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[00:00:08]

It's the 3rd of August, and you're listening to Kobie Time, a podcast on economies and markets from TB's research, I am Thamir chief economist. Welcome to our twenty fourth episode. Today, we are privileged to have access to a highly astute analyst from a highly regarded sovereign wealth fund. Dr. Prakash Kanun is chief economist and head of Total Portfolio Management at CIC Private Ltd., formerly known as Government of Singapore Investment Corporation, was established in 1981 to manage Singapore's foreign reserves.

[00:00:39]

Prakash is currently responsible for medium term global macro and asset allocation strategy for the firm. He also serves as a member of Jicks Currency Risk Management Group. Prior to GSE, Prakash was with the International Monetary Fund in Washington, D.C., where he was a member of the World Economic Outlook team. He started his career at the Central Bank of Malaysia during the Asian financial crisis and has also worked with now Verizon pension fund. Prakash Kanaan, welcome to Copy Time.

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Hi, thank you, Tamar. Great pleasure to have you forgotten. Why don't we start with you giving us a sense of what this does for those who don't know and tell us also what you do there. Sure. Well, firstly, I just wanted to congratulate you on on Copi time. I think it's it's a great success. Very nice for you to have gotten it off the ground. So do you. I see. You know, it's one of two main sovereign Laffont in Singapore were established roughly about 40 years ago now, and we have expanded quite significantly since then.

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So we've got offices in about 10 different countries and we really kind of cover the whole gamut across public as well as private markets. You know, I would say if there's one thing that we pride ourselves very much on, it's it's really our long term orientation. And I would say that, you know, this that culture really pervades everything that that we do, both in our investment, but also just in organizational culture. So within Goutier, I'm the chief economist of the organization and also the head of a group that's called Total Portfolio Management.

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I would say the role is kind of has two dimensions to it. So the first one is really to help map out the forward looking investment environment for the organization. So this includes basically what we think about some of the key macro variables, growth, inflation rates, et cetera, but also some sense of forward asset class returns. Then the second dimension is really about helping senior management with asset allocation decisions. And so here is where our long term nature really comes into play.

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So our horizon that we we kind of base our strategic asset allocation is over a 20 year horizon. So it's really kind of forces us to think about some of the scenarios that could play out over over such a long horizon. So that's kind of in a nutshell of what you guys use and and my role in it.

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Right. You have a long term investment horizon, but at the end of the day, you follow the conjunctural very closely as well. You just published your annual report and there is a feature article there. The first sentence of the feature article is The Global community is facing a public health crisis and economic crisis and financial turmoil all at once, an unprecedented combination in modern times. So we will talk a little bit about that unprecedented combination here. Let's begin with the first team in that feature article, your sense of the macro environment, and maybe you can walk us through your views on the key economies like US, EU, China and perhaps also ASEAN.

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Sure. Happy to do that. I mean, in general, every time when we released The End report, the focus is usually on returns because that's kind of one of the key metrics we have. And so this year, it really is about message of resilience and we have steady long term returns that kind of beat global inflation. And it is against that that unprecedented backdrop that I think the feature article was written. But I think about the recovery really up there for drivers that I see.

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The first is about virus management generally. The second is the structure of the economy. And so this is how much is the economy dependent on manufacturing with the services on external demand versus domestic demand? Then the third dimension is really about the policy stimulus that has taken place. And then the last one is about any kind of existing economic imbalances. So you have these for these four drivers. And in general, we found that the first two, which is how well the economy is, is both able to and as well as in reality handling the virus, as well as the second one, which is the structure of the economy.

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These two end up being kind of the biggest drivers in how we kind of rank countries along the recovery path. And if you look at both of those two factors, China actually course relatively well. So they have really gotten ahead of some of the virus is a little bit of a first in first out principle with with China. And even as kind of new outbreaks have been happening, they really have been responding to them quite well. You know, and then also, I would say having a large.

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Economy in China has been helping. They have been pushing a little bit more on on the supply side as opposed to to to domestic demand, but I think on both those measures, China has been scoring relatively well. Generally, I would say that extend to North Asia. So Taiwan, even Korea to some extent. I think Coswell, on that on the dimension, I think that the part of the world that is is really challenged, even when you look at those four criteria, I think is Latin America.

