What lessons have been learnt over the decade since Lehmans collapsed?

Lehman Brothers collapsed on 15 September 2008. Photo: Antoine Cau/ABACA/Press Association Images

Jayna Rana
@Jayna_Rana
12 September 2018

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In the first of this four-part Big Question, industry leaders and commentators reflect on the last ten years and discuss how the financial system has improved since the Global Financial Crisis (GFC), where more work needs to be done and what could trigger the next crisis.

Ryan Dobratz of Third Avenue

Ryan Dobratz (pictured) and Jason Wolf, lead portfolio managers of Third Avenue's Real Estate Value strategy

Rise of passive strategies

The collapse of Lehman Brothers reinforced our long-held view that investments in common stocks should be focused exclusively on well-capitalised businesses trading at discounts to the value of the real assets underpinning their operations.

To wit, a company with a strong financial position can not only withstand inevitable market dislocations, but likely emerge stronger and more valuable in its aftermath.

Ten years removed from Lehman, it seems to us that less emphasis is being placed on creditworthiness and valuations. This is likely due to the meteoric rise of passive investments strategies, which purchase stock irrespective of corporate fundamentals and now account for nearly 40% of shares outstanding.

While itis impossible to pinpoint the exact cause of the next market dislocation, it does seem very likely that passive strategies will amplify the next market conflagration due to indiscriminate selling.

Just like the financial crisis, this will allow value-oriented active managers who have a strong grasp of fundamentals in their respective niches - and excess cash in their funds - to create enormous wealth for their stakeholders amidst the volatility.

Jerome Teiletche of Unigestion

Jerome Teiletche, head of cross asset solutions and manager of Unigestion's Multi Asset Navigator fund

Untenable debts

The 2008 crisis was driven by greed that led to overly leveraged positions in poor quality debts. Ten years later, we are seeing that old habits die hard.

Total global debt is higher today than a decade ago. Yield-hungry investors have rushed into strategies unlikely to provide the requisite liquidity in the next crisis (such as some alternative credit).

The investors set for a £6bn Lehman Brothers pay-out

Worse, investors are not pricing in such an event with historically low implied volatilities and credit spreads, possibly counting on yet another central bank 'put' to protect them.

We can think of several triggers for the next financial crisis. Increasing inflation pressures could lead to tighter monetary policy, dramatically affecting fixed income but also less liquid assets classes like real estate.

Such a tightening could also make external debts for some countries or sectors untenable, leading to a cascading effect as lenders absorb losses on their balance sheets. To manage such risks, diversification and flexibility is critical.

In particular, government bonds alone might not provide sufficient protection as they did in 2008 since central bank ammunition is lower today than ten years ago.

John Howland-Jackson of Nikko Asset Management

John Howland-Jackson, EMEA CEO at Nikko Asset Management Europe

Regulation

The GFC was largely about excessive leverage, evidenced by sub-prime credit risk and ever more complex and unintelligible debt structures, ultimately triggering a collapse of confidence in the financial system.

Ten years on much has changed but much has not. Regulatory action has forced banks to run better capitalised and less leveraged balance sheets; new capital instruments have been designed to anticipate potential stress scenarios without resort to the taxpayer; and funding is less dependent on the interbank market.

Gallery: September market shocks through the ages

However, there is still a hangover of non-performing loans, particularly in Europe; central banks have experimented with QE and low interest rates to a point at which they have limited policy tools remaining for any further stress in the system; and there is an ominous build-up of debt across the consumer and corporate sectors.

Investors have largely benefitted from the pump-priming of the central banks and there is massive liquidity in the system.

However, there is nervousness about the levels equity markets have reached and the potential volatility in debt markets caused by unpredictable political actions or worse.

Barring an ever-upward bull market in equities, smart money should be focused on alpha generation through basic research and quality stock selection.