INSIGHTS

Link para o artigo original: https://www.bridgewater.com/research-and-insights/gic-and-bridgewater-identify-the-major-issues-facing-investors-in-the-years-ahead

See transcript of this conversation here:

Note: This transcript has been edited for readability.

Jim Haskel

I’m Jim Haskel, editor of the Bridgewater Daily Observations. Today I’m coming to you from Singapore, where we are celebrating the 30th anniversary of a very special partnership between Bridgewater and GIC, the entity that is responsible for managing Singapore’s international reserves. As part of this milestone, Bridgewater and GIC have engaged in a series of research projects to identify and assess the issues that we think are most important for investors to be grappling with in the years ahead.

In fact, today we’ll be sitting down, the two organizations, for the entire day, reviewing the findings from that work. But we also thought it would be a great opportunity to do a videocast and share some of those highlights with all of you. And so, joining me today from GIC is Group CIO Jeffrey Jaensubhakij—otherwise known as Jeffrey J.—as well as the CIO for Fixed Income and Multi Asset Liew Tzu Mi. And from Bridgewater, co-CIO Greg Jensen. So I want to welcome all of you.

Jeffrey Jaensubhakij

Thanks, Jim.

Jim Haskel

Our conversation today will focus on four major areas, three of which are in our joint research projects. They include, number one, US exceptionalism. It’s been a driving force in markets; so, what produced that? Where are we today? And, given the pricing, where are we likely to go in the future? The second will focus on artificial intelligence, or AI, and its impact on markets and economies. The third will examine China, and the deflation that’s emanating from China, and look at the implications of that for investors. And the fourth is because we have Tzu Mi here. And even though we didn’t focus on sustainability in the joint research projects, we easily could have. So we want to ask her, given her role as chair of GIC’s Sustainability Committee, about the sustainable investing movement, and where we are and where we’re likely to go.

So with that, let’s get right into it.

Chapter 1: US Exceptionalism

Jim Haskel

I want to start on the question of US exceptionalism. This was an area that both organizations identified as a key issue for investors in the years ahead and something to grapple with. Jeffrey, I want to turn to you first because the question is, what produced this US exceptionalism? Where are we today? And do you believe it will continue? I say that because so much of global portfolios are in the US, so that if it doesn’t continue, that’s a really big implication for markets, and economies, and so on.

Jeffrey Jaensubhakij

Thanks, Jim. I think we should separate out economic performance versus markets performance. US economic performance has been really good, exceptional. But it’s US asset performance that has been truly exceptional, and particularly compared with everything else in dollar terms, it has been truly exceptional. So I think we should break these two up because I think the economic factors are ones that probably are structural and don’t change.

The US has by resources and by size of the land mass and population—actually it has a huge addressable market, just domestically. Companies and businesses that grow in the US actually can grow to huge size, achieve great economies of scale, just in the domestic market without having to do anything internationally. The US has, by tradition, also been a land of immigrants, which has brought in a diverse population with its ability to create diverse new ideas and innovate. And that’s definitely part of the US exceptionalism that has translated into the economic performance through time as well.

I think on top of that, the system of government, policy making, with its good checks and balances, with its responsiveness to the population, to democratic calls for policy changes—the policy response has also been very reactive to what are changing needs as the economy has grown and developed and restructured through the years. I think all of those remain, and they are definitely some of the key reasons why the US has performed so well economically.

There are, however, some other things that have really helped US assets in the last few years. Some of those things are shared with other countries as well. So, what are those? First is that interest rates have been falling for a long time, and that’s been a big tailwind. That doesn’t differentiate the US necessarily. Taxes have been falling also for quite a while, and that has been shared by some of the other countries but not necessarily by all. But that’s a good tailwind also for the earnings growth that companies and assets get to see.

And then, the additional things are that the US’s innovation, in the last 10 years particularly, has been in areas where there are economies of scale and scope, network externalities, that US companies, because they were the first to develop some of these, were able to take market share—not only within, let’s say, the technology sector, but also taking market share from retail, from advertising, that otherwise would have gone to both domestic and foreign competitors. So I think the question for us as investors is to ask, are these things that can continue going forward?

