into them. And then I want to talk.. a little bit of time to go, “Are these stocks too expensive?” So let’s get the big picture and what’s going on there with big tech.

Joachim Klement:

All right, so it’s a very messy picture. I would say the long term picture to me is much easier to discern than the short-term to medium-term picture, because in the long term picture, I have two things that really worry me about the big tech, especially the FANGs… so the Facebook, Amazon, Apple, Netflix, Google stocks. You might want to add Microsoft there as well. And that is the two things that worry me there is number one: If you look at long term growth expectations for earnings growth for these stocks, they are incredibly high. If you just take these current long-term earnings expectations—and I think for Amazon it’s still something like 15-20% per year—and if you compound that over 10 years, then Amazon would essentially be something like 5% of U.S. GDP and essentially be the entire retail sector. So then let alone if you compound that over 15 or 20 years… And the same thing is true for Apple and a lot of these other FANG sectors.

So we’re in a situation Where people expect long-term growth that is clearly unsustainable over the next 10 years, especially because as we all know, 10% growth if you have 100 million in revenues is easy to do. Ten percent growth if you have 100 billion in revenues is much harder to do. And so at some point, investors will have to come to terms with the fact that these company… and they are great companies, don’t get me wrong… I love them, use them every day. These companies cannot grow at these breakneck growth rates anymore. And that will be a day of reckoning when investors basically readjust or downgrade their earnings growth expectations. When that will happen, I don’t know.

But there’s one potential trigger and that’s the second thing in the long-term picture that worries me and that is what we see in U.S. Congress at the moment with these investigations going on into antitrust behavior, especially for Facebook and also for Amazon and Google, where Congress is increasingly investigating whether these major companies that have essentially a monopoly on what is typically called the “oil of the 21st century,” namely data whether they have such a dominant market position that they form an effective monopoly. And there’s increasing evidence that it is getting harder and harder if not impossible for competitors of Facebook or Google to actually start and grow and gain significant market share. I mean we all might have heard of DuckDuckGo as a alternative search engine, but let’s face it, who actually uses it? It’s less than 1%, and there’s absolutely no growth there, because Google is so dominant when it comes to internet search.

So the day of reckoning will come, either in the form of regulation. Worst case, the standard… example of forced breakup of these companies. I don’t think we’re going to see it a forced breakup, but I think we’re going to see more regulation that will allow new competitors to grow better. And, of course, that reduces the potential growth for the Facebooks and Googles of this world.

Trevor Chambers:

Okay, so let me ask you a very pointed question: Today, do you think they’re pricey, relatively speaking, historically speaking, because it seems like… Well, go ahead, I’ll let you answer that.

Joachim Klement:

No, they’re not. They’re not priceless-

Trevor Chambers:

I agree.

Joachim Klement:

I would still hold on to them, because what we’re seeing at this point in time as you pointed out, is COVID and pandemic has changed our world extremely. I mean, we’ve got, I would say, two to three years of digital disruption in two to three months. And the Amazons, Googles, Facebooks of this world are the main beneficiaries of that, and they will be the beneficiaries for the next one to two to three years. So I would say at this point in time, I would not be a seller of any of these stocks. Yeah. So that’s that’s kind of where I am.

Trevor Chambers:

Yeah, okay. Cool. I concur. You know, you may have a similar statistic in your quiver, so basically March, middle of… What was it? Third week in March is when we got shut down here in the U.S. A week later, there was… A week or two later, a statistic came out that within that first week, 40% of all online grocery orders in the U.S. were brand new. These people had never placed a grocery order. [crosstalk 00:24:17]

Joachim Klement:

Here in the UK, the servers broke down. They literally broke down. So we’ve got a lot of companies that are big names here: Ocado is our biggest online supermarket. They literally broke down on the data. The lockdown was imposed, and it took them about three or four weeks to get their infrastructure in place, so they could handle the demand for that. Our Office of National Statistics has shown that internet shopping as share of retail sales has essentially grown by 50% in the month of April alone, and we still haven’t got the main data. So it’s crazy. It is absolutely crazy.

