Investment masterclass: what’s one of the world’s leading investors buying?

This is an audio transcript of the Money Clinic podcast episode: ‘Investment masterclass — what’s one of the world’s leading investors buying?’

Claer Barrett
Central banks around the world have been slowing the pace of interest rates as they battle to tame inflation. But my guest on this investment masterclass predicts the last mile of this journey is going to be the toughest.

Mohamed El-Erian
Inflation is likely to be sticky, and interest rates would have to stay higher for longer. The world we live in from an economic perspective has changed.

Claer Barrett
If interest rates and inflation are set to remain higher for much longer, what does this mean for investors? Keep listening to hear what Dr Mohamed El-Erian, the renowned global economist, has to say on what the new normal could be like. Plus, how he’s altered his own investment strategy as markets adjust.

Mohamed El-Erian
The time will come when I’ll be much more comfortable increasing again my equity exposure, but I’ve been quite cautious.

Claer Barrett
Welcome to Money Clinic, the weekly podcast about personal finance and investing from the Financial Times. I’m Claer Barrett, the FT’s consumer editor.

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Dr Mohamed El-Erian is a contributing editor at the Financial Times. But his smiling byline photo on his weekly columns about the global economy is often at odds with the warnings and predictions he makes. He’s chief economic adviser at Allianz, the parent company of Pimco, one of the world’s leading providers of bonds and fixed-income investments where he formerly served as chief executive. Over his long career, he’s performed many other roles, including chairing President Obama’s Global Development Council. His voice is one that world leaders, heads of central banks, boardroom directors and newspaper editors listened intently to. But today, he’s talking to us.

Welcome to Money Clinic, Mohamed. How would you like to introduce yourself to our investor listeners?

Mohamed El-Erian
That’s a really tough question. Just as someone who, by chance rather than design, has lived at the intersection of economics, finance, behavioural science and what really matters for the individual investment.

Claer Barrett
Well, that describes perfectly why we wanted to get you on the show. But before we get into the really crunchy stuff about the global economy, let’s start with some easier questions and skip back a few decades. Now, the question that I ask all of my guests on Money Clinic is: what’s your earliest money memory?

Mohamed El-Erian
So my earliest, earliest memory goes back quite a long time when I was staying with my uncle and he would give me — and this was in Egypt — a couple of piastres or think of, you know, 2 pence, for spending money. And then he would convince me to play blackjack with him. And he had, compared to me, an infinite amount of money. So ultimately, he always prevailed. And somehow every day I would agree to play with him, and every day I would lose my, you know, a couple of pence that could have been saved and gotten me some sweets or something. But it was a lesson to me. First, understand what situation you’re in. Understand what you’re trying to do and never lose sight of your bigger objectives. But that memory has really stuck with me.

Claer Barrett
Yeah, that’s a very good one. And how old do you think you would have been when you were being tempted into games of blackjack with your uncle?

Mohamed El-Erian
Oh, young. I suspect, five or six.

Claer Barrett
Wow. So an early lesson . . . 

Mohamed El-Erian
Clearly, he had, he had nobody else to play with. So this was, for him, entertainment. And it was worth the little investment he made every day in this.

Claer Barrett
Well, of course, you came to Britain as a young adult. You attended boarding school here, and you did university here. In fact, you’re very much involved on the university scene still in this country. But tell us a little bit about what life was like living away from home at such a young age.

Mohamed El-Erian
So my parents moved a lot because my father was a diplomat. So it was every two or three years. Change schools, change countries, change friends, change curriculums, and often change languages. And I got to the point at the age of 14 where I found that very hard to do and my father was being moved again, and I said, “I’d like to go to boarding school”, very bravely. And he said, “Where would you like to go?” And I said the US. We had lived in the US, and I loved it. We were living at the time in France. And he said the US is too far. It’s too expensive. What is your second choice? And without knowing what I was saying, I said, Britain. And he said, You want to go to boarding school in Britain? I said, Yes. He said, Are you sure? I said, Yes, that’s your choice. I said, yes. He said, You own it. I should have realised at that point.

Claer Barrett
It wasn’t the (inaudible) . . . 

Mohamed El-Erian
. . . that he was saying, because this is the seventies. But I must tell you that while not an easy experience, I had to adapt enormously. And then what followed, especially at a university where a whole new horizon was opened for me were really, really important experiences. Because at the end of the day I realise it’s not only what you think. It’s also how you think. And that’s really important. And especially in today’s world, when things are changing so rapidly.

Claer Barrett
Especially in the world of finance, where groupthink is something that you have railed against for a very long time.