But maybe I’ll come to the last two thoughts that I have on that, which is that some of that exceptionalism is also cyclical. So one of the things that our joint research has shown is that valuations in the US have really grown well beyond those of other countries and well beyond the fundamentals—the earnings growth, and so on. And today, US companies have earnings growth expectations that are not only well in excess of history but well in excess of what other countries’ earnings growth have as well. But in addition to that, there are still additional valuation premia that are given to the US, which are measured by the risk premia, if you will, on top of everything that has been priced in in terms of growth.

These things, historically, have been quite cyclical. So it would not be surprising to see some of the exceptional performance on the asset-price level actually erode over the next decade or so. We’re always told that if something achieves a market concentration—as the US market is in the MSCI World, of 70%—either competition or other cyclical factors will come in and turn that around. I think we have to watch for that.

The other piece of exceptionalism really is around the dollar. The strengthening of the dollar in some sense works with asset prices to self-reinforce flows coming into the US. As asset prices have done well, more foreign flows come in, domestic investors return to the home market, and the dollar increases in value. Foreigners and domestics alike find that, oh, it allows dollar-measured performance to be even better. Or, if you invest in the US, yen-measured performance is even better. And that increases flows, increases valuation, increases performance. When that reverses, unfortunately, all of it reverses together as well.

So I think there is true fundamental exceptionalism that we see, market exceptionalism, but there is some cyclical stuff that I think could reverse.

Jim Haskel

Greg?

Greg Jensen

Well, Jeffrey shared so much, and we largely see it similarly, but just to add a little bit. So when we did the research with GIC—you could start the clock in a lot of different periods, but I think it’s interesting to talk about the last 15 years because in 2009, coming out of the financial crisis, the markets weren’t expecting the US to particularly outperform. If you looked at expected earnings growth in Europe versus the US, etc., they were about the same. China, if anything, was priced to be exceptional. That period, since 2009, has been this period of incredible exceptionalism—both in growth, although even more so, as Jeffrey said, in markets.

That’s the backdrop. Now you pull that forward and you’ve got, exactly as Jeffrey said, now you’ve got this fully priced in, and actually the market is pricing in the next decade for US companies to be better than the last 15. The last 15 years of exceptionalism was bigger than any other period in history over that time frame, and to expect that to continue is an extremely high hurdle.

So we started in 2009 with no hurdle. US companies outperforming as they did was a huge shock to markets in a sense that played out in the pricing. Now, to get the same thing in pricing, you’d have to outperform by double, because that outperformance is already priced in. That’s hard to do. And as you said, when you think about what it means to have 70% of the equity market in the world in US equities, that means 70% of the money going into equity markets has to go into US equities. Now, that can come from buybacks, that can come from the profits. So there’s reason to believe that’s not impossible. But it does mean that essentially to keep that up, 70% of the money has to keep going in. If they go to 75, it’s 75%. And you do know there’s a cap at 100%, I believe. And so there’s a limit on that side to some degree.

And the dollar, similarly, the dollar benefits. These things are intertwined. The dollar benefits from the equity market because global equity flows, mostly if people go into the benchmark, 70% of their dollars go into the US—that helps sustain a relatively big current account deficit. You take that and the desire, essentially, in the world to borrow in dollars, to hold dollars, because essentially it’s what you need to save in to be able to pay your debts in the world.

So you have that at a very high level, and you’re seeing it—the US suffers from, we call it a “Dutch disease.” But because technology is so concentrated in the US, it’s so much strength, and that recycles its money, the rest of the industries in the US can’t really compete on the global stage. So the US is also very concentrated in terms of global corporations where we really have an edge. Because the dollar is so high, it’s hard in other areas to compete.

Those are challenges going forward. What you really need to reconcile the pricing in the US is you need a compounding of the productivity difference. And it’s possible. One of the benefits US companies have is their profit margins. Those profit margins—so if you take the equity outperformance, revenue outperformed the rest of the world; that was about a third of the outperformance. Margins outperformed—that’s another third. Two-thirds are revenues and profit margins. And the final third was valuations.

Basically, if you stack up how equities outperformed in the US, it was an equal blend of more revenues because they outcompeted; better margins, which have to do with the nature of the companies, the productivity of those companies, but also a shift in the power between corporations and labor, and a shift in taxes; and then the final thing is what Jeffrey described as cyclical, the valuation difference—to the extent it’s right, it’s pulled the returns forward. You’ve already got the returns of the next decade. If the US continues to exceed—already in the price.

So that sets us up for a much more difficult decade, particularly in asset markets for the US, because the hurdle is so incredibly high.