Trevor Chambers:

Unbelievable. You want to hear… See, another thing I like about you is you obviously have access to a lot of research—which you recall it so well—together. But you know what’s interesting here. I talked to a gentleman from North Carolina wildlife Association. These are the people that give you the hunting and fishing licenses… 10% growth year over year for the month for the second quarter. That’s wildlife licenses for fishing. Bikes. People… I’m sure you’re probably seeing the same thing over there, the biking… I mean the sales… There’s no inventory, and guess where it’s all made, at least for the U.S. market-

Joachim Klement:

China.

Trevor Chambers:

… to kind of tie it up?

Joachim Klement:

Yeah, it’s the same here.

Trevor Chambers:

Yeah. I mean, it’s a microcosm of what we were talking about earlier when it comes to… when we were talking about the hegemonic role, U.S. and the dollar. It’s an absolute perfect little story. Um, well, I want to change it up a little bit. What’s the Spotify hedge? What’s going on now? I didn’t hear about that.

Joachim Klement:

That was a funny economics paper that like that I came across recently where… Actually, I didn’t know that, because I’m not an IT geek, but apparently you can program apps that use Spotify data. Spotify, the music streaming service, makes certain data available to everybody. And one of those data points that they make available for every song that they stream is what they call “balance.” So is that an upbeat song, an optimistic song, a cheerful song or is that more something like kind of sad and depressing and like a blues basically.

And what they did was two things. First of all, they looked at what was streaming in the U.S. So they looked at the top 200 songs every day that were streamed in the US on Spotify and then look at the average balance. So how optimistic was the music or how depressing was the music that was played on Spotify every day for the last couple of years? And the interesting… what a funny thing… I mean, obviously, you might have guessed that over Christmas, the balance, the optimism of the music goes up. That’s usually the peak of the year because Christmas songs are all about cheers and good cheer, etc. You see a similar picture also in on Easter. And then in summer, which is strange, but you tend to see a little bit of a dip. So people in summer, especially in 2018, were listening to much more depressive music than average.

But here’s the thing, you can combine that with other research where we know that if people are in a good mood and a cheerful mood, they tend to buy stocks, because that translates into more optimism about their investments, and so they become a little bit more risk loving. And if people are in a sad mood or a depressed mood they become a little bit less risk loving and a little bit more risk averse, and they tend to sell their stocks, just a tiny little bit… but if you add that up over 400 million Americans, it does make a difference. And that’s what these guys found. They found that on days when Spotify shows a very cheerful streaming day, stock markets went up more than normal. And on days when Spotify showed that the music was quite depressive, stock markets had lower than normal returns. Now that doesn’t help you that, because you don’t know what kind of music people will stream tomorrow; however, because mood swings tend to kind of go up and down relatively quickly, what you see is that on the day after and then the week after a cheerful day, the stock market tends to kind of revert to the mean. So it gives back some of that excess return after an optimistic day and after a pessimistic day, it gains some of that excess return.

And that actually allows you, theoretically, to build a hedge fund. So Spotify could theoretically build a hedge fund where you just look at what people are streaming today, and then if it’s particularly optimistic and cheerful day, then just go short the market. And then the next day, when it’s particularly depressive data, you go long the market on the next day. And this way, you could actually make money as Spotify. I wonder if Spotify is top management actually thinking about that.

Trevor Chambers:

Yeah, it’s very… So we’re calling out you Spotify guys and ladies. Interesting, I get it. That’s very, very cool.

Let’s switch gears a little bit. Tell me about your background. And then tell me about who you’re working for now. You know, what’s your day to day and all that stuff. What’s going on? You were born in Germany and then kind of take it from there.

