How to Play from the Coming Pension Crisis (w/ Konstantin Boehmer)
ED HARRISON: Ed Harrison here for Real Vision. I am talking to Konstantin Boehmer of MacKenzie Investments. He is the global fixed income portfolio manager there. Thanks for talking to us. KONSTANTIN BOEHMER: Thank you, Ed. ED HARRISON: Beforehand, I was telling you, the reason that we're talking is we're going to have a pension week coming up going forward, where we're going to be talking about something, I think a lot of people are talking about as the retirement crisis. I think this is a good place to start off the conversation, the concept of a retirement crisis. The question, it begs the question, why would anyone be thinking there's a crisis in retirement and what would pensions have to do with that? KONSTANTIN BOEHMER: I would like to start probably with the background why we started to look into this and why this is such an important topic for us at MacKenzie, and for me personally. I work in the asset management industry. Obviously, there's a lot of interaction with retirement because what we have to do as asset managers is we have to provide financial security for also our clients. That is a big part of why retirement is a key component here. It's also that it is we've seen a massive growth in assets under management and that is partly because so many pension funds have increased their assets, but also individuals had to start saving more and more for the individual security later in their life cycle. We now have the baby boomer generation, which was the dominant generation starting after World War II, that massive part of the population is now shifting towards retirement. Those are crucial moments when a big part of the population is shifting from saving and starting to divest and starting to draw out money out of the system. Those are a lot of things which are making it extremely important for us. For me personally as a fixed income manager, it is important for me because I like to look at data, I like to look at what is happening in financial markets, and I see that there are clear connections, and I've built over my life, multiple models to help me understand the world a little bit better. I've built models on how to look at different countries, how credit worthy they are, also to look at ESG to see which countries are well prepared, which countries are ill prepared. That started also the process into building models looking into countries, how well are countries prepared or how ill are they prepared and to take it into next step looking at US states, also US corporations to see how well is somebody prepared? ED HARRISON: Very interesting. Yeah, I'm excited to get into some of that data later on. Actually, one of the things that I'm excited to think about is, you mentioned before off camera, you have at MacKenzie Investments, a model in terms of the way to think about it, a framing of four different things that are relevant to thinking about this. Can you talk about that a little bit? KONSTANTIN BOEHMER: Sure. The whole pension crisis, what we're doing here is we're looking at the whole industry or the whole country, it is a little bit unfair to overgeneralize a lot of those things. There are phenomenal pension funds and countries which are extremely well prepared and individuals who are doing exactly the right thing. What we do is we try to generalize in order to get a more broad view of what is actually going on. The way that we look at it is that there are four design flaws within pension funds in general. Those four design flaws are demographics, then the underlying assumptions based on discount rate and return expectations is a big design flaw, then what we have in addition to that is the vested interests, so who are the people who make the decisions? Fourthly we have a conundrum where we have extremely high return expectations of those pension funds to hit their targets and that is actually driving the asset allocation. It is not really possibly sometimes the best asset allocation that is possible in that moment. It is more that the return targets that a lot of pension funds have are driving the asset allocation. ED HARRISON: Let's go into that one by one. KONSTANTIN BOEHMER: The first design flaw, I think it's pretty obvious. Pension funds were developed a long time ago and really got into prominence after World War II and you saw a major pickup in corporations, but also local governments and federal governments, but during that time, we had vastly different demographics. Those times we actually had a pyramid where we had lots of workers and very little retirees. The models at that time to determine a sustainable framework for the welfare state were based on the data that they had available at that time and they build those models and came up with different features. Back in the days, in the '60s, people only had to account for roughly 13, 14 years of retirement, so when people worked up until they were 60s, in the 60s. Then you only had to finance on average 13, 14 years in the developed world. If we fast forward to today, yes, the average age or average retirement age has inched up a little bit, but the years in retirement have exploded. ED HARRISON: Let me guess, 20. KONSTANTIN BOEHMER: 20. It's roughly 20, that's right. ED HARRISON: Yeah, that was pretty good. KONSTANTIN BOEHMER: Excellent. That's a 50% increase from 13 and a half roughly to 20. For any financial model, it is extremely hard to adjust for such a major change, because that means that at least, they will need 50% more money relative to what their expectations were at the very beginning. ED HARRISON: How do they get that more money? Some of that probably