Balancing Conviction and Risk: Masters in Business with Maria Vassalou

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I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guest is Dr. Maria Vassalu. She is head of PICTE Research Institute, which she joined in 2024 to help build a staff of PhD-level researchers that collaborate with outside academics and think tanks to PICTE's long-term strategic mandate covers asset allocation, portfolio construction, risk premia, capital market structures, global economic, and investment trends. The firm manages nearly a trillion dollars.

Dr.

Vasalu arrived from Goldman Sachs Asset Management, where she was co-CIO and SAC Capital. She also served as president of the European Finance Association. PICTE was founded in 1805 as a partnership of managers and owners, which it still is to this day. I thought this conversation was utterly fascinating, and I think you will also. With no further ado, my sit-down with PICTE researchers, Maria Vassallo. PICTE Dr. Maria Vassalu, welcome back to Bloomberg.

Thank you, Barry. Thank you for having me. Always a great pleasure to be here.

The last time you were here, you were co-CIO at GSAM. We'll talk a little bit about your career in a minute, but I got to roll back to the academics. Bachelor's in economics at the University of Athens, PhD in financial economics at the London School of Business. which leads to you becoming a professor of finance at Columbia for over a decade, 1995 to 2006. Academia, was that always the career plan?

When you do a PhD, you're expected to go to academia. And the reason I did a PhD was because I wanted to delve deeper into the various topics. I didn't want to have a superficial understanding of economics and finance. That's what made me get into it. And then I had this wonderful opportunity to join Columbia. As a European PhD, this is, at least at the time, it was a very rare occurrence. I was actually, at the time, probably the first or second PhD from Europe that was ever hired at the Ivy League school. And so, of course, it was an offer I couldn't turn down.

And you spent a good 11 years there. I'm fascinated by your work history. It's like a who's who of investing. You're head of quant at Soros. You're a portfolio manager at SAC Capital. You consult for Citadel. You're head of asset allocation at McKinsey. PM at Perella Weinberg. Co-CIO at GSAM. That's an incredible run. How different were each of those shops?

What were the big takeaways? What did you learn?

Well, they were very different, as you know. And also coming out of academia, going into the industry, you know, to some extent you don't really know the cultures of all these places. But the reason I made this transition was because my research in academia was in empirical asset pricing and how macro factors affect asset returns. So I was always working on this interrelation of macro and finance, which at that time was not a very big area.

There were a few other people doing it, obviously. And it started finding applications to hedge fund strategists. So I started being approached by various hedge funds to consult. And so over time, of course, that led to job offers, and I was very reluctant to make the switch because it's a big change.

To say the very least, the first gig out of Columbia, was that with Soros Capital Management?

Actually, it was with another hedge fund that approached me as... to consult for them, and then... Was that Citadel? No, it was a smaller hedge fund at Connecticut, DSD Capital, I think it was called. And then I had various others that approached me, and then Citadel... approach. I was a retained consultant. They wanted me to join full-time, but I was very scared to leave academia, if you like.

Well, it's safe and secure, and out in the real world, they're very demanding.

Yeah. So I said, I'm not ready to leave academia, but I'm happy to consult. So we had this arrangement where I would spend one or two days a week in Chicago in their offices. At that time, that's where their main offices were. And then Soros approached me, and I started consulting for them. Eventually, I joined them to start this quantitative strategies group. But as we started developing the strategies and I was presenting it to the management there, Robert Soros was the CIO at the time. He liked the idea, so he said, OK, take 20 million to try this one, take 30 million to try the other one.

And at the end, I was managing about 200 million for them, which was not a lot of money for SARS. But it was an opportunity for me to, you know, to dip my toes into the markets and start seeing how things work. And these strategies were quantitative in nature. So eventually, when I left Soros, I was able to take the code with me, and I moved to SAC, and then I was a full-blown PM with my own silo and team and so on and so forth. So that launched my career as a global macro PM.

So I have to ask about how different is teaching at a place like Columbia versus managing money at, Soros, Citadel, SAC. What's the biggest gap between academic theory and real-world practice?

Ego.

Is that a big part of it?

I think it's a big part, and one of the biggest hurdles I had to overcome when I moved to industry, when I was meeting different people or people were approaching me for positions, was the first question would be, academics don't succeed on Wall Street. what do you think is different about you? Because it was, you know, LTCM was very recent. Sandy Grossman hadn't done well. I mean, he had done initially, but then he didn't. There were a couple of other examples.

Here's the pushback. Dimensional Funds is a trillion dollars, academically driven. Vanguard is 12 trillion. BlackRock is 13 trillion. I mean, those are big, academically driven shops.

