#21 -The Economist
Gavyn Davies is an economist, co-founder of 4 multi-billion asset managers, a former Government adviser to both Labour and Tory administrations and a former Chairman of the BBC. He takes the bus to work!
Gavyn Davies is an economist and a former partner of Goldman Sachs. He is the Chairman and co-founder of macro asset manager Fulcrum Asset Management and is a co-founder of 3 other multi-billion asset managers. He is a former Government adviser and was Chairman of the BBC, the UK public service broadcaster. Of course we talk about economics, about investing, and about financial services; but we also cover public service broadcasting, streaming and politics.
GETTING INTO INVESTING
Gavyn always wanted to be an economist – he liked the analytics. He started as a government advisor and saw an opportunity in providing macro-economic research to investors – amazingly in the mid-1980s there were very few macro-economists at investment banks, and the quality of economic research was not that high (one of those has changed). He joined Goldman, Sachs in its early days in London when it had only a few hundred employees and had no international economists. He voted for Goldman to go public as the trading risk had become too large for a partnership and partners’ personal exposures.
Today we have a lot more economists than when Gavyn joined Goldmans. The subject has become much more dominant in the way people think about investing. And of course there is a lot more attention paid to the Fed and analysis has become deeper and wider and economics as a discipline has grown along with markets.
Some equity investors who focus on micro company research are sceptical of the value added by macro economists. Gavyn understands their preference but points out that this likely needs a much longer timescale to deliver performance and clients have to be willing to tolerate drawdowns which can last several years – that’s uncommon today and it’s challenging to maintain client trust and confidence.
Gavyn thinks we are too short term in a number of areas – markets react sharply to short term changes in newsflow. He cites the example of the collapse in sterling, a 15% fall in a week, which subsequently recovered. The impact of Truss on the pound and gilts was greater than Brexit. But these are opportunities for a macro fund like his. He also sees short term thinking in politics.
Gavyn is a former Chairman of the BBC. He was always interested in the economics of public service broadcasting and how you could justify such a large incursion into free markets and how you should fund it. (For overseas listeners, the BBC is funded by a licence paid by each household with a TV.)
I set out the objective of my podcast as “to inform, educate and entertain” which are the values John Reith used as the foundation for the BBC’s inception in 1922. They still stand and I could not and cannot think of a better objective for this type of show.
The proliferation of alternatives and the media have changed but the need for an unbiased source of news is greater than ever. And young people today still know they can access a good version of the truth on the BBC. And the proliferation of streaming channels has broadened the choice, although the BBC is now unable to compete for the more expensive media – the most popular sports and the best drama – Gavyn is impressed with the Crown on Netflix.
THE INVESTMENT CLIMATE
We have had 40 years of falling rates but Gavyn does not see this as a massive bubble. Rather, he perceives it as a decline in the equilibrium rate of interest in the economy. Central banks had to follow this with downward rates to prevent a massive deflation in the system. By 2021, in some parts of the market there was a bubble but those have largely been deflated.
But the high returns we have seen have borrowed from the future and hence he expects returns to be lower in the future. And if interest rates have to rise further to stem inflation, that will be a further drag on returns.
Overall his long term prognosis is that the returns from markets he saw in his career as an economist are a lot higher than we are likely to see in the future.
He sees inflation as persistent – not at the levels of 2022, which was fuelled by energy and food, but at higher levels than hitherto.
PENSION FUNDS AND PRIVATE EQUITY
He does not see this as causing particular stress in pension funds or private equity, to name two examples. The move from defined benefit to defined contribution funds makes them less vulnerable to increasing rate or lower returns. Government pension schemes will have to adjust, especially if longevity continues to increase.
Gavyn co-founded two private equity firms, one in the UK and one on the west coast. For the most part, he sees private equity returns as being leveraged public equity returns; he expects them to be healthily positive by lower than in the last 10-20 years.
Interestingly, the demands on the economists at private equity funds have sharply increased. Half the fortnightly calls currently are devoted to the macro-environment. KKR is unusual in private equity firms as having a significant emphasis on economics, but it’s making a lot of sectoral choices.
Gavyn reckons that macro-economists tend to be better in bad times than in good times. They are pessimistic by nature but you cannot be a pessimist in private equity, because you will never buy anything. Gavyn says he is trying to be more optimistic in his day job.
DEBT AND FINANCIAL REPRESSION
Debt matters, it increases economic risk, especially in a period of inflation. And the importance of debt was highlighted in the UK when Truss was Prime Minister. Gavyn agrees that the most likely outcome is that we shall muddle through and flags Olivir Blanchard’s book which concludes that as long as nominal GDP growth exceeds the interest on the debt, serious problems can be avoided. And that’s where we are.
This creates a positive environment for macro. Fulcrum has done pretty well in the last decade, not keeping up with flying macro, but positive returns and more consistent than some of the faster charging higher risk macro wizards. Fulcrum takes much more diversified positions in markets, not trying to blow the lights out and genuinely trying to hedge and managing assets with a n objective of low (8%) volatility – trying to be macro investors rather than a macro hedge fund
ECONOMICS AS A CAREER
Gavyn and Steve share a passion for inspiring young people to adopt a career in analysis or macro economics. Gavyn points out that macro is always about things that matter – it’s about subjects that are in the news that are intrinsically important and issues like inflation and unemployment matter to large parts of the population. It also gives scope to different types of analytical thought – mathematical, econometric and political economics which is not readily quantifiable. But you need to be good at what you do, work hard and you almost certainly need a PhD from the right university to get into a big bank
ABOUT GAVYN DAVIES
Gavyn Davies is a Co-Founder and the Chairman of Fulcrum AM. He started his career as a Government advisor before moving to the City, working as an economist. He joined Goldman Sachs in 1986 and became Partner in 1988 when he also became the Chief International Economist.
Gavyn was Chairman of the BBC from 2001-04. He has had several public service roles including as a member of H.M.Treasury Independent Forecasting Panel and as an Economic Policy Adviser to the British Prime Minister (1976-1979).
Gavyn graduated in Economics from Cambridge in 1972 followed by two years of research at Oxford.
