Ten years ago tomorrow, US investment bank Lehman Brothers collapsed under its own debts, the latest casualty of a mounting US sub-prime mortgage crisis that morphed into a once-in-a-lifetime (hopefully) global financial crisis or GFC.
The consequences of that collapse still reverberate a decade later. US interest rates, though rising, remain at very low levels after seven years of experimental quantitative easing.
That unprecedented monetary policy, which essentially resulted in the printing of money to buy up government debt and keep liquidity flowing in the financial system, is still being pursued by the European Central Bank and Bank of Japan, whose interest rates are even lower.
Other consequences include China's growing debt mountain. The country embarked on a huge borrowing spree in the wake of the crisis to sustain its sizzling economic growth rate and it has continued to do so ever since.
Also, banks across the world are more heavily regulated and have largely pulled back from investing in bonds, or even acting as market makers. Instead, pension funds and insurers now hold vast amounts of credit and, increasingly, loans.
The world is a different place today to what it was in 2008 but 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.
What's more the US Treasury yield curve, which measures the difference between short-term and long-term bond rates, is flatter than it has been since 2007 and threatening to invert -- a historically reliable harbinger of recession.
Does that mean there are risks of another global calamity happening and have investors better prepared themselves at a time when governments, as former UK prime minister Gordon Brown argued this week, are less well equipped to organise coordinated remedial action if called upon?
AsianInvestor asked a selection of asset owners and advisers on the key lessons they have learned. This is the first of a two-part series.
The following extracts have been edited for brevity and clarity.
Chuck Scully, Asia CIO (Hong Kong)
I hope the lesson that the market has learned is that good underwriting is important, understanding the liquidity you have in your portfolio is important, that surprises do happen and there's probably been a lesson on the dangers of excessive leverage.
I don't see something like we had going into 2008, where there was tons of leverage and tons of layered risk within the mortgage market and more risk built upon that. I'm not sure I see a sector like that right now. I do think the financial pressure we've seen with low interest rates probably pushed people into asset sectors that they don't understand as well, and we always try to make sure we're staying in sectors that we know and understand and feel we can analyse.
So I definitely think some of that has gone on, but I don't think it's so off-size where people are just piled into one particular type of risk.
We were well-diversified going into the GFC and performed pretty well coming out of that, we performed in all the major sectors that had difficulties, whether it was real estate or structured finance ... We've basically improved diversification [since then], built an even greater presence in the asset categories that we feel we're good at, so I really don't think there's that big a difference.
Asset-liability management was important back then; it's important now. Having diversification was important then; it's important now. Trying to take advantage of those sectors where you know you have expertise was important then, and that's important now.
Jang Dong-hun, CIO (Korea)
Public Officials Benefit Association
Poba and other Korean institutional investors experienced huge losses from overseas speculative project-based investments in emerging markets ... Some investments had 30% to 40% losses and ... suffered both a price depreciation and a currency depreciation.
It took three to four years of some consolidation and internal reviews [before] they restarted their overseas investments. But they started to move into developed markets first and wanted to have diversified portfolios, not just in a single area.
The GFC is definitely reflected in our strategy as a pension fund. For example, when we bought real estate after the GFC we lowered our leverage ratio. When we invested in separately managed account real estate in Europe, we reduced our leverage ratio to less than 50% [of the total value of the assets]. At the time our counterparts asked why we weren't using more debt, but that wasn't for us. If there was something that happened, and we didn't really like the situation, then we can't control the asset [with higher leverage].
Additionally, whenever we go through investment reviews today, I always ask my colleagues 'what happens if we have another GFC?', so we understand the potential impact. Foreign exchange risk hedging is also more important, but the Korean won cannot be 100% hedged effectively for long-asset durations. You can hedge it for maybe three-year contracts. The hedging cost for dollars to won is about 1.5%, which is a very challenging environment.
The GFC took place because of excessive risk-taking by investment and commercial banks but [the buyers of] those investments have now been pretty much replaced by institutions like Poba. We invest in private debt and re-invest in real estate and infrastructure debt. We always try to ensure we take the right direction and hire external managers with strong track records and experience.
Curt Custard, CIO (UK)
Newton Investment Management
There is a well-known adage that “history never repeats itself but it often rhymes”, and that is helpful in thinking about the lessons from 10 years ago.
I’m surprised by how many people forget how and why 2008 happened. Investors continue to chase recent performance. When we look back at the period following 2008-2011, people were selling out of equities and buying bonds, when in fact the opposite should have been happening, and there seem to be echoes of that kind of behaviour now. A rather worrying trend we are now seeing in the UK is investors starting to sell out of diversified portfolios for straight equities – we think it’s late in the cycle to be doing so. It shows you how much people forget.
Our mantra is really to maintain a focus on the future, identify companies and markets with good fundamentals, and take into consideration the important lessons from the past.
It’s unlikely we will have a repeat of 2008 (when equity markets fell 40%). The structure of the markets has changed considerably since 2008 – firstly we’ve seen an acceleration in market access to beta/ETFs. Investors can access beta very cheaply, which has fundamentally changed how people look at the market. Secondly, fixed income markets have become less liquid. This is yet to be tested and we don’t know what would happen if there was a selloff in credit as we no longer have a banking sector able to intermediate between buyers and sellers. This is a concern we’ve had for the past five years.
Probably the most concerning area is the elevated debt levels perpetuated by an unprecedented period in which central banks have flooded markets with liquidity. However, it is not normal to have a market awash with liquidity for that prolonged period of time, and we would argue that many companies and markets are ill-prepared for any future volatility.
We believe those types of crises and business cycles will continue to happen and there will be [periodic] bouts of volatility.
What we have learnt as an industry is that we need to ask more questions, be more diligent about investments and look at fundamental risks more carefully than we used to.
Our philosophy of investment is the insurance we have against being vulnerable.
The way we insure ourselves is by considering three components when investing: the right partner, the right diligence and looking for disruptions, which can come in the form of technology or other kinds of competition.
For us, it is imperative that we always keep in mind that we are investing the money of retirees and citizens, so we need to be ultra-careful about how we invest that money.