But these are not hedge funds. They're long-only shops. So in the hedge fund world, the perceptions are different. And I think they were very much colored by the failure of LTCM, because there you had all these big names in academia.

And 100x leverage.

Yes, exactly.

It's less academia than a bad.

Exactly.

That's more inexperienced. And here we are, fast forward, and situational awareness... blows up for the same reason. So you mentioned ego. I saw a study, I don't know, about five years ago, women PMs tend to outperform male PMs by something like 80 basis points. And my immediate thought was, oh, I don't even have to read this. It's testosterone poisoning and male ego. Is that an exaggeration or how accurate is that?

Well, you know, at some level in academia, the stakes are not as high in the sense that you can have your views and go with them. And there is most of the time there is no way to equivocally prove whether you're right or wrong. I mean, in some cases, you can.

But there's no P & L where at.

The end of the quarter, you're... point, I have to cut risk. And there, you know, it doesn't matter how strongly you feel about the idea, you get your scorecard every day that says how well you've done. And that's the case, at least in public markets. If you're in private markets, you have a longer runway. But in public markets, it's very brutal. You get a scorecard every day. When you make money, you're happy, but you're not as happy as you're sad. When you lose money.

Isn't that Kahneman-Tversky's classic finding that the reason we have such loss aversion is we feel the pain twice as much as we enjoy the pleasure?

Yeah, exactly.

So how do you balance, I'm hearing a mix of theory, conviction, and risk management How does a PM balance that when, all right, the risk says 5%, I'm out, but I know that this trade is going to work out and I would love to reenter it? How does a PM like yourself, that's so quantitative and theoretical in nature, how do you balance those out?

Well, the premise of my strategy was having a view in the markets and expressing it through many different trades in many different ways. So no particular trade was dominant in the portfolio. And always I was focused very much on protecting the downside. So in that sense, the risk management was integrated into the portfolio construction phase of the strategy.

And I must say, going from SARS to SAC, in each of these places, I learned different things. So SARS was a big macro shop, so it was a great school from that perspective. But SAC was so focused on risk management. So even someone like me coming from academia where risk management is an obvious thing to focus on, I had to spend a lot of time refining that part of my strategy in order to be able to do well and, you know, succeed there. So that's really how it was happening. It would be small trades, and then I would do volatility targeting at the portfolio level.

And then if I would see that I had many metrics by which I was tracking volatility in the markets, and if I would expect that the volatility going forward would be elevated, then I would cut the risk across the board at a portfolio level. So I would basically target the lower vol.

Let's stay with the macro because I want to relate it back to some of your academic work. One of the things you focused on was analyzing how news about future economic growth relates to equity returns. But as anybody who's invested or traded for any length of time, getting the economy right is not enough to get the market right.

How do you reconcile those two?

Well, the market is a predictor of future economic growth.

Mm-hmm.

So that's the case. And actually, relating it... And so it depends on the horizon over which you trade. So my approach was never, you know, day trading. It was more longer-term themes that were playing in the portfolio. And so from that perspective, having this more long-term aspect in the portfolio construction was helpful, but it was complemented with shorter-term themes. So we had a blend of different ideas that were playing out over different horizons.

Really, really interesting. Coming up, we continue our conversation with Maria Vassalu, head of PICTE's Research Institute, discussing the academic theory behind investing. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My guest is Dr.

Maria Vasalu. She is head of PICTE's Research Institute, which runs essentially all of the academic market research for the firm, which manages nearly a trillion dollars in assets. So you joined PICTE in January 2020. I mentioned earlier the firm was founded in 1805, but you joined specifically to build the research institute from scratch. What was that like, starting from, you know, the ground floor? That sounds like quite a lift.

Yes, and that was really the attraction of this opportunity, the fact that PICTE had this vision of creating this institute for quite a while. And being a firm that has been around for a long time, they have weathered many cycles in the markets and the geopolitical developments, obviously. So they're very careful and deliberate about the decisions they make.

But once they make a decision, they really go for it in a very... high conviction way. So eventually, you know, they were looking for someone for a while. Eventually we met and I found the idea fascinating to start this internal think tank effectively that would be focused on the study of long-term trends that can affect the way we approach investing. So effectively, we focus on three areas, geopolitics, macro and portfolio implementation issues. We have a team of PhDs that are dedicated to the Institute, and we do academic-level research. We don't focus on short-term themes, so we're not going to be the ones to tell you whether the market will go up or down next month or where S & P will end the year or things

like that. But we focus more on long-term themes that could be important for how we approach investing, how we develop our investment processes, how we develop our product offerings, if you like, and really provide new insights to our clients and investment professionals.

