Tim O'Neill, global co-head of the Investment Management Division at Goldman Sachs, on the seduction of big data, why a market needs both active and passive investors, and the greatest challenge for investors of every generation.
This episode was recorded on September 15, 2015.
The views and opinions expressed herein should not be construed as an offer to buy or sell any securities and such views/opinions may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. This information may not be current and Goldman Sachs has no obligation to provide any updates or changes. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, as to the accuracy or completeness of the statements or any information contained in this podcast and any liability therefor (including in respect of direct, indirect or consequential loss or damage) is expressly disclaimed. Goldman Sachs is not providing any financial, economic, legal, accounting or tax advice in this podcast. In addition, the receipt of this podcast by any listener is not to be taken as constituting the giving of investment advice by any Goldman Sachs entity or individual to that listener, nor to constitute such person a client of any Goldman Sachs entity.
Copyright 2015 Goldman Sachs. All rights reserved.
This is an unofficial transcript meant for reference. Accuracy is not guaranteed.
This is exchange the Goldman Sachs, where people from our firm share their insights on developments currently shaping markets. Industries in the global economy, objects Jake, Global, had of corporate communications. Here at the firm, the prospect of the FED hiking interest rates and slower growth that of China has anew.
Harold global markets were joined today by TIM, O Neill global Head of Goldman Sachs Investment Management vision to discuss investing in today's climate and how the field could evolve in the future. Tim welcome to the programme. Thank you, Jake.
Having me so during this recent period of market volatility has been renewed debate, maybe a debate that never stopped about the benefits of active versus passive investing. You spoke earlier, youth Bloomberg and called passive. Investing a potential bubble machine talk a little bit about the differences between active and passive. Investing in how you see these to pass developing the future.
While the premise of active investing Jake is that Durban deliver performance, Nedda fees better than the benchmark river, the benchmark might be for the. U S. Global Europe has been a difficult, seven
yours for active investors, because the markets have risen so consistently and persistently higher
the most active managers have net of fees, underperformed the benchmark so led back to this debate,
Whether or not the fees that you pay for active managers are worth it and there's been simultaneously great shift towards passive investing because its
and you would get all the marker returns, ned of five or ten basis points. The prom for passive is that its size at a certain point may be too much for the market to him
and it's also all on autopilot. So in terms of this
eyes a market needs both active and passive. Investing because if everybody
ass of investor there's no one to buy from so there's, no one, your beta,
is my alpha and vice versa. So you need a balance in the market and if passive becomes a certain
oversized percentage of the market. The market does not function, the other problem with passion
horses all on autopilot and when you get to periods of
miss valuation over or undervaluation, you need active decision makers,
I wish it always matters and markets and investing, and it feels like at this point and critically at these big turning points as your preamble save with is the FED Gonna write rates are not active, intelligent enough.
Decision is probably what's needed and therefore should become a more target: rich environment, frack of investing, but the debate continues, and so you talk about it being out.
Oh pilot, explain what that means and what the potential consequences of that are worth pursuing
thing is designed to map directly to a benchmark. Let's pick the world's biggest benchmark, which lets say is the ESA. Ninety five hundred in the way the bench
his designed is that as the stocks are ranked high to low according to market, capitalization number shares times the price so the world's most of it.
We'll start right now is apple, and so is Europe.
Thing in the weights of apple over
the total weight of all the stocks that you less whether the Essen PETE
hundred, whether Russell one thousand of the rustle, two thousand in
That is the market by definition of market is what people are paying for things enlisted hide a well
may or may not be the best way in which to invest in the market or into stock. You can weigh things in many different ways. You can weigh things equally, you can weigh things alphabetically. You can weigh things according to different parameters.
So you can wait. According to value measures price to book price to cash flow, you can wait them according to quality. Factors such as is the company growing doesn't have good management. There are other academically proven factors that you might want to consider other than simply buying stocks rang tied a low according to more
capitalization, and so you can design benchmarks in a lot of different way. But, right now it's well settled that a market is stocks, waited according to evaluation, hide a low market cap benchmarking. So we
But these benchmarks are their necessary evil, or should we be rethinking how we index our investments, where you always
have to measure things, and so you
the design. What the bulls I is before the fact, and right now the accepted bulls I or benchmark is market capitalization you can design it slightly differ.
So you can design it index. That's focus just on value or on growth. You can change the geography of the index make a global. Instead of just U S,
you can change the sizing other you can make it made cap or small cap instead of large cap, but is necessary
We too have benchmarks,
There are a lot of different ways in which you can design the benchmark, as I like to say that a lot of different paths to Heaven we views
Analogy before that.
