Value Investing

Graham & Doddsville Winter 2019 Issue: DG Capital Profile

Interview with Glenn Hubbard and Joseph Stiglitz from the Graham & Doddsville Winter 2019 Issue.

In this issue’s in-depth interviews, you can also read about:

·         What Jeff Mueller ’13 and Damon Ficklin, portfolio managers of Polen Capital’s Global Growth Portfolio, think about geographic diversification and the changing consumer landscape in China;

·         Why Dov Gertzulin, founder of DG Capital, thinks catalysts are an important aspect of an investment thesis;

Glenn Hubbard And Joseph Stiglitz
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Glenn Hubbard was named dean of Columbia Business School on July 1, 2004 and has been a Columbia faculty member since 1988.

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He received his B.A. and B.S. degrees summa cum laude from the University of Central Florida. He also holds AM and PhD degrees in economics from Harvard University.

In addition to writing more than 100 scholarly articles in economics and finance, he is the author of three popular textbooks, as well as co-author of The Aid Trap: Hard Truths About Ending Poverty, Balance: The Economics of Great Powers From Ancient Rome to Modern America, and Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System. His commentaries appear in Business Week, the Wall Street Journal, the New York Times, the Financial Times, the Washington Post, Nikkei, and the Daily Yomiuri, as well as on television and radio.

In government, he served as deputy assistant secretary for tax policy at the U.S. Treasury Department from 1991 to 1993. From February 2001 until March 2003, he was chairman of the U.S. Council of Economic Advisers under President George W. Bush. In the corporate sector, he is a director of ADP, BlackRock Fixed Income Funds, and MetLife. Hubbard is co-chair of the Committee on Capital Markets Regulation; he is a past Chair of the Economic Club of New York and a past co-chair of the Study Group on Corporate Boards.

Joseph E. Stiglitz is an American economist and a professor at Columbia University. He is also the co-chair of the High-Level Expert Group on the Measurement of Economic Performance and Social Progress at the OECD, and the Chief Economist of the Roosevelt Institute. A recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the John Bates Clark Medal (1979), he is a former senior vice president and chief economist of the World Bank and a former member and chairman of the (US president's) Council of Economic Advisers. In 2000, he founded the Initiative for Policy Dialogue, a think tank on international development based at Columbia University. He has been a member of the Columbia faculty since 2001 and received that university's highest academic rank (university professor) in 2003. In 2011 Stiglitz was named by Time magazine as one of the 100 most influential people in the world. Known for his pioneering work on asymmetric information, Stiglitz's work focuses on income distribution, risk, corporate governance, public policy, macroeconomics and globalization. He is the author of numerous books, and several bestsellers. His most recent titles are Globalization and Its Discontents Revisited, The Euro, Rewriting the Rules of the American Economy and The Great Divide.

Graham & Doddsville: Bloomberg’s Matt Levine sometimes writes about the idea that common ownership of firms in the same industry through passive index funds could, in theory, be anti-competitive. He writes that “the premises of the theory – that managers are responsive to shareholders, that shareholders are increasingly diversified, and that the joint interests of companies in an industry can conflict with the interests of consumers – ‘all seem, not just reasonable, but like basic textbook stuff’.” Martin Schmalz, a finance professor at Oxford and a leading proponent of the theory, asks, “Is there any plausible story for why these secular changes in the ownership structure of firms would not lead to a lessening of competition?” So, should index funds be illegal?

Glenn Hubbard: That is absolutely silly. Full disclosure: I am a Director of the BlackRock Fixed Income Funds, and BlackRock definitely has a point of view on this subject. It is crazy to imagine that the existence of large passive investors like index funds and ETFs is facilitating anti-competitive behavior.

BlackRock or Vanguard or State Street own X% of every large-cap company. Take the example that critics of common ownership use: the airline industry. The same people who own X% of the airlines also own hotels and everything else, so trying to monopolize the airlines would hurt them elsewhere. And there is just no evidence of this actually happening.

The bigger question surrounds how you would get discipline on companies if all investment were passive. That’s a more interesting question. If all investment were truly passive, it would be hard to have corporate control. You always need a strong, active market for corporate control. I think there will always be a need for active investors to help solve agency problems in corporate governance, whether that’s a large fund, a rich person, or a private equity organization.