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And here I think, you know, obviously they are experiencing winter right now. So there is much more of those in their behavior, et cetera, that could be exaggerating some of the virus cases. But places like Brazil, Chile, etc., the numbers still still look quite, quite worrying. And, you know, as we kind of go a little bit into some of the secular drivers that you also talk about in the in the annual report, if the if the the kind of pace of globalization also starts moderating, then I think some of these economies that are a little bit further away from, you know, big geographical centers such as China and the US, I think they would would tend to suffer relatively more.

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I think if it's a hindrance to globalization, do really end up being quite, quite strong.

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Right. That last point, I just want you to talk a little bit about it. There was a time when global trade GDP rose steadily, but that was not until recently stop around twenty two thousand and global financial crisis lost a lot of ground, began to pick up very slowly and then got again undermined by a the trade war and B, the pandemic induced global slowdown. So the countries that haven't prospered on the back of globalization and you know, we have a lot of aspiring emerging markets, let's say like the ones like India, Indonesia, should they sort of give up on that strategy?

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Because over the long term, if that trajectory remains flat and countries like China remain competitive, what chance do the new entrants have to leverage off of globalization? So I think it has been proven both theoretically as well as empirically, that really kind of making and the emphasis on export led growth is really the best chance, I think, for a lot of these economies, both to create jobs at home as well, actually, to to increase productivity. I think, you know, it's interesting when you look at the kind of public attitudes towards globalization, actually, you find in Asia generally the attitudes towards globalization, especially in terms of of goods, is actually very high, where a lot of people do think that globalization is a force for good.

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I think in this part of the world. And so when you look at even economies like India and Indonesia, I think that really still is the best strategy for these countries to really lift up the living standards. I think it becomes more challenging when it's it's globalization of of services and especially globalization off of labor. And I think here's where some of the the challenges which we have seen in the in the developed world are also a little bit relevant for these countries.

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But in terms of manufacturing, getting jobs, really kind of lifting these economies up. I think that strategy still has room to run. Right, coming back to the sort of near term, because some of the shortfall in demand there are so large that if you don't have a big ship recovery, this could lead to a major sort of arithmetic impact in terms of the recovery path and keep us below the level that we saw last year for a very long time.

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And since in your report, you do talk about the intersection of financial risk along with a growth risk and pandemic risk, Prokosch, there will be industries that would face massive headwinds through the pandemic and even a post pandemic world. They probably will not see the demand that they saw before. And therefore, consolidation is inevitable even if some stimulus and support measures related bandito is in place right now. And then there's the issue of the balance sheet risk, which also, you know, you have been highlighting for a while that the ballooning global debt burden.

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So share with us your view on this two issues, the kind of industry consolidation we can see in the coming quarters and years and the balance sheet risk that is out there both at the corporate level and sovereign level. Sure, I think on the on the industry consolidation aspect, I think it's probably not surprising to hear that this crisis has been having an uneven impact on small and medium scale enterprises. I think, you know, we've we've seen research, at least for the case of the US, where there's been about 12 percent of SMEs which have basically, you know, closed the business for good.

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Default rates have also started to to pick up. So, you know, it's, as you said, probably inevitable that some of the harder hit companies within, you know, hospitality, retail, cetera, some form of consolidation is likely to to happen. I think the the challenge here is that a lot of the risk is being transferred onto the balance sheet of the sovereign. And I think this has a few implications. I think the first is it's a question of divergences across countries.

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And so some countries, obviously, the more developed economies are the ones which have reserve currencies. They are much more able to badness this risk transfer than some of the emerging and especially developed economies. And so I think here this risk transfer and that that intersection of small medium scale with countries that that do not have this kind of policy space, I think that's where, you know, the risk of, quote unquote permanent impairment, I think lies probably the largest.

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Whereas I think in some of the developed economies where you can have this risk transfer, the challenge becomes when do you when do you how do you how do we countries wean companies off of this this dependence? And so I think you will start to see this a series of these kinds of so-called fiscal cliffs where either programs start expiring and then suddenly you find that companies need to bear the burden of this higher debt on their own. And so I think that those two divergences, one across countries and one between the private and the public, are going to be very important.