Staying or market design seems a little bit like the history of particle physics. In ancient Greece, they ve figured out that this was made of something called an atom
but it was two thousand years later that they figured out that an atom has combined
of a nucleus and proteins and electrons in particle physics, kept going all the way down to the end
date beta may have the same path. You start out with the atomic structure of market cap data stocks is simply rang tied a low according to that index, but there are other components of the design of the market that produce returns, we're not saying that were at the end state yet, but its passage that I think a journey that I think people should go on. So automated asked
matters. Box or all kinds of call for phrases of come up in recent years. Has that fit within this debate between active and passive investing? Well, that's a means of.
every it's not the end in itself. The
moving in every sphere from analogue to digital and investing as one of the participants in that transition. There has to be
more efficient ways to deliver investment information, which is the real part of the story here as to whether that's the exclusive way what's investment decision,
king is made. I think the jury is still out on that. I've always thought that investing is very
ten to medical care. Some people may get advice by looking at the internet, but we still think that they need to talk to a doctor and I think for financial advice. I think it would be improved. Probably
to consult a robo, adviser or machining actually talk to someone and in both instances you actually need someone to advise,
you can get you do something. That's appropriate. You too, for your health or your portfolio
so you in outward that some Botswana take away active, investing overtime. I don't think so on the Tec,
ology side, there's a lot of potential to reshape the relationship
in advance or advising, but there's also been some coverage about how technology could revolutionise the back end of the investment management process. Some talk about blockchain technology as potential application for banks.
Your perspective coming out from the asset managing side of government, not the trading or why think, Jake? You always have to understand
your business model is and how technology AIDS and a bet your business model. I think in the case of investing the business model
and Jameson seventeen. Ninety two under the button were tree. So what you do and investing in
side to buy or sell something. So somebody has to execute and match that order. Then the order has to
He cleared me and you have to match the buyer and seller have all the terms specified that it has to be settled so the dollars have to move against the certificate and then it has to be held or custody till may
So that's the business smile that we're in you have to make that decision than executed clear, settle in custody. It it's been until the last
many years in entirely analogue process
and now as we talked about earlier technology, is automating these processes. Now, the first,
is that we understand what technology? What it does is it makes things go faster, so reduces latency at speed things up the most prominent aspect of the application of technology to that processing is on the execution it so that
but the Spirit is when you match the by against the cell and order execution in high frequency trading. Technology has reduced that two milliseconds
matter, where the bulk of the investment has been on the front end. The true yes, yes, and so after the order is,
imagine that millisecond, you still have to clear it. You still have to settle it, and then you have to custom
now right now in the? U S: securities market, that takes three business days to do
but it doesnt have seconds on the front end three big
stays on the back and yes, so the real benefit of technology going forward is to
short in that order made that make that less latent, some move that from three to two to one to actually happened simultaneously, because every S
of the trade is DE materialised. You don't get the stock certificates
more with the mermaids and the railroad cars on it. Cash. You don't feel any more, so everything is just data in a process. That's been digitized so that technology will make that happen faster than emissions,
our chain? Blockchain is really just another form of clearing settling in custody. The attraction of blockchain is first of all its decentralized. So it's a process. It has
and away from banks away from regulators, and it has the independent
of minors, processing and verifying the system, the chain of custody on each transaction, but the basic concept is just
acknowledging making the clearing settling in custodial function happen at the speed of light, whether that
when's under a regulatory umbrella inside banks outside banks, this little bit of a red hurrying towards
The fundamental issue is
really unreasonable that it takes three days the settlers doctorate. Yet, especially in an era when you can execute the trade so quickly,
you should be able do with an app on your smartphone, so big data have been a big focus in the industry recently, and our firmness invested some big data companies had you reconcile the potential benefits, a big data particular when it comes to making investments with the new kind of risks and introduces two, your business or big David to me also represents the possibility of sense
overload. So, no doubt technology is collecting more information, making it available to you dumping it in a big pile in front of you each morning, and the question is how you process it in separate the noise from the signal. Could signals are
rare in terms of being able to actually understand and predict the future, because big data is in this context. I am using it not in terms of processing something it's already happened, but using big data as an inferential device predicting the future. So trying to see from this informed
given how stocks or bonds or markets are going to move that generally, the seduction, a big data right now for the marketplace
what you need to understand? Is markets like nature? Don't give up their secrets very easily that it takes a long time to prove causality.