Jim Haskel

Tzu Mi, let me bring you in here now, because we’ve heard Jeff, we’ve heard Greg, talk about US exceptionalism. And what they’re really outlining is that the underlying fundamentals are there, but the pricing is going to make it very difficult to replicate this for the next decade as we’ve seen in the last decade, in terms of financial market returns.

But there’s an increasing question about a potential left-tail outcome related to fiscal sustainability. And if we walk back in time, we know that the US was highly, highly indebted—mostly in the private sector—in the early 2000s. Of course, we had the global financial crisis. And since that time, because of a mix of policies, we’ve gotten this huge transfer from the private sector to the public sector, such that today, the private sector looks relatively healthy, and if you look at the government debt, particularly in the United States, that’s at all-time highs.

So I’m wondering how you think about that, in terms of the sustainability of that, and whether as an investor you worry about a left-tail type of outcome that would change this dynamic of US exceptionalism.

Liew Tzu Mi

Definitely. I mean, fiscal sustainability is a key concern for the US and, frankly, for some other countries, too, in the world. And if you look at the level of deficit we have today, and the fact that if you look at the items in the spending, a lot of it is going to be baked in the cake in terms of not having enough flexibility for any governments that come in to change that. So you are almost looking at a level of deficit that will sustain for a period of time. The question is, what are the politicians going to do in order to address this longer-term concern on fiscal sustainability?

Now, obviously, there are different issues here. I think one is a time-horizon issue. Today, the “r minus g” in the US is still negative. So it’s not an imminent problem, but at some point they will get to a tipping point. So that’s one. I think two is also on a relative basis, if you look at the US state of the fiscal sustainability and you compare that to other countries, it may look like, actually, it is not as bad as some other countries in terms of the urgency of the issue. And then third, of course, if you are looking at an easing cycle that’s coming up, you do have the ability for the US to then issue bonds at a lower cost and maybe lengthen duration as well.

So these are some of the tools and levers that the politicians, the government, will need to think about in order to manage it for the longer term. But certainly, we believe that the term premium for the long end on the US bonds will need to go up to reflect the uncertainties around fiscal sustainability and around the issuance and supply concern for the long end as well.

Chapter 2: Artificial Intelligence

Jim Haskel

So, the second topic we want to focus on is the artificial intelligence revolution, AI. And here we’ve had rapid advancements in capability and a lot of excitement about the potential for this technology. And also some worries about constraints and things of that nature. We’ve had major outperformance in AI-themed stocks within the US stock market, and then leading the US stock market, relative to other stock markets in the world. And so, is AI already impacting the real economy, or should we expect that it soon will be? And how do we see the arc of its development?

And, Greg, I want to start here with you. You are spending a lot of time on this subject and are directly involved in many ways with this. How do you see the arc of AI and the impact it will have on markets and economies?

Greg Jensen

It’s an issue that I think is hugely important to get your hands around, and I’ve been thinking about it for a very long time. If you take AI in its current form—machine learning—prior to that, let’s say, even coming to Bridgewater—one of the reasons I was excited to come to Bridgewater was I loved the idea of building systems and taking human intuition and programming that into code, which was obviously how, at Bridgewater, it’s a big part of compounding our understanding over 45 years.

Around 2012, I started getting super interested in this topic of, when will machine learning actually be useful in the creative process? I believe around the end of 2022, I thought the components had come together enough that machine learning could take the next leap in the world. And that’s when we set up AIA labs at Bridgewater to take the stuff we had been working on in small ways in machine learning, but to have 25 people fully focused on this, which gives us two windows into this. A window as chief investment officer, looking down and saying: what’s the productivity impact, how much investment there’s going to be, all of those things. And then having our hands dirty, trying to build out machine learning to essentially determine what’s next in the economy and what’s next in markets.

From both of those windows, I think the bubble is ahead of us, not behind us. I know it seems like there’s been a lot priced in and there’s a lot of euphoria around a lot of these things, but to me, the pieces are coming together in such a way that you can actually get higher-quality decision making and that that’s starting to happen. And that the people that are closest to it are investing massively and recognize it for the risk that it is to them if they don’t stay ahead. If you take a Google or whatever, if you don’t stay ahead in AI, you’re done for. And that’s really right now only across a few companies that feel that way.

I think as you go forward, what the future will look like is many companies across many sectors will feel if they don’t do that, they will fall behind, and that will radically change the investment thinking. And that people will pour money into how to replace their workers with AI agents and how to become tremendously more productive down that path.

