RAOUL PAL: In the first part of this demographic journey, I wanted to speak to Fredrik Nerbrand. Fredrik was well known at HSBC, where he really understood demographics and how it applied to investing. He's now the CIO of a family office. I wanted to pick his brains to see how he sees the big picture, and how it's going to affect all of the asset classes around us, and what it really means for economies and financial markets.

Fredrik, great to get you on Real Vision. We're going to talk about a topic that's close to my heart, which is demographics. I'd love to hear a bit about your background first, just so people know who you are and what you do.

FREDRIK NERBRAND: Fine. At the moment, I work as a CIO for a single family office here in London. Prior to that, I was at BlackRock multi-asset investment team. Prior to that, I was the Global Head of Asset Allocation Research at HSBC for many years. Earlier on in my career, I was a chief strategist for the private bank at HSBC, as well. I've seen anything from wealth management, up to institutional sell side down to institutional asset management, and now back to the single family office. I've done a full round trip.

RAOUL PAL: Absolutely. Talk me through your journey of demographics, and why and how you discovered that it was something really important and probably underutilized by many people. Talk me through that.

FREDRIK NERBRAND: This is back in 2012-2013. I started this journey. It ultimately was like, okay, how can we explain the difference in asset allocation between Japanese investors on one side, and European somewhere in the middle, and then the US at the other extremes in terms of their appetite for risk, whereas the Japanese were [?] the purposes, bonds and cash, and very little part of their asset allocation sat in equities, whereas the US, it was the reverse. I was going to ask myself, whether or not you can explain that difference from a demographics perspective, i.e., just because people are old, does that mean-- all the population in Japan, does that explain the difference? Is it cultural in nature?

Through that research, it was then very clear to me that actually, Japan looked away from a balance sheet perspective, because of demographics, roll in "cultural issues". If that's the case, then it was pretty the next step, or the obvious next step is to look at, okay, so how does demographics then change over the years to come? How might that impact asset allocation not just what it's done in Japan, but looking at that from a more global perspective? That's how it started.

RAOUL PAL: Certainly, your initial hypothesis is the US are risk takers, the Japanese are risk averse, and the Europeans are somewhere in the middle, that was your hypothesis to say maybe demographics is one of the key drivers of that.

FREDRIK NERBRAND: Yeah. As it turns out, I would argue that a large share of that difference is the demographics side. It then starts unraveling in terms of doing all this research because this is one of the few things in life that we can actually predict. In 10 years' time, we all tend to be 10 years older.

RAOUL PAL: Or dead.

FREDRIK NERBRAND: Or dead. I had started from an asset allocation perspective, but then took it further into the growth side in terms of, okay, if I look at demographics from a growth perspective, I think there is like six stages of your economic life, and you can argue with these, but I think that they're fairly safe. You are born, you start to work, you improve, you reach some type of peak output through your life, you retire, you die. I think that those are fairly safe assumptions.

If you take that bottom up view of economic activity in terms of not just expanding growth, but savings, behavior, etc., then after a while, you need to stay away from sharp objects. I would say that from a personal perspective, I remember I published on this back in 2013 in the spring and went around the world arguing this story, and a lot of people were like, why do I care? Then I sat down over the summer months, I had a short holiday and I always came depressed because I was like, actually, this is deterministic. I don't think that there's a way out of this other than cloning Elon Musk.

I still struggle to see how some of these economies are going to maintain some "trend growth". I would almost argue that from an economics perspective, the structural stagnation story, I would almost argue is too optimistic. I would argue that we should talk about peak economies is that actually we have an environment going forward where some countries will shrink in real terms. That's a very different outlook in terms of whether or not you look at banks balance sheets, or you look at credit, or you look at inflation, or you look at assets more generally. I think that's the, unfortunately, that I'm still yet to find an argument of how we're going to overcome all of this outside of like having exponential level of personal productivity gains.

RAOUL PAL: I've been writing down a ton of questions for you, because there's lots of stuff I'm super interested in in this. Let's just, for everybody's sake, watching this, talk us through what you think where the current situation lies in Japan, Europe and the US at broad perspectives. We'll go to other markets later and stuff like that, it's fine. Just understand where we are now in your core hypothesis.

FREDRIK NERBRAND: My core hypothesis, so starting from these six stages of your economic life, if we don't look at that from a bottom-up perspective and look at how many 20-year-olds do we have, how many 30-year-olds, and so forth, then we can create a demographic index, but from bottom-up perspective.

RAOUL PAL: You're creating cohorts and looking at each individual.

FREDRIK NERBRAND: Actually, I do it year by year, I look at how many 20-year-olds, how many 21-year-olds, how many 15-year-olds, and you can then create a continuous index to explain what that demographic dividend will look like, not just now, but also going forward. The good news for the Japanese is that they've aged. The impulse of their demographic dividend isn't as negative as it was before. When they used to--

RAOUL PAL: The rate of change has now slowed down.

