At a time when the last two years have felt like decades, some remember the Global Financial Crisis (GFC) of 2007-09 as if it were ancient history. However, in dusting off the experiences from that time, many investors are discovering there are lessons learnt that can be applied to the current financial disruption wrought by the global COVID-19 pandemic.
The questions I asked when the pandemic began to unfold in March 2020 were: What’s going to happen next? How will this affect liquidity? How will this impact prices? How will governments respond? How will the banks respond?
The first place to start is capturing the general sentiment, intent and behaviour of investors, which is driven by market conditions. Market conditions are subject to factors such as interest rates, jobs and productivity, so those are the areas you should be looking at today to understand the influences.
I was working at an investment bank at the height of the GFC and remember being given a list of investors who had funds in a particular product that geared senior secured US corporate loans, by four times. My baptism by fire was to call each investor to let them know that there was going to be significant write-downs. In that particular case, the large write-downs were avoided when some very clever executives managed to refinance the deal with a second-tier US bank. But in talking to investors about what might happen, I became hyper-aware of the situations that could unfold when markets capitulate, which has made me quite risk-averse.
Anticipate investor behaviour
Risk-aware people become defensive. They want to prevent loss and their investment pattern pulls back to reflect that. The biggest risk is market capitulation, and secondary to this is the change in investor behaviour that sees more recent offerings pushed aside in favour of stable long-term assets with an existing track record. Predictably, the Australian banks constrained their lending books, which opened the doors to a new breed of alternative lender to service disaffected borrowers. The commercial real estate debt sector (CRE debt), in particular, has benefited from this influx of cheap capital competing with the major banks.
Fortunately, the reaction to COVID-19, at least in Australia, was tempered by swift government intervention to provide stimulus for the economy. While there were irrational fights for toilet paper in supermarkets, investors were sensible, which meant the markets bounced back quite quickly compared with the period after the GFC.
With the rise in number of large and reputable CRE debt managers in Australia, the senior debt market is serviced very well. The area in real estate funding that needs more coverage is equity investment, but there is still a tension between investors’ risk aversion and the deeply dilutive effect new equity capital has on an investment when the entry price is reduced, which errodes profit margins for the initial or founding investors.
One solution is a strategy that provides preferred equity and/or mezzanine debt to cover any unforeseen funding shortfalls. An example is our Jameson Special Situations Fund (JSSits), which secured $25 million via two European cornerstone investors and a total of $32.5 million in the first close, to invest in alternative assets that were impacted by the pandemic early on and continue to be.
Unlike the GFC, when a lot of investors were surprised by the market disruption, in more recent times we have greater awareness of uncertainty and are better prepared to anticipate and ride out volatility.
Most investors are acutely aware of where we are in terms of the interest rate cycle, and asset prices have broadly been strong. I believe the majority want to keep invested while avoiding drawdown and the payoff for that is, of course, to accept a lower rate of return.
There will always be pockets of value and growth if you know where to look; I see private debt markets as an emerging source of alpha. Public markets are seen as more rational because more people have access to information, whereas private markets, where the information is more opaque and less readily available, may be the place to look as there’s less competition. Less competition often means better prices, or at least a better entry point for your investment.
Even if you weren’t investing during the GFC, the cautionary tales from that period have primed us well for uncertainty. With the passing of every crisis, we are generally better prepared to minimise risk and position ourselves to capitalise on new opportunities like we are seeing in the new post-pandemic future.