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Credit crunch lessons: 10 years on what have we learnt?

A decade on from the start of the global financial crisis, 10 investors tell us what they've learnt

Not only will the date 9 August 2007 be forever etched into the minds of financial market participants, it is also unlikely to be easily forgotten by millions, if not billions, of average citizens across the world.

This date is generally seen as day #1 of the global financial crisis, the worst systemic panic witnessed since the Great Depression. On 9 August 2007, BNP Paribas blocked investors from taking money out of two of its funds after it was unable to value underlying assets, citing a ‘complete evaporation of liquidity’ in the market.

While this evaporation of liquidity was initially influenced by the meltdown in the US sub-prime mortgage market, the loss of confidence spread like wildfire over the following months and threatened to take down the entire global financial system.

The panic was only able to be finally controlled after the US and other global authorities intervened on a historically-unprecedented scale. Indeed, many actions taken over this period are still yet to be unwound today.

A decade on from this infamous day, what lessons have investors learned?

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Not only will the date 9 August 2007 be forever etched into the minds of financial market participants, it is also unlikely to be easily forgotten by millions, if not billions, of average citizens across the world.

This date is generally seen as day #1 of the global financial crisis, the worst systemic panic witnessed since the Great Depression. On 9 August 2007, BNP Paribas blocked investors from taking money out of two of its funds after it was unable to value underlying assets, citing a ‘complete evaporation of liquidity’ in the market.

While this evaporation of liquidity was initially influenced by the meltdown in the US sub-prime mortgage market, the loss of confidence spread like wildfire over the following months and threatened to take down the entire global financial system.

The panic was only able to be finally controlled after the US and other global authorities intervened on a historically-unprecedented scale. Indeed, many actions taken over this period are still yet to be unwound today.

A decade on from this infamous day, what lessons have investors learned?

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We do not see another Big Short

Steve Eisman, senior portfolio manager at Neuberger Berman

Pre-crisis, the position of regulators – which was the long-held view of former Federal Reserve Chair Alan Greenspan – was basically: ‘We trust you know what you are doing, so carry on’.

This is not the positon now. It is more like: ‘We do not trust you know what you are doing and we are going to watch you like a hawk’. The system is now heavily regulated and closely watched, which I believe is right.

The reality is the system is much safer today and there are not any systemic concerns. For example, Citigroup’s leverage ratio has dropped to 10 to 1, far reduced from the 35 to 1 in the pre-crisis period.

Even if were to see a problem with sub-prime auto loans, which some cite as a concern today, there is simply not enough leverage in the system to create a major systemic issue like a decade ago.

People always come up to me and ask what the next ‘Big Short’ will be. The truth is I simply do not have an answer, and do not want to have an answer to this question. I lived through this period and do not want to see anything like it again.

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The status quo must be challenged

Hartwig Kos, co-head of multi-asset at SYZ Asset Management

The biggest lesson from the global financial crisis is that the status quo must always be challenged. Before 2008, mortgage bonds were deemed to be boring and safe, until they were not.

No one expected half of Wall Street’s banks would disappear, be absorbed by other banks, or be bailed out by the US Treasury, until it happened. No one imagined the Federal Reserve would become one of the biggest buyers of the US bond market, until it happened.

Since the crisis, we have seen further examples of reality interrupting received wisdom. Before 2010, Italian, Spanish and Irish government bonds were seen to be as nearly safe as German bunds, until they were not. Last year, Brexit and the ascent of Donald Trump shattered the sheltered convictions of political analysts.

All of this is further hard evidence that to be successful in navigating financial markets, one has to be open-minded and look port as well as starboard when watching out for gathering storms. But this is not all: one must remember that asset class characteristics and asset class relationships may dislocate dramatically in a rapidly changing market environment.

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Beware of the return of volatility

Steve Kelso, CEO of Ashburton Investments

In the wake of the global financial crisis, many major economies undertook largely coordinated efforts to expand balanced sheets and provide almost infinite liquidity to the system. The by-product of quantitative easing, combined with ultra-low interest rate policies, has been the dampening down of volatility.

However, with volatility at the lowest levels in modern history, the frequency and amplitude of volatility spikes is likely to increase moving forward. We are now in an environment of interest rate hikes, for the first time since the end of the crisis, while the other monetary policy efforts are set to begin unwinding.

We would argue it has been the abundance of liquidity, rather than any economic expansion, that has played the major part in the sharp rise for asset prices over the past decade.

The current combination of high leverage ratios and low volatility is a dangerous cocktail for investors in a backdrop of rising interest rates, particularly with volatility set to return. Leverage is a friend for investors as long as volatility stays low, but is dangerous if it reverses.

Severe volatility on a leveraged portfolio has often led into the territory of stop losses and fire sales to meet margin calls. This is what occurred in 2008 and at the end of every other investment cycle.

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A shift towards profits with principles

David Osfield, manager of the EdenTree Amity International Fund

A significant contributor to the deepest financial crisis since the Great Depression was the shortfall in oversight and governance structures. The underlying premise of ‘waiting for the music to stop’ appears rooted in short-term objective setting and inappropriate remuneration frameworks.

A key lesson for investors remains that management behaviour, and hence company strategy, will be primarily driven by the underlying reward structure. So, voting to approve remuneration reports with KPIs that are too short-term in nature or reward disproportionate risk-taking can have negative implications for long-term returns.