We talked about Martin Wolf, whom Gavyn reckons is the best economic correspondent in the world. He has just published his magnum opus, The Crisis of Democratic Capitalism which Gavyn thoroughly enjoyed. Wolff’s family were refugees from Nazi Germany and he warns that it could happen again.
He wraps together democracy and market economics as two sides of the same coin. They thrive together but the can also be challenged and fail together and there are signs that economies are not performing as well, that the market system is coming under strain and that could lead to negative developments for our democracies.
Gavyn also neatly summarised Olivier Blanchard’s book, Fiscal Policy under Low Interest Rates.
This book, In Defence of Democratic Capitalism, is a favourite.
Fiscal Policy under Low Interest Rates sounds even heavier.
HOW STEVE KNOWS THE GUESTS
Steve met a former colleague of Gavyn’s when speaking at a school careers fair and he kindly introduced us. We had a great introductory call and Gavyn generously agreed to give up his time. He is obviously rich but amazingly, likes to take the bus to work!
00:02 – Gavyn Davies: A Remarkable Career
06:51 – Goldman Sachs and the Partnership Model
13:43 – The Economics of Public Service Broadcasting
22:29 – Market Bubbles and Realistic Returns
33:32 – Macroeconomists in Good and Bad Times
38:57 – Debt, Inflation, and Modern Monetary Theory
44:26 – Macro Investing: Risks and Opportunities
51:57 – Martin Wolf’s Magnum Opus
STEPHEN CLAPHAM: Hi, welcome to the Behind the balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an so on. Our goal is to inform, educate and entertain.
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STEPHEN CLAPHAM: Gavyn Davies has an amazing CV. He was a Government advisor before becoming the international economist for Goldman Sachs. Unusually, he made partner there at a firm which generally prefers traders to analysts. Then moved on to become chairman of the BBC in the last two decades.
STEPHEN CLAPHAM: He’s been the co-founder of no less than four highly successful multibillion asset managers and he’s now the chairman of Macro firm Fulcrum Asset Management in London, Gavyn’s had an amazing career and of course, we talk about economics, about investing and about financial services, but we also cover public service, broadcasting, streaming and even politics.
STEPHEN CLAPHAM: Gavyn is one of those really thoughtful individuals who always offers a really measured opinion. I like the idea that economists come into their own when times are tough as evidenced by half his private equity conference calls. Currently being a discussion of the economic picture. I also love the idea that when he started, macroeconomists were a rare beast. I wonder what happened as they certainly aren’t rare now. Well, except for the one handed economists, I really enjoyed meeting Gavyn and we had a super conversation. I hope you really enjoy it too.
STEPHEN CLAPHAM: So Gavyn, welcome to the podcast. Great to have you. We always start by asking people about their career. And I wondered, did you always want to be an economist because your career has taken them? You know, some quite unusual turns. You started as a Government policy advisor. You end up at Goldman Sachs. What was your school by ambition? And don’t tell me it was to play for Southampton. But what made you leave Government and go to work in markets. And then for Goldman’s well, actually stay boringly.
GAVYN DAVIES: I, I did always want to be an economist. I was good at numerical type subject, but I didn’t want to be a pure mathematician. And I got gripped by economics in the sixties and early seventies. I mean, if you remember we had crisis after crisis in the UK and we were the big news story, I I say we they were the big news story in in those days.
GAVYN DAVIES: So a combination of interest in public policy and sort of numerical analytics got me into economics. What got me into the markets in the early eighties was a belief that there was something missing in analytics in the financial sector.
GAVYN DAVIES: There were very, very few economists around in those really, really few, I mean, probably a handful in the whole world.
GAVYN DAVIES: And I didn’t really think that macroeconomics was done at the level of a university or a central bank in the research that was being published in the markets. So I did think there was a gap I got together with some friends at a brokerage called Phillips And Drew, we built a big and thriving macroeconomic unit and we eventually moved to Goldman Sachs.
GAVYN DAVIES: And that was a choice because we believed that Goldman was going to be a very dominant player in world finance and surprisingly did not have an international economics team.
STEPHEN CLAPHAM: And what made you believe that Goldman is going to be so successful was, I mean, it arrived in the UK. It was a very small organization at the time. Yes.
GAVYN DAVIES: I mean, interestingly in the late 19 and mid to late 19 eighties, they were almost not known at all in the UK, they had about 3-400 staff in London. They were mainly in banking and not really in markets, but they were already the blue chip name. I think anyway, the blue chip name in American investment banking and they did have a good research department with one or two very good us economists.
GAVYN DAVIES: So I thought we will actually fill a gap for Goldman. There’ll be a great platform. I loved the idea that they were a private partnership because all our partnerships in the UK were being taken over by big commercial banks. You probably remember at the time and I just felt private partnership with global scale and muscle without an international economics team.
GAVYN DAVIES: What an opportunity. It took me two years to persuade the head of research at Goldman that they should hire me and one other.
GAVYN DAVIES: But we persevered, we became Goldman Sachs economist. We built a, a big thriving team, there became partners of the firm and it was just a great thing for us to do.
STEPHEN CLAPHAM: And the partnership model, I mean, do you kind of regret that Goldman’s went public? And do you think that’s been a great success? I mean, I was amused to see the economist had the Goldman Sags cover a few weeks ago.
GAVYN DAVIES: I almost, I should have just bought the shares because that’s usually a good, yeah, I mean, a sag by Goldman Sachs standards is not that much of a s a thing actually. Did I, I voted for going public in whenever it was 1999 I guess. And we had an aborted IP O which had to be pulled because of the markets.
GAVYN DAVIES: And then we had a second go round, which was very successful. The reason I voted for it with some regret was that we had become a very large trading entity, the biggest in London by far and the biggest in New York. And it was hard for a private partnership to accept that amount of personal risk.
GAVYN DAVIES: So we, I think we had to become public, the culture changed a bit and probably over time a bit more, but that was partly because we were a public company and partly because we, we became so big.
GAVYN DAVIES: So, you know, I mean, the firm now is unrecognizable from the small sort of almost village store in London that I found in the mid 19 eighties. It’s still a great firm though. And the culture of the firm and the quality of the products and the people I think is still unmatched, interesting.
