Hello and welcome to The Download. I'm your host, Dave Richardson. And let me tell you, I get so excited on certain podcasts. This is one of those days, because we have Habib Subjally, who heads up global investing at RBC Global Asset Management (UK) Limited. It's so rare that we get to talk to Habib because he's so busy. He's global. He's all around the world. He's got so much on his plate. Habib, welcome to the podcast.

Thanks for having me on. It's a real pleasure. David: We often talk about, on this podcast, it's only an audio podcast; it's not a video podcast. So you don't get to see the fabulous experience looks that we have. If you could see Habib and you could see me, we've got a lot of experience. 35 years of background in the investment business; many scars, many wrinkles. With that comes a lot of wisdom and a lot of experience and background in what we do. Of course, if you go and you look at Habib's track record, it just speaks for itself. He's a fantastic investor. I think more importantly, as we've highlighted on previous appearances from Habib, he has a fantastic team that he works with. It's a very special way that they work together to make great investment decisions. But Habib, as we were talking before and talked a little bit over the last year, this is back to the 70s or back to the 80s in terms of the investment environment with respect to inflation and an inflationary environment. You have some interesting things to say about just how new this is, even for someone like yourself and many of the really experienced members of your team.

Yes. This is the thing, we are at a point in market history where the range of possible outcomes is huge. There are a bunch of people out there, very respectable, very sensible people saying, oh, this inflation is just a blip. It's going to recede and it'll be another six months or so and it will be gone. This is no big deal. There's other people saying, no, this is for real. This will go on for a long time. We could get systemic inflation back to the 70s and 80s, and the market is sitting there saying, wow, the range of possible outcomes is massive. The thing about what you were saying, basically, you very politely called me an old guy…

No no! We started young, Habib.

But the point is that I've been doing this a long time, and I studied inflation, accounting, economics, all of that at University. But once I started to work, essentially rates were very high and rates have been falling and rates of inflation have been falling. We've seen that for the last 30 or 40 years. And so, as you and I saw the more mature vintages in this market, there's not too many people who actually remember what it was like to invest in inflationary times. There's a lot of people sitting around scratching their heads. Of course, a lot has changed since the 70s. We have the Internet, we have more technology, more databases, all of that. Even if we do have inflation, it's not going to be identical to where it was before. Another point to make is that, while the market participants, the investors, don't really have experience of inflation, nor to risk models, nor to quant models, because the data set of the last 20 or 30 years is really rich, that's what they're based off. Very few quant models go back to the 60s and 70s. This is a real head scratcher. You can see there's a huge amount of risk aversion. People are saying, I'm not taking a risk, I just want to get in the center, move more towards value with something that is paying me now. Dividend paying stock. I don't care whether they don't have a future, give me something now. Let me just sit on that and we'll see. I think that's very much where the market psychology is right now and has been moving over the last couple of months. It's been very rapid.

As I was saying to you, I've been doing a lot of investor events in Canada over the last couple of weeks, with several thousand people. We're doing them virtually, so I can't look out into the audience to see who's there. But from doing these types of events over 20 years, I know who's sitting in the audience, and typically the age range is 35 to 70 years old. Even then, and particularly if we go back to where how many people invested in equity markets or bond markets even back then, retail investors, there's almost no one in the audience that I'm speaking to who's had any different experience than next year rates are likely lower than they were the year before. Inflation is not something I need to concern myself with. I remember paying 20% on my mortgage back in the early 1980s, but I haven't seen that anytime recently, and I don't expect to see it. In fact, I've paid off my house if I'm one of those people who are sitting in the audience and was living through that experience. So it's just something completely new. And so we've got to think about things differently. As you say, one of the reactions is, I just avoid risk altogether, I take what's in front of me now and play it down the middle. But you're working with your team. Have you changed the process? Do the discussions sound different around the table as you're discussing individual companies? How are you going to move your portfolios around and select the companies you want to own for the next 10 years? Because, just going back, Habib can invest anywhere in the world, but focuses very much on companies, not countries or regions. His team views themselves as company owners and long-term owners, not just trading in and out. So, with that context, what does it look like in the room when the team's talking now versus, say two or three years ago?

