What investors need is additional diversifiers as well as liquidity buffers. There's a real value to having cash in a portfolio today that is actually paying a decent amount of interest. But other allocations, whether it's commodities or gold or private markets, they will add to the overall portfolio. In the US, for example, 85% of all companies with more than 100 million of revenues are privately held. And we all know that the regulatory environment for banks has had them really not be in a position to extend credit. And that's led to the growth in private credit because in some cases, you just can't get the access in the public markets. To think about AI and the impact on infrastructure and data centers that's difficult to replicate but is only available in the private markets.
A few weeks back we were asked if we'd like to interview State Street Investment Management. After 6 years of building the Money Maze podcast, we're incredibly lucky that we get approached by lots of interesting organizations and in fact we turned down over 300 approaches last year. Since size is not a requirement to be a guest, we typically do quite a lot of research ahead of a potential interview. And having been in this business for over four decades, my initial reaction when State Street was mentioned was this was an organization largely in the safekeeping and asset servicing business. Then I went and took a closer look and I'll confess to being surprised and educated to learn that in fact the fourth largest asset manager globally with circa 6 trillion. So updated, re-educated and intrigued as size offers opportunity, but also it can be the enemy of agility, we said yes, please. So it's a pleasure to welcome Yie-hsin here, the CEO of State Street Investment Management into our offices. Welcome.
Thank you. It's great to be with you.
Well, you're over from New York. I'd like to say exclusively for this interview, but I know otherwise. And hopefully we're going to cover, you know, a lot of ground. And you've written some really interesting things about the future of asset management, about the savings gap, active versus passive, and we'll touch on a number of those. But two particular points intrigue me as I started my research. One is that State Street is the second oldest US bank, 1792. So, there'll be some going, well, I wonder which is the oldest bank. Well, I gather it's Bank of New York by a year. I might be corrected. And in the last year, the group as a whole produced over 14 billion dollars of revenue, of which your business was over 20%. And you've been in the UK since 1972. So, that was the first thing. And the second thing was you've been named as one of Baron's most influential women in US and finance. And like me, that is not that you're like me, but like me, you're also a Morgan Stanley alumni. So, I thought those were quite interesting things. So I want to jump in but just before we talk about investment management I read that your father was an engineer. There was this engineering sort of you know I think culture in your family. Did markets and finance get discussed around the dinner table?
You know, markets and finance weren't a big topic around the dinner table. Although I do remember vividly my father was an investor in the stock market. And having advised him when the market had gone down, I caught that bit of news and told him he should sell everything. And now with the benefit of hindsight, I realized what a big mistake that was. Unfortunately, he didn't take any of my advice.
And at what point in your education did you start to think, hang on a second, I'm drawn potentially to this world of finance?
Yeah. So it was after my undergraduate, I had studied mechanical engineering and I did follow my father's footsteps. He was a civil engineer. I love math and science and solving problems. Although I find myself working during the summers and thinking to myself, I'm much more interested in what these companies, what their strategy is, what their products are, how do they go to market. And so when I had the opportunity to go to business school right after undergraduate, that's where I got introduced to the whole world of finance. And my first step coming out of business school was really to go to Wall Street.
So you have spent time at Bridgewater. We had a very enjoyable interview a few years back with Ray Dalio. You were at New York Life for over 12 years as CEO and as we discussed Morgan Stanley for over 10 and I wondered if any one of those institutions particularly prepared you for your current role.
You know they all contributed greatly. I mentioned going into real estate investment banking or at least investment banking at the outset and it was the part of my career where it was pretty much coming in as an associate and moving my way up with greater amounts of responsibility. But having been in the real estate sector, it was an area that had undergone tremendous change. A lot of private companies going public. But at the same time, the internet was taking off. And so I found myself in a group that was call it a little bit topheavy and my ability to just continue to advance was more limited. And fortunately my boss sat me down and said this doesn't look like it's happening here. Let's explore something else. And so I moved into this area that was the intersection between investment banking and technology. And I remember the first six months not understanding anything anybody was saying. And then one day it sort of clicked and it started me on this path for a good part of the middle part of my career where I had a different responsibility, a different job, a different function almost every two to three years. At times that was challenging. Other times it was really exciting. But I would say the totality of all of that when I look back it was the best training possible for the leadership positions I've had at New York Life and now at State Street.
Great. So, let's laser in on the world of investment management. Longer lives demand increased retirement security. And I'm going to just quote a piece of trivia here about aging. And that was I was reading a piece which was talking about the late Queen of England. And of course, she sent out notes when people were 100 years old. It was the telegrams originally. When she started doing that, she was sending 385 a year. When she died, it was 16,000. I thought that encapsulated aging quite well. But retirement security, it's a big deal. There's a big gap. What have been your observations about this whole issue?
