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10 years later: Investing

Managers and asset owners took their hits and adapted

Eaton Vance’s Thomas Faust said the economy’s recovery was ‘sharp, very painful but relatively quick.’

Advances in industry today forged from heat of unprecedented crisis

Money managers and asset owners say the financial crisis that ripped through global markets a decade ago pushed them to raise their games in areas ranging from risk management to portfolio construction.

Their struggle to survive the implosion of financial markets and subsequently recover lost ground reflects decisions made at the height of the crisis, from mid-2007 through early 2009, and thereafter, as they navigated markets driven by unprecedented policy intervention.

"From the perspective of 10 years later, it's been a V-shaped recovery — sharp, very painful but relatively quick," said Thomas E. Faust, CEO and president of Boston-based Eaton Vance (EV) Management (EV). "You can't divorce anything we've done from that broader market environment — from either the crisis itself, or the policy response, the quantitative easing. It all connects," he said.

The specter of the institutions that defined the financial system crumbling led to "everything being called into question," and in a way, "everything changed after the financial crisis," said Kevin Quirk, Darien, Conn.-based principal with Casey Quirk, a practice of Deloitte Consulting.

Whether it's institutional clients asking managers to join them in crafting "total solutions" for their portfolios or an unprecedented focus on management fees, the changes afoot now were "absolutely catalyzed" by the crisis, he said.

Two changes in the retirement industry accelerated by the global financial crisis have been the broad take-up of alternative strategies in lieu of equities and a more agile, goals-based "total portfolio" approach by institutional investors, which should leave them better positioned to be "contracyclical" at times of market stress, said Roger Urwin, London-based global head of investment content at Willis Towers Watson PLC and co-founder of the Thinking Ahead Institute.

For now, if assets under management can be taken as a rough barometer for how well money managers have fared since the crisis, the past 10 years point to both a degree of stability — eight of the 10 biggest managers at the end of 2006 continue to rank in the top 10 more than a decade later — and a wide divergence in gains.

BlackRock (BLK) Inc. (BLK), the biggest manager, with $6.29 trillion at the end of 2017, and Vanguard Group, the runner-up with $4.94 trillion, were up 114% and 323%, respectively, from a decade before. The next eight firms were up between 27% and 70%. (BlackRock's 114% surge reflects the 2007 combined totals of BlackRock and Barclays Global Investors, the giant quant firm BlackRock acquired in 2009.)

Managers with big passive businesses have been "huge asset flow winners" in a post-crisis period where quantitative easing policies by leading central banks have flooded the markets with liquidity, Mr. Quirk said.

Asset owners, meanwhile, on the back of a nine-year bull market driven by that extraordinary monetary policy support, have seen their funding levels rebound from the depths of the crisis.

But if managers and asset owners alike have been able to largely bounce back from the worst financial blowup since the Great Depression of the 1930s, 10 years ago that outcome was anything but certain.

"2008 was like a near-death experience for the market," said Christopher J. Ailman, chief investment officer of the $223.8 billion California State Teachers' Retirement System, West Sacramento. The huge public pension fund saw its portfolio decline 16.5% to $147 billion over the 12 months through Sept. 30, 2008, and then another 11.4% to $130.5 billion for the year through Sept. 30, 2009.

Ten years later, "we're out of the hospital," Mr. Ailman said, but "it's not like we're an Olympic athlete."

Market veterans cited different points along the way — as the U.S. market for subprime mortgages morphed from an isolated problem at the start of 2007 into a crisis threatening to topple U.S. banks like tenpins — when they first sensed they were dealing with something over and above the typical bear market.

Noel O'Neill, head of global investment research with Boston-based investment consultant Cambridge Associates LLC, said for him it was the second week of June 2007, when an "enhanced cash vehicle" managed by a leading manager of passive strategies froze.

That a vehicle like that — supporting investments such as securities lending collateral and equity market futures, in a segment of the market meant to be safe money — could become illiquid was "a real shot across the bow," Mr. O'Neill said.

For Eaton Vance's Mr. Faust, it was February 2008, when the auction preferred share market, which provided liquidity to holders of roughly $5 billion in Eaton Vance's closed-end funds, ceased functioning.

That was the moment "when I realized this wasn't Kansas anymore, or — since I'm from Arkansas — that this wasn't Arkansas anymore," he said.