Joachim Klement:

Yeah, so born in Germany and then left after my military service in the German Air Force to study physics and maths in Switzerland. Originally went there to study for two years, but then stayed 21 years. That’s how much I liked it in Switzerland. Studied maths and physics. So actually, for you listeners, you probably all familiar with the Big Bang Theory, the sitcom. I was a real life Sheldon Cooper, because I did theoretical astrophysics just like he did; however, I found that as boring as it sounds, and so I decided to also get a degree in economics and finance and that got me into banking. Spent most of my career on the buy side, mostly in wealth management working with family offices, high net worth individuals around the world. And unfortunately made the mistake that… One of my colleagues is an American and I make the mistake of marrying her. Yeah, I know. I’m telling you.

Trevor Chambers:

What’s her name?

Joachim Klement:

Robin.

Trevor Chambers:

Robin. Fabulous. Where is she from?

Joachim Klement:

She is literally the colonel’s daughter. Her dad was a US Air Force colonel. Her family’s from upstate New York, near Albany, but she grew up all over the place, as military kids do.

Trevor Chambers:

I’m actually an upstate New York kid myself. I’m from Binghamton, New York, and I actually lived in the greater Albany region for quite some time. What town is she from, does she say she’s from?

Joachim Klement:

Cohoes. Cohoes.

Trevor Chambers:

Oh, yeah, yeah, sure. That’s hilarious. All right. Good for you. So a couple Air Force brats get together.

Joachim Klement:

Exactly. A couple of Air Force brats get together. After eight years of living in Switzerland, Robin tells me, “I don’t want to live here anymore, because there’s cultural differences. There’s language barriers, and all these things.” And that’s how we ended up in London four years ago. And so today, I work as the head of what is called the SAS. Again, a nice military acronym, because the SAS is what the paratroopers are in the U.S. That’s the SAS in the UK. It’s called the Special Air Services. However, SAS in my circumstance stands for strategy, accounting and sustainability. So I’m running the team here at Liberum, which is a brokerage firm specialized in European, small and mid-cap stocks. And I am in charge of doing equity strategy across all over Europe and ESG investing and sustainable investing. And then we’ve got experts for forensic accounting, etc. in our team as well.

Trevor Chambers:

So along those lines, a couple things: What types of equities do you like? Is there any… Let’s say you want growth strategies and value strategies or what do you got going on?

Joachim Klement:

Well, to differentiate a little bit, what I do in my personal account, most of it is index funds for the diversified, and then I’ve got my trading portfolio where, at the moment I particularly… Actually for a couple of years now, I’m particularly focused on biotech firms, especially in the space of gene editing. So some of you might have heard of CRISPR, cas9 gene editing technologies. So that’s the kind of stuff that I like to look at. These are all U.S. companies. So that’s CRISPR and the like. These are kind of more like long term investments in the single stock area.

And then when it comes to kind of from a professional background, because I’m head of strategy, I can’t invest in that, because I’m probably blocked in most of them. But we definitely like growth for the next five years or so, because what we expect to happen after this crisis is that interest rates will stay low and close to zero for a long, long time. And we also don’t expect inflation to rear and increase after this crisis, simply because I was a big inflation hawk after the financial crisis… I expected inflation to rise like so many other people did, but basically, the experience of the last 12 years has shown me that it doesn’t really happen these days. And the question that I always ask myself is what is different in our reaction to this crisis compared to the financial crisis, 2008 and ’09. And so far, the only difference I can see is that we add a couple of zeros here and there, but we essentially doing the same thing. And so I don’t expect inflation to rise. And that means I don’t expect interest rates to rise. And that means that valuations of stocks should actually expand even higher than where we are today on where we were in 2019. So I expect quite a multiple expansion there and that should be particularly good for growth stocks in the next couple of years.

Trevor Chambers:

Yeah, there’s that saying, “Don’t fight the Fed,” right?

Joachim Klement:

Yep.