We've gone back to first principles and kind of just ask the really simple questions. If we do have an inflationary environment—that is, input costs are going up and labour costs are going up— what kind of businesses thrive and prosper in that environment? Now everyone thinks, oh, this is value and it's about rising interest rates, it means that the discount rate goes up and so on. Yes, of course, rising interest rate means the discount rate goes up. The longer duration the asset is, the more impact it has. But what it's really about is being able, if you're creating value, to pass on any increases in input costs or labour costs. That's the key. If you can pass it on and maybe pass it on with a little bit more added on top. The way the maths work is that, if your input costs go up and you maintain your percentage margin, you're actually making more in dollars, a lot more in dollars. So that's the key, how you can pass things on. Of course, when you have input costs going up— and not all input costs are going to go up at the same rate; labour might go up by more, oil might go up by less or more, and then copper and so on—, you have to see how this impacts different businesses and changes the competitive positioning in an industry. One of the examples that we were debating is, what happens in the retail industry? If you just take two very simple, iconic companies like Walmart and Amazon, who is more labour intensive? Who can change prices fastest? For Amazon, of course, as the stuff comes in, you can just change the price on your website, right? You just keep marking it up as your input costs. Now, for Walmart, it might take them a little bit longer to do that, but at the same time, Amazon has to pay for picking, packing and last-mile delivery. Whereas Walmart, the customer, you and I, we drive to the store, we pick the stuff off the shelves, we put it through the scanner, we put it into bags and we put it in our car, we drive it home to get it to our kitchen. We're not charging Walmart for that. Walmart is saving on that last-mile delivery. This changes the competitive positioning of an industry. Then there's also other industries that have long-term contracts, that have a long-term service contract for five or 10 years. If you haven't built in wage increases or inflation increases, or you just put in like 2%, you could be in real trouble. We have to examine company by company, business by business. Who can pass this on? Who has a relatively short cycle, that as input costs go up, you can price up, as opposed to subject to short term fluctuation in prices, but your revenues are fixed? That's trouble. We're having to work through all of these, see who the winners are. We know discount rates are going up. But if you can keep growing your revenues and your cash flows by more than the discount rate is going up, you can do very well. This isn't a value versus growth thing. It's about who can adapt this environment fastest. I think that's the key. And you know, also, it becomes more a subtle thing when labour is in short supply. It's not just who's prepared to pay a little bit more for labour— of course, that matters— but who's actually a good employer. Labour is going to go to people where they feel, of course, they’re paid fairly, but they want to work somewhere where they're treated well, respectfully, where they have a career, where they feel they're progressing. I think those sorts of things, that loyalty of suppliers and loyalty of labour lawyers, those sorts of things also become really important now.

Yes. I know that's something that you spend a lot of time on, with the companies that you invest in, looking at what we would call classic term ESG. But when you really drill down to it, it's some of these important factors that make it a place where people want to work. There's a purpose, there's a way that they're treated by their employer. You've used this beyond these circumstances to identify opportunities in the market. It doesn't show up on the balance sheet or on the income statement, but it does show up in the long-term performance of the company.

Absolutely. There are certain industries today that have historically treated their workers just as a commodity. I'll put you on a zero-hour contract. When I need you, I'll call you up. You come, you work, I'll pay you for the hours. If I don't need you, see ya! I don't care about what your rent bill is, or whatever, that's your problem not mine. Now suddenly you're saying, right, okay. Like if you are in the fast food business or the hotel or hospitality business. Okay, now we need you, come on back. And a lot of these workers are saying, sorry, thanks, I've got another job. These industries have bad reputations now. You're going to have to pay above the odds, significantly above the odds, because people feel, right, I need danger money to go back to that industry because it's antisocial hours, it's uncertain work, they've proven that they don't have a sense of loyalty towards me, the worker, I’d much rather go to someone else that offers a fair job, treats me respectfully, and has a chance of being loyal to me. I think that some industries are going to struggle.

Let me go off script a little bit here, just as I'm thinking, listening to what you're saying, and we talk about environmental concerns, and companies that focus on that, perhaps they have an objective to be carbon neutral at some point in the future. Do you think that what we're going through right now is going to pressure some of those companies to move off some of that commitment? Are you seeing that in the companies that you work with?

No, we're not seeing that at the moment. I can see as margins come under pressure that maybe some will try and slide back on those things, especially to preserve short-term profits. But longer term, if the CEOs and the leaders of that business care about where these businesses are going to be in a 10- or 20-year time, then they really need to move on this. There are three things, really. One is if the CEOs really care, what is the business going to look like in 20-year time, you better deal with carbon and decarbonize your business model because carbon is going to become expensive. If you care what your customers think of you, you better decarbonize because your customers are demanding it. If you care what your employees think of you, and the wider community thinks of you, you better do this too. And we all know that businesses need a social license to operate. I think it's almost become a nonnegotiable pressure on corporates and those that cut corners on that, I think all they're doing is mortgage in the future, and we would see that as quite a negative side.

Habib, why don't we wrap up with how this affects the portfolio? Has this new environment forced you to make a lot of changes in your portfolios? Do you think it's going to force you to make more changes going forward? How does this play out around the portfolio and what it looked like six months ago to now and where you think it looks a year or two from now?

What we've done so far is, we've done some rebalancing in the portfolio. Just making sure risk and whatnot, taking a bit of capital out of names that have done really well and a few others, and just make sure that from a risk perspective, we're not too exposed. One or two changes to the portfolio; nothing dramatic. But what we now got down to is just the basics. In this environment, in a different environment, what businesses do better and what businesses do worse; which ones have a tailwind, which ones have a headwind? That's where we're at now, trying to see how that list of preferences from your first to your second, your third, your fourth. What moves up from the second division to the first division. What moves down from the first division to the second division, and things like that. That kind of shuffling. That's where we're at now. This is a great business but it's going to be in a tough environment. It's going to take two, three or four years to adjust and suddenly its competitors will catch up because they're all in the same boat, and then that may not be the best idea. Whereas wow, this business has a perfect business model for this environment, let's move that up. That sort of relative ranking is what we are going through right now.

Excellent. Well, Habib, a fascinating conversation. Always great to catch up. Just great to see you. You look well. Again, it's actually too bad, I look terrible so I'm glad we're just audio. You look fantastic with that big smile as always. And always incredibly insightful things to say. So Habib, thanks for taking the time to join us today.

It's an absolute pleasure. Thank you for having me on.