goes into the other design flaws, but in general, from a demographic perspective, how do you deal with that, like what are the facets that get you that more money? KONSTANTIN BOEHMER: That's the changes that pension funds need to do that is definitely raised the retirement age, then there needs to be some kind of increased contributions to adjust for the new reality. Then there might also have to be a conversation on maybe the payouts, whether those assumptions or whether the plan that was originally come up with, that's still relevant. Those are all not nice conversations to have and that goes to the vested interests that is another design flaw where we say, look, nobody's really interested in uncovering all the mess that has been created and has basically festered over those years and only tiny little changes have happened. The really big changes are still to be made. ED HARRISON: What about, I don't know if you'd go into this, but I would imagine the first thing that came to mind when you talked about the demographics, and you talked about savings to disinvesting, I thought immediately of spending and GDP changes. What impact does that change in demographics have on the velocity of the pace of GDP growth? Does it have any that you've seen? KONSTANTIN BOEHMER: In general, the super big picture for me would be that we have overspent because we had the security of the welfare state, made people feel a lot more confident about the future, and about the increasing living standards that people were more willing to spend money. Now, the realization phase is kicking in where that security and safety that we obtained since the '60s and '70s is being questioned, and that would probably mean that there will be less spending going forward and slightly slower growth because we also have a massive amount of unaccounted for debt. Debt levels are in general extremely high, but on top of that, we also have those unaccounted debt levels coming from the pension funds. ED HARRISON: Now, what about the second part of the design flaw? KONSTANTIN BOEHMER: Yeah, that's my favorite. The second part are the financial assumptions. It is, for any model that you build, it is okay to put in assumptions for stuff that you don't know, or where you don't have a really good handle of what you put in, what your input factor is. For a lot of those pension funds, and I would say the most prominent cases for that would be US states, that would be public pension funds, let's say the teachers, firefighters, police officers, and so on. Those US state pension funds, they have still ridiculous assumptions embedded in their calculations. What we've done is we reverse engineered that whole formula to see, look, what is your assumption? What would be a realistic assumption? The assumption that is still embedded and prevalent in the US states is that they think that they can discount future obligations at 7.1% and that their assets will grow every single year at 7.6%. To put that into perspective, what does it mean to have a discount rate of 7.1%? That basically means if I had an obligation of $100, so I need to pay somebody $100 in 20 years' time, it is basically enough if I have $25 right now in my pocket, that would be considered fully funded. I don't need to have $100 right now, I just need to have $25 and I would be fully funded. I don't think that's fair. I don't think that is the right calculation. That is not the right assumption, because let's say the time value of money should be significantly lower. ED HARRISON: Well, given the fact that interest rates are so low right now, and to the degree that that persists for a longer period of time, it would suggest that those discount rates are going to be lower and they're not going to be able to discount at that level of in perpetuity. Let's say you have like a 6% discount rate. What happened to that $25 to $100? How does that change? KONSTANTIN BOEHMER: It is dramatic. That discount factor has an oversized impact on the sustainability of a pension fund. What we did in our models is we said, look, why don't we just use 4%? I would say 4% is not even really fair, because you want to give the impression that it is safe money. Because I want to give the impression that is safe money, I think maybe the US government equivalent yield would be a fairly decent proxy but let's just say we use 4%, which is significantly above what the US-- ED HARRISON: More than double. KONSTANTIN BOEHMER: Exactly, yeah. If we go to 4%, all of a sudden, just for the US states alone, the deficit that the pension funds have would go from $1.3 trillion to $4.3 trillion. That is a big difference. That also means that the funding status, right now pension funds are saying we have a funded status of, let's say, 74% or so. If we use a discount rate of 4%, all of a sudden, that switches to 47%. That is a dramatic difference in terms of how funded, how able those pension funds are actually to meet their future obligations. ED HARRISON: The other side of that you said was the 7.6% asset increase assumption. We've already just said, I looked at treasuries today, the 10-year was yielding at 1.8 fours or there about, how do you get to 7.6% in that environment? KONSTANTIN BOEHMER: It's difficult. I am a fixed income manager so for me, those numbers are completely out of reach. Just to give you an idea of what 7.6% would mean maybe in the sovereign bond space, if you buy a Ukrainian bond, a 20-year Ukrainian bond, you're not even getting to 7.6% yield. It is pretty aggressive. Of course, they have a very diversified portfolio and there are higher returning assets, let's say the property in the private equity space and infrastructure, equities, of