How China’s Economic Shifts May Affect Us
Tony Roth, Chief Investment Officer
Shehzad Qazi, Managing Director, China Beige Book
Tony Roth: Hello, this is Tony Roth, chief investment officer of Wilmington Trust, and you are listening to Wilmington Trust’s Capital Considerations.
Today's episode is going to address a topic that is very much in the news and in fact has been in the news, it seems, pretty much nonstop over the last few years; the relationship between China and the United States. Specifically the trajectory of China's economic evolution and investment of market opportunities for China.
What makes this episode so important and so timely is that as China now reopens in the wake of the pandemic and gets its economy revved up, it seems to us that there's a different set of priorities that the government has now in China relative to the development and evolution of China's economy.
That will actually put even more stress both on the inflation situation in the United States and in other areas of the world, which is an idea that we've talked about extensively in our Capital Market Forecast but will also serve to probably ramp up even further some of the geopolitical stress between the U.S. and China.
To help us here today with this topic is Shehzad. Let me give Shehzad a proper introduction. Shazad is a managing director and chief operating officer of China Beige Book, which is the largest China-based data collection network, and it's designed to track the Chinese marketplace and economic landscape.
Since 2012, Shehzad has helped drive research innovation across macro strategies in sector-based products and is a frequent guest on major news networks including CNBC, Bloomberg, and CNN. Prior to joining China Beige book, Shehzad worked at a strategic public opinion research firm and conducted market intelligence polling across emerging market and frontier economies.
He's also an elected member of the National Committee on U.S.-China Relations. So Shehzad, we are very fortunate to have you here today to talk about what is going on in China.
Shehzad Qaz: Thank you for having me on. It's a pleasure.
Tony Roth: So I think the place to start really is to think about the path that China's been on for the last couple decades.
China has been a source of disinflation to the world. They've very much built up this seemingly inexhaustible manufacturing capability. Very cheap manufacturing. And over time, fascinatingly, instead of just manufacturing things like toys, they can now manufacture much more advanced components and even products.
We're now at a moment where there's a term that economists use called a middle income trap to often refer to developing economies, which denotes the moment at which an economy needs to pivot off of a pure manufacturing economic base in order to ensure that the members of its society are able to continue to gain affluence and move into, essentially wealthy or more well off parts of society.
And it seems that we've arrived at that moment with respect to China, something that's very much changed around the demographics of China, the aspirations of China where they're really starting to move away from that manufacturing base. And you can see it in the five-year plans that they put forth.
The most recent one, I think, came out last year if I'm not mistaken. I think probably the place to start is now that President Xi has been anointed, if you will, for a third term. I won't say elected because there's not really any type of election that we would consider to be meaningful, but anointed for a third term.
And there is this new plan in place. Can you start by characterizing how you see this moment in Chinese economic evolution and how important it is as it starts to really move away from that pure manufacturing base of output and towards a much broader and potentially higher income producing for the participants type of economic activity.
Shehzad Qaz: The party and President Xi himself on downward, their primary concern now is that they have had this model for the last two decades, which has been dependent on high levels of investment and high levels of growth. And has been accompanied by this mountain of debt and very serious structural problems that that has created.
And now they want to rejigger the economy, if you will. Change the growth playbook because that model is no longer providing that growth momentum that it did. The era of double-digit growth, even 6%, 8% growth. That's all behind us. And it is that exact fear of getting stuck in that middle-income trap, which is forcing or has forced the Chinese Communist Party to rethink the growth model so that they can transition the economy from that high industrial investment-led high debt, high growth model to something far more sustainable. One that relies on domestic consumption, primarily.
Now that is a very big undertaking, and over the next decade or so, we'll see how successful the party is in making progress towards that. But those concerns, the middle-income trap, are exactly behind this paradigm shift that has taken place, and one which has taken a while for many China watchers to understand.
Some perhaps still don't totally get it.
Tony Roth: When you talk about domestic consumption, two things come to mind for me. Number one is that in order to ramp up consumption, individuals in the society need to have more capital available to them in order to spend to consume. So how is it that incomes will essentially, coincidentally with this consumption, how will incomes expand? What will underlie that shift? And then I also have a question around the propensity of Chinese to save versus spend. Are they a country of savers versus spenders? But, we'll get to that after.