Well, it's unfortunately a very significant issue and I think there are variety of factors we can go and look at whether it's income levels, access to capital markets, the amount that people are investing early on in their careers. And so I think the answer today is not necessarily for investors to take greater risk but to think about smarter diversification and then for firms like us to be able to provide easier access to the capital markets less frictional costs and I think what I see today is there's a lot of really good developments on that front. We're one of the largest ETF players among the asset managers and frankly I'd say it's been just over 30 years now that sort of the ETF industry grew up around the very first that we launched following the S&P 500. And so our idea has always been about democratizing investing. How do you take strategies that are available to ultra high net worth large institutions and make them easy for people who have maybe 100 pounds to invest and so we've partnered with other asset managers like Bridgewater we talked about Ray Dalio's family office was invested in their all weather strategy and so last year we took that and made that available as an ETF and so that's what I mean by taking some of these strategies that are diversifiers that might enable people to help bridge that gap and the other piece for us has been we've seen how the next generation of investors are starting to lean much more towards wealth tech digital access to investing and those partnerships around the world is something that we've been focused on delivering our model portfolios our building blocks if you will to give everyday people the opportunity to access the capital markets to do so in a more frictionless way.
So, we're going to tease a few of those out, but let's just step back up to the foundation of a lot of financial planning, which was the 60/40, the 60 equity, 40 debt, and you know, every optimizer that's ever been run has had some variation thereof. And then we came to this sort of extended period of zero rates. Some could argue like I would central bank negligence. And the 40 started to morph and so did the 60. Just give us a snapshot right now of how in your mind that 60/40 has been reconfigured.
You know, you raise a very good point because the 60/40 traditional model worked for a very very long time, but it was also a period of time when we saw declining interest rates for multiple decades. And so under that scenario, bonds actually delivered pretty compelling total returns. We're now in an environment where we're sort of flat to increasing interest rates. And so the likelihood of bonds delivering that kind of total return is much reduced. And so the 60/40 portfolio would suggest that it's reasonably balanced. But the issue is because of the volatility and the return on the equity side, it's really heavily weighted in that direction. And so it's created much more volatility and the correlations between equities and fixed income hasn't been as uncorrelated as it has in the past. If you think about inflationary environments, typically those are environments that neither fixed income or equities do all that well. And so our view is that what investors need is additional diversifiers as well as liquidity buffers. There's a real value to having cash in a portfolio today that is actually paying a decent amount of interest. But other allocations whether it's commodities or gold or private markets they will add to the overall portfolio and get to the broader diversification that what we had come to expect the 60/40 portfolio to deliver really needs those elements today.
So let's just talk about those private markets. As sort of an all-time investor, I've been somewhat cynical about the substitution of some of the traditionals for private equity and debt. We know that there's already been a retracement from the likes of, you know, the origins of the Swinson approach at Yale. And you know, you only need to pick up the paper every day, even if it's being slightly alarmist to know that the tsunami of private equity and private credit deals and their interconnection is beginning to show up a number of flags. I mean, I was really surprised when, you know, in I think it was in BlackRock's Infinite Commerce goes from 100 cents mark three months later to zero and that had followed from Renova Home Partners. So, you know, private credit, private equity, how do you assess their vulnerability right now?
Well, I would to step back, I do think that there is still a lot of value creation in the private markets. In the US, for example, 85% of all companies with more than 100 million of revenues are privately held. And we all know that the regulatory environment for banks has had them really not be in a position to extend credit and that's led to the growth in private credit. So importantly, I do think individual investors should have access to these asset classes, but they're not the same as David Swensen and Yale, which had the benefit of huge scale, the ability to access some of the top tier asset managers, and their horizon was incredibly long. And so their very substantial allocation I think it was close to 50% to private equity, venture capital, real estate. They also didn't have tremendous needs for liquidity. You sort of fast forward to where we are today and I think there is a true premium placed on liquidity and people's horizons probably aren't the same as what Yale's is.
Yeah. And again, this is an area that is really active management. And so it's important not only to think about the asset classes, but also to think about who are the managers that you're electing to put into your portfolio. And things like underwriting quality, the amount of diversification, those sorts of things matter when you're choosing a private credit manager, for instance. Same would hold on the private equity side where there is a disparity between sort of the top manager and the bottom quartile manager. That all said, I do think it's an interesting asset class. I think it belongs in portfolios because in some cases you just can't get the access in the public markets. You think about AI and the impact on infrastructure and data centers that's difficult to replicate but is only available in the private markets. But because of some of these other factors, you know, having five, 15, 20% allocation to alternatives probably makes more sense for the average investor.
