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Stephen Dover: Sara, you look at the consumer sector globally. How are ESG considerations impacting consumer brands, maybe particularly with the increased focus on diversity and social injustice in the United States and elsewhere?
Sara Araghi: From a consumer perspective, the consumer is actually now demanding a focus on environmental, social, governance (ESG) factors. So, yes, the companies, that’s becoming a part of their strategy, but the consumer is actually buying products from companies that are focused on these issues. So yes, it’s a major focus from a diversity and inclusion perspective. You have consumers specifically, after the events of last year, looking at now diversity within organizations, making sure that employee hirings all include some sort of diversity within an organization. This is what consumers are looking for now. From an environmental perspective, you have brands that are being created, think of apparel and footwear industries, in food and beverage manufacturers, that are talking about how they are trying to reduce their carbon footprint. They actually market that on social media platforms where Gen Z is paying attention to that. And those brands are the ones that are getting consumer demand. That translates into, obviously, revenue and ultimate profitability. So, it’s a very important factor for consumer companies. You’re hearing denim manufacturers talking about reducing their water impact. It takes about 7,500 liters of water to produce a pair of jeans. That is an incredible number, and that is something that a number of denim manufacturers are talking about reducing. You have the carbon footprint of just producing a pair of shoes is incredible. Maybe they can’t reduce that in terms of the actual shoe production itself, but maybe some of the manufacturing capabilities of the facility itself—they are trying to have an impact on that. So, it’s a major focus for all consumer brands from apparel, footwear, food, all areas of the consumer economy.
Stephen Dover: That’s interesting. I certainly didn’t know how much water was used in jeans. That’s an interesting fact. But also, that the ESG considerations are being driven by the consumer. So, it isn’t so much that companies are driving it, although, to some degree they are, but just to be a responsible company or to respond to the consumer, companies have to take ESG factors into account.
Sara Araghi: Yes. Definitely. The consumer is spending their dollars on brands that really care. And I think that’s going to be an important factor that drives the brands that we’re looking at going forward.
Stephen Dover: Zehrid, we’re talking about the consumer, one of your big trends is demographic changes. So how do you see the interaction between demographic changes and how you look at the consumer globally?
Zehrid Osmani: Yeah, it’s a very complex picture, actually. You have to look at demographics in a very granular way. There are some countries that are facing aging populations and shrinking working populations. Others are still very vibrant, and that can create some different dynamics in terms of consumption patterns. An aging population, in itself, creates a very interesting dynamic because you have more leisure time, therefore more opportunity to channel some of your spending and savings into leisure activities and consumption. So, you have to look at it very granularly. One area of interest, is indeed the opportunity that this online shift has offered some of the strong brands because it does capture an ability for them to use their strong brands and the brand following their have with consumers globally through these digital channels. So there are consumers that might not have been able to shop for the brands that they liked because they only travel every so often into a main city where there are flagship stores. These online channels give them more opportunity to consume those preferred brands. And therefore, for these brands, it gives them more opportunity to interact with those consumers. It creates the ability to profile them better and therefore target them in a more efficient way at the same time. Of course, the challenge that this brings is this shift to online channels is reducing the barriers to entry. So, you can have new brands that are able to access consumers more rapidly as well. So it’s another aspect to touch on.
And then the other aspect to mention, Stephen, on your question in terms of demographics is actually maybe shifting it into consumer appetite and linking it to the consumer, but also linking it to decarbonization. You have this drive in electric vehicles and electric transportation, generally as a way to decarbonize economies. And what’s interesting with a consumer’s appetite to upgrade their vehicles to electric vehicle at the same time as government pressure on companies and putting regulatory steps in place to ensure there is more rapid upgrade of vehicles from combustion to electric, creates a very attractive opportunity for investors as we know. And, the way we look at it is, unlike other markets which are really nascent, and then you have to go from that nascent phase into acceleration into maturing, you have a market that’s already been established and that’s taken over 100 years to establish itself. And that is now mandated by regulators to shift to electric at the same time as these consumers are wanting to upgrade to electric. So, it creates this very attractive growth opportunity. So, a lot of aspects to touch on in terms of demographics, consumer preferences, and consumer dynamics, which hopefully I’ve given you a flavor.