STEPHEN CLAPHAM: And I’m fascinated by this idea that there weren’t very many economists. Why are there so many now but you can’t move for, you know, you can’t watch the NBC with Bloomberg. Why are there so many economists?
GAVYN DAVIES: Well, I think macroeconomics has become central to investing and it is difficult to form a recommendation for clients in nearly any area. Unless you have some knowledge of macroeconomic trends and policy. And listen, if you try not to do that, you’ll be asked about the Fed as soon as you walk through the door, everyone is a, is a Fed watcher now.
GAVYN DAVIES: So I just think the subject has, has become very dominant in the way people think about investing and more and more knowledge is, is needed to help people make those decisions. But of course, it’s not just economics, I mean, analysis in general of individual stocks and credit and currencies and everything else has also exploded. So there just is a bigger marketplace of people and the economics has grown along with the market.
STEPHEN CLAPHAM: It’s funny that you say that you can’t make a decision without it and everybody’s a Fed watcher because in, in my sort of corner of the world, lots of value investors believe that you can just buy the stock and own it forever. You don’t need you, you can ignore the Macro which I I personally disagree with.
STEPHEN CLAPHAM: But I think there’s Macro throws up huge opportunities and in investing. But there is a slightly weird school, not weird school, but that, that school of thought that says, ignore the Macro and just focus on the company fundamentals. Do you think that, do you think that could work?
GAVYN DAVIES: Yes. I mean, I think it can work. I think it needs a very different, time scale and time horizon for the investment from the time horizon that most clients will expect from their money managers if the client wants a very long term position, which could go against them for a long period of time and then come back.
GAVYN DAVIES: That’s absolutely fine, but I do think it’s more, it’s, it’s somewhat challenging to maintain client trust and confidence in a value strategy which can have drawdowns lasting multiple years. So yes, it’s a good long term strategy in the right hands. But it, there’s a big danger of pulling out at the wrong moment too.
STEPHEN CLAPHAM: And I mean, the world’s become incredibly short term. I mean, there’s obviously reasons for that. But do you think it’s gone too far?
GAVYN DAVIES: I mean, it depends on what area of the world we’re talking about those Steve. So I, I think we’re Too Short term in lots of the ways that we think about policy. You know, our political system, political careers. And all of those things and markets certainly react a lot to very, very marginal short term changes in the news flow. I mean, for example, last year, the trust Government lasted how many weeks, six weeks, right?
GAVYN DAVIES: And the impact on the pound and on the guilt market in that period was bigger than the total impact of Brexit. Right. So Brexit, by anybody’s standards was a huge shock to the economy. And Liz Truss by anybody’s standards was not likely to last for very long. But the market couldn’t look through that.
GAVYN DAVIES: It, it, it, we saw roughly a 15% devaluation of the pound in about a week or thereabouts and then it reversed very rapidly. There’s no way fundamentals could have changed that much. So, I I do think in times like that short term termism grips psychology, but of course, that can be an opportunity for a Macro fund. So things like that are where where risk Premier suddenly blow out of all recognition.
GAVYN DAVIES: I would always want to try to take advantage of that, especially if there’s a policy change that is designed to bring that risk premium back down as there was in this case with the arrival of a new Conservative Chancellor. So it was both Too Short term but also a big opportunity actually, of course, that the world is a better place for, for Macro investing.
STEPHEN CLAPHAM: We we’ll come back to, to Macro. I wanted to talk about your time at the BBC.
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STEPHEN CLAPHAM: You were chairman of the BBC. What led you to get involved with it? And did you, were you always interested in this or was?
GAVYN DAVIES: Yes, I mean, again, it was economics actually, believe it or not. And I remember when I was at the BBC as chairman, I used to get accused of being, you know, one of those number crunchers that she didn’t understand culture and all of that.
GAVYN DAVIES: But the reason I got into it was actually an interest in the economics of public service broadcasting and how you could justify such a very large incursion into free markets which the BBC clearly represents and how you should fund it. And I wrote papers, academic work and did a study for the Government actually on how to fund the G the BBC.
GAVYN DAVIES: So I became involved through economics, but it, of course, it’s not an economics job, it’s a, it’s a public affairs job writ large as I discovered, but I got into it that way. And I always admired the objectives of the BBC and wanted to help the BBC thrive.
STEPHEN CLAPHAM: And are you sort of sad to see where we’ve got to?
GAVYN DAVIES: I mean, no, because actually, you know, the BBC has many more competitors now clearly, but it still has that thread and I think actually your podcast has inform, educate and entertain.
STEPHEN CLAPHAM: Yeah.
GAVYN DAVIES: Well, I think the, the, the trio, so, and almost nobody can better that as a description of the BBC and, and its objectives, inform and educate are very important. But so too is is entertained. And I think it’s a good mix, look that the proliferation of alternatives and the different ways that everyone but including mostly young people access their entertainment and their news has changed.
GAVYN DAVIES: But the ultimate need for an unbiased sort of source of news and source of discussion is in my mind bigger than ever. And I notice with young people they do know when things are really important to them, they can access a good version of the truth on the BBC. And it’s harder to do that on the web.
GAVYN DAVIES: I mean, it’s really difficult to navigate the noise on the web in order to try to judge what is true and what is not true. So I think it’s still got a massive role and it will never be the same as it was in the sixties and seventies with 25 million viewers on a Saturday night for Morcom and wise.
GAVYN DAVIES: But it will still have, I think a big place in our national life and it’s still funded the same way. And that is, I think key the license fee has proven to stand the test of time. And whenever governments have tried to change that there’s enough disadvantages with any of the alternatives that they seem to come back to the license fee. And I hope that will remain for a long time.
STEPHEN CLAPHAM: So for the benefit, so that this podcast is listened to in over 100 countries, which is quite remarkable in America. The public service broadcasting is, is a really pretty lame, it’s small, right?
GAVYN DAVIES: That, that’s the key. I mean, the BBC is an interesting, I think, very interesting British institution, like a lot of our institutions, it’s kind of unique and it was developed over time by serendipity often.
