Bridge over ocean
3 February 2017 Multimedia

The Case for Global Asset Allocation

  1. Ronald M. Florance, Jr., CFA

Topics include:Global investment decisions and allocation strategies: lessons from behavioral financeThe recent wave of political nationalism and its impact on the global economy and international investment strategiesCurrent globalization trends in the context of historical economic eventsPractical guidelines for designing portfolios that exploit global opportunities while mitigating client behavioral risks

This is an archived recording of a live broadcast that took place on 3 February 2017.


ANDREW SHENG: Where we went wrong is financialization. We think that managing the finance managed real assets. We forgot the future of finance is not about the future of finance. It's about the future of value and values.


MARIA DEL PILAR AMADOR: --joining us remotely via the CFA Institute website, we would like to welcome you to the Latin-American Investment Conference. Please use the online chat to connect with other viewers and answer questions for the speaker.

Thank you for participating this morning in the live session. I am Maria del Pilar Amador from Positiva Compania de Seguros in Columbia, and I will be your moderator this morning.

For, our next session I would like to introduce Mr. Ronald Florance, Jr., CFA. He is a private investment consultant and financial educator. He founded RMF Consulting, LLC after retiring from Wells Fargo Wealth Management, where he was Deputy Chief Investment Officer. Mr. Florance speaks at industry conferences and TED Talks, and he's quoted nationally and internationally in print and broadcast media.

He earned his Bachelor of Science degree in Applied Mathematics and Economics at Brown University. Please welcome Mr. Ronald Florance.

RONALD M. FLORANCE, JR.: Thank you, Maria. Mucho gusto. Buenas dias, everyone. Don't worry, I am not going to this whole thing in bad Spanish. So I'm going to spend a lot of time here, because I was told to be in the light for our friends doing the webcast. I'm not trying to ignore this side of the room.

So as a resident of both Arizona and California, I am very aware of the importance of the relationship between my country and Mexico. It is important economically, it is important culturally, it is important socially. That is why I and the vast majority of Americans are extremely concerned about the hostile rhetoric in today's environment. So I was delighted when the CFA Institute decided to do this conference and asked me to participate. I think it's very important during this time to keep dialogue that is intellectual and open and honest during these sorts of times.

Thank you very much for the CFA Society of Mexico for hosting and inviting us to your country. It's wonderful to be here. And Maria, good luck with your Society in Colombia. It's a great mission.

So what a perfect time to be talking about globalization and global investing. So what we're going to do is we're going to blast through a little bit of globalization and the history. We'll talk about the world, why we need to diversify, and then actually start building some actual investment strategies. And then we'll get to your questions and comments and disagreements, which makes it infinitely more interesting.

So there's my vacation picture. Don't laugh at my little piranha. It may be little, but that thing is fierce. That was in Brazil.

And lacking local knowledge was really an interesting experience there. I had a guide who had local knowledge, but for some reason I thought better. So when we were finished fishing, we went ashore and we cooked them and had them for lunch. And eating piranhas, they're just delicious. They're much better to eat than have them eat you.

But when we were finished eating, the guide said-- you know, it was very hot, it was very humid. And he said, why don't we go for a swim before we go back? I was like, you know, we just pulled piranhas out of the water. I just don't think I want to go swimming. He goes, no, no, it's fine here.

But of course I knew better, so I sat up on the shore sweating and uncomfortable, while he was having the cool swim in the water. And there were no piranhas where we were. And I was like, why didn't I listen to the local knowledge there? Why didn't I allow my experience to be globalized?

This is the picture in Ecuador, on the equator. And I put that up there for a reason.

I think a lot of what happens in today's environment of investing is when we think about globalization, we think about East and West. And we need to start thinking about North and South. This is a picture where you're on the equator and one side is North and one side is South. So it made me think of like, I don't think we're thinking truly globally. We tend to be thinking East and West. We need to start thinking about North and South. So that's pretty important.

So what is globalization? You know, globalization has been going on for a long time. It's the sharing of ideas. It's the movement of people, ideas, commerce, religion, concepts, spirituality, around the world. It's basically been going on ever since creatures could move. So when creatures were in some pool somewhere, you know, a billion years ago, they kind of looked and it was like, I think it looks better in that pool. Let's go over to that pool. And then you know, another couple of hundred million years later they could actually start walking and it's like, let's go see what's happening on that land. Let's get out of the pool and go to the land.

Well, today globalization has gotten obviously a lot more extensive than that. What facilitates it for us is we're able to transport things, people, things, ideas. It can also be done through military power. We can do it just through communication. We actually don't need to physically be there, but we can communicate. We have friends around the world watching this on a web right now. And we can actually move production and distribution around the world.

So as I said, people talk now like globalization has just happened in the last 10 years. It has not happened the last 10 years. This has been going on literally for millenniums. So going back all the way to the Silk Road, this was the ability to move stuff between the Mediterranean and the eastern side of Asia, into China. It was an incredibly powerful change in humanity, where spices and textiles and food and people could actually move, so we had transportation that facilitated it.

We had military might. The Romans went around and conquered virtually everything around the Mediterranean. That was done through just military force, brute force. That is one way to accomplish it. It generally doesn't last forever, because people tend to not want to be hostilely taken over and brutalized, but it is an effective way in the short term to help with globalization.

We had colonization. So this is the Portuguese, kind of the peak of the Spanish and the Portuguese. And it's a good lesson of the lingering of language, of why how does language get cemented around the world?

It's like, why do people in Brazil speak Portuguese? It's a hassle. The labor that's coming from their neighboring countries, they all speak Spanish. It's a hassle. But this is why, because we had colonization that went on.

The British Empire, it still amazes me today how many places you can go around the world and they speak British English. And it's because of colonization. So this was done through transportation and military might.

And the change today that we're experiencing is technological. It's the internet. It's the people watching it right back there on that camera, that today we're able to move ideas and concepts and communicate instantaneously around the world. You can see where the impact of that is.