You get confounded by a lot of correlation variables, but defining
causality. If a happens then for sure be will happen, that is rare in nature in markets, and so big data holds out that problem.
of finding that predictive signal, but its very rare, too much
here's and talk about a new development are reasonably new development in the investment management division, the business you run. We spoke earlier,
here with you: loss in the new head of environmental, social and governance. Vesting and I'm de about investors growing interest in that type of investment management decision, making. What kind of an impact you think? Yes, g investing will have on your business and wire clients clamouring for now. I think shakiest g investing as a very important moment right now in finance. For two reasons. One is that there's trimming
is an appropriate interest from clients in directing their investing that way, so worried
combined social good with monetary value is very important. The second aspect of it, though, as what was implicit in your question
is that it may very well be that using yesterday, as a factor is as important
fucking a portfolio as using valuation, so price, the book and price to cash flow or growth or site
may reveal that if a corporation
is governed according to those principles, it's going.
a good investment as well, and that's the real promise of
ass. She that it may be the
was dominant factor in constructing a portfolio away from market capitalization.
Away from geography away from size.
She may drive everything in terms of causation see,
Your team is now looking at those factors helping institutional asset managers figure at just those kinds of issues now yet it starts Jake, first and foremost is a filter. So a client once a portfolio designed
way and were able to quantitatively tree eyes. Portfolio stocks to focus on any issue criteria
so I'll turn. It investments in other area of focus within I M d for those who aren't as familiar with this term class of assets include everything from real estate commodities to private equity. In the past, these products were typically available justice of his
get it investors or institutions, a limited rights, but their increasingly become retail. What's the significance
development. Is that a good thing for individuals to have access to these kinds of funds? Very good question Jake, to use an example of a couple of
one is that in this business we use labels as a substitute for analysis, and sometimes it's better to just explain things rather than use a label, and this is a good example of that. So, if you want to invest in something,
in terms of how you do it. There's really. Basically, three ways: you can open up a separate account and you can direct that separate account yourself, just an account at a brokerage. You can, secondly, invest in a mutual funds.
that's a coal mingled vehicle of yours and other people's money where there
no limit on the amount of money can put in either as a minimum or a maximum and there's daily liquidity. Then there's this third category, which occupies the label alternatives and is hedge funds and private.
when he funds, but really what it is. These are combings vehicles
not the only investor in it but has, as you pointed out, limit access. We have to have a certain profile as an investor and also
limited liquidity, ceremonies locked out for three months or ten years, whatever it is, so the transition of that vehicle, if you will from alternatives to liquid alternatives, is quite simply reducing those two restrictions. So now,
of who can invest in an alternative. It's now down to the same minimums as it is for mutual fun and it doesn't have the
ill liquidity future any mortal had the daily liquidity the daily and av that a mutual fun has. As you pointed out, that vehicle you can pour into it almost any
ass, a class that you find in either separate accounts. Are mutual funds could be stocks bonds real estate? It can be domestic and international
and so this is really again not an end in itself is another example of a means to that end of achieving higher returns. So one of the arguments
Those managers made in the past was that they were able to focus Leubronn the longer term, a little bit less away from quarterly earnings, because they didn't have
demands of daily liquidity and people wanting to redeem didn't have the threat of a run to make them too conservative. Sometimes
how will the move into more liquid vehicles change the way they offer products to investors again, a very good point, because the
investment style. The manager is really a function of how the vehicle itself is designed. So if you're in
manager of a fun where you're investors can call for redemption. For ten years,
Gonna have a different investment portfolio, then managing a fine we're investors, all of them
and call for their money back tomorrow, so the portfolios will be
picture differently than ill liquid. If you will classic alternatives and they may be closer to the strategies as reflected in mutual funds, Ria carry a higher percentage, less leverage cause. You can leverage these vehicles up. So, yes, the structure will impact the design of the portfolio stepping back a little bit. Pensions still provide long term financial stability, firm,
millions of people around the world probably billions as the population ages, how is that landscape around pension shifting
and what are the challenges that pension funds are facing in this very low yield environment will depend.
Funds are in a low yield interest rate environment on both sides of the equation. So there
I abilities increase when you discount at lower lower interest rates and then, of course, the same low interest
produce no yield on the asset site is like the story. I tell
problem zero. Is it the history of the arabic numeral system? Was that for the first four hundred years of the number system? Zero? Wasn't it because
was a mystical number. It was zero, it was void, meant nothing. Then they put zero
and all of a sudden you could go negative and you
Some of the issues right now in the capital markets, because interest rates are not zero, or at least they worthier and negative in Germany to pick one instance, but his destabilizing the system in particularly involving pension funds, because if you think about a pension
on the value of its assets have gone down in the value of its liabilities, have gone up because of zero or low interest rates, and so the best thing happened to pension fund.