GAVYN DAVIES: But two things I think make it very unusual. First of all, it’s very big in the infrastructure of European and obviously UK broadcasting and world broadcasting, unlike public service broadcasting in the US, which is tiny 1% of the audience or something like that.
GAVYN DAVIES: And secondly, and I’m adamant about this and will go to my deathbed believing this. The BBC is not the state or Government broadcaster, it is the public broadcaster owned by the public. People say it’s owned by the Government. True, they have to rubber stamp or agree to the financing of the BBC.
GAVYN DAVIES: It’s not their decision and they appoint the chairman, but as soon as you become chairman of the BBC. You’re serving the licensed payer, not the Government. And that was written really large on my, on my desk. And I always tried to do that when I was chair.
STEPHEN CLAPHAM: It’s funny because I was reading the F T yesterday about Murdoch and his involvement in Fox News and the, the whole Trump, elections scandal. And it really makes you glad you’ve got an institution. But today the BBC is a much stiffer competition. I mean, what do you make of all the streaming channels and streaming wars? And how does that affect the landscape? The cost of production has gone through the roof.
GAVYN DAVIES: Again, it depends a little bit on the genre that we’re talking about. I think on the whole, that streaming of discussions and entertainment is a good idea. It, it’s broadened the choice and it is greatly broadened the accessibility to an audience for most, you know, people, they don’t any longer have to persuade the producers of the BBC to run a program or invite them on a program, they can do it themselves.
GAVYN DAVIES: And the market speaks the podcasts and the streaming entertainment that is most wanted gets, gets attention in a way that it did not used to do. But of course, that comes with downsides as well. It comes with downsides that rather bizarre.
GAVYN DAVIES: Sort of ideas can get a grip on people more easily, which would never have got air time on the BBC rightly or wrongly.
STEPHEN CLAPHAM: But, I mean, things like Netflix is valuation. I mean, does that make you scratch your head?
GAVYN DAVIES: I mean, do you think, well, a lot less than a year ago, I mean, it’s, I guess it’s down, what, 70% in a year or so.
STEPHEN CLAPHAM: I mean, one of the things that I think is quite interesting, I’ve written extensively about Netflix is content accounting. It’s got a $30 billion asset on its balance sheet for, for content it’s bought but not yet advertised. And I’ve been accusing them of advertising too slow.
STEPHEN CLAPHAM: But the, I mean, the BBC doesn’t have a dollar or a pound of, of content assets in its balance sheet. Do you think that would change the way people think about what they invest in? I mean, do you think it is a good idea, carrying a content asset or a better idea not to?
GAVYN DAVIES: Well, the BBC can borrow if it, if it wants to and it does actually borrow money periodically to fund primarily it’s private entrepreneurial, not entrepreneurial but private sector wing. It does sell content to the private sector. So I don’t think it’s very constrained by that in terms of what it can do. But look, the BBC can’t now compete for the best sports rights. It, it can’t show premiership football live on TV.
GAVYN DAVIES: And increasingly it’s unable to compete for top drama. I mean, if you take the crown for example, I think 20 or 30 years ago, there would have only been one home for the crown and Netflix won, it, bought, it won, it produced it brilliantly. I mean, you know, it can’t, I don’t think you can describe how good it is.
GAVYN DAVIES: And the BBC might have done it as well as that, but they couldn’t get the actors, the production staff, all of the sets and cost. I mean, the whole thing is just done with such perfection. So the BBC can’t actually do that at least in large amounts.
GAVYN DAVIES: Nowadays, you turn on Netflix, look at the front page. There are like 10 different new series, each of which has 8 to 16 episodes that you can watch and BBC can’t do that anymore. So it has to pick its battles and act where it can add to what the private sector is doing and I think it still does do that.
STEPHEN CLAPHAM: Well, hopefully it have AAA big role to play for, for, for much longer. Turn to economics, of course, is your, your, your main job, I guess.
STEPHEN CLAPHAM: We’ve had 40 years of falling rates and we’re not going to have the next 40 years. Aren’t going to be the same. I did a whole series of podcasts last year talking to Macro commentators about, about this. But it, it, it’s, it seems to me it’s got much less air time than it should have.
STEPHEN CLAPHAM: And it seems to me that you know, we’ve been running downhill for quite a long time. We’ve had the benefit of falling rates, valuations have increased and now they’re not going to, I mean, how do you think the landscape changes now? And what do you think is, is everything going to be different? I mean, I think everything is gonna be different over the next decade.
GAVYN DAVIES: Yes, probably. I mean, look, the financial markets have had a tailwind from declining interest rates and that has, has run from the early 19 eighties to the present or recent past anyway. And has underpinned all of the valuations. Of course, it’s produced strong returns in the bond market.
GAVYN DAVIES: But also it’s underpinned all of the equity valuations too. And there is a school of thought that says that was all the product of the central banks and it was not driven by fundamentals. And therefore this is a massive bubble.
GAVYN DAVIES: I don’t actually believe that I I think the drop in interest rates, bond yields and the rise in equity valuations was all driven basically by a decline in the equilibrium rate of interest in the economy. What’s called our star by economists and the central banks just had to over decades follow that downwards.
GAVYN DAVIES: Otherwise they would have produced massive deflation in the system if they had not done that. So I think the the deep structural fundamentals of the economies drove the equilibrium interest rate lower and the central banks just sort of validated that and all of the valuations that we saw, let’s say up to 2021 were basically driven by that on top of which there was clearly a bubble, right?
GAVYN DAVIES: I mean, you know, you don’t need to be a rocket scientist to see that by 2021 in some parts of the market.
GAVYN DAVIES: I mean, there was a massive bubble in stock prices which is now punctured and the the most bubble affected stock prices have dropped the most. And I think we’re now back into realistic territory. But what I think we can’t deny is that the very high returns that we’ve seen have been bringing forward future returns and leave us expecting somewhat lower returns in the future than we’ve seen generally in the past.
GAVYN DAVIES: And if interest rates have to rise back to, you know, very high levels to control inflation, then we could see a period of, you know, abnormally very low returns.
GAVYN DAVIES: So I am worried about that, but I’m more sort of, I would say long term realistic that returns that have characterized my period as an economist in the markets were a lot better than we are likely to be able to see in the future. And that’s a long term thing, not a short term thing.