So I'm fascinated about how you balance all this. So you've said, both here and elsewhere, The focus is long-term. It's macro. It's geopolitical. How do you prevent your whole research team from getting sucked into the daily news cycle, especially here in the U.S.? But globally, there's so much news.

It's so noisy and distracting. How do you keep everybody focused?

Well, first of all, the Institute is a group-level function. We cut across all the different businesses of Big Tech. But under us or in parallel to us, each business line has its own economists and strategists that focus more on the short term and the news flow. So this is not our job. We have other people doing that.

So we take a step back. All the members of my team are PhDs. And we have an agenda of different topics we work on. And we do basically academic level work. But it's not academic in terms of its rigor. But it's not academic in the sense of being abstract. We always ask the question, what does this mean for investing?

What does this mean for our business? What does this mean about how we should plan our future as a firm? So that's the main difference. And then I cooperate with the different businesses.

So I want to talk about some of the academic and PICTE research you've done and how all of this eventually is expressed in portfolio allocations. Your 04 paper is one of the best known in the Journal of Finance, Default Risk and Equity Returns, where you effectively argue that size and value is a default effect, meaning the small cap and value premium show up in the high default risk corners of the market, if I'm not oversimplifying that.

Walk us through what you found. How was it received at the time, and how do you express that with actual dollars?

Well, that's part of my academic work. It's not part of the institute work that we're doing now. Back then, my focus in academia was to explain asset pricing anomalies through economic factors. So what we've done there was, and I did it with a PhD student of mine, So what we've done was to create a measure of default risk, which was effectively the Mertens measure of risk. We're calculating probabilities of default and creating a measure about it and using this measure to basically show that that there was this big debate about small-cap effects at the time and what is driving it. Is it an anomaly? Is there a risk-based explanation? And our approach was to develop a default probability measure based on Merton's model, where we would

measure the default risk of different types of stocks and focus then on the small caps. And what we would show is that the small caps will always... load highly on this default measure. But as the default probability in the markets will vary over time with the business cycle, when default risk was low in the economy, the effect will be diluted. So you wouldn't really see the small cap effect. And when the default probability will rise, then that will become more pronounced. And once we were using that measure, we could effectively explain away all the small-cap effects.

So that was part of this research. Now, at the Institute, we are focusing on other work, and we are also going through a transformative time in our history because we are moving away from the world of globalization, the dominance of the U.S. and the world in a way that was established after the end of the Cold War to a new equilibrium that is yet to be defined. And this is really a period of high uncertainty, a period where a lot of things are happening and where, to be a good investor, you need to also focus on geopolitics and macro. You cannot do your job well by just focusing on the particular asset class that you manage.

And this is where the institute comes in. We developed a framework to understand what is happening in the world and how the different pieces fit together from geopolitical initiatives and policies to economic policies to what is happening in terms of the competition between China and the US, the rest of the world, the position of the US, the role of technology, the role of demographics. industrial policies and so on.

So let's talk about some of the Pictet Institute's published studies over the past couple of years. In 2024, the study was titled The Critical Role of U.S. Debt Sustainability in World Financial Architecture. And that was before we had the tariffs, before we had the Iran War, before the current administration repositioned the U.S. in a somewhat aggressively isolationist way.

Tell us what you found. What is the contested leadership? What is the power battle, the dynamic between U.S. and China? How does that all manifest in markets? What does it mean for the average investor?

After the end of the Cold War, there was a global financial arrangement that was put in place by which the rest of the world will produce surpluses. They will ship those surpluses to the US. And in exchange, the US will provide to the rest of the world the US dollar as a reference currency, US safe assets in terms of US treasuries, and US equity returns. And this arrangement was working so long as the US was the undisputable leader in technology. Why? Because for the US to play that role, it had to issue debt. It had to run deficits. And as we know from economics and the Triffin Dilemma, this is what eventually leads to the demise of the currency, reference currency providers, because you have

to issue debt in order to become a dominant hegemon in the global financial system. But as you issue more and more debt, you erode your own credit worthiness, and eventually you lose that privilege.

Is that inevitable for, because we saw it, Go back over the centuries. First it was Amsterdam, then it was London, then it was New York. There was dalliances with Tokyo, and people have talked about Beijing as possibly the next leader. Is it just inevitable that all empires crumble and every country with the mantle of leadership eventually puts itself in so much debt they no longer can lead the global economy? Well.

