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10 years later: Investing

Some managers, investors converted pain into gain

Disruption spurred improvements that made them stronger

Charles Bobrinskoy said the most important thing Ariel learned from the crisis ‘is that balance sheets matter.’

While the global financial crisis hammered money managers and institutional investors alike a decade ago, it also paved the way for organizational changes that many contend left them leaner and meaner after the storm clouds lifted.

"In a way, the crisis gave me permission to start changing things," said Michael Even, who took the helm at Boston-based quant boutique Numeric Investors LLC in July 2006 — a moment when institutional demand for quantitative strategies was growing by leaps and bounds.

During the first 18 months of his tenure, with Numeric's assets under management surging to $16 billion from $11.5 billion, there wasn't much appetite for changing what was seen as a winning formula, said Mr. Even.

Then the feast turned to famine, and the flood of money that quant firms had put to work over the previous three to four years began to gush out.

In short order, the challenges of the job went from "telling clients why they couldn't have as much capacity as they wanted" in Numeric's new global market neutral offering to hearing clients say, "We're never going to hire a quant again," Mr. Even said.

Outflows from Numeric strategies began accelerating in mid-2008. Some long-term clients explained that, with trading disrupted or hampered in so many other asset classes, the company's big, diversified quant portfolios were one of the best sources of liquidity they could tap, Mr. Even said.

Numeric's $6 billion market-neutral business, used in portable alpha offerings, dropped to $1 billion in a matter of months, while the firm's total AUM fell to $4 billion at the bottom of the market.

Amid the carnage, Mr. Even said he was determined to use the challenges Numeric was facing to be "innovative and creative," pursuing changes that would make the firm stronger coming out of the crisis.

Changes made at that time included centralizing Numeric's research efforts, shifting from the product-specific research approach the firm had traditionally followed; upgrading the firm's approach to technology and deepening its interactions with clients. In addition, the firm dedicated resources to coming out with white paper research reports, something that helped Numeric stay in front of prospective clients over the year or two following the crisis when institutional investors remained reluctant to consider quant strategies, he said.

Mr. Even said Numeric's employee ownership structure at the time helped it get through the crisis. The bonuses and pay of the firm's more junior people were kept "reasonably intact" while Numeric's partners tightened their belts, taking home a fraction of what they had been making before the crisis for the two to three years coming out of it, he said.

Mr. Even retired as chairman of the firm in October 2017.

The firm's latest filing with the Securities and Exchange Commission showed Numeric's AUM now at just less than $40 billion. Man Group PLC acquired Numeric in 2014.

Develop internal talent

For Matt Whineray, CEO of the NZ$38.9 billion ($25.63 billion) New Zealand Super Fund, Auckland, the GFC was a spur to develop the internal capabilities needed to take advantage of the opportunities a seismic market event offers up.

In the event, with NZ Super still reliant on external managers for the vast majority of its market exposures, it remained a challenge "just to get our arms around what liquidity we had and what liquidity we needed," he said.

In the 12 months through June 2009, the fund suffered a 22% investment loss, even as contributions from the government left its portfolio, at NZ$13.3 billion, with a year-on-year decline of 5.9%.

At a moment when suddenly even having cash in the bank wasn't riskless anymore, NZ Super was "operating with a limited information set … making decisions in the context of not knowing stuff," said Mr. Whineray. Effectively, "we were one step removed from all those decisions," he said.

In 2009, New Zealand Super started its "strategic tilting" program, designed to allow the fund to employ futures and derivatives to buy stocks and currencies of markets the fund's researchers concluded were undervalued and sell markets they found overvalued. It put in place internal portfolio completion capabilities, as well as market dealing capabilities, he said.

Those goals already had been part of the fund's development plans but they were "certainly assisted significantly by the experiences we had through the GFC," said Mr. Whineray. It "was not a crisis wasted," he said.

All in all, NZ Super came out of the crisis "with a significant increase in our ability to be opportunistic and respond to changes in the market, said Mr. Whineray. Strategic tilting, the fund's approach to risk allocation, risk budgets — all of those changes over the past five years "have their roots in that time as well," he said.

If quants were among the first to suffer a fall from grace during the GFC, value equity investors weren't far behind — and perhaps suffered through more moments of doubt in 2008 as their penchant for buying what other investors are dumping ran into successive waves of selling.

Focus on balance sheets

For Ariel Investments LLC, a Chicago-based value equity boutique, the GFC prompted the firm's investment team to revamp its research on the balance sheets of the companies in which it invests and review its approach to timing when it comes to catching a falling knife, said Charles Bobrinskoy, the firm's head of investments and vice chairman.

"As value investors, we're always trying to buy what others are selling ... confident that if you buy a company for less than its intrinsic value, you have a margin of safety," said Mr. Bobrinskoy. But in the spring of 2008, Ariel's team bought a lot of stocks of companies the investment team liked that had been beaten up and then watched in dismay as they got beaten down further, he said.

"The No. 1 thing we learned is that balance sheets matter," said Mr. Bobrinskoy. Companies go bankrupt because they're illiquid and can't pay their bills, not because there's no economic value to the company, he said.

In response, Ariel put in place its own debt rating system, said Mr. Bobrinskoy, having judged that the ratings giants were prone to behavioral biases, such as being reluctant to admit error by downgrading a company. At the same time, Ariel limited the companies in its universe to those that were BB credits or better, giving its portfolios "better balance sheet strength" than their benchmarks.

In addition, Ariel doubled down on research into the "moats" — or competitive market positions — of the companies in its universe. The firm's investment team has become "much more precise in measuring those moats," and whether they are getting wider or narrower, he said.

Ariel's AUM has rebounded to $14 billion from $3 billion at the bottom of the market in 2009.