Post-Lehman shock wave

But for many, it was only after Monday, Sept. 15, 2008 — when U.S. policymakers allowed New York-based Lehman Brothers Holdings Inc., the country's fourth-biggest investment bank, to fail — that it became clear the crisis would be one for the history books.

As broader swaths of the financial landscape seized up, the Dow Jones industrial average slumped more than 20% over the month following Lehman's demise, and dropped 40% before the market bottomed on March 9, 2009. From its then historic close of 14,164.53 on Oct. 9, 2007, to that March low, the DJIA plummeted 54%.

That shock to the system wasn't inevitable, market veterans say.

If the government had bailed out Lehman, the "outcome might have been very different, but it chose not to," said Deb Clarke, Mercer Investment Consulting's London-based global head of investment research.

Lehman's demise, with ensuing questions about the ability of the firm's clients to access the securities Lehman's prime brokers held in trust for them, led to a spate of sleepless nights for the broader ranks of money managers and institutional investors.

Every money manager was panicking, no matter how gold-plated the bank they were using as prime brokers, said William Jacques, president and CEO of Boston-based quantitative boutique Martingale Asset Management.

The GFC was more a liquidity crisis than a financial crisis, agreed Brian McDonnell, the Boston-based head of Cambridge Associates' global pension practice. "The biggest panics that I had to deal with had nothing to do with 'I'm losing money,' and all to do with 'where is my money and can I write a check,'" he said.

Mercer's Ms. Clarke found herself on the frontlines of that wave of anxiety, speaking at a hedge fund conference in Athens the day Lehman died.

"Half the people hadn't turned up and the other half … spent the whole time on the phone, trying to … renegotiate their counterparty risks," she recalled.

At that moment, the immediate priority for industry leaders became calming the nerves of colleagues, executives said.

"I'd seen a lot in markets," even if nothing as virulent as the crisis that was unfolding, said Jim McCaughan, CEO of Des Moines, Iowa-based Principal Global Investors. Amid unprecedented uncertainty, the challenge was to keep PGI's team focused and functioning, maintaining a cool watch on the balance of risks and rewards being offered up, Mr. McCaughan said.

One success in that regard: there were commercial mortgage-backed securities, AAA rated, selling for 40 cents on the dollar that would only default if the economy suffered a setback worse than the Great Depression — an "extraordinary opportunity," said Mr. McCaughan.

"We put together a road show in the first quarter of 2009, extolling the merits of those bonds," and the most common response was, 'You're probably right but it's too much career risk to do it,' he said. But a handful of asset owners did invest, and they've become some of PGI's largest client relationships today, said Mr. McCaughan. He declined to name them.

Mr. McCaughan said that ability to remain focused and rational is probably one factor separating money managers that have grown their books of business over the ensuing decade from those that haven't been so successful. Since mid-2008, PGI's AUM has increased 85%, a spokeswoman for the firm confirmed.

Seeking opportunities

Other money management executives reported similar decisions from late 2008 through early 2009 to begin betting — essentially — that the world was not coming to an end, aided by growing confidence that post-Lehman, U.S. policymakers would focus on ensuring sufficient liquidity to keep the wheels of finance turning.

Ben Bennett, head of credit strategy with London-based Legal & General Investment Management (Holdings) Ltd., credited his firm's decision to underweight risk in the run-up to the crisis and then add risk again early, at the end of 2008, with helping the firm triple its AUM over the past decade.

Following a "very lively" internal debate, LGIM decided to buy the subordinated debt of Britain's biggest banks in the final days of 2008 for "a few cents on the dollar."

"You only needed probably two coupon payments to get your money back," so by not buying these bonds, "you were almost betting on the end of the world;" if those banks started to go bust, it would mean central banks had lost control and automatic teller machines would stop working, Mr. Bennett said.

Still, he conceded, at that moment there was a chance those banks would go bust the next week.

When it came to organizational risks, executives of money management firms — big and small — said they never doubted their organizations would get through the crisis, which, however severe and stressful, was thankfully brief.

"Our mantra was first, to get through this crisis period with our business, our investment performance and our client service record intact, and then ... take advantage of the crisis from our position of relative strength — strong balance sheet, no net debt, attractive margins, no organizational change — to make Eaton Vance (EV) a stronger, better company," said Mr. Faust.