STEPHEN CLAPHAM: And what implications does that have because I mean, things like pension funds who are assuming that they’re going to get a certain level of return 8% from equities. And if they’re not gonna get that and inflation is a bit higher. I mean, there’s a whole knock on effect through the whole system because obviously companies are gonna have to top up the pension. What lies ahead that people aren’t talking about?
GAVYN DAVIES: Well, I think the pension system is adjusted already. Remember. So a few decades ago, most pensions certainly in the public sector were entirely defined benefit. So you got your benefits for putting the money into the pension fund.
GAVYN DAVIES: Now, they’re more defined contribution schemes and they’re not as vulnerable to the increase in interest rates that may happen or the reduction in expected returns. So I think that, you know, the pension funds have already a, you know, adjusted to some of this. And I think Government schemes are also going to have to adjust if longevity increases as we all hope it will by delaying the availability of pension benefits.
GAVYN DAVIES: And we won’t be able, I think to run a pension scheme designed for the 19 sixties or 19 eighties in the 2000 and twenties. But I don’t think we’re trying to either stay. I I’m not that I’m not pessimistic that our pension funds are facing ruin or anything of that nature.
STEPHEN CLAPHAM: I don’t think people should fear that at all, but there are, there are a lot of areas where people have assumed that returns will be the same. So I think of say private equity where the returns have been juiced by leverage which has been falling in price or further juicing the returns, the valuations have been rising.
STEPHEN CLAPHAM: So again, they’ve had a, had a, had a benefit from that. I mean, I think that private equity is going to have a much, much harder time over the next 10, 20 years and it’s had over the last 10 2030 years.
STEPHEN CLAPHAM: And at the same time, allocations to private equity are much, much, much higher. And we start off from a position that, you know, many of the private funds haven’t properly marked the market. I mean, and I know you’ve got an inside track in this, but you’ve, you’ve got inside view on private equity.
GAVYN DAVIES: But do you think there’s a risk in that sector or you feel comfortable or, you know, again, I think a, a good deal of the adjustment has occurred as, as you were suggesting there, I did, I have founded two co-founded with partners, two private equity companies, one on the west coast in the US and one in the consumer sector in the UK called an capital and active capital partners respectively.
GAVYN DAVIES: They’ve done very well over a long period of time. The I mean, clearly the, the, the 2021 Fed tightening that started in November 21 has greatly moved the valuations and taken the froth away.
GAVYN DAVIES: As long as the companies are not over leveraged and are not seeking refinancing in a time where markets do not want to provide debt finance or even equity finance. Then I don’t think there needs to be a meltdown. But for the most part, and we all think our own endeavors are different, don’t we? But for the most part, private equity on the whole gives you leveraged public equity returns over time.
GAVYN DAVIES: They are slightly riskier maybe, but you don’t Mark them to market all the time. So you don’t see those risks on a daily basis like you do with your public equities. And I think, you know, that’s what will happen in the future. We’ll get somewhat leveraged public equity returns.
GAVYN DAVIES: I expect those returns to be positive and healthily positive, but maybe not across the whole of private equity as high as they have been in the last decade or two decades because they have private equity has to reflect the valuation of the stock market. Ultimately, it has to, in the end it will, it will like we’re having at the moment where it might take longer.
STEPHEN CLAPHAM: I mean, do you, are you, it’s called active private, are you actively involved in active private equity?
GAVYN DAVIES: I absolutely, I am, I mean, I spend nearly all my time at Fulcrum as a macroeconomist.
GAVYN DAVIES: You said earlier, you know, you’ve done a lot of things. I think I’ve done one thing in lots of places or lots of activities and the one thing is being an economist, right? So the main use in my portfolio at the moment for that skill is Fulcrum, which I’m very proud of.
GAVYN DAVIES: But absolutely, I work with the with the ants team on the west coast in the US and with the active team in London about, you know, picking investments. I’m not on, I don’t actively do that for an and monitoring them and thinking about exits and doing all of those things. So I’m very actively engaged in that with a corner of my life, but it isn’t the main thing I do.
STEPHEN CLAPHAM: And what do you bring to the, what do you bring? What does an economist bring to a private equity firm? Do, do many private equity firms have economies? Well, no, I, I’ve got a big economics team.
GAVYN DAVIES: I know they got a lot of credit. I used to work for K K R as well.
GAVYN DAVIES: So no, I don’t think it’s, it’s not common to have a macroeconomist working in private equity K K R have and always have had analysts with a strong economic bent because they’re picking sectors, you know, a big, a big private equity group like K K R is deciding between the energy sector and the consumer sector and the banking sector and whatever and those sort of big sectoral decisions definitely have an economic content to them lately.
GAVYN DAVIES: What I’ve noticed we have a fortnightly call with with my partners in on the west coast in an, I mean, like half the call is about economics because yes, because they know that what the Fed does is going to impact the length of any downturn or the depth of any downturn in the economy.
GAVYN DAVIES: It’s going to impact when the markets spring back to life. When the IP O markets come back, they’re gone by the way completely. And judging what to do with the investments that we’ve made and are going to make in the future at the moment does have a macroeconomic content, but you’re right.
GAVYN DAVIES: Not normally normally, it’s more, I suppose, judgment and certainly judgment about policy, that does affect them and that’s normally what it is. But when we’re in a bit of a meltdown for markets and confidence and refinancing, then it becomes a much more central activity for us.
STEPHEN CLAPHAM: So, so in, in more difficult times, you need economists more.
GAVYN DAVIES: That’s been my experience in private equity.
GAVYN DAVIES: One thing I worry about and my, my team at Fulcrum will, will tell you our team at Fulcrum.
GAVYN DAVIES: Is that I just have this belief that macroeconomists tend to be better in bad times than they are in good times. I think they’re pessimistic, you know, by nature, you can’t be a pessimist in the world of private equity because you won’t buy anything.
GAVYN DAVIES: You can always find a reason not to take the risk, right. So you can’t be, and I’m trying to get more optimistic in my day job instead of just doing well in bad times, macroeconomists in general have come out of the bond market or?
