Eight years after the collapse of Lehman Brothers' triggered the global financial collapse, fund managers reveal the biggest lessons learned and those which remain on the horizon and are continuing to threaten the asset management industry.
Daniel Murray, chief economist, EFG Asset Management
Uncertain consequences
The financial crisis that began in 2007 and peaked with the collapse of Lehman Brothers was a catalyst for enormous change in the industry, and in the world more broadly.
The environment we had become accustomed to over the previous 30 years was one in which central banks were able to influence activity by changing interest rates.
By altering the rate at which individuals and companies were able to borrow, monetary authorities were able to affect desired levels of borrowing. This was done against a background of global disinflationary forces including the rise of the internet and rapid growth rates in Chinese exports.
This permitted central banks to lower interest rates on a structural basis over a prolonged period of time and this encouraged a culture of debt. The upshot of all this was that debt grew more rapidly than GDP-debt to GDP ratios increased.
When the global financial crisis hit, central bankers instinctively lowered rates. However, such actions provided less stimulus than during previous downturns, precisely because the burden of debt was so large.
When central bankers ran out of room to lower rates they implemented policies that saw their balance sheets expand by enormous amounts (i.e. quantitative easing, QE). With the impact of QE seemingly limited, some central banks have now taken to negative interest rates, with uncertain consequences.
Policy shift
This shift in the operation of monetary policy is one of the most meaningful changes in the fabric of the global economy and the associated investment environment in the post-crisis world.
Policies that ten years ago would have been anathema to the world's central banking community are now commonplace; many such policies were previously considered only textbook anomalies. The likely persistence of ultra-loose monetary policy will be an important and defining feature of the investment landscape for some time to come.
An important implication is that, with more than $12trn of global government debt in negative yield, there are very few low risk assets that provide a safe positive real return.
This has knock-on implications for pension funds and insurance companies for whom safe yield investments have traditionally provided the bedrock of their existence.
In more general terms it presents a challenge to retail savers and also to banks reliant on retail deposits. For banks, it creates operating constraints with respect to the fact that it is difficult to sustain high margins.
An associated challenge for the banking sector has been a more onerous regulatory environment. Among other things, this has seen bank capital ratios significantly increased and leverage reduced.
While this is a good thing in terms of bolstering the strength of the banking sector and making the global economy more resilient to shocks, it also compounds central bank problems in the transmission of monetary policy.
Insurance value
With specific regard to the fund management industry, a world of persistent low rates makes life difficult for certain types of product. Money market funds and other funds specialising in high quality low duration assets struggle to generate positive returns gross of fees in a world where negative rates are commonplace.
Moreover, with central banks owning a high proportion of many government bond markets, it can be difficult to get hold of the paper even if desired to do so. A further consequence of changing conditions is that liquidity in many fixed income markets is now very much reduced relative to where it was a few years ago.
Low government bond yields also create a challenge for balanced and absolute return mandates. For such mandates, the government bond part of the portfolio historically provided ballast that generated low rates of return during normal market conditions but which typically rallied hard - and therefore worked as a hedge - during periods of market stress.
The value of this insurance is now reduced. However, it is not all bad news. For equity managers the rapid expansion in central bank balance sheets has encouraged investors to shift into riskier assets and this has generated strong returns for some asset classes.
The old adage about 'don't fight the Fed' can perhaps today be more broadly applied to all the world's major central banks.