As an example of progress on that second goal, Mr. Faust cited Eaton Vance's decision to buy New York-based M.D. Sass's Tax Advantaged Bond Strategies business on the last day of 2008. That business has since become a growth engine for the firm with AUM of $30 billion, up from $7 billion at the time of purchase.

Focus on risk

Looking back over the past decade, money managers and asset owners point to the sharp increase in resources dedicated to risk management as a key response to the global financial crisis.

"The whole culture of risk management in organizations has changed," moving from a low-profile, middle-office function to the front office, driving decisions that are defensive as well as offensive, said Peter Zangari, global head of research and product development with New York-based MSCI Inc.

"It's about understanding your exposures and your positions — and seeing the potential implications of market events," as well as having processes and systems in place to react and respond appropriately, said Mr. Zangari.

"We were early days into building our risk management function when the crisis hit," said Rob Maxwell, a spokesman for the $151 billion Teacher Retirement System of the State of Texas, Austin. "Since that time, we've developed a robust risk management framework," overseen by skilled investors "who help us manage the risk of the trust, not merely monitor risk," he said.

Michael Trotsky, executive director and chief investment officer of the $67 billion Massachusetts Pension Reserves Investment Management Board, Boston, said putting needed risk tools in place — in PRIM's case, the MSCI's BarraOne platform — was an urgent priority for him when he took the helm in August 2010, a year after PRIM had suffered a painful 24% decline.

Integrating the BarraOne platform "into our decision-making … was No. 1," said Mr. Trotsky, providing a crucial tool for scenario analysis as well as for looking through the decisions the fund's external managers were making to ensure they were "sticking to their knitting" and not exposing the fund to unintended risks.

Money managers described similar efforts.

Bennett Golub, senior managing director and chief risk officer with New York-based BlackRock (BLK), as well as co-head of the firm's risk and quantitative analysis and chair of its enterprise risk committee, said having those systems and procedures in place ahead of time is key, as "you cannot cram for a crisis."

BlackRock's internal risk management system, Aladdin, was central to the firm's ability to navigate the crisis, said Mr. Golub. Aladdin's ability to let BlackRock "better know what we owned (allowed the firm to move) faster than everyone else" in dealing with problem holdings, including subprime mortgage-backed securities, he said.

Even so, BlackRock set up a "war room" staffed by senior executives to "navigate through the fog" of the crisis, and post-crisis has continued to strengthen its risk management operations, he said.

Changes made over the past decade include strengthening the firm's internal counterparty teams, implementing a liquidity risk management system for its mutual funds, increasing the emphasis on stress testing investment portfolios, including a new geopolitical stress test and hiring psychologists to pinpoint behavioral biases and team behaviors that might inhibit performance, said Mr. Golub.

Ten years after the global financial crisis, BlackRock is "much more sophisticated (and) better prepared to fight the last war," Mr. Golub said.

Ensuring liquidity

Along with risk, money managers have worked over the last decade to ensure adequate liquidity.

Liquidity management was "one of the big lessons of the crisis and one of the key elements of the preparation for the next crisis," said Pascal Blanque, group chief investment officer with Paris-based Amundi Asset Management.

While Pacific Investment Management Co. LLC was able to honor its liquidity commitments during the crisis, that topic has become a much greater focus in PIMCO's investment process post-crisis, said Daniel Ivascyn, chief investment officer with the Newport Beach, Calif.-based fixed-income giant.

Today, "liquidity is typically the first thing we think about" when considering an investment, and "we have a very high standard for going ahead with it," Mr. Ivascyn said.

Mr. Blanque said Amundi likewise managed its liquidity needs quite well through the crisis, but the market offered up a number of examples of asset owners being unable to buy or sell when they wanted. "We learned that our business is about risk and return but there's also a third element that is liquidity," he said.

Amundi responded by shaping a "systematic and exhaustive liquidity policy across the firm," said Mr. Blanque. For institutional clients, that has meant "splitting liabilities by liquidity buckets," while for mutual funds Amundi now stress tests the liability side, he said.

Pensions & Investments reporters Sophie Baker, Arleen Jacobius, Christine Williamson, James Comtois, Paulina Pielichata and Rick Baert contributed to this article.