You have no doubt seen all the ‘what we learned from the GFC’ articles in recent weeks. Interestingly, most journalists have decided to publish these on the anniversary of the pre-GFC sharemarket peak, rather than its bottom. We think it is far more relevant and useful to remember the bottom, as this where the real pain was felt, with plenty of tears, difficult conversations and most importantly, lessons learnt for the future.
It seems many financial market ‘experts’ have learned little from the pain of the GFC. Most articles spouted the standard lessons of diversification, avoiding leveraged companies and being sceptical of financial engineering. Whilst these may be right, in many cases they can be difficult to identify, or in the case of diversification, misunderstood or poorly implemented.
We always like to look back at what today’s heroes had to say in 2007, which for some reason is very difficult to find even in the days the google. The widely respected and lauded economist, Shane Oliver, had this to say in 2007:
“There is no sign of any impending crash on my calculations . . . the economic backdrop looks pretty good with pretty solid profit growth, relatively low interest rates, all at a time when the demand for shares is quite high,’‘
I’m not sure about you, but this comment doesn’t give us much confidence to follow his advice today. So rather than provide you with the same templated list of ‘Avoiding a Crisis’ lessons, we have put together a number of real action points for all investors:
1. Don’t invest in the index:
We know exchange traded funds, or ETF’s, are incredibly popular, that or they have substantial marketing budgets. Yet it was the sharemarket indices, which most ETF’s replicate, that were the core of the pain felt by investors during the GFC. For instance, the ASX All Ordinaries dropped from a high of 6,873 in November 2007 to just 3,090 points in March 2009. That’s a 55% fall. Most importantly, it still hasn’t returned to previous levels. Our advice to investors is this: if you like volatility, invest in an index fund or ETF.
2. Always hold some real cash in your portfolio:
This seems to be one of the more difficult things for investors, particularly with interest rates at just 1.5%. Yet, if the GFC taught us anything it is the need to have cash, or truly low-risk Capital Stable assets in your portfolio that can be used to buy shares when they fall. As many learned during the GFC, there is no benefit of simply shuffling your capital from one share that has fallen to another, you need to be able to draw on cash at the appropriate time. Our advice: hold an 5% in cash over and above your usual pension or drawdown requirements.
3. Avoid illiquid assets held through liquid structures:
The best real-life example of this point is the property and mortgage funds that were frozen during the GFC. Unfortunately, most of these investments would have performed particularly well over the next 10 years, yet the actions of a few investors in rushing for the door, resulted in poor returns for everyone else. Anyone who truly understands investment markets knows that the problem with these funds wasn’t the underlying assets, but the fact that the managers were offering daily liquidity or redemption’s, on those assets. The areas we are particularly worried about today are listed investment companies (or LICs), ETFs or managed funds that invest into corporate bonds, high yield ‘junk’ bonds or direct loans. Even more worrying has been the new ‘fractional’ property investment platforms allowing you to buy a few ‘bricks’ in an investment property. These options have been increasingly popular, with many listings over the last few months, as investors sought to diversify their income. We are also wary of exchange traded bonds, particularly where the market maker is also helping to issue the bonds, and synthetic ETF’s like the volatility, short, commodity and currency. If you like these assets, make sure you aren’t investing through a structure that offers daily liquidity, or be prepared for your LIC or ETF to potentially traded a discount to the value of your investment.
4. Make sure you can make money when the market falls:
In 2007 long-short or absolute return funds were primarily the domain of the ultra-wealthy and institutional investors. They were neither well understood, or readily available to Australian investors, who were primarily invested in top 50 ASX-listed shares. We learned during the GFC that there are only two ways to make money when the market falls; don’t have anything invested when it happens (which is nearly impossible) or make sure you have access to a manager who has success in and the flexibility to short the market. The ability to short companies means you can bet on those companies falling in price. It also means that should a major event occur, your long-short manager can change the direction of the portfolio immediately. Today, Australians are spoilt for choice of active, long-short managed funds which don’t have the requirement to remain 100% invested in equity markets in all conditions. One example is Platinum’s International Brands Fund, which has a flexible, long-short approach. The fund’s value peaked in May 2007, hit a bottom some 30% lower in March 2009, but had recovered all of this ground by April 2010; it took the index another three years before achieving this feat.
5.A fixed asset allocation strategy doesn’t work:
The majority of financial advisers and investors operate on a fixed or strategic asset allocation basis. This means your portfolio is set once and forgotten unless you decide to request a change. The GFC exposed this strategy for what it was, lazy, and frankly dangerous, financial advice. What happened was first time investors who walked into a financial adviser’s office in 2007, when most sharemarkets were at all-time highs, were told to invest 70% of their wealth in sharemarkets, and sometimes borrow to do so. The result was the worst sharemarket crash in 50 years and most investors remaining below their original investment value for up to a decade. You would probably expect something like this would change the way they provided advice, unfortunately it did not. Interestingly, it seems many of the industry super funds today are still using the SAA approach, but taking it to a more aggressive level with up to 90% of many balanced funds in risky investments as sharemarkets once again approach all-time highs.
6.Don’t try to pick the top or bottom of the market:
We are all prone to this belief that we can time the market and do better than everyone else. Few people have been successful in repeatedly doing so in history and many people have lost their capital whilst waiting to be proven right. The problem with being too early, as we have seen since 2015 when the market ‘peaked’ according to experts, is missing out on substantial, compounding returns. On the other hand, we can admit that we called the bottom of the market at least 10 times between 2008 and 2009; by the time it eventually happened, we were exhausted. What we know about investing is this: it is businesses (and shares in them) that have been the most successful and consistent providers of growth over the long-term. Even more importantly, we know that the best returns come from compounding, i.e. by staying invested and benefitting from the reinvestment of your capital. Our advice to survive the next GFC, ensure you get your allocation between Capital Stable and Risk assets right today, and have an extra 5% cash on the sidelines to give you comfort.
7. Hold more alternative assets:
In hindsight, the one thing that stood out between the best and worst investors during the GFC, was their exposure to alternative assets. The sole reason industry funds performed well was their combination of alternative assets. These included real assets like property and infrastructure, as well as a diverse range of absolute return, hedge, venture capital, private equity and distressed debt funds. Unfortunately, these weren’t freely available to most investors and advisers 10 years ago, or if they were they were limited to as little as 5% of the recommended portfolios. In a period where most investment returns will be lower than the last decade, with interest rates increasing and the debt problems having not disappeared, alternatives offer the only way to protect and grow your portfolio. Property and infrastructure will be impacted by higher rates reducing their valuations, but data-driven, opportunistic, non-correlated investment strategies are set for success. This is why the likes of Yale Endowment and the Future Fund etc. are investing as much as 30% in these sectors. They know they will not be getting any more capital, so they need to make their current dollars last longer.