Stephen Dover: It’s interesting how all the big trends that are happening, ESG seems to be a part of it for the economy and for a lot of companies, Bonnie, you’re the head of ESG for one of the largest global fixed income groups in the world. How do you look at ESG investing in the corporate area as well as the public sphere?
Bonnie Wongtrakool: Sure. Well, since Western Asset is a fundamental value active manager, we are really looking to identify all of the risks and potential opportunities in the investment set that we’re examining. And so, that would include environmental, social, and governance. And so, therefore it’s really an integral part of our process. And because we focus on fixed income in particular, for us, risk mitigation is a very important element of what we’re trying to do for our clients, and we have seen that ESG does mitigate risk and does protect from the downside in the bond universe. So, we do think it’s very attractive from that standpoint. And we do weave it into all of our strategies, but when you think about ESG and, Zehrid was talking about how it’s going through these mega trends, it’s really interesting to see how corporations have started to approach it versus how they approached it in the past. So, there used to be more of a debate between, should there be a focus on purpose or should there be a focus on profit? But now, I think companies are coming to this realization that ESG is just another part of the business strategy. It is a strategic decision that companies are making. And of course, like any strategic decision, it does require some investment, but that investment can have a return. Aligning your purpose with your stakeholders’ purpose can be very accretive, and I think there are more companies that are coming to this realization, though clearly, there are still companies that are lagging in these practices. It is becoming a lot more accepted and practice and a standard that investors, including ourselves, are looking to see actualized.
Stephen Dover: Bonnie, that’s interesting. So you’re really saying ESG is just part of the corporate strategy. That it isn’t necessarily about some sort of a moral issue, although it may be, but that it is just part of the strategy. So, when you look at the companies that you look at, do you think the behavior of the corporations is changing and that asset managers have some influence on that?
Bonnie Wongtrakool: We’ve certainly seen some very good progress, Stephen. There has been pressure from investors such as ourselves and also from the consumer side. And that has led to some of these changes that I’m describing. And again, this growing recognition that financial value that ESG can bring, but there are still companies lagging, as I mentioned, for a variety of reasons. And so, I think because of that, we do need some regulatory standards to set a minimum for ESG, for companies. We are seeing that in some regions, and I think that will help to accelerate and broaden the progress that’s being made. And we need more systematic pricing of certain types of risks, especially when it comes to climate. I think we know what tools would help to achieve this, and we know that mandatory climate disclosures would help. And we’re seeing that in the UK and the EU, movement on that, China says they’re going to follow that as well, and the US is formulating its own strategy. We know that carbon pricing would help, especially for the high-emission industries. Again, the EU is being a pioneer in this space. And financial regulations. If you require the banking system to evaluate and price climate risk throughout the portfolio, that is going to be extremely additive to all of these efforts. And we are seeing some starts of global coordination around this with the NGFS, the Network for Greening the Financial System.
Stephen Dover: So Zehrid, a big question that we keep getting has been the supply chain is more clogged than it ever has been before. How are you thinking about that?
Zehrid Osmani: Yeah. perhaps I can link that supply chain to what Sara was mentioning about brands and the importance of having the right ESG, in terms of ethical approach to production. Brand perception and brand image is important to consumers now, as Sara mentioned, and therefore, what happens further down your supply chain is also part of what every company that has a brand should care about. And it’s interesting because, in the UK, last year, we had a company in the apparel market that was effectively found to have some issues, a social exploitation risk issue, whereby it was found to be underpaying and effectively getting into gender exploitation as well. And so, you don’t have to go as far as emerging markets to have social exploitation risks. This can be as close as a developed market. So, the importance of your supply chains, knowing them, monitoring them and helping them raise their standards is part of what every company has to be involved. It’s part of their duty. It’s part of ensuring that they don’t have that brand risk. And so, to your broader question about supply chains, it’s also therefore relevant for investors to assess supply chain risk on any company that we analyze. And it’s the suppliers, but it’s also the customers and how they will interact and whether there are bottlenecks that can create some risks for investors. And we’ve seen some major bottlenecks as part of this pandemic crisis. And as we’ve been getting out of the pandemic crisis, the semiconductors industry is one has been quite well covered by media, but there’s also the issues with material shortages in the building and construction sector. And it is just spilling over in a domino effect way from some bottlenecks that we know are happening because of this pandemic crisis and because, as we’re reopening, economies are reopening at different speeds, at different pace, and production lines also opening at different pace with shortages.