And if we come back in 10 years with that chart, the entire chart will just be red, right? The whole world will be completely connected. There will be basically from this point forward generations who will never use a landline telephone. They will look at that as an archaic form of communication. So the internet is what has caused this latest round of really surging of globalization that we're able to take advantage of.

So what does it mean today for globalization? So how long does it take to get a person from New York City to Moscow? Not very long. It takes about 9 and 1/2 hours. The longest flight in the world is 17. I took a flight from Singapore to Los Angeles. It was a little over 17 hours.

It's a bit stunning when you're on those flights. I got on, had dinner, went to sleep, slept for a full eight hours, got up, kind of staggered back to where the flight attendants were. I said, so what's the program? And they're like, we're not even halfway there like. Like, ugh! It's going to be a nightmare. So that's kind of the longest flight.

Basically, you can get anywhere in the world in 24 hours, except Antarctica. I just knocked something off, so hopefully that didn't destroy something.

Antarctica takes a lot longer I've been to Antarctica. And you go down to Ushuaia, Argentina, and then you get on a boat and you cross the ocean. That's pretty brutal and violent for a few days, and then you're there. So it takes a few days to actually get to Antarctica. Not a lot of economic activity down there-- lots of penguins, but not a lot of economic activity. But every place else, you can basically get anywhere you want in 24 hours.

So how long does it take to deliver something, stuff to Russia from the United States? It doesn't take very long. It takes less than 30 minutes, by the way, to get a missile over there. You could put a nuclear warhead on it, which would not be a very pleasant experience. You could put some food on it, which would be a lot more pleasant to deliver. But you can actually get things, we can transport now things incredibly fast. It's hard to transport humans that quickly, because you're pretty fragile. You'd fall apart if you were going that speed, but other stuff can survive it.

So how long does it take to get communication, a message to our friends in Russia? It's instantaneous. Right back there, we're doing it. You know, it's funny that if you use Skype or FaceTime, how instantaneous that message is. Whereas if you listen to Telemundo or Al Jazeera and the reporter is in Australia and the anchor is in Mexico City, you have that weird two second delay. You don't have that with this sort of communication, with FaceTime and Skype and our friends back there on the web.

So today, communication is literally instantaneous. We can get information. So that's what globalization looks like today. That is the change today, that we can get information around the world literally instantaneously. It's quite remarkable.

So what does the world look like today? Before we start diving into what are we going to do for an investment portfolio, let's take a step back. What does the world look like today?

So on that chart, there's a bunch of different colors. This is demographics. Yesterday, we had a whole session where we spent a lot of time on demographics. Every single color on that chart represents one billion people. So if you were investing demographically, you would have the same amount of money invested in each one of those colors.

And if you notice-- the guys back there gave me a laser. They're going to regret ever giving me this thing-- the green sweeps all the way down to the Americas, and then over to Oceania. So it's a huge thing. Most investors tend to overweight northern green and then the gold, Europe, and they neglect the rest of that world. So we want to think of it much broader than that. So those seven colors, each represent the same amount of people.

So more people live inside that circle than outside that circle. But it's pretty rare to find an investment portfolio that captures that. Now, obviously, this very manipulative. You have India and China inside that circle. But that shows where the human population is. And so if we're investing demographically, it would look a lot different than the way most investment portfolios are today.

I put those two things up there to kind of shock people into what does the world look like. Because we think a certain way. We tend to think Northern America and Western Europe, and we need to start thinking a lot broader than that when we think about globalization and investing.

Where are the new people living? So we talked about that yesterday, fertility rates. So it's not about today. It's where are the people of tomorrow going to be living? And the colors kind of go from South America here and then across equatorial Africa, and into Southeast Asia. That's where the new population is growing. So that's kind of like shooting not where the hockey puck is now, but where it's going to be tomorrow. Where are the consumers of tomorrow going to be living?

We've spent so much time focusing on the current developed market consumers. Basically, what happened is we had World War II and we leveled Europe and Japan, and then we spent the next 50 years rebuilding them. They're rebuilt. By the way, they're beautiful. You should go visit. But where are the people of tomorrow? And I think that fertility rates help show us that.

So today, where is the economic activity? The dark blue is higher economic activity. The lighter colors is lower economic activity. That's per capita GDP. So we know that today in Northern America, there's very high per capita GDP. Parts of Europe are that way. You can see that on the blues and the greens.

The problem there is those people are full. They have bought and eaten and worn everything there is to buy, eat, and wear. There is nothing else for these people to buy. The other colors that are lighter farther down, those people haven't bought, eaten, and worn everything there is. So they're going to increase consumption, while the country that I live in, we actually have a phrase, recycle, reuse, reduce. We're trying to tell people to use less, consume less, when the rest of the world, those people are starting to consume more. So I think it's important to understand that.

Where is the economic growth activity? And I think what's important about this chart is it really is a mirror image of that fertility rate chart. You can see the darkness as we span right across there of South America, into equatorial Africa and Southeast Asia. And that's an important part of investing in where's the economic activity of tomorrow. So we've got to pay attention to that. So it's not about what we think about today. It's where's the activity tomorrow, and how are we going to invest there.

So what does the global consumer look like, since the consumer is the economic driver of all of this activity? What does the global consumer look like?

So the biggest shopping day in the world, that is not the day after Thanksgiving in the United States. It's not the day after Christmas in the Christian world. It's November 11, it's Singles' Day, by far. Singles' Day, notice the ones, 1, 1, 1, 1 for all those people that are singles? And it's a made up holiday for Asians to consume.

So got involved in all this, and it's a huge thing of go buy. You're important. You're special. Just because you're single doesn't mean your life sucks. It's good. Go buy something. And they do, and it's stunning. If you are a global manufacturer and you are not tapped in to that shopping experience, you're in serious trouble.