This is exactly the point of this paper, and this is what is different with the U.S. The U.S. has done all these things, but the smart thing that the U.S. has done over its history is to focus on innovation and technology. And that effectively works as a collateral for the debt it issues because What is the problem with issuing a lot of debt? Well, beyond a certain point, the markets start doubting whether you will ever be able to repay that debt. But if you have a great machinery of producing innovation and technology that fuels economic growth, then that effectively will be your guarantee that you will be able to service your debt. And so U.S. has been the indisputable leader in technology all these years until recently, well,

we were seeing this coming, But it has become a real issue in the recent years. Now we see China seriously challenging the leadership of the US as a technology provider. And the moment the US loses its leadership, the whole global financial architecture and this arrangement that we describe crumbles.

And so for the US to maintain its leadership in technology and innovation is not an ego-driven pursuit. It's really existential in nature. And I think this is what a lot of people are missing. So this competition between the US and China is not going to go away when the administration changes, for instance.

So that's really fascinating. When I look at the history of the past, I don't know, the entire post-war era, it began with U.S. as an industrial power. Eventually that migrated, Germany, Japan, and then Korea. Then it was a technology, semiconductor software, Internet. That still the U.S. has maintained somewhat of a lead.

Now we look at A.I., And yet in every one of these areas, China has very aggressively pushed into the space. The central government has funded lots and lots of entrepreneurs and businesses. There's a big industrial policy there. Let's say in the next 10 years, China passes the U.S. in terms of technological leadership. What does that mean for the U.S.

as an economic power What does it mean for the people who are sitting on a lot of bonds and fixed income, the debt of the U.S.

Government? Well, that's really the risk ahead. And how we manage the period between now and the next five to ten years, I'm not even sure we have. 10 years ahead of us. I think a lot of things will play out over the next five years. So how we manage this period will be key in terms of the standing of the US and the global geopolitical pecking order.

which will have profound implications for the global financial system, the standing of the U.S., the standing of the U.S. dollar, of U.S. Treasuries, and so on. So I think we are really under pressure to make the right decisions now. Now, how did we get to that point? We got to that point because the emphasis was globalization, on economic efficiency.

So it was all driven by low cost of production. U.S. was happy to produce the ideas but then generate the goods, produce the goods at the lowest cost wherever that may have been. China was always very far in terms of its policies. So it always insisted that when they produce something, There will be a knowledge transfer. They would learn from that.

There will be JVs with local firms. So it had always a very strong industrial policy as part of its agenda. So it managed to learn and evolve over time. And the other thing that happened was China was very strategic in accumulating key resources around the world. that either it control directly or indirectly or control the processing of these resources that are important for industrial production, for innovation, for the new technologies and so on. So now we are in a situation where China is not at the same level as the U.S. in terms of innovation production, even though the patterns, the number of patterns may give a different idea, but I would say this is misleading. But it controls so many of the factors that one needs

to be a producer of these technologies going forward that effectively it controls a lot of this process. And so a lot of the developments we see also at the geopolitical level have to do with that, how to address this.

So for most of my lifetime, the U.S. deficit and debt has been expanding, and it more or less, there were the usual deficit hawks, chicken hawks always complaining about it, but it felt manageable. It's only in recent years... And I want to talk about policy, not politics. But it's only in recent years where we saw a couple of giant tax cuts that really opened up the deficit. The tariffs sent inflation higher. The war in Iran sent inflation higher.

That made servicing the debt much more challenging and at the same time created even more spending on the military side. It kind of sounds like The risk factor you envision is the result of a series of unforced errors. Is that a fair policy analysis? Did we shoot ourselves in the foot over the past couple of years?

I think the U.S. and Europe have been very naive in terms of their long-term economic policies, letting their countries deindustrialize.

In other words, just outsourcing manufacturing products. To China, to Korea, to Turkey, to Vietnam, to anyone that would do it cheaper.

Yes.

Well, we saw it during COVID where you couldn't even buy masks or toilet paper because nothing was made here.

Exactly. So I think if I remember correctly, after the Second World War, U.S. manufacturing accounted for about 45 percent of global manufacturing. And now it's down to 19 percent. Europe is in the process of also de-industrializing. It's not just that all this manufacturing moves to other countries and primarily to China, but it's also that increases the vulnerabilities of this economy. So now we have moved to a world where the focus has moved from economic efficiency to economic resilience. And that means that the mixture of services and manufacturing has to be redressed. And actually, the current technologies help in that respect. At the same time, you see that the demographics are also changing around the world,

and that also has an effect.

Let's talk about that because you've published several studies on that. What's going on both in the U.S. and Europe demographically? We've seen the fertility rates plummet, the number of people having children drop significantly, and the whole society aging. What does that mean from an investment perspective?