GAVYN DAVIES: Yeah, usually the bond market, they’re not as, usually not as important in equity markets and therefore they’re more comfortable with recessions than they are with lengthy periods of high returns in the stock market. I know that bias exists. I’m doing my best to avoid it. We’ll see when it next happens.
STEPHEN CLAPHAM: And the portfolio companies, I mean, how are they, how, how are they perceiving the world you get? Is, is this like AAA feedback loop for you because you’re opining on what it’s gonna happen. But you’re also getting you, you’ve got feet on the more feet on the ground and you do, you mean in the private equity in the private equity space?
GAVYN DAVIES: Look, I’m not, I am not really ever taking an active investment decision, certainly not by far, not on my own.
GAVYN DAVIES: I’m just an input into the process.
GAVYN DAVIES: The majority of those decisions are very, very, very dominated by the specifics of the company and the specifics of the market that the company is in and I may or may not know anything about that but our general appetite to deploy capital.
GAVYN DAVIES: I am one of several voices that determines how aggressive we should be and I think it’s a, it’s a slightly different point of view but it, it by no means is a single or the most important point of view.
STEPHEN CLAPHAM: I just, I was just wondering in the same way as, you know, when you talk to a, a quoted equity fund manager, he’ll quote back to you, his experience from meeting companies is invest companies and you know what the anecdotes are and what the, the, the, the word is on the ground. I just wondered if you get, if your macroeconomic analysis benefited from the association with all these companies.
GAVYN DAVIES: It can do. I mean, when we are making just pure Macro decisions, with our Macro funds, we always try to take account of more anecdotal evidence that we’re getting from the equity people in Fulcrum. So we try not to fly blind to that anecdotal evidence.
GAVYN DAVIES: When I was at Goldman, we spent a heck of a lot of time trying to make the anecdotal evidence from our analysts, company analysts measurable and produce, produce indices from it about the way the economy was behaving and Goldman still does that exactly the same way.
GAVYN DAVIES: As always, we’re unable to do that as clearly in Fulcrum because we don’t have as many analysts. But absolutely, we do not ignore what our equity people are hearing from companies. It’s a, it’s a key part of our process.
STEPHEN CLAPHAM: It’s interesting. I mean, you, you, you founded co founded four different asset managers, you, you’ve alluded to, I mean, why were you such a popular partner for your co-founders? I mean, that’s a lot. I mean, astonishing.
GAVYN DAVIES: Yeah. No, they’ve all been successful. They all, they have all been highly successful because of my partners. And look, I, I suppose there were a lot of things actually. I mean, when I left Goldman went to the BBC, you’ve been too polite to mention, but I left the BBC rather abruptly. Having had a big falling out with the then labor Government or at least the press secretary of the then labor Government Government.
GAVYN DAVIES: And I just had lots of people find me up saying Gavyn come back into the industry and, I kind of did them believing that I wouldn’t get very actively engaged in some of them. I could allocate money. I could, you know, help them seed the beginning of their, their time, but they are the same partner.
GAVYN DAVIES: They’re broadly here now, the same partners in the same places and they’re my best friends. So it’s worked out well so far. But, you know, I always say so far because you never know what’s next in markets.
STEPHEN CLAPHAM: Well, that’s very, very wise and very sensible. But that, I mean, you’ve, you’ve had a foot in the Government kind of camp. You were an advisor to the labor Government, you were chairman of the BBC and you’ve been in the private sector. Are these skills transferrable? I mean, what are the similarities, what the difference is from on both sides of those fences?
GAVYN DAVIES: I don’t think they’re directly the same, but I think the skills are transferrable, by the way, I also worked for the Tory Government in the mid nineties. So I, I really sort of shrink away from politics if I can.
GAVYN DAVIES: I’ve got a amazingly wonderful wife who’s a labour peer so she can’t shrink away from politics. But I don’t, I’ve never had a, I’ve never had a belief that one side or the other knows everything about the truth and I just don’t believe in that at all.
GAVYN DAVIES: In terms of market economics, compared to policy economics, I do think the time horizon is different, the Macro markets move quickly and over short time horizons, that isn’t so important in terms of policy thinking, economists will always try to get the politicians to think longer term and do things that are sensible, at least over a five year view. So many of the content matters are the same but with a different time horizon.
STEPHEN CLAPHAM: And I mean, you maybe don’t want to, to talk about the personalities, but I just wondered if you had any observations we’ve been through sort of, Trump and Boris versus Biden and Richie. And, you know, I know who you perhaps, or I know who I would want to go to dinner with. But I mean, in terms of running the country, I mean, are we in the right place now?
GAVYN DAVIES: I mean, I think we have a very good prime Minister and I think we have a very good chance to the Exchequer. We went through a few alternatives before we got to, to those two. But of course, was a golden This is going to begin to annoy people who hate Goldman Sachs, so apologies to them, but he is a fine person in my opinion and he is a very good public spirited policy maker who’s very intelligent. So, you know, I like him.
GAVYN DAVIES: I hope he succeeds. I also happen to like, I think he’s good too. So we’ve, we’ve got to a point now where I think in the next election, the prime ministerial choice will be much more sort of standard UK kind of thing. And, you know, we went through a phase where much it was mostly about Brexit, certainly on one side and the alternative in Jeremy Corbyn was even worse, in my opinion. I’m very happy to say that.
GAVYN DAVIES: So it wasn’t a great period. But I think we’re back to a more normal choice now that isn’t really gonna go wrong.
STEPHEN CLAPHAM: But politicians here and in the US and indeed everywhere are very constrained, aren’t they? Because we’ve got a huge amount of debt. And you hear people like Stephanie Coton talking about the M M T the modern monetary theory and saying the debt doesn’t matter because you can just print more currency.
STEPHEN CLAPHAM: I mean, what’s your take on that? Because it seems nonsense to me. It just seems, you know, I’m not an economist but it just seems sensible to think that if you’ve got a lot of debt then there’s less things you can do.
GAVYN DAVIES: And yes, I mean, look, we found out last October and November that debt does matter, at least in the UK. So I think M M T had a bit of a setback there. Frankly, I must say that to be fair to them. They don’t say that debt never matters. They say it can always be monetized by a national independent central bank.