Mohamed El-Erian
Yes, absolutely. You know, if you think in the last 15 years, we’ve had a global financial crisis, then we’ve had negative interest rates. I mean, in 2006, I didn’t know of a single textbook that had the possibility of negative nominal interest rates. It was unthinkable that someone would be willing to lend them money, and rather than receive interest for the risk they’re taking, actually end up paying for the privilege of lending money. That shouldn’t have happened. And yet, at one point we had a third of global government debt trading in negative interest rates. And we had incredible experiments with central banks. And now we have this inflation that is really redefining the financial landscape. So it’s been an amazing 15 years where one unthinkable after the other has confronted not just policymakers but everyday investors that are worried about their savings, and they’re worried about how they’re going to pay for future expenses.

Claer Barrett
I mean, while our listeners to this show might not have as much money to invest as some of the big name outfits that you’ve advised over the years, if there was one message that you’d like them to take away from this podcast episode today, one way that they urgently need to change their thinking, what would it be?

Mohamed El-Erian
Be honest with yourself. Ask yourself a difficult question, but an important question. And that is: If I end up making a mistake, what’s a recoverable mistake and what’s a non-recoverable mistakes? No one wants to make a mistake, but when the world is changing and an unthinkable has become reality, you are likely to make a mistake. Now the good news is that most mistakes are recoverable with time, but certain mistakes are not recoverable. For example, if you owned shares, or the bank loans or the bonds issued by a company that goes bankrupt, that’s a non-recoverable mistake. So it’s important to have clarity as to: If I end up making a mistake, what’s a recoverable one and non-recoverable? The biggest mistake people make is they sell at the wrong time and they buy at the wrong time. And that’s because emotions take over.

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Claer Barrett
A quick note from me here. Before I asked Mohamed more about how changes on the financial markets are forcing people to adapt their investment strategy, a reminder: When you invest, your capital is at risk. Our discussion is not intended as investment advice, nor as a recommendation that listeners manage their own investments in any particular way. Now, where were we? Looking back at the past 12 months, I mean, describing it as a rollercoaster year for investors doesn’t really come close. But I think the really devastating thing has been that equities and bonds have both suffered at the same time when, of course, bonds, one of the cornerstones of your own career, have always been viewed as a kind of safe haven for investors. So give us your thoughts on how that’s changing.

Mohamed El-Erian
It is very, very unsettling. There are good reasons why in normal circumstances, you expect these two to be negatively correlated, meaning when the price of one goes up, the price of the other one comes down. So the classic outcome of all this is the so-called 60/40 portfolio, 60 per cent in equities and 40 per cent in safe bonds. And the idea here is that portfolio can deliver three things that are comforting for investors. One is high returns. Two is risk mitigation. So when equities come down sharply, the bonds kick in with higher prices.

Claer Barrett
A bit of a shock absorber in your portfolio.

Mohamed El-Erian
Well said. And the third thing is less volatility than you would have otherwise. Now, there was a period when central banks were keeping interest rates at zero and throwing in a ton of money. It was remarkable how much money was thrown into the economy by central banks when both the prices of bonds and stocks went up. Now the correlations broke down, but no one cared because people were making money on both sides.

Claer Barrett
Up, up and away.

Mohamed El-Erian
Yes, it was lovely. But then inflation arrived. It proved not to be transitory. Central banks were forced into one of the most concentrated cycle of higher interest rates to bring down inflation. And suddenly the good old days reversed in a violent manner. So, for example, if you were a US investor in 2022 and you were the average investor, you lost 24 per cent in your stock portfolio and your bond portfolio lost 16 per cent. That’s not supposed to happen. But it was really the reversal of a time when the markets got drunk on central bank support. We believe that central banks would be our BFF, our best friends forever. But once inflation appeared, they no longer were our friends. And now, slowly, over the next few years, we kind of go back to something more normal where traditional correlations and therefore traditional risk mitigation come back. But the journey, you know I can tell you about the destination, but the journey is really painful. 

Claer Barrett
Mmm. Now we’re going to talk a little bit more in a minute about what this new normal might look like. But the situation as things stand today, it feels like we’re very much at an inflection point for world markets. The central banks, interest rate hikes, they’ve started to work. Inflation is coming down. But you’ve warned that the last mile of this journey will be the toughest. Why is that?