Mexico has the highest per capita consumption of Coke products in the world. In my country, there's actually stores that specialize in selling Mexican Coca-Cola, because it's different. I think Mexican Coca-Cola is made with cane sugar, and North American Coca-Cola is made with corn syrup, which is corn fructose. It's nasty. So the stores that-- if you can actually smuggle it across, and it's a great thing. Oh, I should get some Mexican Coca-Cola before I go back. I'll be able to make a good arbitrage on that.

So if you are manufacturing tasty sweet drinks, you need to think about where they're being consumed. They're not being consumed in Connecticut, they're being consumed in Cancun.

Cell phones, put it in perspective. So when you go to China and India, the crush of humanity is pretty obvious, and the number of cell phones is stunning. These are people that will, I said before, never use a landline telephone. So if you are in the world of global communication, you've got to get to these consumers. These are the consumers of tomorrow.

Birth rates. You can see that in Latin America, there's a little bit elevated birth rates. That's a good indication of future economic activity. Nigeria is that put in there as the highest one. They have also a very high child mortality rate. Their life expectancy is also lower because of nutrition, so that doesn't equate to the same level of economic activity.

But again, thinking about what is the future consumer of the global consumer look like? What does this person look like? And they probably are not being born in South Dakota. They're probably born in Honduras. So it's important to kind of have that perspective of where these people are.

So what's going on today? We have this nationalism thread going around the world that is causing some consternation. The consternation is because these people are not opening doors, they're closing doors. They're not building bridges, they're building walls. And that reduces economic opportunity, reduces economic efficiency, and causes some friction.

One of the concerns is we have another wave of elections. France in particular coming up, where we'll see how this kind of continues. But this is the way of where we are today.

I also think it's important to understand that politicians, political leaders are like buses, right? They come and they go. There'll be another one coming along. This crowd will leave and is this is the wave. And we will survive it. But it does create some consternation.

The problem, as I said before, of what they're doing is they're not opening up to global consumers outside, but they're building walls and they're creating barriers, which is not good for global economic activity. It is disruptive to supply chains. It's disruptive to currency policies. If you're a global enterprise looking for global consumers, it makes it a lot more complicated when your government is working against you. It's very difficult. So we're going through that period of transition.

That anti-immigrant attitude, you can admit it. That was really the driver of Brexit, I think. There was a lot of the attitude of what happened in the United States, is a very detrimental because one of the great things we have in today's global economy is the transportation of labor. We're able to move labor pretty efficiently around the world to be able to help-- where do we need manufacturing? Where do we need people? Where do we need scientists? Where do we need them?

Unfortunately, as we talked about yesterday, we have an issue with spouses. It's hard to move spouses around the world, apparently. But we can move labor, and that's going to be some consternation there.

So what's the impact about this is I think what's going to happen is it's going to start being detrimental to global firms and start favoring local firms. So if all of a sudden the big global manufacturers can't move toilet paper and watches and auto parts and laundry detergent around the world, local manufacturers can create it.

As we said yesterday, it's not a surprise of how to make laundry detergent. This is not a secret. You can make it in Honduras. You don't need to wait for Procter and Gamble to ship it from somewhere else. So I think that if you are looking at global opportunities today, we need to start really paying attention to local manufacturers and local distributors, because they're able to get to the local consumer a lot faster, and that will enhance local GDP.

The global consumer will shift because of prices. They're looking at where can I actually purchase, do my economic activity where prices are much more favorable, and not being impacted by these silly inefficient tariffs and taxes and barriers that are being put up around me? And I think that today, with technology and communication, the consumer is a lot smarter. They know what is the fair value of a product, and they're able to do that research. So it's impossible to keep that a secret anymore. So the global consumer is a lot more educated.

The other issue that's going to be interesting here is instead of having trade agreements between countries-- so we're starting to see some friction with trade agreements-- we may start seeing some meaningful trade agreements between companies and countries. You know, when a president of a country goes and visits another country, they don't go there alone. They have a huge entourage, and it's not just a bunch of people telling them that they look nice. They actually go with a huge entourage of business leaders, because they're signing contracts. They're making business deals. That's the point of these things.

Well, if your president isn't going to enhance your business opportunities, you'll figure out a different way to do it. You'll go and do it on your own, where there's a lot more eagerness to talk to you than just a world of hostility. So I think that this current wave will actually enhance local business opportunities, enhance local GDP, and also start-- we'll probably start to see some agreements between global companies and countries, individually and not going through state departments and government entities.

So why do we diversify globally? We diversify globally because it makes the portfolio better. So this is a traditional domestic large cap, fixed income cash. Every portfolio I'm going to show you from now on is basically the same 70/30 equity fixed income mix, so you know, we can slap that onto an efficient frontier and bid a bang, bid a boom, there it is. It's not very interesting.

But we know we can do better than that. So we can diversify by capitalization. we can go down the capitalization spectrum and get some more entrepreneurial opportunities in the portfolio. And that actually enhances our return opportunities. And through diversification, it doesn't increase risk very much, so we're able to increase reward, increase total return, not increase the risk very much, increase sharp ratios, so everybody is kind of happy with that. That's a nice solution.

Then we know we can also diversify internationally. We can go beyond our current economic system. We can go beyond that. The first place that people go is the developed world, and the developed world tends to grow kind of it over long periods of economic cycles at the same rate. But the cycles are not perfectly synchronized, so we get some diversification.

So what it basically does is it diversifies the portfolio. It will extract the same amount of capital return out of the global capital markets, while reducing risk through diversification. We've diversified the economic cycle. We've diversified by country. We've diversified by currencies, so some nice diversification there.

But we can go beyond that. We know there's a big wide world out there besides Canada, the United States, Australia, and Western Europe. We can go to developed markets. We can go into frontier markets. We can use the debt markets and the equity markets, so we can really diversify.

And this enhances the portfolio o even better. We continue to diversify the portfolio, reducing risk, continue return opportunities on the portfolio. So that's why we do this.