GAVYN DAVIES: But they add, when that causes inflation, then you’ve got a problem, right? So they, they will, their basic conclusion is public debt doesn’t matter if you have an independent central bank as long as you haven’t got inflation. Now at the moment, we have got inflation.
GAVYN DAVIES: So the new line from the Conservative Government at the moment and was very, very firm about this when he was shout to the Exchequer is that debt can matter, does matter. It increases risks to the economy. We saw those risks blow out of all proportion. A few months back. We’re now back in proportion.
GAVYN DAVIES: But it, it’s still very optimistic ST stroke kind of crazy when inflation is running at these levels to say that debt doesn’t matter, it’s just not sensible.
STEPHEN CLAPHAM: And when you sort of look forward, I mean, Russell Napier, who’s also been in this podcast and is, is, is actually a of mine. I mean, he’s been very vocal about financial repression and he believes the Government will ration credit and force people to buy their bonds here and across the Atlantic.
GAVYN DAVIES: Do you share that pessimism or do you think we’ll just kind of my friend, Andrew Smith who’s also an economist says, well, usually we just muddle through and that we usually do muddle through at least look if we’ve got the right institutional structure and we are a capital, basically a market driven, call it capitalist if you want to system. And a democracy muddling through is the most likely outcome.
GAVYN DAVIES: I think now that can of course, include some financial repression. So it can include periods where we’ve just seen one right where bond yields were driven down to very low levels by purchases of bonds by the central bank. And therefore the returns on those bonds to investors were repressed and, but it was a kind of voluntary thing.
GAVYN DAVIES: It wasn’t done by much, by regulation and by enforcement. So I think that’s a more likely way that we end this saga of high debt or at least control it than a much more resist control regulatory regime where people are forced to save at negative interest rates. That’s what I think. Now in the 19 fifties, we had financial repression. We had very low interest rates for the whole decade after the war.
GAVYN DAVIES: Real rates were low it was easy to refinance debt. But the debt to GDP ratio fell and that that can happen, that can happen.
GAVYN DAVIES: And Olivier Blanchard who is one of my most admired economists in the world has just written a very big book about public debt saying that as long as nominal GDP grows faster, so the growth rate in nominal GDP including inflation is higher than the interest rate on public debt, then you really are unlikely to have a big problem.
GAVYN DAVIES: You’ve got to have a really profligate Government to run into problem as long as the growth rate in national income is higher than the interest rate on the debt. And that’s where, that’s where we are.
STEPHEN CLAPHAM: I think I’m glad you summarized that because I didn’t Fancy reading the very big book a bit too difficult.
GAVYN DAVIES: You would benefit from this one.
STEPHEN CLAPHAM: But the, the, this is a good environment for Macro though, isn’t it? I mean, it’s been a tough sort of decade. Why, why has Macro been so difficult and, and will it now have its have its time in the sun again?
GAVYN DAVIES: You know, I mean, I don’t, we haven’t found it impossibly difficult in the last decade but trying to keep up with soaring equity prices has not been easy, of course.
GAVYN DAVIES: But then those equities as we’ve seen come with great periods of very damaging volatility to clients. So our returns have been positive and we haven’t had big down years or anything like that at Fulcrum.
GAVYN DAVIES: But I think now some elements of our style of investing are kind of better suited to the shocks we’re seeing.
GAVYN DAVIES: So understanding and having lived through the inflation shocks of the seventies is one thing, a belief that inflation will be persistent has kind of worked reasonably well for us and a lot of people thought, you know, team transitory as it was called, believed that most of the inflation shock would just disappear quickly. A lot of it has because it was about energy.
GAVYN DAVIES: But the bit that was not about energy has proven pretty persistent and you think it will continue to be persistent. I think it’ll look, I think that it’s not the main part of the inflation shock we saw last year because that was energy and food.
GAVYN DAVIES: But from now on the lower level of underlying core inflation, I think will prove fairly persistent and that will take a while for us to get it back down to 2%. And it’s a battle. It’s a, it’s a battle to do that for the central banks to remain to continue to have public confidence while they are remaining in a hawkish mood while inflation is dropping towards 2% is, is difficult for them.
STEPHEN CLAPHAM: I think they can do it but I don’t think it’ll be quick and has done well, but the Macro class hasn’t and there have been so I mean, there’s been some classic blow ups that I’ve forgotten the name of the, the fund that was betting against the Swiss Franc. And I, I remember it very well because I bought the Swiss Franc on the basis that it was exactly the same as George Soros and the Bank Of England.
STEPHEN CLAPHAM: Except the other way around, they would have to give up and the Swiss Franc would go through the roof and this fund was betting was doing the Japanese J GB carry trade on the Swiss, right? You think? Well, it just seemed mad. I mean, are there still some mad people left in Macro? Is that, or is it just been a very difficult law volatility environment? And that a more volatile environment gives people more opportunity?
GAVYN DAVIES: Well, I think what you’re doing there is characterizing a version of Macro hedge fund land, where actually rather large risks are taken and the returns can be plus 41 year and minus 10 the next or whatever.
GAVYN DAVIES: We don’t really do that. That isn’t what we do. We’re taking much more diversified positions in markets.
GAVYN DAVIES: We’re not in any sense trying to blow the lights out and we’re trying our best to hedge. I mean, genuinely hedge. We’re not a hedge fund, we’re an asset manager.
GAVYN DAVIES: And one of the things that we say to our clients is there’s a distinction between a Macro hedge fund which has an objective, objective of a vol level volatility level of 15 18% and an asset manager that has an objective of 8% and believes in Macro as one of perhaps the main thing that drives investment decisions, not trading decisions.
GAVYN DAVIES: And that’s what we think we do. We’ve got this mantra which is we try to be Macro investors, not a narrowly defined Macro hedge fund.
STEPHEN CLAPHAM: It’s interesting because I think of Macron as being quite active, quite fast trade because when you think of a George Soros or some, somebody like that, you, you think of them being, having very strong views and having very, very big positions.
