PHILIPP VORNDRAN: People underestimate the importance of the extreme low interest rate.
Look, what is the earnings yield today of global equities? Around 6.5%, versus the global interest rate, which is 0.4%.
Gold is an instrument which you want to be able to take grip upon if something ugly happens.
ED HARRISON: I am here to continue our series on recession watch in Europe. The question really is, is now that we know that Germany, in particular, is probably in recession, what are we going to do about investment there? We're talking to Philipp Vorndran, who is the Chief Investment Strategist at Flossbach Von Storch, one of the well-known asset management companies, independent asset managers here in Germany. We're going to talk to him about what their investment strategy is overall. Also, is it any different now that we see that Europe is not doing quite as well? Hope you enjoy what you see.
Philipp Vorndran, it's very exciting to talk to you. Your company, Flossbach Von Storch, is one of the best known, I would say, asset management groups that are coming into the mainstream, if you will. My understanding is you started 20 years ago with not a huge amount of money under management, but have grown 30, 40 times in that timeframe. Take me back to how this company got started and where you came into the picture.
PHILIPP VORNDRAN: Yeah. You are spot on. Our company was founded roughly 20 years ago. It was, at the beginning, purely focused on high net worth individual portfolio management. It was a lot of German wealthy people who were looking for an individual style of money management. I think that was more or less our business model the first 7 to 8 years. Later on, the mutual fund business, the family office business, and the institutional investors was added. Today, as you pointed out, we have roughly 40 billion Euros under management, of which half of it, it's more or less mutual fund business and the other half is more or less equally split into the institutional and the high net worth private business.
ED HARRISON: In your career, actually I think we spoke about this offline before the interview, you actually started in banking and asset management from pretty large companies before coming here. Tell me a little bit about how you came to Flossbach Von Storch.
PHILIPP VORNDRAN: It's predominantly based on the personal relation to Kurt Von Storch. Kurt and I managed, in the early '90s, the world biggest global derivative fund. He then quit his job with Julia Spare[?] and moved to Goldman Sachs, where he worked together with Bert Flossbach. I stayed with Julia Spare, moved to Switzerland, then moved to Credit Suisse, and even being the CEO of Credit Suisse Asset Management in Germany, I was already sitting at the board of Flossbach Von Storch.
Roughly 10 and a half years ago, we decided that now the time is me to join the company also in a more operational function. I helped to build up especially the institutional and the mutual fund business. Obviously, it's totally different. First of all, there's no politics, no politics. All of your colleagues that in a large company, politics is of the dominant factor of your working life.
We just have here the freedom to do whatever we want to, there is no global committee, there is no fight between asset classes. It's just to focus to the client, to the client's needs, and to focus to make clients really happy. Because only if the client is happy, he will stay with you. We are not a huge brand. Today, maybe we are a well-known brand, but 10 or 20 years ago, Flossbach Von Storch, who was often the answer. You have to fight every day for the respect of the client. It's a total different utility function. It's the client first, and politics last.
ED HARRISON: Well, we were talking a little bit about this before, the segue I would go into in terms of your investment style is what you just told me about the room that we're in and the other rooms on this particular floor named after central bankers who are good at what they do, and investors like Charlie Munger, Warren Buffett, Benjamin Graham, who are good at what they do. What sets your investment strategy apart from other European asset managers of your size? PHILIPP VORNDRAN: I would argue it's a very easy point, it's always thinking in risk reward terms, never about an index. We have changed asset management over the last 37 years from an asset manager who was just trying to perform in a way the individual client was looking for into an industry which just tries to be the benchmark. We have no benchmarks.
We always think about absolute return. We always think about risk and reward. We always think like an investor in a corporation. We always describe that as the old fashioned way of investing. The way the Oppenheimers, the Rothschilds, Benjamin Grahams, Warren Buffett and Charlie Munger, decide what to invest in. That's our basic principle. On top of that, we are pure global.
I think that's what differentiates us from most of our European competitors. They are quite often very index based, even they call themselves really active managers, but to some extent, they are quite often closet indexing and the home bias is something we are not targeting for. If our company would be located in Tokyo, or in Washington, or maybe in Cape Town, our investment process, our portfolio would not look very different into what we are doing here in Cologne.
ED HARRISON: That's the interesting bit for me, other than the fact that your differences is that you're not a closet index, or what I find interesting, because we were talking about you in the European context today, is that you're looking at it from a very global perspective. If you think about American companies of the same ilk now, there's a huge home bias for-- especially because you can get what you want within the index, the universe of American companies. You're telling me that you don't have the same home bias for European assets?
PHILIPP VORNDRAN: We don't have it. Most of the clients, before coming to us, still are clearly German and European bias. It's a very tough training process. What helps to some extent today is that more and more of our clients realize, well, Europe most probably is not the place to be; political wise, economical wise, they don't feel happy with a lot of developments around the globe, but they realize, gosh, Europe is not positioned to be in the driving seat here.