Trevor Chambers:

Yeah. I get it. So growth for the next five years. Okay, so talk about… So just a couple more questions. Talk about market efficiency and large cap growth and large cap value and small cap, because this is obviously an area that you know pretty good, so…

Joachim Klement:

Yeah, yeah. I mean, that’s an interesting phenomenon, because at least in my-

Trevor Chambers:

Joachim, can you define “market efficiency,” so everybody’s on the same page?

Joachim Klement:

Yeah. Yeah. So, when it comes to “market efficiency,” what we mean or what we typically mean is that you cannot make money. So it’s the efficient market hypothesis, which means that you cannot make money except with insider information. And so any kind of public information or analyst forecasts, etc., will not help you outperform the market. Now, I have my doubts about that in general, because I think that you have to differentiate between micro and macro. So on an individual stock basis, I think markets are efficient most of the time, almost all of the time. So when there’s a news item coming out for Apple, Facebook, you name it, it is incorporated in the price almost instantaneously. And I think investors have a hard time kind of profiting from that; however, there are two exceptions to this deficiency rule. And the first one is that on a macro level… So if you look at the market overall, it can get very inefficient, because people can get carried away with optimism. So let’s look at the FANG stocks or let’s look at the tech bubble in the late 90s as a classic example where microscopically individual stock basis markets were very efficient, but the overall market was completely overvalued and inefficiently priced.

The second thing is…and that I find very important to know… is that over the last 10-20 years, we’ve seen this proliferation of data that is available publicly to everyone, not just professional investors, but every retail investor today has access to CNBC to Bloomberg TV. They have tons of websites where you can always look at the latest news flow and the latest price data, etc., etc. And that has focused the attention on the big names. So there’s a lot of news coming out every day. I mean, there’s tens of thousands of stocks in the U.S. alone.

And of course, nobody has the time or the energy to actually look at all of that. So we focus on the most important ones. We focus on the General Electrics, the Apples, the Facebooks, the Amazons, etc. And they are incredibly efficient. But what happens is, because we’ve got that information overload, we start to forget about the smaller ones and the smaller stock, the less efficient the price is. And that’s actually where you can see that markets become less than less efficient over the last 10 to 20 years, because fewer and fewer investors are taking the time to look at that news flow and incorporate it to the price. So there is a little bit of a strange phenomenon where in the small and mid cap space, markets have become less efficient. And as a result, it’s let’s say in quotation marks, “relatively easier” for a fund manager or an investor to outperform the market. While in the extreme large capital and the mega cap space, it’s become harder and harder.

Trevor Chambers:

So active manager is going to find some opportunities versus playing an index?

Joachim Klement:

Yeah.

Trevor Chambers:

And the in the small cap… Oh, okay. Interesting. I like it.

Joachim Klement:

Well, it’s what we see with our clients. We actually have a little bit of an index of the fund managers that are our clients and they have systematically outperformed over the last 5 to 10 years.

Trevor Chambers:

Speaking about performance, women in boards… Women in boards in ESG. Did I hear… did I read company have boards with with more representation women and do a little bit better?

Joachim Klement:

Yep, that is one of the few really broadly supported results of ESG investing, that if you have a more diverse board, what happens is that there’s less groupthink, especially if you have women on boards, because usually if you have an all male board and there’s no complaint about that… I’ve been in the military for long enough to know that if you put a bunch of men into a room and throw away the key, these men will behave very differently than if you put in a third of the group as women. And so there’s a lot of testosterone, and that means that men are taking on more risks. And you see that actually in all male boards as well. If you have an un-diversified just all male board, the board tends to take on more risks for the company. And that is all fine and well as long as things go well, but obviously, at some point, your recession will come, the bear market will come and that’s when these companies get into really serious trouble.