GAVYN DAVIES: That is classical Macro hedge fund. Look, we do do some of that. I’m not, I’m not pleading innocent here. We do do some of that, but it isn’t the only thing or even the main thing the fund does. And the fund has many other aspects to it, which hedge and protect against those, those positions going wrong and they’re not concentrated over the whole fund. So that’s our style.
GAVYN DAVIES: We don’t think that that style has gone out of favor, but I think that Macro investing is certainly more appealing to many clients at the moment than, than it has been in the past.
STEPHEN CLAPHAM: Now, when we talked about this, when we had a phone call beforehand, we, we share this view that analysis is great fun. And I set up this podcast to inspire young people to become analysts and, and and thought it was a great job. Tell people what it’s like to be an economist because they, I mean, I’ve been preaching about analysis but why should people think about being an economist?
GAVYN DAVIES: Well, I mean, lots of things. First of all, it’s always about things that matter. At least being a macroeconomist is always about things that matter. So you are occupying territory which is always leading the news and is intrinsically interesting and which matters to a great number of our fellow citizens, unemployment matters, inflation matters, returns on their pension matters enormously.
GAVYN DAVIES: So it’s hard to avoid things that are intrinsically important. Actually, when you’re a macroeconomist, the other thing I would say is it gives scope for lots of different types of analytical thinking.
GAVYN DAVIES: So some of it’s purely mathematical algorithmic econometric and some of it is Political Economy, it’s not necessarily directly measurable. It’s about what the politicians are going to do next and how the central banks are going to view the multiplicity of different pieces of advice they’re getting. What, how are they going to imbalance them and what are they going to do?
GAVYN DAVIES: I always actually have another thing I tried to ask our team to do is don’t use too much of the word should and use more of the verb will because actually what we’re trying to do is predict and position ourselves for our clients on what will or may happen, not on what we think should happen I remember the evening that Trump won, you know, when he beat Hillary Clinton.
GAVYN DAVIES: Very surprisingly, a lot of people said this is a complete disaster for the stock market. I mean, the guy is going to introduce protection, et cetera and, and, you know, who could trust him and, you know, all of those things. But I remember the night that Reagan won in 1981 I was a bit younger.
GAVYN DAVIES: And people said the same thing in late 1980 when Reagan won, they said this guy, I mean, how can you have a Hollywood actor being president of the United States? I mean, he can barely speak. And there was a big bearish tendency in, in the stock market certainly in the thinking that we had at the time.
GAVYN DAVIES: And then of course, the stock market did well because actually the markets liked the market friendliness of Ronald Reagan and the tax policies, I think to some degree and they quite like the market friendliness of Donald Trump and the market went up, not down over the next 12 months. So things like that are fun. I think if they go right and very, very not fun. If, if they do do not go right.
STEPHEN CLAPHAM: Advice to buddy economists, young economists in the audience. What, what’s the best way of, of getting a job at Goldman Sachs?
GAVYN DAVIES: And you got to be good at what you do. Listen nowadays, you have to have a probably anyway, a phd in my day, you didn’t, I had a post grad experience at Oxford, but you didn’t have to have a phd. Now, my head of economics, I think would really only hire you if you had a phd from a school that he approved of.
GAVYN DAVIES: So, you know, it’s used as a selection mechanism. But I don’t really think that, I mean, I, one of the things that John said on your podcast recommended listening was investing is not religion, right? I always worry about people who think that there’s a right and a wrong about investing. It’s gray zone stuff, it’s not black and white stuff.
GAVYN DAVIES: So do you always have to have a phd? No, in my view, you can see things, a lot of the finest economists in the world in the markets don’t have phd S. Anyway, I do think you have to work hard though, but that’s the case for almost any in endeavor.
STEPHEN CLAPHAM: And tell me, I normally finish by asking people to recommend a book, Jim O’Neill, recommend an economics textbook.
GAVYN DAVIES: Are you going to do this?
GAVYN DAVIES: I don’t remember. I could, I could have done that. So you saved me from that fate.
GAVYN DAVIES: No, I’m going. However, I will recommend an economics book or at least a Political Economy book. So Martin Wolf, the chief economics commentator in the for the Financial Times for decades now and the best in the world at that job. In my opinion, has just written what has been called his magnum opus, his sort of life’s observations, I guess.
GAVYN DAVIES: And it’s called in defense of Democratic capitalism just come out. And it’s a book that in parts is pessimistic in Parts is very personal about Martin’s family, which was a refugee family from the Nazis during I think the war or just before the war.
GAVYN DAVIES: And you know, his warning and creed occur is this can happen again and be careful. Don’t take our stability for granted and he wraps together democracy and market economics as two sides of the same coin in a sense and they thrive together, but they can also be challenged and failed together.
GAVYN DAVIES: And I think at the moment he’s warning that there are signs of our market system coming under strain, that our economy is performing a lot worse than used to be the case. And that beginning to lead to rather odd developments in our democracies.
GAVYN DAVIES: And he has some solutions, many observations and it’s brilliant and everyone should read that book.
STEPHEN CLAPHAM: I really, well, I should add it to my list. I’ve got rather long list and Martin is, I mean, he’s obviously a brilliant guy but it’s writing those very dense columns. They’re not the, the, the easiest reads. So I imagine his book will be some of it is challenging a little bit.
GAVYN DAVIES: But I I, what I think about this is, it’s written in pure English. I mean, there’s nothing in there that you can’t understand. It’s written about one of, if not the most important things that is going on in the world. I mean, probably is the most important thing, I guess.
GAVYN DAVIES: And it’s not just economics, it’s, it’s politics and society and how we should cope with the massive challenges that our next generation will face. So, it’s a serious book.
STEPHEN CLAPHAM: Oh, it sounds, it sounds like it’s gonna be interesting. Listen. Thank you so much for coming on. I really enjoyed talking to you. I appreciate it.
STEPHEN CLAPHAM: Well, you can see why Gavyn Davies has been so successful and in such a wide range of endeavors, commercial success often proves elusive for economists unless they happen to be the founder of a Macro hedge fund that Gavyn has succeeded in so many different spheres is an indication of the quality of the individual as ever.
STEPHEN CLAPHAM: Thanks for listening and for subscribing. It’s great to see the podcast growing. Please tell all your friends and colleagues.