The key lessons for investors from the GFC are:

1. There is always a cycle. Talk of a ‘great moderation’ was all the rage prior to the GFC but the GFC reminded us that long periods of good growth, low inflation and great returns are invariably followed by something going wrong. If returns are too good to be sustainable they probably are.

2. While each boom-bust cycle is different, markets are pushed to extremes. The asset at the centre of the upswing becomes overvalued and over-loved at the top and undervalued and under-loved at the bottom, which for credit investments and shares was in first half of 2009. This provides profit opportunities for patient contrarian investors.

3. High returns come with higher risk. While risk may not be apparent for years, at some point when everyone is relaxed it turns up with a vengeance. Backward-looking measures of volatility are no better than attempting to drive while looking at the rear-view mirror.

4. Be sceptical of financial engineering or hard-to-understand products. The biggest losses for investors in the GFC were generally in products that relied heavily on financial alchemy purporting to turn junk into AAA investments that no one understood.

5. Avoid too much gearing of the wrong sort. Gearing is fine when all is well, but it magnifies losses when things reverse and can force the closure of positions at a loss. When lenders lose their confidence and refuse to roll over maturing debt or when a margin call occurs, investors are forced to sell when they should be buying.

6. The importance of true diversification. While listed property trusts and hedge funds were popular alternatives to low-yielding government bonds prior to the GFC, through the crisis they ran into big trouble (in fact Australian Real Estate Investment Trusts (REITs) fell 79%), whereas government bonds were the star performers. In a crisis, correlations go to one except for true safe havens.

7. The importance of asset allocation. What matters most for your investments is your asset mix – shares, bonds, cash, property, etc. Exposure to particular shares or fund managers is a second order risk.


Source: Dr Shane Oliver is Head of Investment Strategy and Chief Economist at AMP Capital