Looking for canaries

Several big scandals over the past year have got our veteran head of multi-asset investments, David Coombs, reminiscing again. But is that a canary he hears or tinnitus?

Canary blog

Have you noticed how everyone is getting younger? It doesn’t matter where I look, I see teachers who look younger than my kids, police officers who could be mistaken for tuck shop security, and politicians who look fresh off school council.

I know, I know, it’s really that I’m getting older. I’ve noticed how adjectives like ‘seasoned’ and ‘veteran’ are increasingly slipped in front of my name in articles and introductions at speaking events. I don’t get it. I still feel gripped with youthful enthusiasm and vigour. Well maybe a slight exaggeration, but I feel there is plenty to go yet. Besides, I hardly complain at all.

Of course, being seasoned – or is that salty? – does have some advantages. I have worked in finance for 37 years, giving me invaluable perspective: I have witnessed much exuberance and crises in markets over that period. The heroes and villains come and go, but the storylines and the plot-twists tend to get recycled. Fund managers, celebrity investors and CEOs are built up as gurus, then often derided as they fall from grace or just disappoint us. Some are bombastic incompetents who get out of their depth, others are plain vanilla criminals.

Lately, I’ve been hearing birdsong more frequently, but I can’t tell whether it’s in the trees outside my house or in my head.

Singing the same old songs

The most recent is the blow up at New York-based Archegos Capital Management due to, yes you guessed it, leverage being pulled. In the UK, we have also had the fallout from Greensill Capital, a supply-chain financier that started lending on non-existent supply chains until, yes you guessed it, their own loans got called in. Several investment banks and brokerages were caught up financing both – Greensill had even bundled up its “loans” and sold them to specialist investment funds. Ouch.

A bit further back there was Luckin Coffee, which fabricated hundreds of millions of dollars in sales ahead of a Wall Street IPO. And halfway through 2020, German fintech darling Wirecard crumbled after admitting that €1.9 billion – a quarter of its assets – simply did not exist. Meanwhile, just last week two retail more retail investment funds were suspended because they had significant investments locked into illiquid debt securitisation funds.

I guess the question is: are these isolated cases, or is a pattern emerging?

Is Archegos a repeat of Long Term Capital Management, the too-big-to-fail hedge fund of 1998 infamy? Is Greensill a repeat of subprime mortgages – shaky assets dressed up as high-quality loans? Is Deliveroo (a meal-subsidisation service in pursuit of a profit) a repeat of dot.com exuberance?

One of our responsibilities is to constantly challenge the status quo. These days, markets are awash with cheap money. Companies can tap cheap capital from bond markets and from stock markets. Banks seem to be slim on investment options – or in razor-sharp competition with each other – going off the deals revealed at Archegos and Greensill.

Echoes of the past

In my view, there are shades of past mistakes here.

We need to see over the coming weeks if the investment banks start to review their lending criteria or withdraw leverage across the board as a result of Archegos and other scandals. Prime broking activities in particular do worry me, as they can result in large share price volatility if large positions are unwound rapidly. However, such slumps should create opportunities rather than systemic risk. It could be bumpy though.

The full consequences from Greensill will likely take longer to materialise. I think it shows that you should be wary of ‘shadow’ financing (credit extended by non-banks), a sector that has grown materially over recent years, and investments that dabble in it. According to the Financial Stability Board, almost half of global finance is now extended by non-bank institutions like money market funds, securitisation and hedge funds and other providers of capital. It’s hard to see more monetary easing from here, so the risk of some of the racier vehicles crashing as borrowing costs rise in the coming years does seem to be moving higher.

In my view, it’s time to be cautious, not fearful. The companies that dominate indices today are – in the main – more profitable and better capitalised than during the dot.com crash. Back in 1999, the risks for stocks were right there in the spotlight: poor-quality companies at huge valuations. These days the risks are hiding in the shadows, in the lightly regulated vehicles that supply a growing amount of financing to businesses and households.

That’s why we’re maintaining quality equity portfolios with strong cash flows and no low-quality debt. It’s possible to accuse me of being too old and too cautious, that the scars of past crises have taken their toll. That might be right. But it might be that the canaries are singing and the most important thing I have learnt is to listen. My wife, Tracey, probably wouldn’t agree though.

 

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
Average: 5 (8 votes)

Subscribe to the In the KNOW blog email

Archive