And I think it's important to go through this so people understand and international investing is a hassle. It's hard, it's complicated. To deal with custodian banks. You have to deal with currency risk, different trading rules. You have a compliance department that's always yelling at you don't do this, don't do that. But it's worth it. The struggle, the pain, the hassle is absolutely worth going through, and I think it's important that we remind ourselves about that.

So if we're going to go and do some global investing, how do we do this? Well, we have to have a process. We have to have a kind of a methodical process that shows some integrity as we enhance our fiduciary responsibility in the portfolio around the world. So we start with asset classes.

And today, global investing isn't about buying just some international index fund that invests in developed markets of you know, Japan, Western Europe, and Australia. International investing can take place in all asset categories, all asset groups in the portfolio.

We can do international investing in fixed income world, in the equity world, and the alternatives world. And I think that's very important to do. Most people tend to think about the equity world, which is an important one and it's a good one, but we can do better than that. We can diversify internationally across all of the asset groups and the investment options that we have out there, and I think that that's how we need to start looking at international invested in the portfolio and going beyond that.

So once we identify whatever asset classes we're going to invest in, then we have to develop our capital market assumptions. And I talk about this is why-- if I'm going to invest in something, I must have some expectation of what it's going to do. I must have some expectation in terms of return, in terms of risk, in terms of currency exposure, in terms of diversification. I'm not just investing in it because it's fun. I'm not investing in it because it's pretty. I'm investing in it because it's supposed to do something. What do I think it's going to do? And that's why we develop these capital market assumptions.

We start with what is the expected inflation rate that's applying to that economic system that this investment is in, and then we build on that. What's the expected return above inflation? What's the yield? What's the cash flow we're going to expect out of it? What's the risk? That can be standard deviation volatility, downside risk, whatever risk measure you want to do.

And then very importantly, the correlations. How does this correlate to the other investments that we have available to us? Because otherwise, we don't really know how it's diversifying.

Starting with inflation, it's important to kind of take that step back because when we look at inflation globally, it's very different. Latin American inflation looks very different than a dozen other parts of the world. Other parts of the world, and especially in the developed world have been fighting deflation. I'm very worried about that. The bottom three charts there, that's Mexico and Brazil and India are the inflation rates. You can see they're higher.

Why that's important is because underlying inflation has a massive impact to all investments in that economic system. It impacts interest rates. It impacts currency exchange rates. And then everything from there from the inflation rate up is where we're getting positive capital return. If you're just being compensated for inflation, you're kind of treading water.

So it's important to understand what are those inflationary pressures for that economic system you're invested in. We just talked with our economists in the previous session, who spent quite a bit of time on inflation. So that's important. And also understand, what is the future prospects of inflation, and what are they doing?

Inflation is incredibly corrosive. Excessive inflation really alters consumers' decision making process. Deflation is just catastrophic. It's a very, very negative cycle. It's very hard to break out of, and it makes people not want to do anything. You just wait and sit around, and then it basically puts everything on hold.

So starting with inflation is incredibly important in understanding how that works, in terms of money supply, interest rates, central bank policies, and how it's going to affect the economy going forward.

Then once we have that-- this is a chart from JP Morgan-- many firms create these. You can find them out there. They are publicly shown.

We map out what is the expected return and what is the expected risk of every asset class. You can kind of see the arc there, kind of a capital asset pricing line, kind of a almost an Efficient Frontier. So there we have an expectation.

When I do this with clients, I always remind them, and I said, so that's our expectation. Every number on that chart is wrong. Otherwise, we'd be clairvoyant. We'd know what we expect over the next five, seven, 10 years. But it gives us a perspective.

And as things change, elections change, central bank policies change, that we're able to make modifications. But at least it gives us what is our expectation for this investment in the portfolio. And we don't want to be so head in the sand to think that we're actually so smart that we've anticipated what the capital markets are going to do for the next 7 to 10 years. That would be a little arrogant on our part.

So once we get-- these are the ones people like to talk about, because they're fun and they're kind of tangible. You can actually experience it. Correlation is actually incredibly important. And I put this chart up there for a reason, to shock people of how low those correlations are when we start looking at investing around the world.

Putting it in perspective at the bottom of the chart there, you'll see people say yes, I diversify. I diversify by I go down the capitalization, some mid-cap stocks and some small cap stocks. So that's barely diversifying. Those correlations are extremely high, well above 0.90. But when we start going around the world, those correlations really start to collapse. You can just go across the EFA equity and emerging market, and see how low those are.

The reason we do that is that is actually, what we're doing is producing economic opportunity while diversifying existing risk. Understanding those correlations is extremely important. Now, if correlations are trending higher around the world as we get more and more globalized, that would be a trend. But those trends are glacial-- I mean, incredibly slow. And correlations are also very volatile.

These are correlations over a long market cycle. We know that over short periods of time, correlations are incredibly unstable. They change with moods and elections and news cycles, and things like that, so a very short term volatility.

What we don't want to do is have to trade on those. If you're going to figure out market timing and make it work-- which nobody, by the way, has ever been able to do-- what you've basically done is you're going to figure out the short term shifts in the correlation matrix. If you can anticipate that, then you've just figured out market timing.

So if you think you've got that algorithm where you can anticipate short term shifts in the correlation matrix, please come talk to me afterwards. We will get a Nobel Prize, and it will be really earthshattering and change and the investment world, but that correlation is extremely important. So when we look at expectations of what we want to do in the portfolio, we want to make sure we understand what are the diversification opportunities and how is that working.

So that's the process to develop our global investment strategies. We start with what is the list of asset classes we're going to do. We then develop all those capital market assumptions, and we've just come through that with risk and return and yield and diversification correlations. And then we start building our asset allocation. Now that we've got all those pieces, now we have to start putting it together into the pie.

So let's talk about that. What is this asset allocation supposed to look like if we're being a truly global investor?