What it means from an investment perspective is that Successful investments going forward would have to basically fulfill three criteria. First of all, they should use technology to improve productivity. Productivity has been low at various parts of the world, particularly in Europe. But with the current technologies, there is an opportunity to increase productivity even with reduced use of labor, which in a way mitigates some of the effects of the declining demographics, these new investments should cater to the evolving demographics in the sense that It should cater to the needs of this cohort of people that age over time.

And they should be developed in an economic environment that has the infrastructure to allow this potential productivity gains to get realized. So as an investor, you can invest at various points of this process. It could be in the infrastructure, it could be in the development of the technologies, it could be applications of these technologies and so on. But when we talk about technology, we shouldn't just think in terms of the tech firms. A lot of the productivity gains will be in the use of these technologies in other products. And I think some of the more, you know, old economy sectors, for instance, can greatly benefit from these technologies and become very attractive in terms of their investment potential.

That's Joseph Davis at Vanguard's book, which is technology arrives in two waves. First, the tech companies, then everybody else that sees productivity gains. But I want to stay focused on Europe and how different they are from the U.S. in terms of productivity. First, how much of that is purely cultural knowledge? And second, do you really want to give that up? I'm so envious of the lifestyle in Italy and France and Greece where it just feels so much more relaxed and less stressful than the United States, especially New York, San Francisco, L.A., Chicago, any of the big cities, just a go, go, go. I don't get that vibe in the major cities in Europe.

Yeah, so I think there is a middle road. It doesn't mean that these countries have to change their culture, but they have to improve their efficiency. They have to invest in productivity gains, which have been very low. Even if you look at Germany, for instance, which is the manufacturing heart of Europe, productivity has been effectively zero.

No gains at all for the past couple of decades.

Yeah, very, very low gains and certainly not in total factor productivity.

Even with automation and software improvements and robotics, Germany hasn't seen an uptick in productivity. That's amazing.

Not really. And you can see that also in real wages that haven't gone up. And so that increases the income inequality in the country. But they can, I think there is the realization that they need to invest in those things. And at the same time, there are also certain constraints because these technologies also require sufficient cheap energy.

And Europe hasn't really invested enough.

They seem to have embraced more electrification and solar and wind and geothermal than the U.S. has, but not nearly as much as China has.

Yes, and this is all nice and good. I don't have anything against the green forms of energy, but just like in the case of the structure of an economy, you need to have a diversified pool of energy resources. You need effectively a portfolio approach to energy resources, and that should include also other sources of energy, including nuclear.

And it was a mistake that Germany got out of nuclear power. We see the benefits of nuclear power in France, for instance.

90 plus percent of their energy comes from nuclear.

Exactly. For the foreseeable future, I don't think we can walk away completely from fossil fuel. This is going to be in the mix. But we see now what's happening with Hormuz and. And Russia. And Russia. So having alternative ways to provide cheap energy is very, very important. And you can really invest in automation technology if you don't have access to cheap energy and abandoned energy.

Last question about Europe. The changes in the United States have been leading Europe to consider reinvesting and raising their own defense spending, and especially with homegrown manufacturing and their own various defense products, what does that mean? They've been reliant on the U.S. for so long. The change in the U.S. relationship to NATO and just who the U.S., or at least who this administration is, considers an ally.

What does this mean for spending if more and more of European spending has to be steered towards defense?

Well, first of all, in terms of U.S. interests, Europe is not as strategic as it used to be. It's important to have it as an ally. But in the past, the main adversary of the U.S. was Russia or the USSR before that. Now the competition has moved to China. So the role of Europe in that respect has been degraded.

That's number one. Number two, Europe is a very affluent part of the world. It doesn't need this military power. subsidy that he has been receiving since the Second World War. Not spending 3% of their GDP over 80 years on military has allowed them to build their social safety net, free education at a very high level. free health care and so on. On the other hand, of course, Europe has been investing a lot of its surpluses to the U.S., but most of these surpluses were invested in the stock market and in treasuries. So they have been receiving the dividends from them that have been supplementing the growth rates of Europe. And this effort from US administrations to really convince Europe to increase their spending on military is not

a new thing. It started with President Obama, even with President Bush, I would say, before that. But the tone was gentler and less pushy, I would say. The current administration has been much more vocal about it. And in a way, I think it led to an overdue wake-up call for Europe because Europe now starts debating how they are going to structure their economies going forward, what they need to do to become more self-sufficient. And in a way, when you have a reordering of countries in terms of their geopolitical importance, Being able to stand on your own makes you also more valuable as an ally to other countries and especially to the U.S. So I don't think that this is necessarily a bad thing. Now, in terms

of the military, if you leave aside the fronts where the French defense system is independent of NATO, the rest are all linked to the center command of NATO. So they can't really function on their own unless they go through the NATO command, which is controlled by the US. So this is a major issue they have. So of course, they can produce some drones or some other equipment, but they can't really work together as different countries as they stand now unless they build a new framework to integrate their military.