course, and other assets, but still, achieving or trying to achieve and trying to hit 7.6% every single year is extremely ambitious, because it doesn't account for market variability. It doesn't account for that we had record highs in almost any asset class. We are at record highs in equities, in fixed income, in real assets. At some point, we'll have a few years where we don't hit those 7.6%. ED HARRISON: That gets back to the risk and that's part four that you're going to talk about in a second, but what's the third flaw that you've-- talk to me a little bit about that. KONSTANTIN BOEHMER: The third one would be, let's say vested interests. ED HARRISON: I think of it as an agency problem. KONSTANTIN BOEHMER: Exactly. Here it is, just nobody wants to uncover what's really going on. Even it hits the pensioners themselves, it's tricky to ask the difficult questions and to demand answers on is my pension sustainable because, in a way, like one sleeps better, believing that one is safe than to ask and put all that effort into those probing questions and making sure that you get those right answers. ED HARRISON: The media say that let's say you're a US state and you're underfunded by 53%, that's 47% that you said versus 26%, then suddenly, you're going to have to cough up a lot of money and from a budgetary perspective, that doesn't look good for you as someone who needs to be elected in a year or two years. It's a lot easier not to make that decision and let someone else make the decision like five, 10 years later. KONSTANTIN BOEHMER: It's better to pretend because the real consequences of this would be for states to pony up a lot more money. Who wants to do that? Everyone wants to get reelected? Do you really want to-- and you have two choices where you can either reduce expenditure, or you can increase revenues, taxes. Both of them are not really vote winners. It is difficult to make that decision now. It's better to just say, let's let somebody else deal with it, or let's just put some lipstick on it and hope nobody will take another critical look at it. ED HARRISON: Well, the other option is to roll the dice. This goes to the fourth structural flaw, you could move out the risk curve, you could move out the duration curve, which you could tilt your asset allocation. Tell me about that. KONSTANTIN BOEHMER: I think that is what's going on. The pension funds half that stick a target of we need to achieve a significant return on assets, which is good. Yes, it is good to be ambitious, it is good to have certain goals that you want to hit but if that is going to the extreme that it actually influences how you make your asset allocation decision, it might tilt you away from what is actually a sensible asset allocation to something that is overly aggressive. I would put it into the context of all those pension funds on maturity. It is just like us, when we're young, we should have a high tilt towards risky assets, towards also illiquid assets in order to gain that extra return, that extra liquidity premia for example. It makes sense in our early days of our personal career or personal lives to have a very high exposure to those higher potential assets. As we progress, as we get older, of course, we need to adjust how we're positioned because the sequencing of returns will become much more important. If you are in the payout phase for a pension fund, then you cannot really have drawdowns, which are significant, because that will really compromise your ability to pay back. If you have that drawdown early on in your career, there's a high chance that you will recover from that. Later on, it will be difficult, which is why a lot of pensioners will get the advice from financial advisors to reduce their risk, put more money in fixed income and cash and so on. ED HARRISON: Now, given those structural flaws that you talked about, you talked already about the general level not being enough, you started to drill down in three different ways, you've already done the data sets for countries, you've done the data sets for US states, and you're in the process of doing the data set for corporates. Let's take those one by one and talk about places that are prepared and other places that are ill prepared, and then also how you can invest against that. Let's look at country risk first and foremost, what does your data set say on the country risk factor? KONSTANTIN BOEHMER: It's pretty broad. It covers, I think it's 43 different countries. We have seven major indicators, and then 33 sub-indicators. It is a big amount of data that we have there, and we generally get those information from publicly available sources, whether it's through Bloomberg or OECD or some other places where we collect that data. Then we try to make some educated guesses and educated decisions based on the analysis that we've done, the data that we see and the outcome that we get. What we have right now is we have the full data set and the key indicators for us are number one, demographics, that is a crucial, crucial, crucial aspect where we see different demographics and demographic trends in the various countries that we look at. We look at government health. How, let's say how strong or how well equipped the government is. Maybe the interesting features here would be debt to GDP or stuff like that, or if they have a sovereign wealth fund, the Saudi Arabia's and the Norway's, for example. We look at government stress, and that is how big of a component, for example, is already, or is your public sector as a total of your workforce. Here we see some Scandinavian countries which have very large public sectors and then some other countries more in the