Shehzad Qaz: The biggest challenge for the party now and for the government in China is that the private sector needs to grow and access to credit is critical to that.
But as you've sort of correctly pointed out, that is not exactly happening right now. You get to hear a lot of press conferences and policy pronouncements about the fact that SMEs and private enterprises will have better and easier access to loans, et cetera, from banks. But when the rubber hits the road, one thing that has been clear in China Beige Book data quarter after quarter, almost for the last 12 years, almost consistently, is that SMEs are always last in line to get credit.
Tony Roth: SMEs?
Shehzad Qaz: Small and medium enterprises and these firms that are in the industries of the future and the services economy and the technology economy the industries that really need to drive China's more sustainable growth pattern and be the employment drivers of the future. Well, access to capital is not exactly something that they have had access to so far.
Tony Roth: Does that have to do with the fact that one of the tenets that, before President Xi was reanointed for his third term, that he really seemed to espouse and promote was the idea of in the common good. I would just sort of describe it as more of a hardcore socialist leaning, if you will, and these enterprises, small and medium sizes are private.
And it almost feels that there's hostility towards accretion of wealth and value and welfare in private hands as opposed to the state distributing it to everybody. Does that have something to do with it or are there other factors at play that would prevent the government from making this capital available?
Because it seems pretty obvious that if they want to grow that private economy, they need to provide the financing, so that these smaller firms can invest.
Shehzad Qaz: We've seen a massive crackdown on the private sector and especially some of the biggest names that are out there, Alibaba and others.
And we've seen the government taking golden shares in Chinese private enterprises. But this problem of poor access to credit that we're talking about, this actually stems from banks being unwilling oftentimes to lend to smaller firms and private enterprises. And the reason for that is that when you lend to large state-owned enterprises, and if they, as they often do, are unwilling or unable to pay their loans back, you know that they're backstopped by the government itself, by Beijing, you will be made whole.
That is not the case naturally with private enterprises, which also happen to be more high risk because they're smaller firms. And so, I think a lot of that uncertainty has pushed banks in the direction of saying no more often to these enterprises. And yes, more often, you know, there's a crowding out effect, if you will, that's taking place.
And it seems like, again, that the party or Beijing policy planners are unable or so far have not been super successful at getting the bankers to change their ways.
Tony Roth: Okay, so we have a problem of availability of capital. But going back to my original observation, it’s sort of a chicken and the egg situation. How is it that the economy could be driven by domestic consumption if in turn the consumers wages are not increasing rapidly because the private businesses are not able to get access to capital.
Shehzad Qaz: That’s exactly going to be a major challenge for Beijing. If they do indeed want to change this economic model so it is driven by domestic consumption, they have a long way to go to develop the new industries, which are again linked to the private sector, which are going to have to be the growth drivers and will pay more money.
I mean, think about it right now, you've got a problem of a vast number of graduate students who want occupations and jobs in these higher-paying industries not being able to find work. The talent is there, the opportunities are not there. And that mismatch needs to be addressed. So, it's all good and fun to talk about. New economic model and sustainable growth and rebalancing and so on and so forth that you are hearing out of Beijing or have been for y ears. It’s much more tough to actually make it a reality on the ground, and we are yet to see those moves take shape and, and of course success is far out into the future. A lot of uncertainty ahead.
Tony Roth: I alluded to the propensity to save on the part of the Chinese, which, you know, they are better savers than we are here. We sort of are the poster child country for consumption, which may not be the best thing in the world. Good for the economy though. Be that as it may, there's two things that are happening in my mind as I look at China when it becomes to expansion of domestic consumption.
One is that the incomes are not growing, as we've just discussed, quickly enough. But the second is that it's an incredibly aging population. It's 1.4 billion today. I've seen estimates that in 40 years it'll be 700 million. The population, could shrink by 50% over the next four decades, which would be astronomical.
How is it that the economy could grow with those types of, if you will, actuarial projections for where the economy is going? It just doesn't seem to be tenable.