So I think that we’re only in the really early stages of this. There’s a ton of stuff going on that’s a little bit hidden, because everybody’s looking at the language models, and everybody knows their thoughts on ChatGPT, and it does this dumb thing, or whatever, and missing—or not necessarily, I mean, some people are not missing this—the impact it’s having on the physical sciences, the impact it’s going to have on healthcare, on vaccines. Those things are moving incredibly quickly. And so you look at where we are just over the last three years in terms of the impact, that growth rate is massive. So those are my big-picture thoughts.

Now, you could easily have an 18-month stumble along the way. And the biggest problems I see are that it’s easier to do destruction than production, and that there’s a lot of the AI stuff that can be used for destructiveness, and I wouldn’t be surprised at all. There’s a massive regulatory risk: the DoJ, there’s these investigations, and there are these things, it’s going to be very hard. I mean, we talked about US exceptionalism, and it’s not clear how tolerant the rest of the world is going to be to US corporates taking another leg of share via AI. So it’s very likely there will be reactions in other countries. The regulations will be different across countries about where you can and can’t use it. So that’s how I see it at this point.

As we turn back to the US pricing, the only way the US pricing can make sense, I think, in the end is that you get a productivity miracle about twice the size of what you had in the last decade. And that’s possible; I do think the fuel is there. The ability to make higher-quality decisions at scale is huge. I think the power that is about to be unleashed in the world has many possible productivity benefits and a lot of things to worry about as you go through it because I think there will be lots of accidents along the way. So that’s my view of where it’ll go.

Jim Haskel

Jeffrey, there’s a lot to digest there from what Greg said. How are you seeing the AI arc in your position as Group CIO at GIC? And how is it affecting the decision making here at GIC?

Jeffrey Jaensubhakij

I think in many ways I agree with Greg that the future impact, the future adoption and use, will be great because the potential to improve your processes, outearn what you’re doing today, and outcompete will be huge. And everybody will eventually need to adopt it.

But I think Greg’s example of what Bridgewater is doing itself is illustrative of many of the issues that as an investor in this trend, we have to think about. So today, what you have, let’s say, in the large language models—and there are three to seven relevant ones and so on—are tools that are being built that require a massive amount of investment—investment to learn, to train the models, and so on. And it’s already pulling in a lot of capex, whether it’s buying of Nvidia chips to allow the models to learn, the data centers that are needed to house them, the energy that’s required to power it.

The next question is, can these general models actually be used by themselves to improve productivity? Can they just be adopted and adjusted? Actually they can’t. So I think unlike search models, or social media, where the consumer or the company can just port it into the company, and immediately you know how to use it. To be able to use large language models for the business applications that you want—as opposed to asking them to write you a trip itinerary for Croatia, or whatever—requires an ability of the company to adapt those models for its use. And if they’re used quantitatively, those models by themselves are not good at handling numbers and math and mathematical concepts. So you need some know-how and ability to then convert that into the needs that you want to fulfill for your own company.

I think the next stage of investment—apart from these purveyors of picks and shovels—will be, what are the companies that can differentiate themselves by being able to use the large language models and apply them specifically for their company’s use? Even better, use proprietary data to really enhance the competitive edge that they get out of that.

I think what we will see is that there will be a stark differentiation between the companies that have that DNA, have already been using it, and will differentiate themselves positively, with all the others who won’t and who will struggle—because talent at the higher end to do this is very scarce—will struggle, maybe for years, to be able to do that.

From an investor’s point of view, we have to look for that differentiation. Every legal firm potentially could replace a lot of associates with AI. Those that can use it well will initially be relatively few unless—and this is the second point—unless we see a proliferation of companies that adapt the large language models for the industry uses that could really take advantage of this.

Chapter 3: China

Jim Haskel

Tzu Mi, let me turn to you on the question of China, which is the third big topic that our two organizations have done research on. And that is, basically, China was the success story of the global economy for many, many years. The growth rate was very high, there was a lot of urbanization—all that was a positive story.

Then, in the last few years, what we’ve seen after a period of over-investment and high leverage is now stagnation. In fact, even more pernicious—deflation that’s emerging from the Chinese economy. So I want you, if you would, to start in and just tell us what the arc is of China. Where are we? Where are we likely to go? Is this going to be a worry for investors looking into the future?