Mohamed El-Erian
Several reasons. Let me start with a simple one. It is assumed that, by the marketplace, that once inflation comes down, central banks will bring down the interest rates. But the inflation we are experiencing now, because central banks were late in reacting, is quite sticky. So markets have got to internalise, not just that rates have gone higher, but they’re going to stay there for longer. Higher for longer being the phrase you’re hearing now. And that means that your forward looking returns are going to be less than you thought otherwise. That’s adjustment number one is a recognition that inflation is likely to be sticky and that interest rates will have to stay higher for longer. But then there’s a deeper issue. And that is that the world we live in from an economic perspective has changed. Coming out of the global financial crisis, our main problem was that there isn’t enough demand in the system. But then the pandemic accelerated a fundamental change in the way the global economy changes. We went from a world that when there wasn’t enough demand to a world where there wasn’t enough supply. Supply became inflexible. And we see that in the labour market. We see that in energy. We see that in supply chains that broke down. We see it all around. And when supply is the problem, then central banks tend to have to hit the brakes because inflation rears its ugly head.

Claer Barrett
The price of everything is getting more expensive because more people want access to fewer things. Just simple Economics 101. 

Mohamed El-Erian
Correct. Correct. Absolutely correct. And what they need to come with that which hasn’t happened enough as yet, is a recognition among policymakers that this is the world we live in. And you need a massive emphasis on the supply side. It’s not enough to simply trying to lower inflation from the demand side because you risk pushing the economies into recession. And this is the last mile. It’s a complicated last mile. You have to think differently. And we go back to the groupthink problem. It’s very hard for institutions that have been around for a very long time to think differently. And the mistakes that we have made over the last 15 years have had a significant element of lack of cognitive diversity, not enough diversity in decision making. And as a result, by the time you realise you have to do something different, you’re already late.

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Claer Barrett
Well, that’s the big economic picture, if you like. The high interest rate, high inflation world that we’re all grappling with at the moment. Does Mohamed El-Erian think that this new normal has any upsides? When we’re thinking about what the future will look like, how the central banks around the world and policymakers will take us through this difficult last mile, what do you think of the risks and the opportunities from an investor’s point of view?

Mohamed El-Erian
So it depends on what happens. So the first thing is just to be open to the sense that there are many potential outcomes. You’ve got to recognise that this is the world we live in. And once I tell you that there is no dominant outcome, you’d be surprised how unsettling that is. We tend to make mistakes. Good decision making when you’re facing multiple potential outcomes, is really hard.

Claer Barrett
Because you just can’t work out which scenario might be the best. But also, like the central banks, you’re on the back foot. You’re not expecting this scenario to have played out as quickly as it has. So we’re kind of lurching from one crisis to another almost. So the watchwords for the future are be agile, be prepared for volatility and be prepared to act on it. Be prepared to be more active with your investment choices, maybe, rather than being passive.

Mohamed El-Erian
Correct. And I summarise it in three words: resilience, optionality and agility. Resilience meaning you can absorb a mistake. It’s not the end of the world if you make a mistake. We go back to the notion of recoverable vs non-recoverable. So you need resilience. You need optionality, you need an open mind. You need to recognise that there are certain things you don’t know. You need to think differently. And finally, agility, as you said, the ability to move quickly.

Claer Barrett
As if the day job wasn’t enough to keep him occupied. Last month, Mohamed El-Erian published a book called Permacrisis: A Plan to Fix a Fractured World. He co-authored it with former British prime minister Gordon Brown and Prof Michael Spence, the US economist and Nobel laureate. I have a picture in my mind of this eminent trio going down the pub and chatting in a quiet corner about economics. Was that how it works?

Mohamed El-Erian
So we didn’t go down to the pub because we started getting together during the lockdowns.

Claer Barrett
OK.

Mohamed El-Erian
We knew each other and then someone had an idea, why don’t we do a call? And we enjoyed that call so much that we then ended up having more calls. And what brought us together was we all have teenage kids in the twenties and thirties, and we were worried about the future. We worried about the world that they are inheriting. So we started talking, and then a year later, someone said, You know what, we also have solutions. We should write this down. And that was an “Oh, no” moment because no one had taken notes.

Claer Barrett
You weren’t recording the Zooms.

Mohamed El-Erian
No, this was a social event. We didn’t record any of the Zooms. And I certainly don’t know how to record Zooms? And then everybody said, Well, I think I can reconstruct this part. I think I can reconstruct that part. And then we decided to put it all together.

Claer Barrett
Now, I have to say, Permacrisis is not the most upbeat of book titles, perhaps. But nevertheless, you are hopeful that the world can get its act together.

Mohamed El-Erian
It is fundamentally hopeful because we think we can change the equation, and we can get out of this permacrisis mode that we’re in.

Claer Barrett
And when it comes to those solutions, one of the big themes of the book, like you said, is changing the way we think about things. And the four of you touch on all kinds of different economic transitions that the world economy needs to make. Could you give listeners a little bit of a taste of what kind of things you’re debating about those changes in the book?