Stephen Dover: Sara, supply chains are an area you’ve explored within the consumer sector. How are you looking at supply chains and your view how they impact the consumer sector?
Sara Araghi: So, we were actually seeing a lot of diversification of supply chains the last decade, a number of consumer brands in the apparel space, a number of consumer staple companies, were diversifying from specifically Greater China into other regions of Asia, and even shifting some of that to areas such as Mexico, Latin America. That’s what we were seeing for a long period of time. Interestingly, that was going to be accelerated with the tariffs that were put in place in the region a couple of years ago, and the pandemic kind of paused that a little bit because China and those regions were up and running a lot faster than a number of other regions. And so, that’s where you could actually produce your product a lot faster and get that through the supply chain. To your broader question, though, I mean, this is obviously a shorter-term issue, but right now, at this moment, we’re seeing clogs everywhere in the supply chain, just because labor has not come back as quickly as needed, you have a number of new processes that you need to implement due to the pandemic and the COVID-related structural changes that need to be made. All of this has created a little bit of a clog in the supply chain. And so, you’re seeing production slow down. There are some factories in China that are talking about actually not taking new orders. And so, I think brands, specifically the consumer companies, the ones that have a larger footprint have scaled benefits can fortunately take advantage of production anywhere in the world. But, the diversity is very important. I don’t think we’ll ever see a situation where the brands and the consumer companies rely on one region. Having the diversity makes it such that they can actually evolve and respond to such a difficult environment today. So we should continue to see a diverse manufacturing footprint for a number of companies in the space.
Stephen Dover: Bonnie, as Sara and Zehrid talk about some of the changes in the supply chain being tight, low unemployment numbers, of course, everybody’s read about all the big changes in commodity prices and building prices. How does this impact your view of inflation? How are you thinking about inflation now?
Bonnie Wongtrakool: Before I talk about the inflation angle on this, just really quickly a comment on the ESG angle of all these supply chain adjustments. This trend that we’re seeing towards supply chain resilience and away from efficiency is actually pretty positive, I think from an ESG perspective. There used to be a focus purely on cost and now there is this focus, as Sara and Zehrid were talking about, on sustainability of your supply chain, whether that’s having resource efficiency or having automation or regionalizing your supply chain. All of that is something that, from an ESG perspective, we’ve been seeking for a while and primarily around the transparency in your supply chain and understanding how companies are able to react to these different crises is very important. But really moving on to the inflation angle of this, we don’t have a supply of certain inputs that are key to many processes. Everyone knows about semiconductor chips, and you also see it in lumber and copper. So, you’ve got an imbalance both on the labor side and on the input side that’s creating kind of this perfect storm and this confluence of factors, that’s making it really difficult for investors to figure out what’s going on in inflation. But I think you’re seeing not just some price increases by companies, but also actually just some creative solutions around how they’re shrinking package sizes, making the packages weigh less, so they can keep prices steady and manage their top-line growth.
So, I don’t think it’s a given, I don’t think companies are assuming that they can increase prices forever. One of the two key questions around this is will we continue to see wage increases past the time when the economy is reopened and the labor force is back fully, will companies really still need to increase wages? Will they still be willing to increase wages? Because if they aren’t, then these price increases that we’re seeing, especially in consumer staples, they’re not sustainable, you know, consumers won’t be able to afford the products if they don’t have a higher wages. So, you’ll probably see that taper off. Those will be one-time price increases in consumer staples, or you’ll see the, again, more of these creative [strategies], like let’s make the product smaller. So, I think we really need to keep an eye on wage inflation. Our view at Western Asset is that runaway wage inflation is probably not very likely given that there is still a lot of slack in the labor market. You know, we just had the [US] jobs report and you can still see that these trends are ongoing. That participation in labor force is relatively low. There are still over 40% of the people that haven’t worked, they haven’t worked in over half a year, and that makes it more difficult for them to reenter the labor force. So, all of that could weigh on wage inflation and we’ve seen this happen in the past decade as well.