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So here, you know, I think the move by the G20 as well as some of the other private debt reorganization efforts, I think are absolutely essential because for the low income countries, developing countries, if they're going to find it very difficult to to to shoulder this this burden. And so some kind of of relief, I think will become necessary. And so I think, you know, even even as we go into twenty, twenty one, this higher debt issue will definitely be one of the legacies which will have very long, very long tail effects.

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Indeed, one thing that I worry about is the likely politicization of this debt relief, because I fear that particularly with the US having such a strong influence in the IMF, World Bank of the world, that any type of Paris Club type restructuring would come with the U.S. insisting that there's a bilateral debt relief from China to all the countries that have borrowed under our belt and road initiative. And that could probably muddy Waters. Do you have a view on that?

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No. I mean, I think I think definitely over the last few years, China has become a very important creditor, I think to a lot of these countries. I think actually they have started to make efforts that, you know, kind of quasi moratorium on some of these bilateral debts. But I think you're absolutely right. I think insofar as any of these efforts are likely to succeed, I think China has to play has to play a very important role.

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Right in your section, in the annual report. You also talk about paradigm shifts in policy making. Both fiscal and monetary are supercharged already around the world. And then you highlight a couple of risks. One is the. Is risk of higher inflation over the medium term and then the risk of currency moves affecting asset returns, why don't we weigh in on those two issues? Sure. You know, when we were writing this this report, you know, we realized that actually, you know, this issue of of post covid trends is probably one which many commentators globally have already talked about.

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We really try to think about, you know, well, what value can we can we add to this to this debate? And I think from from my perspective, I think the one really underappreciated change, which I think is likely to be with us for a while and especially for investors, I think is going to be the key post. covid trend is really about this paradigm shift in its policies. And I think that there are a few aspects of this.

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So the first one is really kind of you can think about it as an acceleration of a trend that was already happening a couple of years before, and which is that central banks, especially the major central banks, are really moving along the path that they are going to be changing the reaction function. And so while we're all very used to a central bank which hikes interest rates in anticipation of high inflation, I think this time is going to be very different.

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Central banks are actually going to commit to being behind the curve. They are probably going to include higher inflation into the new strategic reviews is not just happening at the Fed, also the ECB. And so this this this changes in the reaction function, I think is very important. Then the second one, I think is is on fiscal. And here I would say the change is really that there's a lot more colet ambivalence or a little bit more acceptance that the low rate, low interest rate environment really changes the dynamics on on debt sustainability.

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And I think this this change is very important for especially places where in the past that political pendulum always tended to swing back towards austerity. After you experience such a such a big fiscal expansion like this. And I mean, we only have to go back to what happened in Europe in 2011, 2012, where, you know, the the the push towards austerity was was was very strong. I think that's changed. I think that policymakers and, you know, across the ideological spectrum have are willing to actually tolerate higher deficits, tolerate higher higher debt levels.

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And I think this is this is also a very meaningful paradigm shift. Now, what are the consequences of that? I think the consequences are a refusal. We'll start to India in the annual report. One is, you know, probably for the for the first time in in many years, I think the risk of higher inflation is meaningful. And, you know, here it's not just about inflation going to two or two and a half, but actually even even going to three and at the birth.

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And then the second one, I think, is that it does create more more fragility, I think, on the part of the balance sheet of the sovereign. I think there is a increased reliance on the belief that interest rates will always remain low. This need not necessarily be the case. You could have the next crisis being one where for some reason, whether that's because of increased risk premium, so because of inflation shocks were actually interest rates are going up and then some of your debt dynamics become become a lot worse.

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And so these two these two things, I think are very important, at least for for investors like us to really think about how we how we should price assets and. The reason I say that is because I think there is a belief that, you know, lower interest rates automatically translate to a lower cost of capital and then that could justify higher valuations, whereas we think that, well, the cost of capital also has equity risk premium embedded inside there.

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And given that you not only have a riskier world going forward, but also that the longer term growth has been impacted somewhat, that you don't necessarily cancel out. And so, you know, I think this this changes in the in the policy paradigm. You know, if I was to name one thing that that I think is probably the most meaningful for investors to deal in this post covid environment, I think that that would be a. Absolutely, Prakash, I fully agree with you, the way I sort of look at it is that there's a reason rates are low because long term potential growth rate is declining.