I just want to pause on returns because we've got 125 years data on the S&P 500, 9% nominal returns. I sit on several investment committees and we often have this discussion. We get this series of private equity returns, but they're a fraction of that. There's all sorts of problems with the data as well. Is it realistic to expect private equity to deliver superior returns to public equities over time?
It's a very good question. I think the thinking has been yes that private equity should be able to deliver return premium to the public markets by virtue of the illiquidity premium. Now I think in recent years that has not been the case, the level of distributions that have come back from private equity investments has been much less than most investors expect. I don't have a crystal ball but I do think that there should be excess return coming from the private allocation but again it needs to be the case that investors are able to stay invested over that right horizon and to realize the benefits of that and often times the best returns are basically if an investor is very consistent in their allocation that they have vintage year diversification over time.
Yeah. And of course ultimately return is a function of your entry point in so many cases and so this disruption etc might well be affording that. The other side of the 60 is you take this enormous weight in the world index of the US stock market for all the reasons with which we're familiar. We also look at the valuations which by any measures are expensive and a starting point from which returns disappointed. So it's not Japan 1989 but you know you can see the big dispersion globally in stock markets around the world creating sort of opportunity. How are you as you design products as you think about solving that equation thinking about US overweights, dollar fragility etc?
Well, today if you look at our asset allocation model, we are overweight slightly to US equities and then secondarily to emerging markets. Because we see the fundamentals on corporate earnings very strong and even throughout the first quarter of this year, we've seen earnings revisions to the upside where likely EPS year-over-year is going to be sort of mid-teens, if you will, in the US. And then you add to that the one big beautiful bill that has also encouraged companies to invest in capex. It provides tax relief to individuals. And then of course the effort of AI investment all around which is just creating a number of tailwinds for the US. That said, we do see investors broadening out their holdings, not nearly as concentrated as it has been over the last several years. More ownership across the broader equity markets and increased diversification. Where the emerging markets for us is the other place that we think is really quite interesting because you have those strong fundamentals but also as you mentioned probably a weakening dollar as we head forward and inflation has largely been at bay and so from both whether it's equities or fixed income that's another sector that we find quite interesting.
So let's talk about emerging markets both debt and equity on the debt side. It's been intriguing how well the emerging market debt indices have performed which reflects healing whilst at the same time you've had deterioration in western balance sheets and consequent debt levels. How do you think about that mix of emerging market debt and equity going forward? And is it simply that you want to be overweighted both of them, or do you have a strong view to the contrary?
No, we like both actually because many of the macro factors, whether it is a strength of balance sheets, falling or contained inflation, weakening dollar, all of this bodes well for frankly both equities and emerging markets debt. So, we tend to be pretty favorable about that. And one of the reasons why I'm actually here in London today is that we announced a listing of the very first actively managed Saudi Arabia equity ETF this morning and it reflects Saudi Arabia's also very great story. It's one of the strongest credits among the emerging markets countries as well as a very vibrant equity marketplace where we think applying more quantitative approach is interesting and gives investors an opportunity if they like emerging markets and like the story that they see coming out of Saudi Arabia a way to add to it. And then you think about broader themes. In Saudi it's a focus around technology and AI that's been very prevalent in the Korean and Taiwanese story. You think about nearshoring, friendshoring that's benefited Brazil and Mexico. India is a really great structural growth story. And then China I think from a valuation perspective it's very very attractive. So there's different stories going on across the emerging markets but on balance we think it's pretty favorable.
And I had noticed that in addition to the Saudi equity fund you have a Saudi fixed income fund as well but just for a second staying with that China because a lot of US allocators withdrew from China investing for all the reasons that have been well documented. The valuations as you say are pretty compelling on a global basis notwithstanding or whilst at the same time we have those geopolitical tensions that are simmering. Are US investors willing to re-enter the Chinese asset pool?
I think they are selectively. The conversations that we're having with some of our largest institutional clients, I would say going back several years, there's a big focus around investing in EM ex-China. That's not necessarily the conversation that we're having today. And as I alluded to, you have different dynamics in each of the countries that comprise the emerging markets. And so we're actually having more conversations around what over-allocation, under-allocation are investors interested in having as they participate in the emerging markets.
Now your roots of course are active or passive, we all know the tailwinds that have pushed passive but where in your thinking do you absolutely not want to be passive?
You know, I think the key thing to focus on is the efficiency of the markets and typically we've seen take the US large cap market. It's very difficult for an active manager to really truly differentiate relative to the index. It's an incredibly efficient market. Other areas that may not be as efficient, emerging markets often times small cap, mid-cap those are kinds of strategies that lend itself to more active and then if you think further about private markets I mean for the most part we don't have index in private equity or private credit and I'd say that we've seen so many investors really take much more of a barbell approach to investing where they'll have a core that's really index oriented, the wide river categories that are very efficient and then reserve their risk budget for different areas but typically in more the private markets arena.