The easiest way to start is always with understanding what are the other people in the world doing? You know, and we look out there and we see a lot of different choices. The numbers are vast and wild, and I was put up there, you know, what does Yale do? Because they always hold up Yale as one of the great investment vehicles out there, even though their performance recently has been just terrible.

But this is based in the United States. And I think it's interesting to see how different they are. So philanthropic portfolios-- so these portfolios that are a charitable in intent, so the distribution is going for charitable causes not for personal consumption-- relatively high. Private banks, the world that I worked in, pretty low at 15%, but even that's exaggerated.

Where I was working, we had a target of 15%. We never got there. I was lucky if I looked at our assets under management, the Book of Business, I was lucky if it was a 10%. It was usually 7%, 8%, 9% there.

And I always kind of thought it was funny during the investment policy committee meetings, when they would talk about doing a tactical shift. We're going to increase our allocation to global investments, international investments in the portfolio. Really? We're not even at our strategic allocation. What makes you think-- I mean, it was a joke. So that number is the target, and it's very far from that. So you can see where the private banks, private clients on their own that are not having fiduciary influence on their portfolios, it's extremely low.

I thought what was very interesting is balanced target date funds. So these are funds that are an asset allocation strategy, and that it changes over time as you approach, as you shorten the time horizon of the portfolio, like a retirement fund. People could invest in a retirement fund today, they have 30 years to go, and over the next 30 years the portfolio gets a little bit less aggressive, less volatility, and more income-oriented. Those target date funds tend have an incredibly high allocation to global investments beyond the domestic market, beyond what normal people have. And I thought that was just an interesting case study there.

So those numbers are out there. My premise is those are low. That is not showing a global portfolio.

If we allocate by capitalization from a US perspective, I think it's always interesting to note that about 3/4 of the world's bond market is outside the US. So if you're doing it by capitalization, you have a long way to go, by the way. If you're doing it by capitalization in the equity market, about 50-50, 55% of the capitalization is outside the US. Most portfolios don't look like that.

If we're going to be allocating by population, just by people, so we would be stunningly overweight Asia. Right? There are just so many Chinese and Indians. Now, I've been to both countries. I have never felt the crush of humanity like I felt in India. It is just stunningly populated. And as we talked about yesterday, the Chinese aren't having that many babies anymore and the Indians are still having babies, so it's going to continue to be interesting.

You can see poor Oceania down there with New Zealand and Australia, and they just don't have very many people down there. It's a fun place to go, but not a lot of people there.

What I think is interesting about this chart is if you were doing it by population, South American allocation is almost double the North American allocation. Double. Good luck finding an investment portfolio that shows that sort of an allocation, but that's what demographics tells us.

If we're doing it by economic activity, we're pretty evenly split between North America, Europe, and Asia. So we get those three continents out there. South America, Oceania, and Africa really fall apart, and I'll take a step back.

So does that really represent what the future economic activity looks like? That's what it looks like today, but I think that those big three will continue to shrink, and the small three will continue to grow. And if I'm investing, I want to be growing. I want to be investing it in the growing slices, not in the shrinking slices.

So if we do it by per capita GDP-- the previous one was just net GDP, this is per capita GDP. We'll see, we're stunningly overweight developed markets, right? All of a sudden, Oceania with their four people down there, apparently those four people down there do a lot of stuff. And obviously, the North America and Europe. But again, is that the future of global economic activity, or is that just today? And I think that as an investor, I want to be overweighting the small slices and underweighting the big slices.

So if I look at population growth rate like we were doing at yesterday's session, all of a sudden we see start seeing a much more evenly distributed global allocation. Now that's starting to get a little bit interesting.

Those poor Europeans, apparently they're not having any babies over there, are they? It's really quite sad. But now all of a sudden, we have a much more even distribution around the world. And that's by population growth rate. That pie chart looks extremely different than that pie chart, or especially by that one.

So I think it's important when we think about global investing, it's not about where is the opportunity today. It's where is the opportunity going to be tomorrow and positioning ourselves appropriately for that.

So home country bias. Every single investor around the world has a home country bias, and they should. There are good reasons for that and there are bad reasons for that.

The good reasons for that is you always want to overweight your liability currency. I'm assuming that most of your liabilities are priced in your home country currency, so most of your assets should be priced. You should overweight the exposure to that currency in your portfolio. That makes sense, so that the returns are coming to you kind of as a liability matching to your primary liability currency. That makes sense.

You also do want to support your own team, right? You want to support your own country, so you invest in your country and you do business in your country. And that's a normal kind of go team attitude around the world, and there's nothing wrong with that, right? You want to support your local economy, so that's a good reason to invest in home country bias.

We also live in a world of regulatory and government rules. So there are some rules about moving money. Money moves a little bit more freely than it used to, but not as freely. So we have regulatory issues.

What we don't want to do is overweight that home country bias because of prejudice and ignorance. And I think too many investors do that. It seems scary. Now, when you listen to or read news stories, they generally don't-- all the new stories aren't going to be about butterflies and roses in other countries. They're going to tell you about the bad stuff that's happening. Well, bad stuff happens everywhere, but we seem to be overweighted that in terms of our news feed, right? So we have to be careful about not being prejudiced about that.

It's also the stubbornness, right? There is that I am not, I am, you know, this is where I live and this is where I'm going to invest, and that's the way it's going to be. And it's a little bit of shooting yourself in the foot, looking at the opportunity. Again, also working with our regulatory partners to understand the importance of the global opportunity.

So good reasons and bad reasons for a home country bias, and I want to make sure that we understand that every investor around the world does have a home country bias. And we want to be very careful that we do that for the right reasons and not the wrong reasons.

So when we take a step back and say, how do we put all this together, I think the easiest way is we start with a cap weighted model, for a lot of reasons. It's easy to invest, and it rebalances on its own. You're kind of overweighting liquidity. You know, all of this kind of makes sense.