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Therefore, the return on capital is declining. So I hear in the market everybody talks about low rates and there is nothing to invest and therefore the equity risk premium could be justified. But at the same time, at some point, earnings better and earnings are a function of nominal growth, which is a function of real growth and inflation, and we may end up getting some inflation. I'm still unsure about how we're going to get any meaningful growth to make all this work out.

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So that takes me to the hot button question of the moment. Are equity markets in a bubble production? But, you know, I actually came across some some academic articles which are still debating whether the 2000 bubble does constitute a bubble. Look, I mean, you know, I think I think these things are always difficult to to call. And I think it's it's a little bit it's a little bit you know, it's been interesting that that that we can actually entertain a question when we are faced with a pandemic.

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And and, you know, GDP is a record contractions globally that, you know, that could even be a bubble. So I think I think where where most people are worried about, I think is really kind of a subset within the the equity universe. So if you look at broad indices, I think, you know, outside of China, NASDAQ and slightly S&P, but most most markets are still trading below the all time highs. But I think you definitely get some pockets of exuberance in in global tech and particularly kind of large cap tech.

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And, you know, this is not this is not just a U.S. phenomenon. I think you you see it also in in China, you know, some of the big tech names and even some of the the smaller ones like Taiwan, etc., and I mean, some of the the price trajectories really has gone has gone parabolic. And I think this this in a way, goes back to to our earlier point, which is that, you know, it's it's typical in an environment where you don't see growth coming that the market really chases after whatever growth there is.

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And so here it really is the the tech companies who arguably have been the beneficiaries from from this pandemic. And then at the same time, you have this kind of lower interest rates where a lot of these companies, you can see them as kind of long duration assets. And so they do benefit disproportionately when when interest rates fall. You know, from from our perspective and obviously we are you know, we are invested in this tech companies and we have kind of enjoyed the performance and they really are in general, very good, very well-run companies.

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But I think where we are a little bit more concerned is kind of the periphery around this. These these big these big tech companies where I think you are starting to see, you know, very exuberant growth projections. And there is a lot of extrapolation that, you know, companies can either be the next Google and Amazon, et cetera. So you are starting to see, I think, some froth around the around the edges. And so as an overall portfolio is still very cautious, very defensive, because, you know, our mandate is kind of twofold, right?

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Not only enhance the value of Singapore's reserves, but we also have a vendetta to preserve the value of reserves. And one of the. Indicators that we use for which, you know, there can be a higher risk of becoming independent is if you really buy it at a very high price. And I think that's one one thing, which I think at least for this subset of companies, I think you are you are seeing those those levels absolutely gush from equities to currencies.

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Now, again, some of the very short term dynamic. But this could be the beginning of something for a long term trend as well, which is the US dollar for the longest time, every time there is a risk aversion, related development around the world. Global investors flock to the US dollar. And we saw this as recently as in February, March, when the dollar spiked at a time of the first set of worrying news about the pandemic was spreading around the world.

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But since then it's coincided with a rally in gold at easing off of the US dollar, especially against the euro, but also against other major currencies, not against emerging markets yet. Your thoughts on the currency markets? Sure, yeah, we actually highlighted this is one aspect of some of the consequences of the of the paradigm shift, which is, you know, once you have interest rates all falling to closer, kind of an effective level about currencies are going to start playing a bigger role in determining total returns from investing.

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That's actually most of our valuation metrics. Just show a pretty mild overvaluation. So it's not what we had, let's say, in the early 2000s when when the US was running a current account deficit of close to to six percent at that point. So, yes, there is some headwind from valuations, but not not that meaningful. I think the interesting thing sometimes you think about the dollar is not so much what happens in the US, but actually what happens in the in the rest of the world.

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And so if we do have that scenario where the rest of the world growth really takes off. And so, you know, whether there's some notion of of of of confidence that that returns going back to my kind of full effect, a framework that, you know, whether you think that the impact of the stimulus in some of these economies has to start improving, the virus gets better manage or relative to the U.S., then then, you know, I think you could see actually the dollar kind of depreciating in line with these kind of better, better global growth.

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Unfortunately, that's not our our baseline scenario at the moment. You know, we think it's it's still going to be a stop start trajectory, I think, at least for the next year years. So I think at this point, we really hope that that the virus is not seasonal, because if it truly was seasonal, then, you know, in the fall in the winter, we may see another another spike up in cases. And so because of that, you know, I think, yes, the dollar probably still has a bit of room to depreciate.