While if you tend to have a more diversified board, particularly with women who are naturally inclined to look more at the risks–because women are slightly, tiny bit more risk averse than men on average, but it’s not a big difference—but they start to ask these questions like, “What if? What are the risks that we’re taking here? Can we survive these risks? Are we comfortable with these risks?” And it’s these discussions that are extremely valuable, because they reduce the risk taking off the board for the company and same thing for in senior management of the company. And that helps the company survive, when there’s a bear market or recession.

Now here comes the “but.” There’s a “but” there in the sense that it depends obviously on what kind of women you have on the board. And that is an interesting effect, namely that usually the trailblazing women… So the first woman on the board, an all male board, these are women that are really tough, and I take my hat off of them because they have to kind of climb the corporate ladder in an all male environment and kind of get their elbows out and get in there… but because they are so tough, they also tend to be thinking a little bit more like their male colleagues. So, usually the trailblazing women, the first woman on the board, isn’t that risk averse as the average female board member. She just manages to break the glass ceiling, and then what happens is that afterwards, the women that come afterwards, they are the ones that help you with diversification and with the reduction of risk taking. So, when you take women on the board or into senior management, you have to make sure that you take on the right women and not just any woman.

Trevor Chambers:

So, we’re talking about ESG and just for clarity, ESG, for lack of a better word, is some sort of measurement, if you will, the environmental science and governance of any particular publicly-traded company. So the question… I think this has been a little bit…This issue has come in many different forms and then rising, but it seems to be rising and really taking root in Europe, much more than U.S. So how are those companies doing? Are ESG… are they doing better? Are we seeing flows?

Joachim Klement:

Yes.

Yeah, so tell us… I did see… and I’ll let you go… I did see that a social index here… There was a social index inside one of our client’s 401(k)s, and we were kind of helping them, guide them on the investments in their side of the 401(k), and one of the strongest funds was a social index. So, how’s it doing as an asset? How’s it doing?

Yeah. I mean that’s always that’s always the big discussion point, and that’s I think where the cultural difference between the U.S. and Europe is a little bit different. In the U.S., a lot of investors say, “All I care about is the profits that the company makes for me and the share price that comes out of that profit-making activity.” In Europe, we are a bit more in the stakeholder management sphere where it’s not just the bottom line but we also want to know how that how these profits are achieved and whether there’s sustainable. Now, there is a big, big push in Europe compared to the U.S. towards ESG investing, so taking these environmental, social and governance criteria into account when you invest in shares. And by now about one-third of all the institutional assets all over Europe are managed with ESG factors in place in the investment process. So it’s really substantial.

Trevor Chambers:

one third?

Joachim Klement:

One-third. And in some countries, like France and the Netherlands, where pension funds and insurance companies are already forced by the regulator to have ESG criteria in place for their assets in their portfolios, it’s way more than that. Now, what we’re working towards to is that within the European Union, there will be regulation coming in the next two years, that every pension fund and every institutional investor all over the European Union and that includes the UK even after Brexit, will have to include ESG criteria into their investment process. So it will jump over the next five years to something like 80% of all assets in Europe that are managed for ESG.

Trevor Chambers:

Wow.

Joachim Klement:

It’s a massive, massive thing. The usual question is, “Well, does it kill my performance?” because obviously, how we did it in the past was, “While I do in this ESG investing by cutting out my investments into tobacco, guns and similar things” and that obviously doesn’t do really well, because let’s face it tobacco companies have been one of the best performance for the past 20 years. What you do nowadays is different. You don’t do just exclusion and just divestment and… Well, some people still do it, and they’re all these divestment campaigns about fossil fuel companies, etc. and my personal opinion is very simple, that doesn’t work at all. I typically use a four-letter word that I can’t use here, but it is absolute nonsense to kind of think that if you take your money out of Exxon shares that Exxon will change its habits. They won’t. So instead what you’re doing is you do much more active engagement as a shareholder, which means you continue to invest in these companies, but as a shareholder you push the management either through shareholder resolutions at the general meeting or through active meetings with your company management to change their habits.

