In 2008, my partners and I were managing fixed income portfolios in a hedge fund. It was a fascinating time to have a front row seat to financial markets and, to a large extent, that period shaped the way that we have thought about the world and built our businesses ever since
Today, we once again find ourselves in challenging times, both in our personal lives and in markets. In this blog and the accompanying webinar, we discuss our learnings from the last crisis and explore if and how this time might be different.
Back in 2008, as today, most funds were open-ended structures, offering clients liquidity on redemption dates that ranged from daily to quarterly. On the other side, assets were typically [much] longer-dated than the redemption frequency, resulting in an asset-liability mismatch – put simply, if all investors in a fund wanted their money back at the same time, the only way to meet those redemptions was by selling assets prior to their maturity.
As the crisis unfolded, we saw fixed income liquidity disappear overnight, even from markets that had been trading regularly just days earlier. At the same time, droves of fund investors ran for the door. As more clients ran, more asset sales were required and the price of liquidity increased dramatically. Lower prices led to more redemptions, causing greater selling pressure, even lower prices and so on… a classic “death spiral”.
The result – hundreds of funds were gated, suspended and ultimately liquidated, hundreds of billions of dollars were lost and the Fed was forced to step into support MMF’s for fear of the entire banking sector collapsing if they did not. To us, the lesson was simple: never run an asset-liability mismatch in a fixed income fund.
Around September 10th 2008, we started to hear rumours that Lehman Brothers was in trouble and spent the next five days scrambling to move money out of the troubled firm (the 158 year old investment bank was the fourth largest in the U.S). Ultimately, we failed and were left with a large unsecured claim against the bank when it filed for Chapter 11. Realising that the bankruptcy process would take years, we ran a competitive auction for our claim, which yielded a fraction of face value and took eight weeks to complete.
Meanwhile, across the City, one of the senior members of our TreasurySpring team had been lending much larger sums to Lehman. Unlike us, however, his exposures were collateralised by assets, through the repo market. Lehman’s bankruptcy constituted an event of default under repo agreements, allowing him to sell his collateral and recoup all of the money lent, within a matter of days. Our second major lesson from 2008 – taking collateral vastly decreases credit risk. If you can take it, you should.
So, how does any of this relate to today? The liquidity shock that we saw in the second half of March 2020 was larger and moved faster than anything that we saw in 2008. MMF’s requiring Fed and sponsor support again, US Treasury bills trading negative, a UK Treasury Bill auction ending uncovered, certain “cash-plus” funds fast becoming “cash-minus” funds as their NAV fell below 1; and investment-grade bond ETFs trading at discounts 100 times larger than normal were just a few of the lowlights. Had central banks across the globe not stepped in at a speed and a size never seen before, things could have got very ugly indeed.
But it’s all OK now, right? Central banks are just going to bail out everything until a magical v-shaped recovery sends the economy back to the boom times? Well… maybe… but maybe not. Recent moves in oil prices and Sovereign downgrades serve as a reminder that financial markets are anything but stable right now.
If, like us, you are concerned about the economic impacts of partially shutting the global economy for many months, you might agree that sadly, the financial consequences of the current crisis are only just beginning. Our strong view is that the best way to protect vital cash balances through these uncertain times is to get secured, diversify, and be very mindful of asset-liability mismatches.
Articles of interest
USD90bn of Central Bank Support Underscores Mutual Fund Systemic Risks
Money market stress adds to case for more ECB action
Central banks prop up fund industry with $100bn injection
An FTF or Fixed-Term Fund is a regulated fund investment that offers exposure to a single investment-grade obligor for a fixed term, without the need for any client infrastructure. An FTF has many of the same characteristics as a term deposit, but can offer exposures outside of the banking sector. TreasurySpring is originating FTFs with sovereign, financial and corporate obligors.