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But, you know, it's not it's not a meaningful downtrend from from where we are today. Right.

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And you said it really depends on the rest of the world, particularly with respect to the euro. I think this this big one point eight trillion Europe fiscal package that would formalize late last month certainly has put some tailwind behind the euro. But at the same time, the outlook for the eurozone is by no means clear sunshine. And hence I think it will take a very brave investor to be outright positive. The euro against the US dollar over the longer term, Prokosch, from fixed rates.

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Of course, you know, negative rates are the most striking characteristic of the developed market debt market. Just unbelievable amount of outstanding paper with negative yielding coupon. What's driving this spread and how will this all play out over the long run? Yeah, you know, there definitely is something which I would say maybe even 10 years ago, we probably thought this was unimaginable. And I think I think at the end of the day, it's it's a question of it's two things.

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One is that how much equilibrium, equilibrium rates have fallen? And then second is, you know, whether central banks have been willing to to cross that Rubicon into negative rates on the policy rate front, I think on the first point, I would say that equilibrium, real rates have fallen probably globally. And so this is this is true, I think, even even in the US. But I think on the second point, you know, it's it's only the to the Japanese or the Europeans first and then the Japanese on the policy side, if they have decided to cross that Rubicon into into negative rates, the US hasn't.

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And in a way, there are still some, I would say, legacy issues on the on the money market side, which which makes it a bit more difficult. But you know that that has kept the 10 year rates in the US relatively better support it, because I think once if the Fed signals that it is is willing to go negative, then that changes the distribution of rates all over the curve. And so, you know that that will meaningfully impact rates even even at the long end.

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But, you know, I think the the fixed income investors for them, you know, the curve matters a lot more than the level of rates. And so, you know, at least for at some point in the past, when when the European curves were still relatively steep, not many of them minded negative rates, because for a, you know, kind of a bond portfolio, you are still getting kind of decent carry and roll that that compensated you for the negative negative rates.

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I think that's that's changed a little bit now. So so, you know, curves are flat all over the world. And I think what the consequence of this is, is that people are getting pushed into riskier assets. And so I think fixed income, especially sovereign bonds, used to play this very unique role in in a portfolio because not only did it give you protection, but it also paid you for it in the sense that it was able to give you income.

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I think going forward, most asset classes are going to have to split, split that rule. So they're going to have to seek income from a separate source. And this could be a high quality credit or possibly even high dividend paying stocks. And then they're going to have to try and find protection from from somewhere else. And so I think this this kind of splitting would likely be the the trend that that happens. Well, because you touched on it, so we will transition there.

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We have seen credit spreads narrowed substantially in developed markets. We're basically back to pre pandemic levels. He hasn't compressed as much in emerging markets. But at the same time as you and I have already talked about that there's considerable uncertainty about growth and returns. And yet investors seem to be lulled by the wall of liquidity and have a great deal of comfort in holding these assets being very low yields. Geographically speaking, you're comfortable with the credit outlook in China, US, Europe.

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Yeah, I think especially when you take. The all in yields for credit. So, you know, not just a spread, but also how the base rates have fallen. You know, you're seeing kind of record low yields across the credit spectrum. And so, you know, at least from a top down perspective, let's get back to some of the risks we've been talking about. You're not getting compensated, I think, for for the risks.

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And then I think the second thing to think about is just what are your thoughts on recovery values? You know, I think what we have been more concerned about is just that when you look at the overall debt levels, we've been concerned that actually recovery values may not be as high as they used to be historically. So they could just be in the 20 to 30 percent range. Other than that, something much higher in the in the past. And so you've got to factor that in as well into into how much compensation I require.

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So our our strategy, at least in the House, has really been about kind of staying away from the broad indices and actually kind of going in at the at the company level. And here, I think, you know, you still can find good names, names that you think will be will be money good at the end of the day. And so it kind of almost goes back to to an investment one where you're kind of underwriting company by company, looking at the balance sheets, looking at the fundamentals.

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And I think that has to be the the way to to do it, because I think, you know, the the broad index, I think kind of covers a lot of a lot of variation within the index. And you could find an environment where, you know, yields blow up such that they wipe away, you know, let's say five or six years of carry in in a very short in the short span. So unless you're really comfortable with the names that you're that you're holding, I think it's it could be a very challenging environment.