Shehzad Qaz: Chinese consumers have a higher propensity to save is absolutely on point. Especially because you're looking at again, a social structure where social safety nets are incredibly weak and you often have situations where you've got one earner in the house who is responsible not only for taking care of elderly parents, but oftentimes also grandparents and such. So that setup leads one to needing to save, not just wanting to save and being conservative and saving up for homes and so on and so forth. So again, as part of this reconfiguration of the economy, a big chunk of it has to go towards China actually developing a social safety net, which mirrors the likes that we have in the developing world in rich countries.
Because without that, again, you're going to have a big problem. That said, culturally, also, we’re not going to see this change come overnight. We're not going to have Chinese going from being one of the best savers in the world to being like the Americans, as you pointed out, where you have higher amounts of spending and low rates of saving that is going to take a long time.
So several factors have to move in the same direction, which is why it comes back to the idea we mentioned up top, which is this reconfiguration of the economy is going to be a long-term project. And success is absolutely not guaranteed. You may just have China get stuck in the middle somewhere.
Tony Roth: So I'm trying to look for the ray of sunshine in this story. How about technology? Technology's an area where we see some significant progress on the part of the Chinese. We look at, for example, their military, where they've made amazing strides in terms of deploying some very advanced capabilities.
And I imagine that bespeaks a significant acceleration of technological advancement throughout their economy. Is that an area, perhaps, where the Chinese are poised to not perhaps take over but really accelerate and maybe garner significant economic growth on the back of technological advancement?
Shehzad Qaz: That’s the large idea behind Made in China 2025, which exists still even though perhaps not so much in name. The idea is that they want to transition from being the world's factory where they were producing t-shirts and sneakers to high-end manufacturing, high-end technology.
So, the most advanced semiconductors, the machinery and equipment that is needed to produce those items as well. The ultimate goal here is that rather than China relying on Japan or the Netherlands or the United States or elsewhere for access to machinery and technology and inputs to be able to produce high-end technology, and again, specifically semiconductors and other items, they want to be the global supplier of those items.
They want to position themselves strategically, so the world depends on China for those inputs rather than some of the lower end or low value manufacturing that we've typically we think of China as doing
Tony Roth: They want to be in that position, but what's the outlook for that occurring?
Shehzad Qaz: Well, I think it's too early to tell, right?
Now people will say, well, hey, look, we've got very strict export controls here in the United States and the goal is to stop China's march to achieving that because that is a national security threat to not just the United States, but the U.S. allies as well. The fact is that it's way too early to make these sorts of calls. I continue to believe that export controls in these restrictions, while they most certainly will delay China's ability to achieve that status and it won't entirely derail it, I think we've seen that come hell or high water and by hook or by crook, China will probably manage to make much more progress than some folks would have you believe.
Tony Roth: And is that primarily due to the appropriation of intellectual property from other countries, or is it that their own domestic research and development (R&D) apparatus is in fact evolving to become in certain industries, state of the art, et cetera?
Shehzad Qaz: They're both linked, right? Because there are certain areas where I'm sure Chinese R&D is ahead or has much more to add. But there's an established state program here, the thousand Talents program and so on and so forth and other forms of just outright intellectual property theft and things such as forced technology transfer that American companies have long complained about, of course, that are at play to take intellectual advancements, knowledge, research that is conducted primarily in Western countries and to bring it back to China. IP theft in all its forms or borrowing or whatever you might want to call it, is most certainly part and parcel of this project.
Tony Roth: This is all very fascinating on an economic level. I don't think we can focus strictly on the economics. We have to also talk about the political reality that exists on top of the Chinese society today. So let's just pivot back and one of the things that happened in the last, call it year, six months perhaps, that I found to be very profound and didn't really receive all that much attention once it was over, was you can re recall the situation.
The Chinese government was really being really tough on the Chinese people relative to COVID Lockdowns. Omicron was starting to show up and the Chinese were not happy and they started to protest and hold up these white sheets of paper because they weren't being heard. And it was really remarkable how quickly the government pivoted and we're not willing to confront the people of China and opened everything.