emerging markets, which only have a very small public sector. We look at the health of the individuals. That's not the how actually how healthy they are, but how financially healthy they are, which is more, let's say GDP per capita or to see that their assets and liabilities or household debt to income or other indicators. Then we look at whether those pension funds are funded or in a pay-as-you-go structure. Here we have some countries like Netherlands, Denmark and others, Canada also who have a large portfolio of funded pension funds. Then you can see others such as in many European nations, which are in a pay-as-you-go structure. That is very, very different. ED HARRISON: That includes Germany. Is that right? KONSTANTIN BOEHMER: That is correct. Another one is that we look at mark to market risk. That is a little bit of a controversial one. At least that's the one pushback that I've always gotten from my colleagues, which is, it is great. Without a doubt, it is great to have a funded pension plan but if that funded pension plan is, let's say heavily invested in equities, and they experienced a significant drawdown, just that headline, front page of the newspaper, pension fund of the Netherlands lost 30% that will have an impact on confidence, that will have an impact on how people feel. In Germany, this would not happen because there is nothing that they can lose, really. That is, let's say a small thing on the extremely positive feature of having funded pension plans. Then of course, we need to look at the difference between what is promised and what is actually, what the pension fund or what the what the countries can deliver. Here it is. We look at what are let's say the median salary, what is the pension as a percentage of that median salary? For some countries, it is very close to 100%. You get almost 100% of your salary. For other countries, it is only 60% and of course, there will be massive differences in terms of your ability to fund a promise if you didn't promise that much. If you promised the world, of course, it will be pretty hard to satisfy that. ED HARRISON: I want to go into the relative health of all these different countries. As you were talking about the promises, immediately, I thought about Greece in particular, and I thought that this would be a good test case, to think about how these parameters are put into place because one of the more important pieces of the IMF Austerity Package that Greece had to undergo involved the pension problem. Talk to me about where Greece as an example stands on some of these issues. Where is it that they have difficulties? KONSTANTIN BOEHMER: I don't know all the data by heart of my models, but it is Greece consistently scores badly in all of those indicators. Of course it is on the government health side. Of course, they have debt levels, which are extremely high. We have a dip in the population health or financial health of the population, especially throughout the crisis, then you have extreme obligations, you have a very bloated public sector. I would say, reasonably generous promises, and they have been reduced. That is one thing where we can see that Greece has improved in their ratings, but it is not to an extent where we say they solve their pension issues. They have quite a few issues where you say, or where we see Greece actually scoring at the bottom of each of those indicators. I would say, in the overall ranking, and we can also share this with your viewers, is Greece is probably in the bottom, three or four nations, globally. The other prominent-- ED HARRISON: That's even after the pension was formed. KONSTANTIN BOEHMER: That's right. With all of those models, I think it's also fair to say that they don't explain everything to the last bit of the detail because there's always a lagging effect. Then the major lagging effect that occurs is that data for a lot of those international organizations only come out once a year. We do see some minor improvements already, but that is where we take the qualitative part and the quantitative part of the models so we just say, look, we know that they're working on it, we know that they're making improvements so that is something that we can already adjust in our minds. The pure data is still a little bit lagging in this and it will probably catch up based on our qualitative assessment of what's going on in Greece. ED HARRISON: Mentally, as you say that, I immediately think back to Greece issuing a negative yielding bond for the first time ever recently. You have that dichotomy and that's really the heart of where you're going. Can you tell me on a macro level, who are the best prepared, and who are the least prepared countries? Then perhaps as a bolt on later, we can talk about what does that mean in terms of how you invest against that? KONSTANTIN BOEHMER: The best ones are like in Iceland is extremely good. Netherlands is very good. We have South Korea's very good. For us, it is like one is the overall rate ranking but another one is always to see why do we get to those overall scores. Here, we have to see why is Iceland, let's say top and that appears, let's say a little bit of a surprise. It was a surprise to us where we say then we have to drill in and say what is the reason why Iceland scores so well? It basically comes down to them having made tough decisions in the '08 crisis. They have made quite a few adjustments during that time. It's also that they don't promise so much. The promises that they are giving out to their public employees are reasonably moderate based on how, let's say, advanced the nation is because usually, there's a high correlation to how advanced you are to what you promise