But then we apply a home country bias. And one of the things I talk about is on the cash flow assets that are the intention is this is creating cash flow, that home country bias would probably be a little bit higher, because the cash flow should be matching to your primary liability currency. So we see the 75/25 allocation when we talk about cash flow assets.

When we talk about growth assets, we want to reduce that home country bias and really start to be a little bit more global in our portfolio. So we're seeing the 65/35 mix. And I think even this is pretty timid. Even that is not being a truly global investor, but it's a lot better than where we are today.

So when we look at that in a pie chart, it's important to understand that that applies across every single asset class. So we're seeing that in the equity asset class. We have domestic and international equities and international equities that's regional, that's emerging frontier, you know really around the world. But we're also seeing that sort of international diversification in our fixed income allocations, in our hard assets allocations, in our alternative investment allocations.

The only thing I didn't do is cash. I'm assuming the cash is there for a reason. It's not really there for an investment reason, it's there for a consumption reason. And the vast majority of your consumption is in your primary liability currency, so having cash being held in a currency that is not going to be used for consumption is a little bit noisy in a portfolio. Some people like to play that game with currencies, but I would move that. I would have that actually shift into fixed income. I wouldn't have that in cash. So cash is the only allocation there that doesn't show that.

So when we think about global investing, let's start thinking about how much is an appropriate home country bias and how we really globally diversifying our portfolio in all aspects of that, of the asset class.

So and just to review before we go to questions. Did we get any questions so far? Yes, Maria's sitting there with questions and smiling at me.

Globalization has been going on for a long time. I know there's a lot of rhetoric going on right now about how globalization the last 10 years, blah blah blah. Globalization has not been going on for the last 10 years. Globalization has literally been going on as long as organisms could move to the next pond. That was globalization. What has happened is it has accelerated, become very visible because of technology, of the way that we are able to communicate around the world. So that has changed a bit.

One interesting thing about the changes in the technology is while a lot of stuff has changed in terms of globalization, air travel really hasn't. If you think about the last 30 years, airplane travel really hasn't changed. Maybe the planes have gotten a little bit bigger, right? But the speed hasn't really changed. The comfort hasn't really changed. I guess the personnel has gotten a little nastier, but beyond that, it really hasn't changed.

You know, it'll be interesting to see if the next technological wave will actually be able to change air transport. So if you know, hyper speed, where we can go out of the atmosphere and move at much greater speeds. We had a short term experiment of traveling above the speed of sound. That didn't work very well. It was extremely expensive, and it was incredibly inefficient. You could only move between Western Europe and the eastern side of the United States. You couldn't fly from the Western side of the United States to Hawaii, or Hawaii to Asia. It was incredibly limiting.

So I just think it's interesting that air travel is the one thing that hasn't really improved. Maybe somebody will figure that out.

Regardless of what the current trend has been said, and the latest wave of nationalism and populism that's going on, globalization is here to stay. It's been going on for a billion years. It's going to go on for the next billion years. It's going to continue, because humanity, the drive for humanity to learn about other people, to improve our own lifestyle, and the curiosity, and just our greed and being able to have economic opportunities around the world is so great, we will burst through these barriers of restrictive, short term ideas that is currently going around on the political spectrum.

So I think that it could be unpleasant and uncomfortable in the short term, but this is literally a short term trade. There isn't a wall big enough, thick enough, or tall enough to stop humanity from finding its friends and neighbors and working with them.

Most investors are painfully underallocated around the world. And today, as investment professionals, we need to take a step back and educate our clients, educate investors about what are these opportunities, what do they look like, how are we going to exploit them, and how are they going to work in the portfolio and get investors today much more global than they are today? And we do that by going through the process of defining the asset class that we want to invest in, build in the capital market assumptions, understanding what is the globally neutral portfolio, and applying the appropriate home country bias on top of that, because every investor has a home country bias, and they should.

So in conclusion, last vacation photo. Thank you for the CFA Institute, for allowing me to put my vacation pictures in my presentation. That is in Peru. So that's one of those guns where you shoot the dart up to the monkeys and the birds up in the trees. And by the way, they're incredibly accurate.

So the only lesson there is when you're filling your lungs to blow through the dart gun, don't bring the dart gun to your mouth and then inhale, because you'll end up in yourself, which would be humiliating. And so you kind of hold it out, inhale, and then you blow it into the--

But what's interesting about this picture is the man standing in the corner, right? That guy. So rest assured, that man does not wear that skirt and that hat all day long and sleep in that hut. That man is there to help tourists blow a dart through a dart gun. He then goes behind there at the end of the day and puts on jeans and a t-shirt, and he gets on a motorcycle that uses petrol and then goes over to his town or village, and they have solar panels that are charging batteries that are then using satellite dishes that are putting information on the television so he can watch soccer games, or here they would call it football, around the world. That's the lifestyle that that man is living.

If you notice, that man is not 17 years old. He's not as old as he looks, by the way, because he doesn't use sunscreen. But he is not 17 years old.

So that is the global consumer. So when we're thinking about the global investment opportunity, it's not the guy in the purple shooting the dark gun. It's the guy on the other side. He's the global consumer. Are you investing to satisfy his needs, his economic needs, his education needs, his nutrition needs, his housing needs, his medical needs? That's the guy that you want to be addressing.

The guy blowing the dart gun is full. He's bought everything he can buy. It's the other guy that we want to talk about when we talk about our portfolios.

So with that, I'll stop and see if Maria has any questions for me.

MARIA DEL PILAR AMADOR: Thank you very much.

How much do regulatory restrictions and availability of investable assets limit the global diversification portfolio?

RONALD M. FLORANCE, JR.: So we're talking about regulatory restrictions. Most of them come to us-- there's two forces there. One is at the government level, and it's really about controlling the flow of capital. What they don't want is capital leaving their economic system. It's kind of a short term viewpoint. So sometimes getting capital outside of an economic system is painful.

