The world marked the 10-year anniversary of the collapse of US investment bank Lehman Brothers over the weekend. It was among the more high-profile casualties that sent the global economy into a downward spiral and towards what we would eventually call the global financial crisis or GFC.
The consequences of that collapse still reverberate a decade later. While the global economy is different today compared to what it was in 2008, there are some parallels.
US economic growth is strong but some asset classes are beginning to look expensive. Volatility has picked up, especially in emerging market assets.
In the second of a two-part series, AsianInvestor asked a selection of asset owners and advisers on the key lessons they learned and where they see pockets of overvaluation today.
The following extracts have been edited for brevity and clarity.
Hugh O'Reilly, chief executive (Toronto)
OPTrust (a Canadian public pension fund)
The most important thing when you run a pension fund is that you have to learn the lessons of history. Before 2008, if you had put the global financial crisis forward as a stress test, people would have thought you were out of your mind.
So it taught us a number of lessons. One is that taking steps to preserve your surplus is critical. When markets were high, many people thought things were going to continue as they were. They often didn’t take steps to preserve their capital.
With this in mind, one thing we’ve done since the crisis is to hedge off the interest rate risk in our liabilities. This way we are best positioned to preserve the funded status of our plan in the event of a sharp decline in interest rates.
Another thing 2008 taught us is that diversification is a lot more complicated than just asset allocation. One of the hardest lessons for investors was that all correlations went to one during the crisis; everything declined at once.
The crisis also made everyone a lot more conscious of liquidity; its value and the need to have it at all times, particularly in a tough market. And to understand what a safe asset really means. A lot of people had gone into asset-backed paper, and when the crisis hit it was just that: a piece of paper.
We also learnt that we have to be very careful about reversion to the mean – in good times you need to be conscious of where you are in the market. You need to put capital to work but you have to make sure you are being rewarded for the risk you are taking.
A long bull run can lead to actions where investors do not fully understand the risks that they are taking because the market looks safe. All financial crises have the same origin. They occur when investors are no longer rewarded for the risk that they are taking.
David Park, CIO (Seoul)
Korea Teachers Pension Fund
[Following the crisis] we recognised that building up and managing core portfolios is quite important and we completely diversified portfolios to provide more alpha with less risk. In that sense, our investment process and risk management always have been executed to manage the risks at the portfolio level.
Maintaining and improving our strategic asset allocation is essential for successful investment ... Currently we review and fine-tune our strategic asset allocation on an annual basis for a more balanced global diversification ... [and] to understand the risk-return profiles of the underlying assets and [their] correlations [with] other investments.
To make our portfolio more efficient we have been rebuilding and increasing our global exposure and decreasing the return volatility ... Korea's fixed income market is not high yielding any more, so demand for increased alpha is quite high. However we are focusing on more core and core-plus strategies rather than searching for opportunistic investments such as collateralised loan obligations, collateralised debt obligations and fixed income derivatives.
To cope with the policy changes at the Federal Reserve and other central banks in developed markets, we are cautiously tilting our fixed income portfolios toward core assets by reducing credit exposure. Instead, we have been embracing alternative investments [and] broadening our overseas alternatives exposure, focusing on property, infrastructure, and private equity.
By unhedging our currency exposure in overseas alternatives and equity investments, we could reduce investment risk as well as improve the risk-return profile of our pension assets. And, reflecting the high level of uncertainty in the market, we are maintaining a bit of cash and cash-equivalent assets for better liquidity management and keeping duration neutral with less credit exposure.
Sunil Sharma, CIO (Mumbai)
Sanctum Wealth Management
One key takeaway is that investors who sold into the crash of 2008 booked heavy losses, and that was a painful mistake for many portfolios.
Between 2009 and 2012, investors swore off equities and didn’t even want to discuss about equity investing. They started to come back to the market in 2014. But there was really good money to be made [in local equity markets] in 2009, 2010 and 2012.
There were a lot of gloomy predictions and people were buying into an excessively pessimistic narrative – that we would see more market falls, another bigger crash was coming, etc. But if you had bought and simply held stocks, you would have done well.
That is where we learnt that being overly bearish can be harmful to long-term portfolio returns. Of course, there is one caveat: you need to have bought quality stocks at reasonable valuations in growth-oriented economies.
Another takeaway is that there will be bouts of mania and euphoria as well as gloom and doom – that is the nature of financial markets.
Finally, we also learnt that it is tough for investors to go against what central banks are doing. In the past decade, central banks have stood behind markets and it made sense to be bullish. Today, central bankers are withdrawing liquidity and that is a different scenario from before and investors need to take that into consideration now.
Today, we think global real estate seems overpriced in pockets, but we don't see excesses in our domestic markets or, for that matter, most overseas markets.
And while the Indian economy is healthy, in terms of portfolio positioning, we are slightly conservative. That is because of the environment we are in – Fed liquidity withdrawal, rate hikes, emerging market stress, trade wars, domestic elections, rising crude prices and a depreciating currency are all factors that we need to watch for and it is still unclear what the overall impact will be.
Nevertheless, we remain positive on the long-term structural India story.
For the first part of this series, click here.