FREDRIK NERBRAND: Exactly. Then used to sit with-- I'd like to think that they sat with some 2% or so of average growth back in the 1970s, and so forth, just coming from demographics. That's now slightly negative, and it's going to remain negative for the foreseeable future, but it's in the 50, 100 basis points mark through the next few decades, whereas if I look at parts of Europe, we're where Japan was back in 2000, 20 years. The US doesn't look this poor, but it's still like the change of that growth element is coming down. I think that the really scary arguments, of course, and we know some of these, is that we know that Italy, we know that Germany, etc., but it's more the way of quantifying that.

The way that I've quantified that is suggesting that at the moment, the demographic dividend is about zero, in Italy. It will drop to minus 130 basis points per annum. Then the interesting argument here is that-- there's something called the Solow Model. I don't know how familiar you or your listeners are to economic theory, but basically, the Solow Model says, economic growth is number of people plus productivity gains.

Let's just play a very simplistic game here. Say that we're 10 people in our little economy, you, me and your producers, etc., and we're producing widgets. Then for whatever reason, we have a 65-year-old person that retires and we bring in, strapping a 20-year-old to bring into our little economy. Now from an economics perspective, it all looks the same number of people working but initially, there's a significant drop in our overall output, assuming that the 65-year-old has learned something through his life because--

RAOUL PAL: They've dropped from peak productivity to out, and the new person is at low productivity and increasing.

FREDRIK NERBRAND: Yeah. The next year, it's going to look like you've done a huge amount of productivity gains. All of this is a function of the composition. That, I like to call this a grad to granny ratio. It's like a replacement ratio in the wider economy. If you look at how many people coming in versus those leaving, and across the board, across the board, this is looking problematic to say the least. I've run through every single number on the UN population database and there is only like two or three that are going to see an increase in that grad to granny ratio over the next 10 or 20 years.

RAOUL PAL: What does that mean then?

FREDRIK NERBRAND: Well, that brings me back to what I was saying before is I think that it means that we need to reexamine, one, what our historical productivity numbers ever looked like, and adjust that for the compositional element of the workforce, number one. Number two, actually, we might be in an environment where we don't have trend growth, we have trend declines. That to me is-- from an economics perspective--

RAOUL PAL: We're looking here, therefore, at as this ratio skews, as this baby boom population leaves the labor force and becomes less productive in the economy, we're going to find that trend rate GDP growth keeps lowering, which is observable already, it seems to. Same with CPI for similar reasons. It seems to be driven by that because obviously--

FREDRIK NERBRAND: It's different reasons, but yes.

RAOUL PAL: Just before we move forwards, let's talk about the asset allocations of those different three regions. What does a Japanese asset allocation look like? What does a European asset-- the core pension or household asse, how are they different? Is that a phase that the US is going to go into, and Europe go into the Japanese phase? Talk me through that a bit.

FREDRIK NERBRAND: Just a few look at where we are at the moment, because I think your initial conditions matter in this. In Japan, we're of course now seeing we're past a threshold where people are selling equities. We're now into the part where actually a lot of these savers are now selling bonds and they're sitting on cash instead. We can see that because we can clearly now see that Japanese pension funds are net sellers of JGBs.

RAOUL PAL: And the BOJ is buying them essentially.

FREDRIK NERBRAND: It's the only buyer. In Europe, we're not quite that extreme, but that's where we're going to. If I look forward for another 10, or even 20 years, let's keep it at 10 for now. It's the same type of transition. Actually, I did some of the numbers on this, updated some of the numbers, but did back in 2013, to look at, okay, what does this actually mean? I took the US where you actually have pretty good panel data in terms of looking at who owns the number, because what matters is that you need to follow the money.

As it turns out, in the US, but it's also the case in all the other economies is that the composition of the wealth has changed significantly. Here's a stat for you. Back in 1989, the people who were there less than 40 years of age, they owned about 25%, slightly about 25% of aggregate wealth, and the people below 35 and then 35 to, I think it was 45, they also owned about 25% plus. Both of those cohorts.

Today's younger population, either one of those like zero to 35, or 35 to 45, own less than 10%. You've seen a relative halving of the wealth of the younger population, whereas on the flip side, the older parts of the population, specifically the baby boomers, are significant owners of all assets, and they're the ones that are going to change their asset allocation, more so than anyone else. Because their duration-- because you have to remember that if you sit inside of an institutional asset manager or a pension fund manager, you're not really trying to optimize returns. You are trying to mitigate risks, because that's what you do.

If you have a bunch of policies holders in the pension assets that you're running, then they're all in their 60s and 70s, you're going to have different asset allocation compared to if they were all in their 40s. It's actuaries that drive markets, like the real structural story. I updated this, so I estimated that over the next 10 years, the overall, so if I take the current asset allocation of the US in terms of by cohort, and then I look at how they're going to change over the next 10 years, I estimate that the average weight in equities will drop by about a 12%, which is pretty significant. You guys see an increase in bond ownership and an increase in cash holdings, for all these purposes, because these people don't buy bonds for yields, they buy bonds for safety.