What does that tell us about the power of the Chinese people, if you will, and how fast does the Chinese government need to move in order to create greater economic satisfaction for the people before the people become dissatisfied or disaffected? Is there a lot of pressure on Xi and his apparatus, if you will, to move really quickly here?
Or is it really that that was a one-off situation where people were really pretty put upon by being repressed in their homes and probably shouldn't look at that as a model to be repeated?
Shehzad Qaz: Let me make a few points here cause this is important. The first thing is China is of course no stranger to protest.
Protests take place in China all the time, and Chinese factory workers especially tend to be quite militant. But what we saw happen in Shanghai, in the major cities, was sort of this white-collar protest that broke out, lasted just a few days, but did of course then lead to this about face on the zero-COVID lockdown policy.
Now people will argue that this was political pressure of people in the street but the reality is that you didn't really see street power. And of course, Beijing has the ability to crush protests, and you saw none of that being utilized. A big chunk of the reason why I believe he's got this rapid about face was because the pressures in the economy were really starting to mount.
And a decision was made that further losses were not tenable anymore. And ultimately that goes to the larger point that you've asked about, which is the deal between the party and the people is economic stability and economic progress in exchange for lack of democracy, in exchange for complete support for the Communist Party politically.
So that end of the bargain has to be naturally kept. That goes back to the preoccupation that we talked about at the very beginning of why the old growth model had to be essentially abandoned because it was not longer going to work. And it's going to lead to things like high levels of unemployment, low levels of productivity, low levels of growth, and so forth.
So certainly the party is very concerned about the idea that they need to deliver economically. Along with that, of course they're pursuing a series of national security priorities as well, and political priorities also. And you sometimes get into this dance and this balance of what takes more precedence over the other because they don't necessarily work together perfectly fine all the time.
Tony Roth: Yeah. And I wonder whether the personal ambitions of President Xi from an authoritarian standpoint as it relates to his alignment with President Putin with respect to the significant acceleration in the development and production of the Chinese military, the South China Sea, Taiwan. It seems as though there is something more going on here than just an economic desire to act as a counterpoint to the U.S. for the benefit of China.
There seems to be something that's more ideological going on because if all President Xi was looking to accomplish was to, even if at the expense of the ideas and production of other individuals and countries change the orientation of the Chinese economy, it wouldn't seem to be in his interests to so rigidly align himself with this sort of authoritarianism.
Because it doesn't seem as though it's going to really ingratiate the Chinese to many countries that are really productive countries. If you look at the countries that seem to be on the side of the Russians, they're really small, sort of apparatchik, very isolated countries with very small GDPs with the exception of China.
How do you see that? Is that a totally different non-economic objective, or is that somehow tied in?
Shehzad Qaz: Xi sees China as a great power whose time has come, which means that just being economically big isn't enough. You have to be militarily very very strong and be able to compete with the likes of the United States. And politically on the global scale, you need to be big now. So it's not just what's happened with Russia, but also what you saw recently happen with Iran and Saudi Arabia. The idea that China is this global peacemaker with the ultimate goal that China wants to revise this global order, right? And wants to have its own influence in there, and it's been working on it for, for a long time. So there's no question about the fact that I think Xi sees China's economic might. As a matter of fact, the next level that China needs to get to as squarely tied in with military might and political heft on the global stage.
Tony Roth: So when you think about what's likely to happen over the next half decade, let's not get too far ahead of, ahead of ourselves here, but the next three to five years. On the one hand, many countries are going to align with the us certainly the, the European social democracies, et cetera, as well as Japan, Australia, et cetera, as it relates to trying to isolate China economically, particularly with regard technology transfer. So as that happens on an economic level and China continually seems to align itself with these countries that don't really have a lot of independent economic contribution to be made to China's development, what are the things that we should be watching for that might be flash points?
Shehzad Qaz: Well, I think the biggest flashpoint as we all know, is Taiwan. That's the first and foremost thing everyone's concerned about. It is linked very very heavily to obviously the idea that Taiwan's one of the biggest producers because of TSMC of semiconductors. And it's requirement for advanced technology manufacturing out here in the west, including of course, the United States.
That is probably the biggest preoccupation. Related to that, is looking at shipping lanes. In the South China Sea, we're increasingly concerned about China's access to critical minerals and its work in Africa in order to obtain those.