And on top of that, we obviously have the regulation changes where the EU is not only forcing institutional investors in Europe to invest with ESG criteria, but they’re also about to introduce in two years time, so-called climate change benchmarks, where they basically say, “These other criteria for companies to be included in that benchmark,” and they have to be working towards reducing their greenhouse gas emissions. And if you’re an institutional investor, you have to justify why you invest in any of these companies outside of these benchmarks. And that’s tough.

Trevor Chambers:

Yeah.

Joachim Klement:

And so that gives you that thing. In terms of performance, I think… My stance is very simple. In the research that I’ve seen is it doesn’t give you more performance, it doesn’t give you less performance. To me ESG investing is a form of risk management. So, especially the governance side, so the “G.” If I have a company with bad governance… Just think of the Volkswagen diesel scandal in 2015. There was bad governance within the company and because of that, the engineers could cheat. And guess what happens? Eventually the regulators find out and Volkswagen has billions and billions to pay in fines. We had a similar situation just two weeks ago here in the UK with a company called “Boohoo. You have never heard of that, but it’s a 5 billion sterling, so about $7 billion market cap company, and they’re fast fashion company. So they are like, what’s the U.S. equivalent? I mean, you know H&M probably and Zara and these guys.

Trevor Chambers:

Yeah.

Joachim Klement:

So they are like that, and there was a newspaper report two weeks ago, that they have modern slave labor factories in Leicester in the UK. And guess what? The newspaper report was on Sunday, on Monday, the stock price dropped 25%. On Tuesday, Amazon banned all Boohoo products from their platform. Guess what that’s going to do to their profits?

Yeah, yeah. It’s not good, people. Not [inaudible 00:50:04].

Joachim Klement:

Exactly.

Trevor Chambers:

What are you doing over there.

Joachim Klement:

Yeah, exactly. And that’s, that’s why I call it risk management. It is just to kind of think about things that could possibly go wrong that most investors don’t expect and that are not priced in the market.

Trevor Chambers:

Yep. Very interesting. All right, one or two more… Do it you got a couple more minutes and then

Joachim Klement:

Sure.

Trevor Chambers:

Perfect. All right, cool. Let’s talk about just investing in general. You know we deal with people who have wealth management much like you, longterm horizons and we love serving people in that frame of mind. So let’s talk about smarter people aren’t better investors and better investors aren’t smarter than the rest. Discuss.

Joachim Klement:

It is interesting, and it is frustrating and funny at the same time.

Trevor Chambers:

Yeah.

Joachim Klement:

We we have this kind of impression that people like Warren Buffett must be super smart or Charlie Munger or all those kind of legendary investors… They must be super smart because they make so much money. There is… You can actually test, I mean you can go to fund managers and ask them to do an IQ test. And then you can look at their portfolios and then look at their funds that they manage and you check whether they actually perform better than the average person. And guess what? No they don’t. You can be as smart as you want to. That doesn’t give you an edge in terms of performance. You can be as dumb as you want to. That doesn’t give you an edge in performance, and it doesn’t give you a handicapping performance.

There is simply no correlation between intelligence and performance, which makes me wonder, “So what does make a good investor?” And I just… My personal discussion that I had with a lot of friends and other investors and people that read my blog, is that probably what you need is you need smarts. You need to be street smart in the sense that you have to have a certain intelligence in order to be able to deal with numbers, because let’s face, it investing is a numbers game, and you have to make sense of valuations and earnings and all these things. So you need to have a certain level of intelligence and analytics skills that will get you the entry ticket. But beyond that entry ticket, it doesn’t help you to be extremely smart.