Really interesting. Coming up, we continue our conversation with Maria Vassallo, head of Pictet's Research Institute, discussing how to turn theory into practice. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guest is Dr. Maria Vasalu. She's head of Pictet's Research Institute.

The firm was founded in 1805 and manages nearly a trillion dollars in assets. So I'm fascinated by the concept of taking all of this original academic research and expressing it in a portfolio. Walk us through the process.

How does a.

Research finding actually become a portfolio decision?

So the role of the Institute is to provide some new insights or a new way of looking at what's happening in the world. And then one of my functions is also to discuss those findings with our investment teams and see how they can affect a different products, the different ways we invest, and so on. I'm not a risk taker anymore, so I'm not going to incorporate them into a particular strategy. But I am working with our investment professionals to help them understand what we are doing or express those findings into potentially useful things for their investment process. So, for instance, a lot of our work points to the fact that this compartmentalization we have in countries between developed markets and emerging markets becomes increasingly obsolete.

Explain that, because that's so fascinating. You would think there's a huge difference between Greece and Japan, between Turkey and the United States. How are those distinctions becoming less important?

Well, there are big differences among those countries that you mentioned, but it's not a matter of where they are now, but it's a matter of what is likely to affect growth going forward. So we have those important factors that are affecting growth that have to do with... productivity, with access to important commodities, with access to energy, with demographics.

And so the mix is changing. And that's why it's also important for Europe or other parts of the world not to neglect how their economic structure evolves over time, because the fact that this part of the world is developed does not necessarily mean that it will always stay at that high level of development going forward. So what defines a developed economy? It's their GDP growth. It's their trade.

it's their manufacturing, it's their use of technology. But those five elements are changing. So technology is not necessarily produced all in the currently defined developed markets. There are economists that consider emerging. China shouldn't be an emerging economy, but it is still considered that it's a leader economy. in technology.

On the other hand, you have various bottlenecks in economic growth, which have to do with access to minerals, to commodities, to energy. So some of the emerging markets that have control over such resources can become much more important going forward. So there is a change in that respect. We think that if you look at what defines a middle power or a great power, the factors that define them are changing going forward.

So let's stay with that for a second because you've said the investment playbook needs a complete reset. What we've been dancing around is little changes around the edges, but you're really saying, hey, we need a clean sheet. We have to rethink the geopolitics of the world are changing. The macro side of the world is changing. So what are the assumptions that the old playbook had built into it that have to be thrown away? What is that clean sheet, new investment playbook look like?

So first of all, there is a reordering of countries in terms of their geopolitical economic importance. And what one needs to focus is not what has happened in the past. The past is becoming increasingly less helpful in predicting the future. One needs to see what are the driving forces of growth going forward and which countries control or have already in their possession or have the ability to develop those elements that will lead to growth going forward. So this is really the key. And so one needs to focus on who is likely to grow going forward. Commodities and technology are important factors in the standing of these countries going forward. So that's one thing. The second element is where you're standing in the spectrum of technology. Are you

a producer of innovation? Are you a competent adapter of innovation? Are you someone who is providing the inputs for the development of this innovation? And so on. And the third one is demographics. How you use your demographics to promote your growth and effectively ensure that productivity growth will continue going forward.

One of the themes I'm hearing over and over from you is economic growth seems to cure a lot of problems.

Yes.

And if you can grow fast enough, it offsets geopolitics, it offsets deficits, it offsets almost everything.

Exactly. And that has always been the case for the U.S.

U.S.

Has never really paid off its debt even after the Second World War. It just grew at high rates and reduces debt-to-GDP ratio. And actually, in all fairness, U.S. has been the only developed economy that has grown a 2% real growth rate for the past several decades. So this is quite spectacular. And when you look also at the debt, as you mentioned before, of the U.S., U.S. had a pretty modest level of debt until the financial crisis. So there have been two episodes that led to the increase of debt. One is the financial crisis, and the second one is COVID. And I would say that the second time, that was a bit of a misguided increase of debt.

I think there was way too much accommodation, fiscal accommodation thrown in the economy together with a lot of monetary accommodation that eventually led to this inflationary episode.