to your public employees. They are undershooting on that score, plus they are reasonably wealthy, let's say as individuals, and the government has cleaned up their act quite a bit. ED HARRISON: That's a good juxtaposition to Greece in that case, because both of them had crises. Iceland made the adjustments that you're talking about, and they didn't already have the preexisting high promises that Greece had relative to their per capita GDP. KONSTANTIN BOEHMER: Those promises, usually they just ramp up. During good times, it's easy to just promise a little bit more and to give in to demands in order to avoid whatever it is, strike or some trouble. We see now in France, also how-- exactly. He's doing exactly the right thing. He is pushing hard, in my mind, pushing hard for the right things but the opposition is pushing back. It's basically, as it can easily happen with public sector employees, they basically are in control and in charge of a lot of really, really, really important parts of our society. There is a very, very fine line of how much can you push, how much can you increase, let's say, the retirement age or increase contribution versus still making sure that you get all your essential services and of course, treating your public sector employees well who are in some cases relative to the private sector, not adequately compensated. ED HARRISON: Where the rubber hits the road is where you talked about the South Koreas, the Netherlands and the Icelands of the world and then do you play that from a macro perspective, because number one, obviously, when you look at how you would invest, say, on government bonds or any other asset class, it's not just about what's happening with the pension but also there is the relative factors like in terms of are they relatively the relative value of the assets that you're looking at. What's the process that you use in terms of putting this into an investment management component? KONSTANTIN BOEHMER: One goal for us, of course, as investment managers has to be, so what? It's great that you do all of this work, and that you maybe write a paper and have this fancy model, but what do we do with that? I think for me, one of the important pieces is that I want to educate so I want to also show people look, this is what's going on. At the same time, I am a paid employee so I need to also make sure that whatever I do will have a positive impact on the tasks that I've been given. For sure, we want to make investment decisions based on the information that we're getting. I would say one is that it is an informational piece. It is something where I'm not really saying you should have been invested like this yesterday. This is something that has a timeline or horizon, which is still some time out. What is important for me as a macro investor is to also look out into the future. Everyone is focusing on the zero, two or three months and we're also, of course, taking a look at it and making our decisions on a very short term tactical basis. It is number one, it is highly competitive, and therefore there's a little bit less alpha in this space. There's more alpha if we look out further into the future, and that is a one-year, two-year, three-year time horizon and we need to be game ready. We need to have our game plan of how we want to be invested if something happened, which we think there's a high, or there's a reasonably high chance that this will become center stage. We can talk about what will be the triggers to bring this center stage, but I think number one is we need to see, are there any glaringly obvious decisions that we need to make based on the model that we've seen and the qualitative analysis on the background? I think the glaringly obvious decisions are that we look at Europe, because it's always easier to make those decisions within the same currency. If we look at Europe, there we have one central bank, but we have multiple different countries, which are actors in that environment. Then you have some, like Netherlands which is extremely well prepared. Then you have others like Austria, which is extremely badly prepared. Then I look at those two bonds and as a barrier minimum, I would say let's not buy Austrian bonds, because they trade at the same level. I think it's maybe eight basis points difference, but it's not worth those extra eight basis points for going from one country which looks, let's say, stable and solid and well prepared to something which on the surface looks decent but if you look under the surface, there are a lot of challenges. I will put a massive disclaimer here that this is not investment advice that you should put on that spread trade right now, this is more going into the direction those trades we would look at and we also need to factor in of course, what other pieces of information are there? Sure. We need to factor in that Austria just got a new leadership and that is actually extremely progressive and might be the blueprint of how European politics will look in three, four or five years and maybe with that young dynamic tilted towards environmentally but still sustainable growth, maybe that is a framework which works extremely well for Austria. We need to take all of those things into account, but if we were to just look at pensions, that is a pretty clear case, to be long Netherlands and short Austria. ED HARRISON: Can you play this in derivatives like CDS and things of that nature? Because I would imagine that when you look at the price of those derivatives, when you're looking for trigger events later on, when the trigger event happens, that protection will crystallize towards the values that you're already predicting. KONSTANTIN BOEHMER: I think that's great. I think that's possible. You could do those things. I think what is maybe the more cost effective way would be to wait a little bit more until it hits the most critically exposed ones. I think having a good roadmap or a good game plan ready, it is okay to miss the worst case, if you then play the second tier because it will always trickle down, it will always be there will be one country which will become center stage, let's say in Greece or in Italy or Spain or France where you have a really big move based on what is going on in that country on the negative side. Then the second tier countries will not move for very long time. There will still the opportunity to put on those trades, let's say let it ride for a little bit longer, but at least it is right in front of you, the playbook, you can just pull it out and say look, I'm getting ready. That's one thing. The financial part is one thing, another one is politics. There, it has already huge impact where we see how maybe the political divide in countries is not based on ideology anymore. It is maybe a little bit more based on the intergenerational split between the older generations, the, let's say the okay, boomers and the millennials and under where you see, well, who's actually going to pay for it? Is it the young through the contribution, or is it the old or older through lower entitlements? I think that's what we see increasingly in a lot of places in Europe, but also globally, and definitely in other places, too. You have that financial aspect, you have that political aspect. Then you have, let's say, the really big structural impact of saying like, okay, how big is that problem in general and how does that affect inflation rates going forward and GDP growth going forward? There, I just see a major drag from that particular aspect. That doesn't necessarily mean that I will be a permanent bear on growth or on equity markets, but it is one contributing factor which is extremely important for me. ED HARRISON: Let's use this as a transition point to think about US states. A lot of our Real Vision viewers are US based. I think that the framework that you've laid out is pretty solid in terms of thinking about the States. When you talked about the obviously good states, the obviously bad, but then there are the ones that are not quite there. Talk to me about who's in those trenches, and how you came to that determination. KONSTANTIN BOEHMER: I think for the US, it is a lot more interesting to put those spec trades on. It's a very diverse pool. I do have lots of states in the US which are offering general obligations, so other securities and you also have, let's say, not a super liquid, but you have some CDS market on a lot of those states. I think the basic logic and again, that's not investment advice, it's just the way that we would think about that issue is that you disregard your Kentuckys, your Illinois, you New Jersey. Your worse tear, where everyone knows that they have issues. It's no secret here. What about the tear right below that? Like what about the Mississippi, Nevada or some other places where you say look, nobody has talked about them, but-- ED HARRISON: What are the states that no one's talked about that I would be surprised to know is the second tier below New Jersey and Illinois? KONSTANTIN BOEHMER: It's the Mississippi definitely, we have Connecticut would probably be the first here, New York would probably also be the first here. It is let's say a lot of states which do not have natural resources. Those would be generally the top tiers and extremely populous countries or with a lot of high population are, let's say oftentimes a little bit more challenged. Texas being an exception here, given the oil wealth, but it's like middle to smaller states around the fringes, which are, like oftentimes overlooked in in many ways. It's oftentimes the flyover states, which are not at the coasts. Those are oftentimes, let's say, a little bit more challenged. ED HARRISON: You mentioned Nevada, they would be a second tier potentially? KONSTANTIN BOEHMER: On the bad side, yes. ED HARRISON: Interesting. Where are the obvious choices on the other side of that in terms of wellfunded, and how does that play into when you think about a relative value or a CDS play for that? KONSTANTIN BOEHMER: The obvious ones, for me would be a district of Columbia or Utah. Extremely stable and good country. Wisconsin, which is also pretty good. You have some which are super strong. Then you have, as I mentioned, some which are really bad and in the news and then the medium to bad. Those are ones where I think it would make sense in general to buy some CDS protection. A logical trade for me would be that you are long certain high quality states, let's say, Idaho is a good one. Utah, great, Tennessee is also pretty decent. You can buy, let's say, some assets in those states, let's say GOs, general obligations, and then simultaneously, you purchase some credit default swaps on the medium to lower tier and those would be the Mississippi, let's say, and Nevada. You roughly pay the same. The spread that you gain is roughly the spread that you pay, because it is not obvious. Because the market is treating them all the same. It is only treating the bad ones differently, but everyone else is being treated the same. CDS on Nevada is maybe 36 basis points and the CDS on Utah is maybe 33. Three basis point difference, that's not a big deal. You can buy those general obligations, you buy the CDS, and you're left basically with a package which is the US Treasury. It is the underlying duration component because the spread that you gain or the credit that you