Instead, what you need to be is you have to have what I call “common sense,” the ability to think… to know when your models or your analytics, your numbers don’t tell the full story. Because you can have a really, really smart model, and you can be super smart just think of the guys who won Nobel Prizes and then started LTCM hedge fund in late 90s, and they had fantastic models. But the real life doesn’t always work like your model says, and when Russia defaulted on its international bonds but not on its domestic bonds, well, the entire hedge fund blew up, because that wasn’t part of the model. And so, what they were missing was common sense of when to deviate from the numbers, when the model and the numbers don’t tell you the full story. And that’s what makes a really good investor, who knows when to trust the numbers and when not to.

Trevor Chambers:

And as far as retail investors, the ones that we deal with here, let’s talk about patience in them, because it seems like obviously… You wrote on this that patient people tend to be wealthier and happier.

Joachim Klement:

Yeah.

Trevor Chambers:

And we have some… You started some interesting research, but you know that’s… Back in March, really any distance back in the market, you got to get people thinking longer term and being more patient. And we tend to attract that type of client anyway, but this is… When you’re onboarding new clients, you have to say these things, because everybody’s a longterm investor until the market drops 35%. You know what I mean? When in fact, they just need to be patient and realize that when these things go on sale, it’s a great opportunity to buy, not run away from it. So, talk about patience-

I think patience is one of the key success factors, especially if you’re a private investor and you’re saving for retirement, for example, or for a down payment on your house if you’re younger. Because essentially we know that stocks in the long run perform much better than bonds. Yet, if I look at stocks every day of the week or even every month, I see all those short-term fluctuations. As you rightfully say, if I did that in March, I saw my share prices on my stock portfolio down 35-40%, and of course I’m freaking out, and of course when I’m freaking out, I have the tendency to sell everything and go into cash. And by now we know that this was about the worst thing you could do at the end of March and early April, because by now, we’re back to zero and even in the positive for the year. So, just by looking at your portfolio too often, you just kind of reduced your patience, because you saw all those short-term fluctuations that we would not as seen if you just look at your portfolio once a year or once every quarter, that much.

And so what are you doing? Well, people who are patient, who are able to withstand this urge to kind of act on short-term things, they tend to have the better performance. They tend to have a bigger retirement nest egg. And in general, in life, they tend to be happier, because it’s not just about investing. Other things in life, a lot of these things, take a lot of patience to do. I mean it’s getting a nice house, it doesn’t come overnight, not since 2006 when the housing bubble burst it. Those days are over actually. And the same thing in your career, if you want to be successful in your job, it’s not something where you can expect to become the CEO of your company overnight or within one or two years. Similarly, if you’re starting your own business, you know it’s not going to be a success after 6 months, after 12 months, after two years. It’s often a long slog of 5, 10, 20 years.

Joachim Klement:

Look at Jeff Bezos. He might be the richest man in the world, but it took him 26 years to get there. So, even if you’re extremely successful, it takes decades. And so really successful people are able to hang in there. They’re patient enough to hang in there and keep on running that marathon, and they don’t give up in the meantime if they experience some obstacles. And let’s face it, if we just stick with Jeff Bezos as an example, Amazon shares were down 80-90% in 2001 from their peak. He could have basically said, “I give up. This is game over.” No, he kept on going, and he continued to build this business step by step and in the end, he is not only the richest man in the world but probably one of the most powerful businessmen in the world as well. And that makes all the difference.

And then, that is interesting, because there are cultural differences. So, if you wonder why there are so many successful entrepreneurs in the U.S., and by extension in Europe and in the UK, is because culturally, we are a bit more patient than for example, people in Russia, the Middle East or Africa or Latin America, which tend to be societies where patience is less pronounced in general. And as a result, they have difficulties, saving for retirement. They have difficulties with all sorts of things.

Trevor Chambers:

Are Germans patient?

Joachim Klement:

Yes, very much so. I think actually being married to an American, I typically say that Robin my wife, she doesn’t understand the two words that are called “forgone consumption.” She doesn’t understand that concept. While we Germans, we are all about saving. I mean, we are extremely debt averse. Germany is a country where people don’t like to take on debt. As a result, home ownership, for example, in Germany is much, much lower than it is in the U.S. or in the UK. Only about a third of all Germans own their home. And that has to do with the fact that a lot of Germans aren’t willing to take on debt to even have a mortgage to buy a house, let alone leasing your car and having an auto loan to buy yourself a car. That is unthinkable for most Germans.