How a CEO, staring the credit crisis in the face, felt there was a significant disincentive to de-risk a business operation is a prime example of overt myopia. Our focus on appropriate governance structures stems from our conviction that it possible to achieve superior long-term performance through sustainable and responsible investment.

In this vein, we aim to identify multi-year sustainable trends with greater certainty and predictability, than forecasting short-term global macro-events, such as monetary policy or political outcomes.

Post the global financial crisis, investors are increasingly embracing this concept, but it requires a shift in mind-set beyond the short-term to a new era of profits with principles.

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Flexibility needed to avoid complacently

Mitch Reznick, co-head of credit at Hermes Investment Management

One of the principal lessons learned from the financial crisis is that investors must not be complacent. During periods of low volatility and diminished risk premia, investors must remain disciplined about valuations.

This need not undermine the ability to deliver superior-risk-adjusted returns. Instead, investors should embrace a flexible approach to investing. From a credit investor’s perspective, if you have the ability to invest under more broad-based mandates, there is no need to chase risk to deliver returns.

It is imperative to have the ability to construct portfolios from building blocks carved out of valuation anomalies that exist across geographies and sub-asset classes within credit – such as investment grade, high yield and emerging markets.

By not being a forced buyer of anything, it allows a portfolio manager to mitigate the suffocating downdraft of being caught in a crowded trade when sentiment turns against that particular over-bought corner of the market.

Following the ebbing of the financial crisis, the structure of credit markets has evolved and we are compelled to invest in a way that aligns with where credit markets are going, not where they have been.

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The importance of self-sufficient growth

Hugh Yarrow, CIO of Evenlode Investments

With the current backcloth of disinflation and disruptive forces, the financial crisis and the decade following it have been a good reminder of the importance of self-sufficient growth.

Companies have not been able to rely on a 'rising tide to lift all boats’, and even businesses operating in the most stable, rational industries have needed to move with the times and continue to evolve business models and adapt to innovation and new entrants.

Many of the most successful businesses during the period – as with any period – have had the competitive position, cultural willingness and financial strength to invest consistently in their long-term organic futures through both thick and thin.

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Digging deeper in fund research

Darius McDermott, managing director at Chelsea Financial Services

We now have a greater emphasis on company debt when researching funds. We learned that if companies have too much debt and get into trouble, there is nowhere to hide.

Fund managers always say they like companies with strong balance sheets – so we dig deeper. It is not that a company has to have no debt whatsoever, but they need to have a good capital structure and generate enough free cashflow to service that debt.

On a more personal level, I learned that you have to keep your investment horizon front of mind. If you were investing for the long-term when markets fell, and did not panic, you soon recouped your losses.

If you were brave and invested when market had fallen a bit – not trying to time the bottom, but at some time during falls – you made money in pretty much every asset class.

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We must learn the lessons of the past

Joe Harvey, CIO at Cohen & Steers

After the collapse of the open-ended direct property fund sector in 2008, it would have been inconceivable at the time that these funds would again return to popularity over the next decade. But this has largely happened in the UK.

Investors often have a tendency to forget, or perhaps hope things will be different next time. The harsh reality descended on direct property fund investors in 2016. Less than a decade since the global financial crisis, the UK market again witnessed the mass freezing of property funds on the surprise UK referendum outcome. It took many months before these issues were resolved.

Australia also twice faced issues with its once popular open-ended direct property fund market, first in the early 1990s then in the global financial crisis.

When the liquidity buffers failed to provide protection during the crisis, investors voted with their feet and generally turned their backs on open-ended direct property strategies and embraced the listed real estate market, which has now developed dramatically.

In the UK, it is time we recognise the inherent flaw of these vehicles and follow in the steps of other developed investment markets – such as Australia, the United States and Japan – and embrace the highly-liquid REIT market.

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Are we there yet? Not quite

Mike Pinggera, manager of the Sanlam FOUR Multi-Strategy Fund

'Are we there yet?’ While this is the question every parent fears, it can also be used to describe the thinking of many investors ten years on from the financial crisis. Unfortunately, this question still remains unanswered.

The banking sector was at the heart of the crisis and this sector will need to be given the all clear if we are truly able to we have ‘arrived’ on the other side.

With the Bloomberg European Banks and World Banks indices trading 60% and 25% below the 2007 highs respectively, there is still some way to go. It is worth remembering the technology-heavy Nasdaq index took 15 years to recover from the bursting of the tech bubble.

Investors must also remember that recovery is a process not an event. Part of the process will be the tapering or removal of stimulus.

While this stage of the process may itself cause some market turbulence, it is an important step back to normalisation. So, ‘are we there yet?’ Not quite. We have come a long way, but there is still further to go and bumps along the way should be expected.

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Active management never more important

Eoin Murray, Head of Investment at Hermes Investment Management

Policymakers rightly undertook extraordinary measures to see us through the global financial crisis, but they must now move from crisis management to crisis resolution. The extraordinary measures seem to have created severe distortions in capital markets, while the purported benefits for the real economy are under question.

It was never realistic to expect that unconventional monetary policies would lead to conventional outcomes. We now find ourselves at the beginning of an era of low natural interest rates, and investors should carefully consider their strategic asset allocations in response.

The importance of getting these decisions right, as well as the value of good active management, has never been more important.

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