Lehman’s 10 years on
As I sit here and write this article, it is 10 years to the day that 158-year-old Lehman Brothers went bust and the world realised that we were entering a financial crisis, albeit perhaps not quite of the magnitude it would become. Of course, the clues were there long before this and as always they were blindingly obvious in hindsight, but then managing money has always been a lot easier in hindsight.
What has followed since that dark day 10 years ago has been interesting to say the least. Most notably, those of us who were investors before the crisis have had to throw away the text books that taught us economics and learn a whole new vernacular. We’ve also had to witness the biggest monetary policy experiment in history, with Quantitative Easing (QE) taking place on a phenomenal scale, and now phase two of that experiment – tapering/post QE.
What none of us expected in the nadir of the crisis was that 10 years on, we’d be sitting in one of the biggest bull markets in history with just about every asset class ripping higher over that period, from bonds to equities to property. In fact, a glance at the best-performing funds over the past 10 years shows us that those brave enough to pile into Japanese smaller companies, technology or UK smaller companies would have made an enormous amount of money. For the record, the best-performing fund over the last 10 years is the Legg Mason Japan Equity fund, managed by veteran investor Hideo Shiozumi, which managed to grow by a remarkable 686%!
As I reflect back on those past 10 years, it seems pertinent to ask myself what I have learnt, and has it changed the way I invest? I’ve listed a few things below that have resonated with me:
- Don’t assume things can’t happen because they are not rational. I thought bond yields wouldn’t go negative and was proved very wrong, even if my rational thought was correct.
- Don’t take counterparty risk for granted. When everything looks great (maybe like now?), it’s easy to forget the basics. Counterparties can go bust and when investing in certain assets, your returns are only as reliable as your counterparty.
- Understand the liquidity of your investment. Perfect liquidity is getting your money back when you want it at the price you want. Something that looks liquid can have a very different liquidity profile when sentiment changes.
- Stress test your investments. While history doesn’t repeat itself, it does rhyme and therefore stress testing your portfolio will help you understand where your risks really are. This is particularly important because many new alternative assets that have become available over the last decade haven’t yet seen real market volatility.
- Try and separate skill vs luck. Many managers’ track records are now looking strong but how much of this is simply flattered by market beta? The next shake out in market performance will, as Warren Buffett says, ‘show who is swimming naked when the tide goes out’.
With markets now at, or close to, record highs, it is appropriate that we look to see whether the factors that drove the financial crisis could happen again.
As we all now know, the issue that caused the crisis was debt and perhaps worryingly when we look around the world, the level of indebtedness has increased rather than decreased over the last decade. With the monetary response to the crisis being the slashing of interest rates, this has fuelled borrowing and in many ways made the problem worse. The fear is what the impact of this might be when the next crisis inevitably comes around.
At the heart of the crisis was the banking system that was up to its neck in poor quality debt. As we wind the clock forward to today, one of the encouraging things has been that banks have been forced by governments and regulators to deleverage and restructure their businesses. While we can never say never, it looks likely the banking system is in much better health than it was back in 2008.
A third factor was one of excessive risk taking. When looking at markets today, there are clear signs that investors may be forgetting some of the lessons of the past. Volatility has been running at record low levels and equity markets have been driven up to very high valuations. These valuations have also been seen in a relatively narrow range of stocks, particularly in the technology sector which in some ways has echoes of the problems seen not in the last crisis but the one before that back in 2000. While this may not in itself be a sign that problems of the magnitude seen before are coming, it is perhaps an indication that the basics of effective risk management are being forgotten in the pursuit of attractive returns. History shows us that this doesn’t often end well.
So, after a decade that has seen ultra low interest rates, Quantitative Easing, tapering, sovereign debt crises, bail outs, Brexit, trade wars and a whole host of other major influencing factors on investors, it will be interesting to see what the next decade brings. As Yogi Berra, US baseball pitcher said “it’s difficult making predictions, especially about the future”.