Is a rising interest rate environment because it old make income go up and therefore the
kind of present value of the liabilities will also shrink and life will be more normal. The other thing is happy
the pension funds area now? Is it more more that technology they investment technology is marrying the vessel inopportune on the asset side, with the key
flows actual early on the pension side, because you have a lot of people with different life expectancy. Different income needs different benefit. Payments that need to be assessed
in a certain way against an investment portfolio and the two of those I think
need to be synchronize more. We now have the technology to do that. Better thinking to the future, as
more and more millennials come into the workforce and anyone people older the millennials, removing away from that system predicted in United States more to define contribution scheme how's it going to change the nature of your business, were fewer and fewer pension assets to invest more more
Individuals investing this is definitely a generational issue is so the baby boom generation. My generation was the first to experience, moving from defined benefit where you didn't have to
you bet your retirement in the company that you work for wood provided for you until you died to the four one Kay
Jeanne, where you're responsible for your own savings for retirement. This is a very important
you, because managing your own personal wealth is a very difficult issue and as we talk about earlier about Robo advisers technology,
and the answer there you still need to have in full
guidance, says about how you're supposed to assemble a portfolio for retirement. It is the biggest pool savings now in America. Particular it it's much larger than the pool of money and dedicated defined benefit pension,
and how that pool of money is advised now it is structured
new. That's are offered inside the plans very important policy decisions as much as investment decisions, because a lot is governed by what Washington DC decides to do in a number of differ
ways is most important for the millennials, because there is a generation is gust from tee.
Euro gonna have to deal with saving for retirement, yeah, no possibility of defined benefit plan, r, P,
prepared for that to me, we ve talked a lot post financial crisis, but financial literacy, financial education, but these are difficult decisions
Megan. The data shows that a lot of millennials are actually fairly conservative and the weather investing. Yes, I think so,
best thing to learn about investing from the earliest possible age is discipline that you have to have a,
and then you have to stick with it, so you have to save, and you have to have an investment plan that
You continually underwrite or re examine if you off period of time and you stick with it- that's why I used the word discipline because that choice B,
we consuming a dollar in saving a dollar always been a very difficult one, whether a baby boom generation or millennial and the discipline of savings
then a discipline around investing those savings is
four millennial as it has been for any other generation, timid
women gram we're alive today? What would he think about the investing landscape we see today?
We'll background was still have the same philosophy. That he's always say, which is that the valuation is the first tenant of investing and certainly his most famous people. Warren Buffett would say the same thing. The thing is different in two thousand fifteen verses right after nineteen, twenty nine, when Ben, Graham, whereas most active in investing. Is it there's many more things to do? There's many more markets to invest in more ass, a class
more instruments to deploy in. So this is word the word days before discipline is so important and that's what gram priest and what Warren Buffett will preaches, that you have to define your son of competence and stick with it.
so you may be knowledgeable about technology, maybe now toolbar Industrial here, maybe not about finance, but it's rare that any
Is a renaissance person these days, where you can actually absorb all
The information that comes running to you, you have to pick an opportunity, have a frame and then stick with. It
there is a tendency when we talk about the future of anything, the future investing the future of cars, the future whatever it is, we talk about what will look different,
and we ve talked about a lot of things that are driving change today: technology, demographics, new asset classes, but when you stepped back and think about what looked very similar, what will the same ten fifteen years now in this space and investing space? What do you think is most likely to look very similar in the future? I think almost all the issues that we talked about will still be resident in the marketplace of investing and Jake. I think that the act of verse is passive. Debate will still be there. The use of technology will still be there. Big data will be even bigger, although
cascade into the one thing I keep mentioning, which is what will be the same? Is you need more discipline because it is going to be more formation, more opportunities, and so that's the one thing I always preach about investing. Is it it's not how smart you are necessarily, but how focused and discipline you are about applying a particular point of view about the opportunity set. Ten thanks for joining us today. Thank you, Jake. That concludes
set pursuit of exchanges of Goldman Sachs objects. You are, we hope, you'll join us again next time. This part gassed was recorded on September, fifteenth two thousand fifteen. The views and opinions expressed here and should not be construed as an offer to buy or sell any securities, and such views and opinions may differ from those of Goldman Sachs. Global investment, research or other departments are divisions of Goldman Sachs and its affiliates. This information may not be current, and Goldman Sachs has no obligation to provide any updates or changes. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast in any liability
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