Liew Tzu Mi

Let’s take a step back and look at the perspective from history. China enjoyed a very exceptional period of growth rate—on average about 10.4% between the year 2000 and 2010—in part thanks to this really fast and strong export market share gain, especially post WTO entry in 2001, but also because of a very favorable demographic profile as well as fast urbanization.

But then, the decade after that, and maybe just before COVID, you see that growth has also moderated, but it’s still very impressive at 7.3% on average between 2011 and 2019. And thanks to the three traditional growth engines—this would be exports, investments, and consumption. But also, like you say, rising leverage.

So this rapid rise in leverage really increases the vulnerability of the Chinese economy. When it comes to COVID—when COVID hit in 2020—we see quite a remarkable adjustment to the Chinese growth rate to now 4.7% between 2020 and 2023. Now, there is obviously a confluence of factors at play here, some cyclical, some structural, but both sets of drivers are really acting in the same direction at the same time on the Chinese economy.

Let’s start with the cyclical factors. One is this post-COVID recovery has been quite subdued. So that has knock-on impacts on confidence, business confidence, but also on job availability as well as wage growth. Year-to-date, till July, we have seen that personal income tax has declined by 5.5%, and that is after a -1% year on year in 2023. Based on the latest statistics that we saw, average wage growth in 38 major cities in China has decelerated from 2.2% in Q1 this year to now 0.5% in Q2.

This very soft aggregate demand has also led to an increase in competition, especially in some industries. We have seen, for example, companies having to bear very thin profit margins in order to squeeze out other players. There’s a term for it in Chinese actually—it’s called neijuan, which I think the English translation is involution. So, for instance, the number of loss-making manufacturing companies has surged to something like 180,000 as of May of this year, and this is about 30% of total firms in China. This number is double what we saw in 2021.

There are some other cyclical factors as well, such as lower prices in pork, in commodities, and so on, that are acting as a deflationary pressure on a cyclical basis for the Chinese economy.

But perhaps more important are the structural drivers. These would include things like demographics; we have passed the peak of favorable demographics in China. There’s also a profound shift in the Chinese economy model, as well as the accompanying priority changes in terms of policy makers trying to now target quality growth instead of quantity growth, as well as a policy-led structural adjustment and deleveraging in the system, especially in the real estate market.

So, take real estate, for example. The impact from deleveraging in real estate in the economy is very significant. Real estate used to be something like 26% in terms of GDP share in 2020; today, it’s 17%, as of 2023. The property market also has very large knock-on impacts in terms of the credit chain—for example, in local government financing; in the consumption of and demand for commodities—as well as accounting for something like 60% of household wealth in China.

This structural adjustment is going to take some time because it’s very difficult to find something like the real estate contribution that can replace it in terms of a growth engine for the Chinese economy in a short period of time. This structural deleveraging in real estate also coincided with a peak in population, decline in the number of marriages in the system, in the country, and it also has coincided with a low level of urbanization rate as compared to the past, as well as elevated property prices to income, and high household ownership as well. So all these will take time for us to be able to find a new growth model.

Lastly, in terms of external pressure, we have rising geopolitical tensions and talks on trade frictions and so on that will continue to exert pressure on the Chinese government to look for other ways to which they could think about national security and also the system’s self-sufficiency, so that in the next phase of growth, they will have to focus on some of these other things.

Greg Jensen

I think that paints the picture extremely well. When we look at this in our framework, you’ve got a long-term-debt- cycle problem for the private sector and for the state and local government in China. And deleveragings are hard; you have these choices to make. Right now, China’s decision is more to tough it out. If you take COVID, every other economy in the world more or less filled the gap. That there’s a massive gap between you basically close down the economy—and in China’s case, for the longest also. You close down the economy, fixed costs keep running, and revenues drop. There’s a big gap. When we went into COVID, I was calculating that gap across countries and said it was a huge problem. I didn’t know the fiscal response in the developed world would be large enough to more than fill that gap; that’s been an interesting learning.

But in China, they didn’t. These problems were building going into COVID—you had the problem of the massive leverage going into it. Now you take COVID, you get this incredible gap between—the revenues go essentially to zero and the costs keep building. The way they chose to handle it in China was, tell the banks you have to lend the money. But unlike the rest of the world, those debts were not forgiven. Those debts have just built up on those balance sheets. Banks are the mechanism through which bad debt is managed. The defaults don’t really happen.