Joseph Stiglitz: The reason index funds became so popular was that they were doing a better job managing funds for ordinary investors, net of fees and transaction costs. The one caveat I would add to what Glenn said is, as more of the stock market is owned by passive funds, assuming they’re really passive and do not exercise any control, that means that you can get control of a firm with a lot less capital. If you had a company that’s worth $10 billion and is 95%-owned by index funds, then you can get control with $500 million. So you lower the threshold for getting de facto control. It becomes an empirical question. I haven’t seen that as a major problem, but I haven’t really been following it.

Glenn Hubbard: On the competition point, what are the policy implications of banning index funds? For the average person, index funds are the low-cost, efficient way to invest.

Joseph Stiglitz: What Vanguard has done has just been amazing.

Glenn Hubbard: It’s ironic for me to see these arguments and then simultaneously see Jack Bogle being rightly lionized after he passed away, because he truly made enormous contributions to the welfare of society at large.

Joseph Stiglitz: He didn’t make a lot of money out of it.

Glenn Hubbard: By my standards he did! Fortunately, Columbia Business School is blessed to have some non-ordinary investors as donors, otherwise we wouldn’t be building Manhattanville. But most people aren’t those star investors. Index funds are, in my opinion, the right investment vehicle for most investors. If you ban them, how are average people better off as a result? They would be thrown back into a world where fees are relatively high and performance is relatively low. That doesn’t strike me as a good idea.

Joseph Stiglitz: I think the real issue is the danger that someone could get control of a firm with relatively little money. But with regards to index funds reducing competition between firms, there has been some literature recently on cross-ownership.

Glenn Hubbard: Yes, and I don’t buy it.

JS: I’ve been very skeptical. I just don’t see the mechanism for it.

Glenn Hubbard: You’ll be seeing some papers coming out on the other side of that argument.

Graham & Doddsville: The trade war is top of mind for a lot of investors right now. What is the political rhetoric getting right and what is it getting wrong?

JS: Well, the focus is on the bilateral trade deficit – I don’t think you can get any economist to say that makes sense.

Glenn Hubbard: Except Peter Navarro.

JS: Yes, except Peter Navarro. You’re not even an economist if you say that, almost by definition. Whether you believe in free trade or not, bilateral trade deficits are not what matters. Trade agreements don’t determine the multi-lateral trade deficit. That’s determined mostly by macro.

Glenn Hubbard: Meaning the financial gains and the opportunity for investment and savings.

JS: Trade agreements, i.e. what you import from which country, affect standards of living but don’t affect the macroeconomy. As macroeconomists, if there is an unemployment problem you use macroeconomic tools: monetary and fiscal policy. If they’re not working, something’s wrong.

Some discussions on China are obscured by the fact that there is a very big difference between value-added production and gross production. A lot of what we import from China is stuff that is not Chinese. Probably 90% of the iPhone is not made in China. The value added in China is 10%. But when we talk about imports, we treat it as a $1,000 phone imported. In the case of China, the confusion between the gross numbers and the value-added numbers is a big deal.

That in turn relates to some of the confusion about what is at stake. The things that we export to China are by-and-large much closer to 100% value-added. When we export soybeans, 100% of the soybeans are made in America. When you account for the difference in value-added trade, it significantly changes the numbers and the trade deficit appears much smaller.

And finally, I think there is a broad issue that has come to the fore. It has always been with us, and we have never been able to face up to it. And that is managing trade with countries that have different value systems and different regulatory systems. We see it in the controversy between the U.S. and Europe on GMO. Europe says it cares about GMO, while many Americans think it is just superstition. But if Europeans really do worry about it, and it affects their utility, their view is they should have the right to regulate it.

We view GMO as a trade barrier. Even transparency is an issue. If Europe passes a law saying that you have to disclose GMO, then Europeans won’t buy American wheat, and we view that as a trade barrier. That has been a source of contention between the U.S. and Europe for a long time. That's a narrow area, but you can see how two differing societies with different values come into tension over the right legal framework. We are so deep into GMO that if they restrict GMO, we can't export many of our agricultural commodities.

Where this is coming up now is in privacy, secrecy, AI, big data – and I think I'm more on the European side of those issues. Privacy and the norms around cyber security are really important. But there are still huge benefits from trade. The question is: what are the appropriate rules for getting those gains from trade on something that might be called a roughly level playing field?

Glenn Hubbard: I think that’s one of the reasons we’re struggling with the trade discussions, even though everything you learned in freshman economics is still true. Free trade is a good thing. But, the thing we always say under our breath, as economists, is that the gainers will compensate the losers. Well, we’re not doing that, and it’s a shame that elites around the industrial world are telling average people they should just suck it up because we’re going to be better off collectively. We are better off collectively, but not every person is better off.


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