RAOUL PAL: I've got an issue with this. The US baby boomer asset allocation versus Europeans and Japanese at the same stage, they seem to be still heavier weighted, there seems to be more risk taking the US than there was in European equities, for example, by European pension plans at the same age. My fear is these guys are going into-- right, we're in the middle of a recession. Yeah, the market has gone to all-time highs in the middle of it, but maybe it doesn't. Maybe it doesn't. Maybe it goes back down again, maybe.

Well, the problem is that all retirees are sitting on high risk assets, I can't get my head around a world which they continue to take risk considering if you retire and your pension, the equity proportion pulls 50% and stays low like it did in Europe and it did Japan, what that does to US wealth is staggering, because they're all in equities still, quite late in their lifecycle.

FREDRIK NERBRAND: You can make the same argument to what happened in Japan in the beginning of the 1990s, late 1980s going into the 1990s. You saw a complete collapse of valuation metrics in Japan following that. Listen, it's all about initial conditions. I think there's generally five things that drive risky assets. Demographics is one of them, but I think you have the initial conditions where they have low valuations, you have high real interest rates so they can go, you have low profitability that can then improve, you have a high regulatory burden that you can deregulate, and you're improving demographics. That drives risk.

Out of those five pillars or whatever you want to call them, they're all crumbling, they're not where you think that they shouldn't be. On that basis, I would make the same argument as you do, is that if you're a pensioner, you should now take this opportunity to sell. Because it's not just about how much they own, it's about their changing behavior. It's the change of behavior that really drives markets more than anything else in my mind. How do you then-- I would struggle to see that they're going to pump more money into equity markets, and the money that goes into equity markets are probably different than what they've been in the past.

Because there is a function of, okay, do we believe this "fundamental growth" story, and is that what's going to drive market, or do we think that momentum and liquidity drives markets? You can talk until you're blue in the face that this fundamental story looks really poor but in the meantime, the momentum and the liquidity just continue their unrelenting path. I think that's the dichotomy that I think is the most interesting.

RAOUL PAL: One of the things we've discussed a lot on Real Vision is the value goes to growth trade. We've seen this, it's ridiculous levels. It seems that the key driver is demographics. The seller of active funds are the baby boomers, as they should be, because that's what they own their whole lives, is active management. The buyers are millennials in their 401ks in passive and the passive flows a signal significant and the active flows are relatively significant, and what we've got is a market supply and demand mismatch.

How do you think about the millennials in the US where they're much larger than anywhere else in Europe, for example? How does that affect your outcome within this? There's other cohorts who are much poorer, who don't have assets, do they have a different story, have an upside, that we're not considering within this?

FREDRIK NERBRAND: Yeah, I think there's two stories here.

RAOUL PAL: Obviously, record valuations. All of these things, expecting returns to most assets is negative, but.

FREDRIK NERBRAND: I think there's two, two factors. Number one, there's a momentum story, which is basically, if everyone buys ETF, the winners keep on winning and the losers keep on losing, because it's a function of relative performance. It's just on that basis, just be on momentum, relative momentum. The other thing that I think that's also interesting is that the baby boomers will die, and the ones that have enough money that will hand down assets to their children, those children will have different investment behavior compared to their parents.

It's a function of how much will actually be handed down and then that rotation in terms of ownership. I think, though, especially in the case of the US, it's not now. I think that's a story for the 2030s rather than for the 2020s, if that makes sense.

RAOUL PAL: Yeah, because the Japanese one was interesting, because they live so long, they handed on to their retired kids.

FREDRIK NERBRAND: Yeah.

RAOUL PAL: Which is really fascinating, because that demographic dividend in terms of inheritance didn't play out because it went to the wrong people who were retired anyway, so they just sat on it.

FREDRIK NERBRAND: They consume some of that wealth, and there's then less for the following generation and so forth. The stuff that gets handed down, ultimately, in terms of size is going to belong to the upper echelons of the wealth distribution.

RAOUL PAL: Yeah, because the rich/poor divide is so skewed, I guess, as well.

FREDRIK NERBRAND: Yeah, but that's also part of like-- when I did this research, looking at the wealth dispersion, what I found was that, yes, there's clearly a wealth dispersion happening. Actually, the majority of it seems to be between cohorts rather than within cohorts, i.e. it's the older generation have become so much more wealthy, and the young has become less wealthy in relative terms. Actually, within those cohorts, there's course of dispersion, but not as extreme as what it looks like on an aggregate basis.

RAOUL PAL: Okay, it makes sense. If you're looking at asset allocation, and again, I think the US is at a stretched point more than the other countries is, I guess the advice to the baby boomers is get out ahead of everybody else, because everybody has to sell. The millennials, how do they deal with this? They don't have much money. They've got an all-time record valuation equity market, all-time record low bond yields, all-time record low credit spreads.

FREDRIK NERBRAND: Yeah, [?] it doesn't look great.

RAOUL PAL: What the fuck do they do?

FREDRIK NERBRAND: They've answered that question. They've answered that question by, I'm going to buy Apple, I'm going to buy Amazon, I'm going to buy Zoom. Their buying behavior is--

RAOUL PAL: Momentum.

FREDRIK NERBRAND: One, momentum, but it's also things that they know and things that they buy, and things that they utilize.