10 Years after the Financial Crisis: What Have We Learned For Asset Management?
Let’s ask a simple question. After a decade, what are special lessons that money managers internalized from the Financial Crisis? If there was no financial crisis, money managers would have learned many of the concepts of behavioral finance. Investors would have learned the value of passive investing and ETFs. Asset manager would still have allocated to hedge funds, and diversification strategies would still be employed. Perhaps the Financial Crisis intensified these trends to alternative diversification strategies, but ten years after the crisis many of the concerns, fears, and behavioral changes may have been lost in a bull market
My view is that the lessons learned were limited and it will haunt investors when the next crisis arises. Here are some investment issues and my view of whether there were lessons learned.
- Pain from diversification – “If there is no pain, there is no diversification.” Diversification has a cost where the true benefit may only exist in a crisis When there are strong beta returns and asset bubbles, the cost of diversification is high based on under performance Many investors have forsaken diversification and the diversification engaged by many investors is likely to see correlation move to one. Lesson not learned by everyone.
- Strategy diversification – This is a corollary to the non-diversification without pain argument. Investors still seem to chase returns through picking strategies that follow may follow market betas. Even if there is style diversification there can still be a significant increase in correlation during a crisis. Lesson not learned.
- Risk factoring – Many investors are looking beyond asset classes and thinking about risk factors, which focuses on the core components of risk. Lesson being learned.
- Behavioral Biases – More investors can identify the behavioral biases but it seems as though the same biases from ten years ago can be seen with today’s investors. Biases may be ingrained in the market even if many investors are more aware of their behavioral shortcomings. These biases are not going away. Lesson not learned.
- Liquidity – Most will agree that we will have liquidity problems in the next crisis, but few have done effective liquidity assessments of their holdings. There will be a liquidity shortage in a crisis. Lesson partially learned.
- Low confidence in ratings – Even triple-A assets were hurt during the Financial Crisis which made bond ratings suspect. There still seems to be a focus on ratings as a risk measure and the average ratings for corporations have been lowered. Lesson partially learned.
- Confidence in policy-makers – The Fed has worked at trying to provide better forward guidance and transparency of systemic risk measures, yet clarity of central bank actions is still wanting. Central bank actions during a crisis are better defined through systemic risk assessments, but confusion and uncertainty should be expected. Lessons partially learned, but not tested.
- Active versus passive investing – Active managers still underperform benchmarks and hedge funds have not hit their return expectation targets. Investors are getting the message that active management will not protect during a crisis, but ETFs may have a different set of problems. Lessons partially learned.
Everyone will tell you that they are better prepared for the next crisis, but asking for specifics will lead to mixed answers. Strategic crisis risk assessments should be done for all portfolios.