Trevor Chambers:

That’s interesting. I didn’t know that about the German financial profile in that regard. That’s interesting.

And just going back, going to cash, I know a lot of people.. Very few of our clients did that happen, but I did hear just out and about, friends… People that are knocking on 60 with 100% to cash. I think we have four trillion in the money markets alone in the U.S. Four trillion. And it’s gotta be… I was thinking probably the same in Europe. It’s probably just crazy. Yeah, but it’s clearly shown you just gotta ride it out. You got to ride it out.

Joachim Klement:

Absolutely, absolutely. Especially, especially in an environment where in the U.S. where you still have positive interest rates, even on your money market actually gives you a little bit of return, less than inflation but still a little bit. In Europe, if you’re in the euro zone, it gives you negative returns, and why on earth you keep that in cash or in government bonds, I cannot understand it. I seriously do not understand it.

Trevor Chambers:

I just don’t see where we’re going to be going in fixed income.

Joachim Klement:

It’s just not a possibility.

Trevor Chambers:

Yeah. Well, that was awesome. I just want to do two other things. Can you please give a nice shout out to your blog and your firm again. I definitely want to give you a little promotion.

Joachim Klement:

Yeah, yeah. The firm Liberum Capital. L-I-B-E-R-U-M. Liberum Capital and it’s liberum.com. And my blog is the simplest thing. Just go to Klement on Investing, which you can just Google and you will find my blog.

Trevor Chambers:

Nice. One other thing: favorite local restaurant/pub in where you are. My family’s in… My in-laws are in the restaurant business, so I have a kind of close tie. My sister-in-law and brother-in-law own a beautiful Italian truck, the [inaudible 01:02:06], here in Raleigh, and so I am always interested… So I want to, in these times where restaurants are a little bit of peril, at least some… I’m assuming you you guys… Are you guys restricted from getting into pubs [crosstalk 01:02:22]-

Joachim Klement:

We’re allowed. A week ago, the pubs and restaurants opened with social distancing rules.

Trevor Chambers:

Okay. Okay. Okay. So anyway, challenging business model, so tell me… shout out to a couple, one or two places that you love and you want to give a little promo to around you.

Joachim Klement:

So, I mean, if it’s close to where I live, I live in the southwest of London, and my local pub, The Sun Inn, is brilliant, because it’s got a really, cozy country pub style thing with good beer and you’ve got a beer garden right opposite to a pond, so you can hang out there in the summer, that is brilliant.

Trevor Chambers:

What’s the name of the place?

Joachim Klement:

Sunn Inn, like the sun.

Trevor Chambers:

Oh, okay. Cool. All right.

Joachim Klement:

And in terms of restaurants, definitely The River Cafe, which is, as the name says, on the river. And guess which river it is in London? And it’s across the river. It’s an Italian place, has been around for 30 years, makes simple Italian food, but to the highest possible quality, and it is gorgeous.

Trevor Chambers:

Nice. All right. So we got The Sun Inn for beer, but you first have to hit The River Cafe for-

Joachim Klement:

Italian food.

Trevor Chambers:

Yeah. Fabulous. Well, Joachim, thank you so much for your time. I really appreciate it and perhaps we can do this again sometime in the future. We’ll review the tape of all our prognostications and then talk again, but thank you so much for joining us. I really appreciate the time. And let’s stay in touch, all right?

Joachim Klement:

All right, thanks for having me. That was good fun. It was great.

Trevor Chambers:

Thank you. I appreciate it. All right, we’ll talk to you soon.

Joachim Klement:

Cheers. Bye, everybody.

Trevor Chambers:

Bye bye.