They're a host of those geopolitical flash points that we certainly want to be more careful about. One that I urge that a lot of attention be paid to outside of these, which I would call the more obvious one—Taiwan is an obvious one, critical minerals is an obvious one—is America's supply chain dependencies when it comes to critical goods, especially things like pharmaceuticals and medical components and pharmaceutical products, medical products when it comes to the relationship with China and other high-end electronic goods. So those supply-chain vulnerabilities probably merit a lot more attention than they continue to receive. When we talk about geopolitical context and conflict, potentially those are going to be for some of the first places where you can see an aggressive China strike, rather than trying to bomb a U.S. naval ship somewhere in the Pacific.
Tony Roth: Is it even feasible? Even thinkable, really, that supply chains could be diverted sufficiently in areas like key technology even non-key technology, if you will, meaning apple AirPods, pharmaceutical compounds for drugs that are taken by the U.S. populist, U.S. pharmaceutical companies relying on China for that supply chain? It would seem that spaghetti is so deeply intermingled that it would take decades to unravel those relationships literally and there's just no way that we could possibly accomplish that.
I mean, on the margin, perhaps create a few more advanced manufacturing plants under the CHIPS Act in the United States, and so on and so forth. I commend those actions, but it doesn't seem that it's really realistic to think that we're not going to have a very deep and enduring dependency on China and very key areas of our existence.
And therefore would be very hard pressed to do very much if and when China decides to encircle Taiwan and move from there. What's your thought on that?
Shehzad Qaz: These questions are the ones that are kind of pressing folks on the hill right now. CHIPS is an interesting example because it is something that there's a lot of support for within Congress and of course the White House that America needs better domestic chip production.
But the rollout and the rules around it of course, and, the amount of money that was agreed to and so on and so forth. There are lots of complaints about how this may not be terribly successful. The other side of the argument is, it's not a bad start, perhaps. But I think the process of securing, supply chains, especially for these critical goods that you've just mentioned, it is an uphill battle.
There's no question about it. Between political will and political infighting and even though everybody in Washington DC agrees that China is a strategic competitor, or some would say a threat, there's far less agreement on the action side of it. There's a lot more bluster, a lot more talk and political point scoring that comes along with it.
So I'm with you. It's not a given that the U.S. will be tremendously successful in doing so. Now we'll see in instances there's evidence of narrow supply chains moving out to other countries like Cambodia, Vietnam, and India.
How far does that go? That's a big question mark. How far do you go in the goal of that bifurcation of the supply chain? Ultimately that producers who produce for America, you know, do not have China in their supply chain. If they produce for China, then it doesn't matter. We're at the very early stages of it.
And in five to 10 years we'll see how much progress we've made. Of course the question is in five to 10 years, will it be too late?
Tony Roth: One question that I think is really important to flesh out in a bit more detail, which I've alluded to, is the idea that in this sort of bipolar world, China is aligning itself with a constellation of countries that are really economically feeble, whether it be Iran, Russia, Venezuela, et cetera. Whereas the U.S. really has the full might of the European, Japan, Asian, Australian economies, so on and so forth. How accurate is that? In other words, does China really evoke the same type of deep concern and hostility, if you will, in these other countries as it does in the U.S.? Are they isolated in the same way?
For example, I know that in the case of some of the most advanced manufacturing equipment, we really had to engage in quite a bit of handwringing in order to get the Dutch to step back from selling this equipment to the Chinese. And we like to think that in the U.S., our sort of righteousness extends sometimes broader than it actually does. I’d be curious to understand how unified that block really is from an economic standpoint.
Shehzad Qaz: I think you're absolutely correct. That unity is very surface level at this point. I don't think Europe all given altogether and the various countries with their very deep trading relationships with China, not unlike ourselves, or Canada, are in agreement that China is as big an economic threat and a strategic threat as the U.S. is. And of course, the U.S. being the leading global superpower. It makes sense that American policy makers would feel that threat more than say, perhaps the Dutch would or the French or the Italians or even the Brits would.