That helps to make them more and more from a European to a global investor. Our global idea is just a very simple one, we want to invest in the best companies available, totally irrelevant whether their home base is Timbuktu, Bohn, or Shanghai. We are going for the best companies available. We rank them predominantly based on their cash flow yield. We compare that to their risk level, and then we start to invest in quite a concentrated way.
ED HARRISON: Let me ask you a question in that context, because we were talking about this offline before, you were saying that the European investors, German investors are-- they're open to global companies. However, the question then becomes what about the European companies? Are European companies in any way different than, say, US companies? When you're looking at your investment universe, are you saying, "These European companies, they have lower growth potential than these American or these emerging market companies?" How are you looking at that?
PHILIPP VORNDRAN: It's a lot of ways we look into a company. One, obviously, is the earnings and the cash flow growth level. The other is also the governance of a corporation. GE is very important for our investment decision. I think that's the level where you have the most important difference between corporations in Europe and in the US, at least, on average. Whereas in America, corporations are clearly focused on improving the situation for the shareholder. In Europe, and in Germany, predominantly, the stakeholder question, a much more important one.
I think it's also the identity of incentive structures between management and shareholder. When we have companies showing up here in Cologne to present themselves, we start with raising one question to the CFO or the CEO. How much of your personal wealth is invested in the corporation you are a manager of? American, and also a lot of Asian managers are very proud to announce here, "Well, it's about seven, eight or nine years of my annual income," and some of them even hedged-- not hedge, they're leveraged by credit. Whereas here in Europe, it's about one or two years.
If they fail producing higher returns for their shareholder, that's not directly punished by their private investments here. Whereas in the US, a manager really feels the pain, skin in the game. That's the difference. You have quite often skin in the game in corporations in the US and in Asia, whereas here in Europe, it's the exception of the rule. Obviously, you have great companies here, market leaders, but it's a different attitude, how important the shareholder is to the decision of the management?
ED HARRISON: How much does the macro environment influence with your investment decisions, like, for instance, going back to the whole concept of Europe, if you're looking at European based companies from a bottoms up perspective, now, having talked to your colleague,Thomas Mayer, who says that Europe is not growing nearly at the same potential as, say, the US, how does that influence you when you're looking at individuals stock selection?
PHILIPP VORNDRAN: Not to a very large extent, because the vast majority of our investments are stocks of corporations, which one could describe as a deal would play out? Let's take just one example. We have to be very restrictive on dropping company names based on regulation, and compliance. One exception, for example, is Nestle. It's a European company, it's in Switzerland based, it's a Swiss company, at 99% of their revenues are coming outside, from outside Switzerland. What of an importance is the development of the Swiss economy to a corporation like Nestle?
ED HARRISON: Not a whole lot, it seems.
PHILIPP VORNDRAN: Not a lot. Maybe it even could be a negative macro environment in Switzerland leading to lower interest could be a positive to them, because the refinancing would be cheaper than in a booming Swiss economy. I think that's the magic of globalization. It's not about defining the macro environment of a country or a region, you have to define the macro environment of the world. Yes, there are recession risks in Europe, and especially in Germany.
I think they are absolutely acute, but we don't think there is a recession risk around the world, neither in the US nor in China. Even if it's a very lackluster environment here in Europe, some of the European corporations still will profit a lot from the gross outside. German car companies are not German companies any longer, at least in terms of turnover. China is much more important than the US, Germany, or the UK.
ED HARRISON: I had two questions based on that. One goes with multiple differentials as a result of that globalization they are talking to. The second goes to regulatory risk. Let me ask the second first, and hopefully, I'll remember the first one. The regulatory risk, because now in a world in which Donald Trump is very hardcore about tamping down and what he sees as risks to globalization, you have the potential that that's going to negatively impact the companies that you're investing in. How do you deal with that from an investment perspective?
PHILIPP VORNDRAN: Where there's a loser, there always is also a winner. In the end, I would argue it's not a zero-sum game because the scale effects of globalization are remarkable. I think it's too easy to only argue, well, that points a lot of risk without indicating that on the other hand, there are some opportunities. Yes, we have some deglobalization. Yes, I think it's highly unlikely that the earnings will grow the same way they did over the course of the last 10 years. Maybe they are flat, maybe they even fell a bit over the course of the next 10 years.
Look, what is the earnings yield today of global equities? Around 6.5%, versus the global interest rate, which is 0.4%. For a 10-year global government bond, that's a risk premium of 6. Even if the earnings stay flat for the next 20 years, and the interest rates certainly won't go up in such an environment, then it's a coupon of 6% per year.
People underestimate the importance of the extreme low interest rate because investment alternatives are just not existing anymore outside the real investment world. Some real estate or equities. If interest rates stay low, or at zero, for the next 20 years, and you in the US have not yet made the experience of how this is going to change the world. We always define it, it's like reaching the zero point in Celsius with water. It's from being liquid into getting ice. It's a totally different physical material.
