Lessons from the GFC 10 years on

04 October 2017 | Investment principles


We recently marked 10 years since a little known bank in northern England became a worldwide brand for all the wrong reasons.

A family holiday to Yorkshire in 2007 delivered a front row seat to the unedifying - and chilling - spectacle of long queues of desperate savers lining streets outside branches across northern England. Despite assurances of solvency from the Bank of England it quickly spread to England's first full-on bank run since 1866.

Northern Rock was eventually nationalised and the savers' deposits secured. But the global financial crisis as it became known had begun and it would unfold throughout 2008 and result in the collapse of major investment firms like Bear Stearns and Lehmann Bros.

Fast forward to 2017 and ask yourself this question: If your investment portfolio lost 20 percent overnight, what would you do?

Would you:

  • Invest more funds to take advantage of the lower prices
  • Leave your investments in place expecting performance to improve
  • Be concerned but wait to see if the investments improve
  • Cut your losses and transfer funds to more secure investment sectors
  • Lose sleep – security of capital is critical and I don't intend to take risks

These were the options given to investors in the ASX Australian Investor Study 2017 released last month. The broad study covered 2300 investors and 1600 non-investors and was done by Deloitte Access Economics.

What was interesting on both this question and others in the research study relating to risk was that younger Australian investors were more risk averse than older investors. The age groups 18-24 and 25-34 were more likely to respond to a 20 per cent loss event by transferring funds into more secure investments.

Investors over age 55 were more likely to be concerned but would wait to see if investments improved.

This seems counter intuitive on a number of levels. Older investors within sight of retirement might be expected to take a more cautious approach and head for a safe haven to park their money and preserve capital. But that was the preferred route for younger investors and it seems unlikely that the GFC could have had a significant influence given a 25 year old today would have been 15 back in 2007 and it seems unlikely that high school students would have been losing sleep over their investment portfolio's performance – or fretting about their future retirement savings – at that stage of life.

A recurring theme through the ASX study is that as investors Australians are a rather conservative bunch, with 48 percent in the study saying they prefer stable, reliable returns with only 34 percent prepared to accept moderate or higher variability in returns.

But there seems to be quite a contradiction between the stated risk appetite of investors and the returns they expect from their investments. One in five risk averse investors still expect double digit returns from their investments. The research study speculates that financial literacy among these investors may be low and that the risk/return trade-off and the current low return environment was not well understood.

What was also concerning was that 46 percent of investors claimed to have a diversified portfolio but held investments across less than three asset classes. Perhaps most alarmingly 75 per cent of share investors hold only Australian shares.

The ASX Australian Investor Study highlights that the concept of diversification – a key way investors can manage their investment risk – is still not well understood.

Let's rewind to the Global Financial Crisis. From when the market hit rock bottom in March 2009, let's look at the outcome for three investors who were all invested in a diversified balanced portfolio of 50 per cent equities and 50 per cent bonds when the GFC hit.

Our first investor decided to cut their losses and get out of their investment portfolio and stay in the relative security of cash; our second investor also felt the impact of the GFC and retreated to a much more conservative bond portfolio. Our third investor opted to stay within the balanced portfolio and hope that investment markets would recover.

If we look at the performance of these portfolios from the end of February 2009 to January 2016, we can see that the investor who fled to cash would have seen a cumulative return of 27 per cent. Meanwhile, the investor who sold off their equities and went entirely to bonds would have seen a significantly higher return at 71 per cent. Yet the investor who stayed balanced and retained their target 50/50 allocation to shares and bonds saw a handsome 93 per cent return – albeit with higher volatility.

Hindsight provides tremendous clarity on the right thing to do – sadly only after the fact. The point here is that even through one of the most dramatic market periods of the past century investors benefited from taking a patient, diversified approach to their portfolios.

For an investor to achieve their goals, it is critical that they have a clear understanding of the role risk plays in their portfolio and how it can help or hinder them from getting to where they need to be.

What this analysis reinforces is the relationship between risk and reward and the need to have the discipline to take a long-term approach.

This article first appeared in the Australian Financial Review on 20 September 2017.


Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.
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Robin Bowerman, Principal, Market Strategy & Communications at Vanguard Australia, shares investment and personal finance insights gained from over two decades in the finance industry as writer, commentator and editor.

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