And I think the other question that one has to ask is really, let’s say we do have this more prolonged period of adjustment where there’s this uncertainty, will that actually cause long-term inflation expectations to shift up? That’s really important because that is something that has been relatively manageable and has kept inflation pretty low. It’s a self-actualizing phenomenon. So, if public expectations for inflation do rise, that is going to be a change from years past. And we know that the Federal Reserve is definitely watching for this. So, I think that we still have a few months where we have to wait. We have to wait for the economy to reopen, for schools to reopen, parents to get back to work and to see how these trends are going to broaden and whether they are going to last before we can really read too much into this high-frequency data. But for now it does not seem that the inflation risks are more than transient.
Stephen Dover: Zehrid, one of the big and fascinating, heroic movements over this last COVID period are the pharmaceutical companies and the vaccines that have come out so fast. Will these companies make any profit on the vaccines? And maybe a follow-up question is what’s going to be the long-term effect of their ability to put out these vaccines? What other things might they be able to do in the future, and what opportunities do you see with those companies?
Zehrid Osmani: Under WHO [World Trade Organization] rule, because it’s a pandemic, there’s going to be very little opportunity for these companies to generate excess profits from the vaccinations program. So, really what’s exciting is more about what could come in the future. And we think that the rate of progress is going to be much stronger, in particular, in the whole bespoke health care, as genomics research and development continues to come through, as the cost in that area is reducing quite rapidly. There’s going to be an opportunity to make medical progress much more rapidly than in the past, and effectively then, go into targeted health care therapy, which will be more efficient, but also less costly generally. So, there are a lot of opportunities in that space, in genomics in particular, where US companies are leading but with implications globally. There are going to be opportunities as well in the whole drug trials and development outsourcing which there are some companies that are well-positioned in that space to harness what will be of very strong growth over a very long period of time. Also, what’s interesting to pause and think about is the speed at which these vaccines have come through when you channel so much effort into one area. And when you increase collaboration between scientists globally, and that can provide some interesting potential to tackle other global diseases in future.
Stephen Dover: What’s the big thing on your mind that you think that investors might not be thinking about right now?
Zehrid Osmani: Yeah, we’ll go optimistic, Stephen. So, if you think about the magnitude of the fiscal stimuli that have been deployed, and some of them going into infrastructure spending, whether it’s renewable energy, electric transportation, health care infrastructure, we think that this creates a longer duration economic cycle, because by definition, these infrastructure projects are long duration and therefore, we could be facing a more prolonged, positive industrial cycle as a result of it.
Stephen Dover: Sara, what’s on your mind in that way?
Sara Araghi: Because of the impact of the stimulus right now, you’re seeing rising tides across all the consumer areas right now, and you’re seeing a number of companies be beneficiary. And I don’t think investors are really differentiating between the ones that are ultimately longer-term winners and beneficiaries of these trends longer term. So, I think for us, the focus right now is making sure that we identify the winners coming out of this pandemic over the next three to five years, rather than just focusing right now, the market is really focused on everything within the consumer space. So, we are really focused on picking those winners for the long run.
Stephen Dover: Bonnie, from a global macro fixed income perspective, what are your final thoughts about opportunities?
Bonnie Wongtrakool: Clearly, there’s a lot of talk about climate and ESG is a very hot topic, but I think investors need to think about exactly where those green financing needs are, and when you look at that, a lot of that is actually coming from emerging markets, particularly within Asia, where we are going to see a lot of economic growth and population growth, but where we have a lot of physical risks. So, when you look at that gap between what financing is needed and where the focus should really be on emerging markets, and that is a big opportunity, both in particular with ESG, but also in particular with valuations and where they are now, especially in the local currency market.
Stephen Dover: Interesting. Well, thank you everyone for joining.
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