We tend to have higher restrictions in less efficient emerging and frontier countries. What's interesting is they don't even use their own currency, typically, in global trading. There's really only two global currencies being used today, maybe three if you include the yen, but that's not very high.

The other one is at the firm level, at our individual firm levels. We all work in a world of compliance and risk management departments, and their responsibility is to come and see not necessarily what is in the best interests of our clients, but what reduces our opportunity for litigation and being sued by our clients. That's their job. So they put up another layer that sometimes can be even more restrictive than the government's.

So I think it is our responsibility as investment professionals to continue to communicate with both government regulators and internal risk and compliance departments to help them understand the importance of international and global investing. If we're really doing our fiduciary responsibility and investing money for the best interests of our clients, how does that work in that, and then working with them to have prudent restrictions, regulatory restrictions and internal compliance restrictions that just make sure we're not making a mistake, right? There is a process and a procedure that we're following, but it's not just so restrictive because of ignorance or stubbornness.

MARIA DEL PILAR AMADOR: In that regard, if you're thinking about global asset allocation and thinking adding new assets, new countries, alternative investments, sometimes there is a lack of understanding of this product. Should risk management areas be a key element of successfully implementing this global asset allocation?

RONALD M. FLORANCE, JR.: Absolutely. So as we start to invest around the world, we're going into different economic systems. There are different regulatory systems. There are different accounting systems. It is our responsibility to understand that. That's why we are investment professionals. That's why we study things like the CFA study programs and the guidelines, and we continue to do continuing education.

Nobody else is going to do this. This is our responsibility. A government regulator is not going to sit there and figure out how do we build appropriate commodity funds with multiple currencies for you to use? They're not going to do it. You have to do this. It is our job to do this.

We are the ones to look out there and find what the global investment opportunities, and how do we make it happen? It is then our responsibility to come back and communicate that to regulatory personnel and risk people about how is this going to work and what processes have we gone through to ensure that there is some realistic safety measures, in terms of fraud and corruption, and that sort of stuff?

So yes, it is an incredibly important part of this process. But again, repeating myself, I think it's important that the regulatory tail doesn't wag the dog. We have to help educate them, and I think will be a much more beneficial relationship for everybody involved if we kind of took that lead and not played the victim so much.

MARIA DEL PILAR AMADOR: From a practical perspective, how can the truly global investor listen and benefit faith from a local market perspective?

RONALD M. FLORANCE, JR.: So there was one client in my career that I thought was actually a truly global investor, and he wanted to have a truly global portfolio with no home country bias. And he worked for a big global company that distributed cigarettes around the world. And in his personal life, he had liabilities in about six different currencies. He'd paid tuition in three different currencies for his children. It was just an incredibly unique portfolio. But what does that look like?

And his thing was, I don't want to invest in global companies. I work at a global company. I want to invest in local companies doing local business with local clients and local manufacturers in local currency. We spent a lot of time doing that. And I think today the capital markets are getting better at those opportunities for us to be able to invest.

One of the anxieties that people go through is really private equity. As we go into these markets that don't have quite as developed capital markets as we're used to in other parts of the world, can we do private equity and private debt financing that are not part of a big global market? And that requires a lot more due diligence.

So I think that when we talk about global investing, a little bit of the phrasing of the question of let's think about not global companies spanning the world, right, but investing in the local companies, doing local work with local labor, local consumers, in local currencies.

MARIA DEL PILAR AMADOR: And on the local correlation between GDP growth and countries' corporate earnings growth, thus equity market returns, how should we consider this while investing globally?

RONALD M. FLORANCE, JR.: GDP growth and earnings growth.

I think when it comes back down to the core of, is this economic system growing? And it's not just growth of GDP, it's per capita GDP. And is there a nice distribution of that?

I think in a lot of economies, there is not a great distribution of that. You know, the rich are getting extremely rich, and the poor are just staying poor, and so we have to look at that distribution. So it's a combination of GDP growth, per capita GDP growth, and the distribution of that across the entire economic spectrum of the very rich, down to the very poor. And if we start to see that distribution evening out and getting better diversified, that shows opportunity.

If the economy is growing, that means that people are doing stuff, they're buying stuff, they're investing in stuff. And we should be able to identify the opportunities. And that could be in health care, in consumer durables, non-durables. Energy is a typical thing.

You know, we're sitting in a building here where we don't even think about it. I mean, it's so cold in here, you could hang meat, right? Well, it's not that cold outside. And so we take for granted this electricity. This electrical grid is so stable here. But when you go out into the rest of the world, it's not. So you know, start thinking about the local needs and not thinking about it from our own perspective.

It is cold in here, isn't it?


Using the concepts of behavioral finance, what are the major mistakes global investors make in their global asset allocation process?

RONALD M. FLORANCE, JR.: Behavioral finance, I do a lot of sessions on this, and it's been a lot of fun since I've left the corporate environment and I can be a little bit more liberal and loose in what I say, so I don't have a compliance department behind me hitting me with a stick.

Behavioral finance is really about what people do where they're comfortable, they're familiar. I've done this before. I know this. I'm just comfortable with this. It's like a warm blanket around me. I'm very comfortable with it. Our job is to break through that and make them uncomfortable.

So as I said before, when we hear about the rest of the world, we tend to not hear the stories of the great things that are happening. That's not the immediate news that comes to us. We hear the scary things, the horrifying things.

There are people killed in virtually every city, every day, in a violent way. It happens around the world. People are generally-- there are going to be people that are not nice people. That doesn't mean you hide.

So I think that when we deal with behavioral finance, it's helping clients be uncomfortable, test new waters, get some experience and help them learn that that experience may be different from what they've had in the past, but it can be extremely beneficial going forward in helping them break through that.