So you’re stuck in this limbo of defaults happening at a very slow rate—basically, hardly. Banks forced to continue to lend to companies that are losing money. And that circumstance keeps the ball rolling, but the problems don’t get dealt with.

Now, at the same time, there are some fundamental, really strong things about the Chinese economy. The central government can handle a lot more debt than it has, and they’re choosing not to do that. Two thoughts on that. When you look at the underlying strength—the underlying strength in technology, and the fact that the central government is choosing not to; it’s not that they can’t do it, it’s they’re choosing not to do it—those are powerful levers that still remain in play.

Finally, on pricing, we talked about the US. China’s the opposite. The market pricing is extremely depressed in terms of what’s being expected. Now, there could be good reason for that because of the political challenges and whatever. But it is, by our measures, anyway, an extremely high risk premium—a well-earned one at this point—but an extremely high risk premium that is pricing in negative earnings growth into the future compared to something like the US where there’s priced-in exceptional earnings growth. Those make interesting differences.

Liew Tzu Mi

I want to add that there are different considerations for the government.

So, what are some of these? You must have (1) regime and social stability; (2) financial market stability; (3) national security; and then (4) economic growth. So I think above all it’s going to be a very tough balancing act because you have got so many different considerations and they are all acting at the same time in terms of some of these pressures.

The broader picture is that we are coming to a very significant transformation in growth and the economic model in China, and it requires a different lens to look at the state of the economy as well as how we invest in the market.

Jim Haskel

I want to turn to Jeffrey with a question. In the joint work that we did, one of the interesting things there is that there are 21 case studies of deleveragings. What you see there is that the distribution around the outcomes is very stark. If you’re early and active and you’re essentially monetizing away the debt, you may have some repercussions from currency, but you’re going to have a better economic outcome. If you wait too long the other way, then the reality of deflation expectation starts to set in and can be highly damaging and very difficult to get out of without really radical policy.

Sitting here, we see what’s happening. As an investor, do you—we’ve said, well, a balanced portfolio of bonds and stocks and other things is the best way to play that, and it’s actually done quite well even as this deleveraging has occurred. But as an investor in China, how do you see playing this situation given that they’re sort of going down this one track?

Jeffrey Jaensubhakij

I think the problem, if you will, for policy makers as well as for investors, is pretty much the same one—which is, trying to understand whether this is a stable equilibrium. That the lower growth and all the deleveraging that’s occurred, can they still hold it up here? Or in a semi-market economy or a full market economy where you don’t control everything, you definitely don’t control the sentiment, and therefore the economic consumption decisions that consumers make. Is it an unstable equilibrium? Which means that once you don’t arrest it early, as you put it, actually you are already in this vicious cycle that leads to a much worse outcome.

If you look at history and so on, clearly it shows that the risk is actually on the left tail—very fat left tail, lots of examples of this not being controllable. I think the Chinese policy makers historically have looked at Japan and said, “We don’t want to be Japan,” and they’re very worried about that. But this time, their policy response and so on seems very constrained, as Tzu Mi described it, and I think as investors, as opposed to policy makers, if we think that this is an unstable equilibrium that could lead to a vicious cycle.

Unfortunately, it’s a very tough one—doesn’t mean that there isn’t a range of things that an investor can do in China. You can build a very nice balanced portfolio. I think for long-only asset owners, it’s a very different problem. It’s one where you say, “Well, I can own Chinese bonds and start at a low bond yield, and I’ll get some capital gains, but if I keep investing there, I’ll just get that low bond yield.” So the question is, is that what you want?

On an equities’ perspective, I think there is a difference between investing in an aggregate index that gives you the whole economy and therefore all the problems that come with managing an economy and deleveraging, versus looking for companies that can still perform well and absolutely in an environment like this. So there are opportunities—whether in private equity, going in and taking control of a company, or looking for the companies where they’ve really decided to govern themselves corporate governance-wise, govern themselves well—where you can really translate what is still decent revenue growth—maybe they’re even gaining market share—into earnings-per-share growth.

Chapter 4: Sustainability

Jim Haskel

For our last question, we want to focus in on sustainability. Over the last decade or so, there’s been a real significant movement for investors to look beyond just risk/return and also include sustainability as part of their investing paradigm. And that includes both GIC and Bridgewater.

