The credit crunch began five years ago. What have investors learned?
For many people, it was the run on Northern Rock in September 2007 that first brought the looming credit crunch -- and ensuing recession -- to their notice.
But the generally accepted 'official' start of the credit crunch was actually just over a month earlier -- 9 August, precisely five years ago, when French bank BNP Paribas prevented investors from taking money out of two funds that were heavily exposed to subprime-related investments.
And while it took several months for all the dominos to drop, the collapse of Lehman Bros, HBOS, and Bradford and Bingley -- not to mention the almost terminal implosions at many other financial institutions -- can be traced back to the events of August 2007.
So, five years on, what are the lessons for investors?
1) The story's changed -- but have the facts?
In a few short years, financial stocks had morphed from being dull and boring yield plays into a 'Masters of the Universe' investment thesis that was altogether racier. Thanks to an acquisition spree and lending largesse under go-getting ex-Sir Fred Goodwin, for instance, Royal Bank of Scotland (LSE: RBS) had become Europe's second-largest bank.
Far from being reviled, bankers were lauded as wealth-creators, rewarded with 'light touch' regulation, and seen as supermen -- with bonuses to match. As with former pipeline operator Enron, several years earlier, the boring had become brilliant, with a glitzy new business model to match. It couldn't last -- and it didn't.
2) Valuations matter
A rising tide lifts all boats, and propelled by a sea of cash, share prices rose faster than earnings -- much faster. On 15 June 2007, for instance, the FTSE 100 (UKX) closed at a lofty 6,732.
In its wake, huge numbers of shares had been carried along. Some sectors more than most, of course. A lot of that cheap cash and easy credit had gone into the construction industry, propelling shares such as Barratt Developments (LSE: BDEV) and Taylor Woodrow (LSE: TW) skywards.
Canny investors, we now know, had moved into cash, awaiting the return of genuine bargains. It takes nerve to go against the crowd, but that's how money is made.
3) Cash is king
Read any account of the credit crunch -- my own favourite is Andrew Ross Sorkin's Too Big To Fail -- and one lesson is crystal clear. And it's a lesson that holds true for investors, as well as the companies that they invest in. Hold too little cash, and you could be stuffed. Hold enough, and you can duly load up when bargains appear.
The directors of Lloyds Banking Group (LSE: LLOY) doubtless thought they were getting a bargain when they snapped up HBOS. As we now know, it was a poisoned chalice.
48 hours before Lehmans went bust, Barclays (LSE: BARC) had come close to buying all of it -- including its dodgy subprime portfolio. But post-bankruptcy, fast footwork and ready cash bought it the bit that it actually wanted: the Lehman 'broker dealer' operation.
4) Diversification matters
Lured by tasty-looking yields and the prospect of capital gains, many investors lost sight of the age-old wisdom of diversification. Many, for instance, convinced themselves that Royal Bank of Scotland was one sort of bank, and mortgage-centric Northern Rock quite another.
Today, equally alluring yields are on offer from RSA Insurance Group (LSE: RSA), Aviva (LSE: AV) and Admiral (LSE: ADM). Very different businesses, to be sure -- but all, at heart, insurers. Tempted? Tread with care.
5) Don't invest in what you don't understand
Mocked for less-than-stellar returns during the dotcom boom, Warren Buffett robustly defended himself, pointing out that he didn't invest in what he didn't understand. And as he didn't understand how many of the emerging dotcom businesses could make money, he wasn't going to invest in them.
That same wisdom would have served many investors well pre-credit crunch, as they poured money into funds and stocks that we now know were awash with subprime mortgages and over-priced construction projects. For those with eyes -- look at Michael Lewis' The Big Short, for instance -- the signs were there. As were the opportunities to profit.
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> Malcolm owns shares in Lloyds Banking Group and Aviva. He does not have an interest in any other shares mentioned.