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Absolutely. It's going to be challenging because with the government's role expanding substantially in the way the economy will be managed going forward, they will also have a lot of say in restructuring of large corporations and industries. And I cannot imagine the public being very sympathetic to making credit investors from the private sector whole, and therefore there'll be pressure for further haircuts and so on. Something that I feel like the market is fairly oblivious of at the current juncture, whereas I think anybody who sort of recognizes the government's role increase should probably be a little more cautious.

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I want to switch to something not at all conjunctural, but more of a broader issue, and that is to deal with sort of jicks both mandate and views on sort of the investments, which is broadly known as ESG or sustainable investment or things that need high degrees of environmental, social and governance related criteria. What can you tell us? Yeah, sure. I mean, I, I kind of started off the conversation highlighting our long term focus. And so in that sense, I would say sustainability is kind of really core to our Toivo mandate.

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Know, when you look across the ESG, I would say at least elements of governance have been, you know, probably one of the number one criterion from our investment philosophy almost almost from from day one. And so that that that it's really kind of been wired in into our our our DNA and. Right. That roughly translates to to a belief that that actually companies with stronger sustainability practices will will generate better risk adjusted returns over the long term. And so I think this notion that that there could be a trade off, I think maybe true for for short term horizons.

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But, you know, at the end of the day, we think that these two things. Are consistent with each other, and I think they're going to be increasingly so when the rest of not only the investment community, but I think the broader stakeholders demand that. And so these two these two principles are kind of being long term oriented nature and sustainability, I think, to just going to two to merge with with each other. And so what we have done is we have this this kind of a three pillar framework, which, you know, the first one is called offense.

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Second one's called defense. And then the third one is we call it an excellent but it's kind of more organizational nature. So on the on the on the offense side, it's really about, you know, how can we capture opportunities? You know, how can we kind of get ahead of the curve? And so that is, you know, we've got internal efforts about trying to invest in sematic opportunities. So this is everything from renewable energy. And then our real estate business, for example, you know, these guys have really been been ahead of the curve when it comes to this notion of green buildings, et cetera.

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So that's been a big a big push as well. And then all these other technologies that kind of support a transition to to a low carbon economy, that's also been been a big, big push. So a lot of things, I think, on the on the offline side and then on the defense. The defense, I think, is really looking at some of our existing holdings, particularly those that that just kind of sit in and Benchmark's. And so this has everything to do with, you know, physical risks that could lead to potential stranded assets, et cetera.

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And so I would say probably since about three years ago, we started regularly screening our existing portfolios. We've actually also started actively engaging our portfolio companies, just kind of at least for the bigger companies, kind of maintaining that regular dialogue with senior management boards of directors, et cetera, acting responsibly on some of these issues. And so I think a lot of these efforts at least looking, you know, kind of taking a more serious look at things that we that we already already own.

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And then the last pillar, this kind of excellence pillar is, like I said, really about our own organization. So I think, you know, it's it's not enough to just push the ESG lens through. I do the things we own or the things we want to buy, but I think we've got to push it through our own institution. And so here, you know, it's it's everything about cutting down the use of non-recyclable materials which improve the energy efficiency of buildings.

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In fact, we've we've actually tried to become carbon neutral, I think, in our operations by the next financial year across our 10 global offices and then embedded in some of our business partners. You know, like we've we've become a lot more strict about what we expect from them. You know, we don't enter into contracts with those that don't meet our standards. So so, you know, I think it's really been a very comprehensive effort in all these dimensions.

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And, you know, to be honest, I would say it's one of the few issues in Jessey, which is really is really kind of motivational almost. So I think some of the younger staff going to join you could argue that they even even demand it from from us. And so, you know, it's been it's been actually quite a quite an interesting journey this over the last three to five years because we see very similar thought processes within DBS, too.

[00:45:41]

So nice to know that, you know, we have these aligned on that matter. Thank you so much for your insights. Greatly appreciate your time. Thank you. Thank you, Tom. I was enjoying the conversation. Me too. Thanks to also our listeners, Martin Tuqay produce capitate, which is available on YouTube and major podcast platforms including Spotify, Apple and Google podcast. You can also find our livestream webinars and research publications by Googling. Davis Research Library.