gain, you pay it away. Net-net, you're at a US Treasury yields, but the return profile in a crisis will be dramatically different. Because if we go into that crisis, you would see those spreads massively changing where you see the second tier of worse, adjusting up right to the worst, and the best ones just staying roughly where they are. ED HARRISON: What about leverage and duration in terms of plays of that nature? KONSTANTIN BOEHMER: That depends on what abilities everyone has to access leverage, it would appear to be a natural play to use some leverage, because it's very small differences in spread. It would make natural sense, but everyone has to see how that fits in their own profile. For the funds that I manage, we wouldn't be able to access leverage, or at least for the majority of our funds. For some, we could, but that's something that everyone needs to leverage themselves. ED HARRISON: And duration, like what time frame are you looking at? KONSTANTIN BOEHMER: I think there's, again, this is not a trade that you had to put on yesterday, which is great. I always dislike when somebody says I've been right for years, and now we're getting to the last little bit and I still believe in it, but I've already made so much money in the past. This is you at the very, very, very early stage putting on a trade. You have not missed anything, you have not lost anything, but you have not missed anything. You work with feedback loops, and you work with non-linearity where you say this is actually not moving until it completely moves. This is something where, and I also liked those investment ideas in general where you have very little movement, and then you have a massive event which restates and makes for outsized gains in that case. ED HARRISON: That's why the funding structure you're talking about makes a lot of sense, because it's fairly stable over a longer period of time, but very small, but then it adjusts. KONSTANTIN BOEHMER: I think in terms of timing, what I would look at is it's actually just equity performance, because the sequencing, what I mentioned earlier, the sequencing of returns is becoming center stage because a lot of pension funds have matured so they don't have the capacity to have a bad year, maybe, but two bad years would be really, really difficult. Once you get a couple of bad years and a bad year is not -10 or -20, a bad year is-- your baseline is 7.6%, a bad year is already zero. Let alone minus something. A couple of bad years will make everyone look at those pension funds again. They will say, look, what does it mean if you have-- if you underperform, if your performance was so bad for a couple of years, what does that mean? Then I think there's also this reinforcing feedback loop where you had possibly a bad year or two bad years but then what do you do as a pension fund manager? You have your pool of money, and you see your target slipping away, you have two choices, either you go for the Hail Mary, or you say, look, I'm going to protect what I have, so that I at least have something reasonably to pay back. I would say that most will take the latter option of saying, look, we had too much risk on the book, the market called us, we are swimming naked, and we have to make those adjustments and then sell even more in an already declining market. ED HARRISON: Very interesting. Any last thoughts on how to think about this entire retirement crisis? Because as you were speaking, I was thinking to myself, in a down market, a sustained bear market of 20% or more, when you say that zero percent is already when you have a 7% assumption are going to be difficult. That's a difficult thing to for these companies or these countries and states to deal with. KONSTANTIN BOEHMER: My few thoughts would be policymakers do know that this is broadly going on. There is an increasing and large incentive of policymakers to not make it happen. To see that there is an implicit put in the equity market, because that would be a much lesser evil to deal with-- ED HARRISON: A Fed put basically. KONSTANTIN BOEHMER: A Fed put or even a government put. It could come from either the monetary side or from the fiscal side, but I think there is a put because the consequences will be pretty dire. I think there is an underlying put, and we need to take that into account. While I'll see all the doomsday scenario, I also have to recognize that there are players who are extremely powerful and who can move the needle and can move the market. I think that's a an extremely critical aspect. I think another one is that we need to see what would a scenario be of somebody bailing out those institutions? Let's say if that put we're not to work with conventional policies like what is the next step? What will happen if one major pension plan, another one, the third one all go bust? What will happen? Who will step in? I think that it has to get, like for the easy puts that are in place from the fiscal and from the monetary side, if that doesn't work, and we actually see some defaults, some more defaults, then what will the consequence be? I think that here, the path will be that the federal government will have to step in because it's too critical, too crucial of a component of society that they can just let it go and say okay, you, California, you deal with your own mess and New York, you deal with yours, and Wisconsin, you deal with yours. I think there will be a federal bailout eventually going to happen, but it is something that probably needs to get a lot worse before it can get better. ED HARRISON: Very interesting conversation. Thank you, Konstantin. It's been a pleasure. KONSTANTIN BOEHMER: Likewise, thank you very much. Thanks, Ed.