We think exactly the same is going to happen if interest rates are falling below the zero line. In our company, we are betting right now when this will be happening in the US, too. My personal bet is in three years' time for one of the points of your interest rate levels, but then it's not necessarily an important factor how strong earnings are growing, it's just the fact that they are still able to produce profits, because producing profit is more than having zero or negative.
ED HARRISON: Let's go back to the first question that I was asking, which is about European companies. I think that the general view that a lot of people say is that okay, the United States it has been outperforming but Europe is cheaper. First of all, is that even true? Secondly, how would that, if it were true, inform your investment outlook?
PHILIPP VORNDRAN: Yeah, we disagree with that argument. Given the disagreement, it's not very important for our investment style and philosophy today, we disagree based on very simple arguments. If you recalibrate the European and the American equity indices, by quality of the corporation, and by the sector, you will find something very interesting happening. They are more or less both equally cheap or expensive.
The problem is that investors, coming up with that argument, compare apples with bananas. Where is the big chunk of technology company in European indices? Where is the big chunk of energy companies in European indices? The US index, S&P, is much less cyclical than the indices in Europe are. If you do it one by one, recalibrating quality in sector, they cost the same. Europe is not cheaper than the US based on fundamentals. I think even the US is cheaper than Europe but that's not represented if you only compare indices and their price earnings ratios.
ED HARRISON: The interesting bit is when we talk about that, we're thinking about industries that so now we're going into specific sectors, what are the global sectors that you're thinking about that you can make those cross country comparisons where they're operating at a global level, and therefore, there's no cheapness or richness from a regional perspective?
PHILIPP VORNDRAN: Yeah. Obviously, the consumer sector--
ED HARRISON: Like Nestle.
PHILIPP VORNDRAN: For example, the Nestle likes, then you have all the pharmaceuticals, healthcare, technology, obviously. Also, some the cyclical, cars are more or less today a global business. It doesn't work with utilities, for example. Utilities are predominantly dependent on the growth of one region, or one country. It is also not happening in the banking sector. I think the way after the financial crisis 2008-2009, the governments in the US and in Europe handled the problems with banking, separated the two regions dramatically from each other.
ED HARRISON: I definitely wanted to get to the energy sector in Germany, things like RWE. When you started talking about banks, immediately, I thought to myself, let's talk about that. Because when I was talking to you about this before, you told me categorically, actually, you have no banks in your asset allocation position. That's been the case for years.
PHILIPP VORNDRAN: For decades.
ED HARRISON: That is a huge red flag. One of our flashpoints here at Real Vision goes around the banking sector. For me, it's very interesting that you said that, and now, you're talking about banks as one of the outliers in terms of non-globalized industries. Why is it that you decided to take a hard pass on the banking sector?
PHILIPP VORNDRAN: Yeah. The decision was taken in 2007. When the first real information that the mortgage crisis could be more relevant appear to us, we looked into some of the German banks and realized there are some special purpose vehicles. Nobody could give us a clear information what the value of them was, what the risk involved was, we had the feeling the CFOs of the banks had no clue about what was going on. Then we made a very easy decision; if you don't understand the corporation, if you don't have a sound feeling for the quality and the profitability of a business model, then we can't justify investments like that to our clients.
ED HARRISON: Warren Buffett, basically.
PHILIPP VORNDRAN: Yeah. It's very easy. Since 2007, we have not held any European Bank, with one brief exception, an asset manager in Switzerland, because we don't believe in the profitability story of European banks. The regulation is getting stricter by the day, the capital requirements are getting higher. More and more niche players, like us, are jumping into the classical fields of universal banks, you in America often don't fully aware about the business model of banks here. It's a universal bank, they are doing brokerage, they are doing asset management, private line, institutional, corporate business, all together for what you have in the States, Glass-Steagall Act still in place to some extent, niche or sector players.
We have that all together. You have huge cost structures. They are quite often placed in the most expensive real estate. They have the most expensive people. They have to think about cutting branches. They have the political pressure not to do so. Then they have the blockchain, which most probably is going to kill part of their business on a 15- to 20-year time horizon. It's tough business and we still are not invested there because we think the environment is getting even tougher with a flat yield curve below zero.
ED HARRISON: Tell me about that. The yield curve, the flat yield curve, or even inverted, actually, because if you look at German rate, the yields are actually worse out to five and seven years. What does that do for the bank's profitability?
PHILIPP VORNDRAN: Look at the credit spread. The credit spread is very important for most of the regional banks here. The yield curve is even more inverted than the one you are able to observe at your Bloomberg screen, because, in theory, it looks the way Bloomberg is showing it to you. In practice, there is a pressure from politicians on German banks not to have savings and current account yielding negative and sell-- they are still offering zero rates for the maturity of their clients whereas the market rates at minus point seven, and that really kills their credit spread.
That's something which we think will cause a lot of troubles going forward. Not today, not tomorrow, but maybe in three or four years. That, of course, will change the structure of the