But with you here, because you’re the current chair of GIC’s Sustainability Committee, I’d like to ask you about GIC’s approach to sustainability.

Liew Tzu Mi

I think before we talk about the approach, it may be useful to take a step back. It’s useful to explain the three core beliefs or philosophy, if you will, that really govern and anchor the way we think about what we do on sustainability.

First is that we believe companies with sustainability practices, or good sustainability practices, will achieve better risk/return over the long run. And the reason is simple. We think that the rules and norms of how society is operating are changing very fast in terms of policies, regulations, consumer preferences, business operations, and so on and so forth. So we think that for companies to be profitable in the future, they must be sustainable. So that’s a key belief.

Second is that it’s important for us to take a long-term and holistic approach toward sustainability. Now, we operate in many countries and many industries across the world, and we find that there may be sometimes some trade-offs between different sustainability objectives, especially between the “E” and the “S” in, say, emerging markets. So for long-term investors like ourselves, it is important that we integrate sustainability considerations in a way that recognizes the idiosyncrasies and also the diversity of the markets and industries in which we operate, the trade-offs that are needed, the time that’s needed, in order for this transition to take place. So we think that a much more bottom-up, much more nuanced approach toward sustainability is much more effective in helping companies on a transition pathway rather than a sort of top-down, one-size-fits-all approach where you may divest in the whole of an industry, for example. So that’s the second thing.

Then the final thing, which we believe is actually very important, is that we want to be able to contribute to decarbonization in the real world. The focus is on the impact on what we do on real-world decarbonization, as opposed to focusing on portfolio decarbonization. Because the latter can be, frankly, achieved by portfolio engineering, divestment, and you name it, but we think that by doing so, it may not necessarily be constructive to what’s happening to the real economy. So that’s the third key pillar for us to then think about, “OK, what should we do on sustainability in order to meet some of our key objectives here?”

In terms of the approach—let’s again look at the world in terms of a sustainability spectrum. If you put all the assets in the world along a sustainability spectrum, on the one hand, you have sustainable assets or green assets; on the other hand, you have stranded assets or assets that have a high risk of being stranded because they may be very high carbon intensity; and then everything in the middle is what we call “transition.”

If you use the MSCI All Country World Index as a proxy for the global investment universe, then you find that the green bucket has about 7% of assets today. The left-hand side, which is your stranded asset or high-carbon-intensity bucket, that’s about 10%. But by the way, they are responsible for something like 40% of the whole index WACI, or weighted average carbon intensity. And then everything in the middle, which is the bulk of it, is 83%—and that’s called “transition.” Our approach is to recognize that the companies in each of these three buckets have got distinct capital needs, have got very distinct transition plans and trajectories—so for us, the approach is quite differentiated.

Conceptually, what we want to do is that for the green bucket, we want to put in capital to help scale up some of these decarbonization solutions. So things like some of this green fuel, green hydrogen, EV charging infrastructure, green steel, carbon capture, and so on. So the whole range of decarbonization solutions, technology, that require a lot of capital to scale up and to commercialize. So that’s one end.

The other end is to say, “OK, do we have a viable alternative, or do we have a pathway for transition?” If the companies do not want to transition or do not have any ability to do so, we will choose to divest from them, and this is one way of managing the stranded risks in our portfolio as well.

Then finally, in the middle bucket, it’s the transition bucket, which is where the bulk of the work is because we have the largest amount of assets in this bucket. Unfortunately, the work is quite complex because it’s very nuanced. There are so many different types of companies, industries, in different parts of the world, and the rate of decarbonization and transition depends a lot on things like where you are in terms of geography, what industry you come from, the type of technology that’s available for that transition, the economics of it, and then of course policies and regulations. So what we want to do conceptually is to look at different situations and then ask ourselves, does it make sense for us to then help these companies in terms of the transition pathway, in terms of transition capital? Will it make sense in terms of risk/reward? Active engagement, to understand what are the different levers that can be pulled in order to decarbonize the operations? And then also in terms of our ability to look at our proxy voting process and to vote responsibly?

Jim Haskel

So with that, let’s bring this conversation to a close.

I just want to say what an honor it’s been on this anniversary, our 30th anniversary, to be with all of you. Jeffrey, Tzu Mi, Greg, thank you so much for being with us.

Jeffrey Jaensubhakij

Thank you.

Liew Tzu Mi

Thank you.

Greg Jensen

Thank you guys. That was great.