I want to just jump in because the criticism... of the spending post-financial crisis was it was all focused on Wall Street banks and brokers, and they ignored the average person, homeowners, mortgage owners, who were also suffering from the same problem. The overcompensation in COVID was, let's just flood the economy, and I want to remind people The CARES Act 1 and CARES Act 2 under President Trump, CARES Act 3 and the infrastructure bill under President Biden was the single biggest fiscal stimulus as a percentage of GDP since World War II. I mean, it was people don't realize how unprecedented that fiscal surge was.

Yes. And at the same time, the Fed cut rates to zero. They started QE. And so you had stimulus on both sides. And there's no surprise that we ended up with inflation.

So let's stay with the U.S. and debt. You've called the United States the ultimate too big to fail. And I've said the main risk to U.S. debt sustainability is geopolitical, not simply numbers. Explain that a little bit. What does that mean for fixed income investors?

First of all, we were used to very low rates because of financial repression. So the yield curves that most people active in the markets are currently used to are rates that were established under the involvement of the Fed by buying at the different parts of the curve, treasuries, and so on. the rates weren't really reflecting reality. The purpose was to push investors out the yield curve and take risks. So as the Fed started stepping back, it's normal to expect the yield curve to start becoming upward sloping.

I don't personally find the stiffness of the curve particularly worrisome. in terms of how steep it is. The problem is that, of course, we have a high debt that needs to be rolled over. And now, if you look at the budget deficits, a greater part of the budget deficits goes to servicing the debt. And obviously, as the yields go up, that becomes more onerous. But in terms of this, if you remember before the financial crisis, the 10-year was at 6%.

So let's talk about that because all my friends who were bond managers have said, now we're just reverting back to long-term average. These rates aren't high. They're just higher than the financial repression rates. And a 5% 10-year yield and a 6.5% or 7%. Mortgage rates, that's the average for the past 50 years. It's not a crisis. Yeah.

It just feels that way relative to zero.

I agree. I completely agree. The difference is that back then, the debt to GDP in the U.S. was, I don't remember.

Off the top of my head. 80%, 90%.

Even less, I think. It was, I think, even less than that.

And now it's well over 100.

Yeah, so that's the main problem that we have.

Although, where's Japan? 220, 240?

Yeah, but it's different because 90% of the debt in Japan is internally held.

Yeah.

And so you don't worry about refinancing that debt. In the US, the foreigners hold close to 28% of US debt. So there is a bit more risk. However, people only focus on the extent of debt of the US. If you look at all the obligations of the federal governments or the governments in different parts of the world, and we do that in a new study I'm working on with Professor Donaldson from Columbia, where we look at reindustrialization, the fiscal space that exists in different parts of the world, and so on. And you add, for example, the pension obligations that exist across the world. Europe scores actually higher than the US. So it's one thing to focus on external debt. It's another thing to focus on the total

obligations that these governments have.

So as long as we're talking about debt, I feel obligated to talk about the US dollar as the reserve currency of the world. As the geopolitics change, as China continues to ascend, as we continue to make a series of unforced errors, What does it mean for the dollar? Are there any other currencies that are potential replacement? I've heard people float a basket of everybody versus it. That's not really reserve currency. Is it the dollar for the foreseeable future?

There is no obvious alternative to the dollar. And it's not in China's interest to make the remedy be a reference currency.

Why is that?

Because they will have to run deficits. And China is doing exactly the opposite. And they have capital controls. If China lifts capital controls, a lot of money will leave China. And, you know, then they cannot really be the manufacturer of the world and produce all these surpluses. So what they are doing is effectively just some trade it does with other BRICS countries or other emerging market countries. They do them instantly at the Remnibi. But then, you know, whether this is attractive to the other side depends also... to the extent that they trade, both countries trade with each other.

Because if China doesn't want to import anything from the rest of the world, then the rest of the world can't really do anything with the remedy they receive for selling.

Uh.

or from uh... you know from selling to china in other words.

You need to be a big importer in order to be the reserve currency you need.

To be a big importer uh... so and you need to be a producer of safe assets because if you hold the remnibus you don't have anything to invest them in whereas if you receive dollars then you you invest them in treasuries you you earn a yield.

All this is so fascinating and so incredible. I'm simultaneously hearing from you that on the one hand, there are huge changes happening geopolitically. We really haven't even barely touched on AI and what that might do for productivity. At the same time, there's no substitute for the reserve currency of the U.S., the the safe asset of US Treasuries, it would probably be in our interest to not alienate a lot of our allies, but the world really doesn't seem like it has any other choices, does it?