And that goes back to what I talked about with the home country bias of just prejudice and stubbornness. I don't understand it. I haven't done it before, so I'm not going to do it in the future. Well, if that's the case you'd still be living with your parents. Well, that wouldn't be a very satisfying life. You need to go beyond the comfort zone, and that's our job in international investment is helping them get beyond their comfort zone.

MARIA DEL PILAR AMADOR: How does an advisor explain global diversification to a US-based client who focuses on the S&P 500?

RONALD M. FLORANCE, JR.: That is a very good question, a US based investor with the S&P 500, which is just a large cap domestic index.

One of the struggles with that one is there is a lot of earnings that come into the S&P 500 that are from around the world. I won't get the number exactly right, but I bet it's close to 20%, 25% of the S&P earnings come from outside of the United States, so they feel like they get some global diversification there. Most of those earnings are converted back into US currency fairly quickly. If they're not, they're left outside for tax reasons, and there's, you know, a gazillion dollars left outside for tax reasons, and that's kind of inefficient.

But as I talked about the current economic, the current political environment I think is not helpful to that. So as all of a sudden, we're going to start putting trade barriers and friction in the global trading environment, that actually benefits local companies. We talked about yesterday of Yum Brands and what was the other one? Oh, McDonald's, that have diversified and sold off their brands in China because of trade friction, right? There is concern there.

So I think that that was a nice index for the last 50 or 60 years, as the developed world rebuilt itself from World War II. Well, we need to look at what's going to happen for the next 60 years. And what are the companies that are going to address the consumers for the next 60 years, that man in the skirt with the hat, right, that goes to his motorcycle, that's where we want to invest in. So I think that a little bit of the S&P 500 is looking at the post-World War II era, and not at where we are today and over the next 60 years, and what does that global consumer look like.

MARIA DEL PILAR AMADOR: What do you think about the bad performance of the Harvard endowment for the last years?

RONALD M. FLORANCE, JR.: Well, I went to Brown, so I'm gleeful about the whole thing, to be honest with you. And I know that's very judgmental and not very open minded, but it just puts a smile on my face.

So the Harvard endowment is a huge pool of money. So one of the struggles with the Harvard endowment is just being able to move when you have that sort of amount of money. You know, you're moving a supertanker, and it's very difficult. The Brown endowment, by the way, is 1/4-- that's a guess 1/4 the size of the Harvard endowment.

And I'm going to go into a whole diatribe here. If they really did the Harvard endowment correctly, nobody should have to pay tuition to go to Harvard. It is so big, they would be able to pay the entire operating budget of the university and tuition for everybody. But for some reason, they still make people pay to go to Harvard, which I don't understand. That was a political opinion on my part about what they should be doing with the Harvard endowment.

But a lot of the Harvard endowment is about alternative investments and owning illiquid investments. And I think that illiquidity is a benefit that can be used prudently in a portfolio, but we have to be careful about it. So we don't want to be overly exposed to illiquidity, because it reduces opportunities and flexibility in the portfolio.

So I think the Harvard endowment was just an example of they got ahead of their skis and a little overly aggressive with alternative investments, and then were paying a lot for these specialty fancy-dancy managers, and they built this massive infrastructure internally that was just way overcompensated. And they're starting to shut that down and go to a more prudent external manager. So as a graduate of Brown, I'm very happy. And thank you for asking about Brown.

MARIA DEL PILAR AMADOR: From our virtual audience, would China also fit into the nationalism list, but in a unique way?

RONALD M. FLORANCE, JR.: Yes. So China is very unique. So they have an extreme nationalism in China. They've done a very good job of building that kind of patriotic fervor inside of the country. A lot of attention goes to China. I think that the charts we had from The Economist earlier, it's important to understand that the Chinese economy is kind of coming down to its stabilizing rate. And we also see a dramatic shift in demographics there.

So China is whatever, 20% to 25% of the human population, so it can't be ignored. But I think too many investors today are thinking about their developed portfolio and then China, and they're missing enormous opportunities in Latin America, in Africa, in other parts of Southeast Asia. And I think Latin America is one of the most grossly under-represented in investment portfolios, just because of a lack of understanding, currency concerns.

And I think that China is probably-- people spend too much time and emphasis about China, and they're ignoring the rest of the world. And that goes a little bit back to the behavioral finance of what are they comfortable with, and if we need to get them beyond the comfort zone.

MARIA DEL PILAR AMADOR: Do you expect a trade war to erupt? And if so, how does this affect asset location?

RONALD M. FLORANCE, JR.: Do I expect a trade war?

It's hard to answer that in terms of what I expect and what I hope. I think that there will be some bluster to satisfy promises made, but I think in the grand scheme of things, there will not be a significant enough trade war to spiral the global economy into a global recession. I have faith that at the end of the day, smart enough people will have a big enough and loud enough voice to have influence in that world, and we will not just listen to the loudest voice that may not be the smartest voice in the room.

So I would expect in the short term there will be some friction and tension, but I think in the grand scheme of things, we as the human population underestimate our power and the strength of our voice. And we will be able to stop a disastrous thing from happening. So I think there will be a little bit of friction, but I don't think a full blown trade war. Once people realize that the price of the food they like to eat is going to go up by 50%, they'll change their mind about trade barriers.

MARIA DEL PILAR AMADOR: We're running out of time, but we have one last question. Do you anticipate the look of product producers, they will be traded firms or firms that will need private equity funding.

RONALD M. FLORANCE, JR.: Well, funding for the local producers, initially, I think will be done through the private equity, the private equity and the private debt markets. I think that that's how it will happen, just because the global lenders will not be sufficiently ready to handle that. So I think that that provides us with some opportunity going forward, but at the beginning, I think there will be private financing, but over the long run, we'll finally get back to the normal capital markets, and realize there's enormous opportunity there.

MARIA DEL PILAR AMADOR: Thank you very much.

RONALD M. FLORANCE, JR.: Thank you very much.

MARIA DEL PILAR AMADOR: This was very interesting.

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