Mohamed El-Erian
Yes, I mean, our problems come from three failures. One is the inability to grow — grow in a durable, inclusive fashion that respects our planet. That’s problem number one. Problem number two is we’ve made things worse by repeated policy mistakes. And then problem number three is that we haven’t collaborated and co-operated enough at the global level for problems that are common to many countries and require a common approach. So we look at these three issues, and they tend to explain most of the failures we’ve had. And we go through how it is that you can fix these things. Now, the growth side is very hopeful because we’re going through three major revolutions. First is the technology revolution, which has been taking it to a completely different level by AI, by generative AI, and that is incredibly powerful. The second is a revolution in life sciences and the third is a revolution in energy, the energy transition. Those three can be used to change our growth model in a way that produces high, durable growth that is inclusive, brings more people. Growth for many, not for a few, as we put it, and also respects our planet. We also go through why are policy mistakes repeatedly made? And we go around the world and our best practices that can be applied. And then the hardest one is the global policy co-ordination. So we have this notion of we are not going to go back to hyperglobalisation, but we can go back to a managed globalisation light, and that involves, first and foremost, strengthening some of the institutions that are key to global co-operation.

Claer Barrett
Of all the challenges we’ve talked about, what keeps you awake at night?

Mohamed El-Erian
I think the planet is the most significant problem. I mean, if we’re not careful, we’re going to start hitting tipping points. I mean, once you get to tipping points, things get a lot harder. I often apologise to my two daughters because of what our generation is leaving theirs. The climate issue, the debt issue, the inequality issue. You know, these are big problems. Now, I want to stress, there are many more tools emerging that allow us to deal with these issues. That’s the exciting part. But this toolset needs to be understood, needs to be used and needs to be supported. And that’s going to be the challenge of the next few years.

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Claer Barrett
In 2014, Mohamed El-Erian surprised the financial world by stepping down as chief executive of the investment company Pimco. He later wrote that one factor in the decision was his then 10-year-old daughter taking him to task. I asked him to tell me a bit more about that.

Mohamed El-Erian
It was an incredibly humbling experience, and I’m very proud that I have fiercely independent girls who tell me things exactly as it is. But the story is it’s my youngest, it’s May. She’s not even 10 yet. And I asked her to go brush her teeth. She doesn’t. And ask again to go brush her teeth, and she doesn’t. And then I say, What’s going on? Tell me what’s going on. She goes to her room, comes back with a little folder. And opens it and says, Dad, do you know that this school year you’ve missed 22 of my events? And I said, No way. And then she started reading: on September so-and-so, you missed my first day of school. On September so-and-so, you missed my first football game. On October so-and-so, you missed teacher-parent meeting. And I started defending myself. Oh, no. I remember I had to go to Japan. I had to do all this other stuff.

Claer Barrett
There was a crisis.

Mohamed El-Erian
You know, and then she looked at me and said, But Dad, these are my special moments. And then she did worse, which I didn’t write about it in the articles I put enough to embarrass myself, but I’ll tell you. She went back, and in the US, they love what they call the yearbook. Every year the school produces a yearbook. Each year, each class has a few pages. So she opened a page on her class on one of the events, and there I was in the background sitting on a tiny stool. And I thought, at least I did turn up to some event. And she said, Look at that picture. And I looked at it and said, Look what you’re doing. And it turns out I was looking at my phone and then she said, Dad, even when you’re here, you’re not here.

Claer Barrett
Gosh.

Mohamed El-Erian
And that was it. So the next day I went to see the founder of Pimco and I said, in the next 12 months, I’m stepping down. But my daughter, my youngest, is very proud of the impact she had because the next few years were really magical, and I would have missed it otherwise.

Claer Barrett
Wow. Yeah. Well, I must say, I think if I were her and then suddenly you were like, Right, OK, I’ve quit my job. I’m here now. I’d be thinking, like, what have I done?

Mohamed El-Erian
She did hear when I finally stepped down, which happened, this was May, that happened in the beginning of January, and I finally stepped down. Her first reaction is, Dad, can we afford to live? That was her first reaction.

Claer Barrett
Well, my next question to you is: what lessons are there about money in investing that you passed on to your two daughters? I mean, as you said they’re young adults now facing an uncertain world. What are the things that you would like them to carry with them?

Mohamed El-Erian
So I tell them, pay yourself first.

Claer Barrett
OK.

Mohamed El-Erian
Which is where they, when you got your pocket money or my 27-year-old is working, the minute you get paid, take a percentage of it. She takes, I think, 10 per cent, and put it into your savings. And that should come before everything else. And I think having a saving culture is really important.