It doesn't have any other choices. Of course, you know, weaponizing the dollar beyond a certain point is not a good strategy because countries and people have memories. But I think what is key is for the U.S. to remain, if not the world's leader in technology, but certainly one of the main producers of technology. And it has to improve its economic resilience. So I think the U.S. needs to some extent reindustrialize, not produce T-shirts and plastic toys, but be a self-sufficient industry. In certain key industries.

Semiconductors, everything from solar cells.

Chemicals, pharmaceuticals, you know, certain equipment and so on. So things where at a pinch they can be self-sufficient, but they can also, it's not just that. It's also that the process of producing innovation passes through the production of the product. And there is a lot of knowledge acquired there that then feeds into new innovation. And it also creates a pool of labor that can migrate from one subsector of the economy to another and cross-pollinate and enhance the production of further innovation.

The Silicon Valley flywheel.

Exactly. China is benefiting from that, and we are missing out.

So I only have you for a few more minutes. I'm going to jump to my favorite questions that I ask all of my guests. Starting with, tell us who your mentors are who helped shape your career.

A lot of people, but I'm not the typical case where I had one person that was my mentor through my career. because I moved around a lot. I moved, as we said, from academia to the industry. But I'm someone who likes to study people. And whether they are officially my mentors or not, I try to learn from them and, you know, try to emulate their good sides and try to avoid things that I find... that potentially were not very helpful. So there were professors at the various schools I went, my thesis advisor, people I worked with at different firms.

I'll let you in on a little secret. That's the motivation of this whole podcast for 12 years. Let's talk about books. What are you reading? What are some of your favorites?

Well, I spend most of my life studying the themes we just discussed. So my spare time now, I've started a new book by Romain Garry, La Promesse des Lobes. It's a book in French.

You speak several languages, right?

Yeah. Well, three. Not too many, but yeah. So I'm reading it in French. And it's a very nice, partly autobiographical book that also talks about his relationship with his mother. And it seems like a very nice book to change ideas from everything that is going on in the world.

A good break. Anything you're streaming these days? Are you listening to anything or watching anything in particular?

I must say that since I moved to Geneva, I have much more opportunity to be outdoors and do sports. So that means less streaming after work. And so it's a really wonderful city, very livable, very inhumane dimensions. So you can be from one side to the other in 20 minutes. Very walkable. And so after work, I try to spend some time doing sports and then limit my screen time so I don't stream very much these days.

I'm jealous. We were in Lake Geneva a couple of falls ago, and it was just spectacular. It's like an hour or two from Geneva. Have you spent much time up there?

Oh, yeah. I mean, even 20 minutes, you're in the countryside.

It really is very spectacular. Our final two questions. What sort of advice would you give to a recent college graduate interested in a career in either financial academics or actual research and hedge fund asset management?

I don't envy the people who are starting their career now. I think every generation has its own challenges. I think people now have to remain very agile, very adaptable. You have to continue learning all the time. That has always been the case for everyone. But I think the pace of change is so much higher now.

So fast.

And so all these people need to constantly re-educate themselves. They have to be very proficient with the development of technologies, with the implications of their technology, of these technologies for their own career. But I think my view is, in general, technology... in a sense, eliminates certain jobs, but that also pushes people to use their creativity and intellect at a higher level.

And I think these technologies that we're facing now will lead people to be more creative, to try to come up with new ideas. And so I think they need to invest in that process and also invest not just in the technology, but on the full set of their skills.

And our final question, what do you know about the world of investing and research and just looking at all the opportunities that any allocator of capital has to manage? What do you know today might have been useful 25, 30 years ago when you were really first starting out?

I think we live in a very different world now than 25 years ago. 25 years ago, you could study the past and learn something about the future. Now we are in a phase of our history where the future will look very different. We are in a transformational, pivotal time. So I would put less emphasis on the past. and more in understanding the drivers of the future. So sitting now here and looking at what happened in the past hundred years, yes, there may be some elements you can extract from that, but there is so much innovation also in the markets, in the asset classes, in the drivers of those asset classes, that you can actually come up with very misleading ideas you know, conclusions if you put too much weight on the past.

Maria, this has been absolutely fascinating. Thank you so much for coming back. We have been speaking with Dr. Maria Vasallo. She's head of PICTE's Research Institute. If you enjoy this conversation, well, check out any of the 667 we've done. over the past 12 years. You can find those at iTunes, Spotify, Bloomberg, YouTube, wherever you get your favorite podcasts from. I would be remiss if I didn't thank the crack team that helps me put these conversations together each week. Elizabeth Sedrin is my video producer. Sean Russo is my researcher. Anna Luke is my podcast producer. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.

Balancing Conviction and Risk: Masters in Business with Maria Vassalou

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