Lehman Brothers – 10 years on: lessons learnt

In the third and final instalment of a series marking the 10-year anniversary of Lehman Brothers’ collapse, Liontrust fund managers reflect on the lessons learnt from the Global Financial Crisis (GFC) and how close we are to it happening again.

 


 

What have been the key lessons from the GFC?

 

Anthony Cross, Economic Advantage team

The ‘dash for trash’ bouts of risk-seeking investor behaviour in 2012 and 2013 saw sharp gains for sectors such as banks, which didn’t meet our investment criteria. While this was painful in terms of short-term performance at the time, one of the key lessons we learnt was to stick to our process and be resilient to pressure – refusing to bend our criteria in order to capture short-term trends. This approach has subsequently paid off handsomely.

 

Stuart Steven, Sustainable Investment Fixed Income team

We’ve learnt that when central bankers say they will “do whatever it takes”, as European Central Bank President Mario Draghi did when he promised to save the euro, they mean it. Moreover they are grudgingly prepared to turn a blind eye to the unintended consequences of their actions, and would no doubt do it all again!

 

John Husselbee, Multi-Asset team

We now have a generation of fund managers who haven’t been able to learn the lessons from the GFC themselves by investing through it. This cohort has enjoyed very benign investment conditions created by central banks, so we have a preference for managers who have battle scars and experience of more than just a decade-long bull market.

 

Olly Russ, European Income team

For Europe, the central bank initially made a bad situation worse by raising interest rates in 2011 under ECB Chairman Trichet. Under Mario Draghi, the ECB has been much more proactive in attempting to defuse the crisis and force the European banking sector to prepare for the next one by repairing balance sheets. The key lesson learned for the ECB is that there needs to be a lender of last resort for every financial system to underwrite confidence in the case of market failure. As the ECB has increased its potential liabilities therefore, it has also increased its level of supervision, gaining the power of life and death over troubled banks.

 

Harriet Parker, Sustainable Investment Equities team

In the ten years since Lehman’s collapse, we have seen a fundamental shift in the expectations of companies from both investors and customers. It’s now routine to question a board’s gender balance and corporate culture. As fund managers, our own investors increasingly require we state how we engage with investee companies on material issues and the wider risks they pose. We welcome this shift with open arms – asking these kinds of questions can really improve our understanding of companies’ ability to produce sustainable returns.

 

Mark Williams, Asia team

Although the GFC had a large impact on Asian markets, the biggest lessons were actually learnt a decade earlier in the late-90s Asian Financial Crisis (AFC). As a result of this painful experience, Asia was far less reliant on foreign capital by 2008, and suffered less from the GFC than it otherwise would have. The emergence of China obviously helped in this respect.

 

Samantha Gleave, Cashflow Solution team

During times of crisis, it is more important than ever to focus on the power of process. The GFC reinforced our conviction to not get distracted by panic in the market but rather, to stick to a tried and tested investment method. Our investment process concentrates on cash flow instead of P&L earnings which can be manipulated by companies to look better than they actually are. Cash flow doesn’t lie. In a more volatile market environment, such as the GFC, it is more important than ever to implement the process in a rigorous, consistent and disciplined way.

 

Jamie Clark, Macro-Thematic team

The primary lesson should be one of humility under conditions of uncertainty. As is human nature, bankers were overconfident, mistaking abstract financial models for concrete truths. Overconfidence combined with overleverage was a toxic mix in 2008. Banks now look more humble. Regulatory pressure has seen balance sheets shrink and capital buffers grow; high quality assets assuaging liquidity concerns.

 

Matt McLoughlin, Head of Trading

Liquidity has now become such an important factor for asset managers when constructing portfolios. During the period while Lehman Brothers was in danger of collapse but still functioning, the ability to trade assets without affecting its market price varied depending on the level of distress in the market.  Less liquid assets became extremely hard to sell and trading them caused a large negative market impact.  Nowadays liquidity is one of the main factors that institutional asset managers focus on so that they can easily trade in and out of assets at sensible prices.

How close are we to events repeating themselves?

 

Donald Phillips, Global Fixed Income team

There are currently signs of hot conditions in credit markets with, for example, covenants extremely weak and leveraged buy-out (LBO’s) financings with very high levels of debt. I would say these characteristics are true of any late cycle period. However, I do not believe conditions in credit markets are in the pre-2008 realm. Although there were many examples of awful lending standards, the GFC was caused by leveraged vehicles buying leveraged investments and banks having miniscule levels of capital to be able to absorb the losses that were amplified by that leverage. Combine this with the level of interbank lending and lack of liquidity, and the financial system found itself in dire straits. Today, banks have a lot more capital.

Mark Williams, Asia team

I am now often asked whether China’s current debt levels could spark its own crisis. We acknowledge that China has grown its debt too quickly, but the aggregate debt levels are misleading as they largely constitute loans from government controlled entities, to government controlled entities. This is by no means ideal, but it does mean that an imminent financial crisis is pretty unlikely.

 


 

In previous weeks we’ve analysed the policy response to the GFC, and its impact on the banking sector.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Disclaimer

This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Friday, September 14, 2018, 9:46 AM