Claer Barrett
I mean, I can foresee over the next few years, as we do see the full effects of inflation unwinding on the stock market, this big transition, there may be times when young investors might think, well, what’s the point? What’s the point of me sticking with my regular investment plan of putting so much into the market every month if markets are falling all around me. Like you said at the beginning of the show, those behavioural biases, the feeling that we want to take our money out when the stock market does something that we don’t like, how would you counsel investors to keep their cool when everyone around is losing theirs?

Mohamed El-Erian
So there’s two decisions that are very distinct. One is whether you save. And two is what you do with your savings. You should always save and you should always make it a priority. Now, what to do if you wait out the market? Well, the good news of high interest rates is you actually can get something on bank deposits. And we’ve seen a major move from depositors to higher paying interest. And banks are having to pass on some of the higher savings. And I would encourage people to look at different banks, look at different saving instruments. And yes, if you are uncomfortable in the stock market — as I am, by the way — if you’re uncomfortable in the stock market, then there’s a really good place to park your money where you can get paid 4 to 5 per cent on your money and that will compound. So it’s important to separate the decision of when to save and how much, to what you do with your savings.

Claer Barrett
So it’s very striking to hear that a highly experienced investor like Mohamed El-Erian isn’t comfortable investing in the stock market at the moment. Does he think that’s a situation that will change, or is he going to stick with cash for a while. Or will he follow his own advice and keep an open mind?

Mohamed El-Erian
So I’m keeping an open mind. You know, like others, I benefited enormously, especially from the move in tech. And that’s really what’s been driving the stock markets higher. Tech names have done, especially in the US, have done much better than elsewhere. I also have, you know, a lot more training. So I do something that’s not available to a lot of people, which is called a barbell approach.

Claer Barrett
A quick aside from me here, the barbell approach is a strategy experienced investors use to split their asset allocation into two equally big chunks, a bit like a barbell weight you try to dead lift at the gym. On the one side, low-risk assets and on the other high-risk assets, but nothing in the middle.

Mohamed El-Erian
Rather than take public equity risk up to 60, 70 per cent of the portfolio as many people do, I have taken it down. I’ve reallocated the money to, on the one hand, high-interest paying, basically cash. But cash is defined as one to two-year maturities, including very highly rated companies that give you a little bit more. And then on the other side, there’s a lot of opportunities in what’s called distressed investing in private credit and things like that. The time will come when I’ll be much more comfortable increasing again my equity exposure. But I’ve been quite cautious.

Claer Barrett
OK. So you see an opportunity in investing in distressed credit. So this is, you know, company bonds, corporate bonds that many other investors might think are too risky. So very risky approach on one side of the barbell and then on the other side, cash and cash-like investments, which, as you say, can easily yield 5 per cent or even more at the moment.

Mohamed El-Erian
Yes, absolutely. And the distressed credit is because the price is so low. So investors tend to lose sight of valuation. So we end up buying a company we love, and we don’t pay attention to the price. At some point, even the best companies are overvalued. And similarly, which is harder for people to comprehend, sometimes the worst companies are undervalued. I mean, the best thing, of course, which is find a really good company that’s undervalued. That’s the dream, right? But life, unfortunately, sometimes isn’t that easy.

Claer Barrett
Well, all that remains for me to say is thank you so much for joining us today on Money Clinic, Dr Mohamed El-Erian. I look forward to reading your book, which is out now. The Permacrisis. But above all, it was just so exciting to speak to you uninterrupted for so long and to hear all of your amazing ideas about what the world might have in store for us in the future.

Mohamed El-Erian
Allow me to thank you, Claer, and to thank our listeners. Thank you very much for having me on the show.

Claer Barrett
Don’t forget what Mohamed said at the start of our interview about non-recoverable mistakes. As investors, we shouldn’t take risks that we cannot afford. He’s comfortable with this barbell strategy, but he’s an experienced investor and a high earner. Just because he’s decided it’s the right strategy for him does not mean it’s the right strategy for you.

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That’s it for Money Clinic with me, Claer Barrett, for this week. And we hope you like today’s investment masterclass but always open to your ideas. So if you’d like to suggest an investor you’d like to hear from on a future show, then email us. Our address is money@ft.com, and of course, you can find me on Instagram. I’m @ClaerB. This week’s episode was produced by Philippa Goodrich. Our executive producer was Manuela Saragosa. Sound design was by Breen Turner, and original music is from Metaphor Music. Cheryl Brumley is the FT’s global head of audio. And finally, our usual disclaimer: the Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that, you’ll need to find an independent financial adviser. That’s all the small print for now. See you back here next week. Goodbye.