I think we're in a very unique place now because the old models of the Cold War just don't work. They don't play out. The world is so integrated. Trade relations to economic dependencies are so integrated that the level and type of conflict that we are talking about potentially taking place or forget conflict, even competition taking place, it’s sort of competition between, I don't want to say friends, but they're certainly not enemies. Let me, so there somewhere in between. And what that means is that forging any type of alliance will probably, for the foreseeable future, be an issue-by-issue, case-by-case matter rather than these blanket alliances of East versus West and first world versus second world and underlined third world and all those things that we are sort of used to thinking about from the old model.
I think we need fresh models to understand what this might look like moving forward.
Tony Roth: You would agree though, that the degree to which countries other than China and its constellation of actors align against China, that's something that China would be very concerned about because when we think about the strategic rivalry in context of the Ukraine-Russian War, and the possibility of China providing lethal force to Russia, et cetera.
It would seem that that might be a red line that President Xi recognizes if he goes over that line that could really serve to galvanize a reaction of these countries geopolitically against China and he might not be willing to do that.
Shehzad Qaz: I think there's no question about that. Look, I mean, one of the things that Xi, President Xi saw in the aftermath of what happened with the Ukraine invasion is how swiftly the United States moved on financial sanctions against Russia and to cut Russia off from the dollar system.
Sands of course, critical things like energy and, and gas and all that, and institutions that were relevant to that. But since then, of course, there's been some action on those fronts as well. Same thing with Europe being on board. So I think, China is very much aware of that, which is why even the evidence that is now starting to emerge of some amounts of help to Russia militarily by China, you know, it is not very clear that it's happening directly and they're very many layers, and it's very small in nature. It's small arms and ammunitions being sold by, you know, one Chinese company to another company altogether in Europe, which it's ending up in Russia, et cetera, et cetera. So, there's no desire by Chairman XI who actively violate major U.S. red lines and risk, of course, the types of financial backlash that could potentially happen that is at least on the table. So I think that there's a lot of careful maneuvering going.
Tony Roth:I'm going to derive some reassurance from that because I think that the conflict over Ukraine is quite critical from other geopolitical perspectives, and the idea of China becoming involved in a more unhampered way would be concerning.
So I'm happy to hear that you sort of corroborate that perspective. We have to end. I always summarize the episode and one key takeaway, and I think here it's obvious that the key takeaway is that that global rivalry between the U.S. and, and China on a strategic level is really probably the defining rivalry of the 21st century.
And it's something that we're going to have to keep a very close eye on. And interestingly, when we look at the market in the U.S., I think that we had been at a moment where last year as China's moved towards reopening, there was almost an inevitable rally in Chinese equities.
And it's really stopped. And I think that the range of entanglements that we've talked about today serves to demonstrate that the investment opportunity in China may not nearly be as attractive as it has been perceived to be over the last couple of decades as just an ongoing uncapped opportunity.
Let me give you the last word, Shehzad. How do you feel about Wall Street's most recent take on the investment opportunity in China, which is to say it's been much more muted and much more cautious than it had been even three or four months ago?
Shehzad Qaz: The China-watching world has changed pretty dramatically, and how we think about the Chinese economy moving forward has changed pretty dramatically, which has obviously direct investment implications.
You're looking at an economy that structurally is inevitably going to slow. You will get cyclical upturns and downturns, which are natural, but the era of double-digit growth or high single-digit growth is now behind us. In the next four to five years, you might be looking at an economy that is barely growing at 2%. So that's the world that we need to prepare for and, and markets need to prepare for, a Chinese economy that is undergoing a lot of structural challenges that is slowing down. That may eventually turn into an economy that grows sustainably and at a healthy pace because of domestic consumption. But there's no guarantee of that.
There's high levels of uncertainty except the slowdown that I mentioned. And that's how I would frame any long-term China investment strategies moving forward.
Tony Roth: All right. Well, that's a beautiful summation So thank you so much, Shehzad, for being here today.
It was really a great conversation.
Shehzad Qaz: It was my pleasure. Thank you for inviting me.
Tony Roth: For all of our listeners, please go to Wilmington trust.com for a full roundup of our latest thoughts on the investment markets planning and banking. Thank you for joining us today.
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