Bye Asset Managers, Hello Liability Managers !
People have been asking me what to buy and what to invest in and is it time to look at bonds and sell stocks, all raring to invest those bucks.
As I was talking to an old friend in New York who works in a bank and he was saying he spends more of his time on liability management these days. In banking, liability management has always taken the backstage, particularly for cash rich Singapore banks all of whom collect more money than they can lend, or so it was in the past. In the rush to optimise balance sheets and deliver maximum shareholder return, the focus was always on lending every single last buck out.
The bucks come from many sources, primarily customer deposits and that is true for DBS for example. DBS has total customer deposits of SGD 241 bio (76%) vs their total liabilities of SGD 317 bio. Citibank NA for instance, on the other hand, relies more heavily on debt to fund their activities. As at end 2012, Citibank has customer deposits of USD 930 bio (55.5%) out of total liabilities of 1.673 trillion.
Liability management is the key during taper time ? The secure source of funds over time and not cheap “hot” money by way of reverse repos and POMOs.
There is the alternative. To unload the assets. And that is what we have been seeing in bond space – the realisation that liabilities had to be managed and not just the assets.
“….between Q1 1998 and Q1 2013, fixed income assets held by households and pension funds increased from $4.7 trillion to $12.1 trillion. Accordingly, their share in the market value of financial securities of U.S. households and pension funds rose to some 35%.
The asset class was also helped by exceptional policy support from the Federal Reserve Bank. This served to both bolster returns and suppress volatility…. the Fed resorted to repressed interest rates as their main transmission channel to meet their economic objectives, including higher employment. Specifically, in an attempt to use the portfolio channel to trigger a beneficial combination of the wealth effect and animal spirits, central bankers supplemented their traditional policy lever (namely, a federal funds rate floored near zero) with two more unconventional policy tools: aggressive policy statements (or “forward guidance”) and large-scale market purchases of U.S Treasuries and mortgage-backed securities (“quantitative easing” or QE). As a result, and despite a multi-decade journey during which the yield on the 10-year bond declined from 16% at the end of September 1981 to below 2% at the end of April 2013, investors in fixed income were comforted by the notion that they enjoyed a “Fed put” at overvalued levels – which encouraged the justification of artificially high prices.” Source : PIMCO http://www.zerohedge.com/news/2013-09-13/el-erian-whats-happening-bonds-and-why
The ballooning of assets is accompanied by a growth in liabilities – cheap funding and that is fast running out.
“Bank of America served the latest indication that the US housing “recovery” (also known as the fourth consecutive dead cat bounce of the cheap credit policy-driven housing market in the past five years) may be on its last breath. Namely, the bank announced that it will eliminate about 2,100 jobs and shutter 16 mortgage offices as rising interest rates weaken loan demand, said two people with direct knowledge of the plans and reported by Bloomberg.”
Banks are still concerned about their loan books (assets) as investors are worried about their liabilities and the refinancing market is slowing.
This is contradictory to another article I read that “Just 2.1% of mortgages originated in April were sold to private investors, while roughly 90% were purchased by government agencies, according to Lender Processing Services, a mortgage-data tracking firm. ”
Perhaps banks are wising up to the idea of asset quality in a time when liabilities are threatening to get more expensive.
Pimco is still bullish on bonds and so is Loomis Sayles because they are assets managers and hope to rebuild their portfolios that have been battered by outflows.
Bears are raising their voices with the latest report from Deutsche calling bonds the world’s most expensive asset class. The emphasis is on “normalisation” of interest rates that have been suppressed in the past 5 years to plump up economic growth.
For us, the man on the street, what does this mean ?
We cannot ignore the signs and the macro themes. Our investment strategy has been to chase assets that promise the quick buck, preserve wealth and high yields. Perhaps the better strategy for the future would be to pay attention to our liabilities and future liabilities. It may be boring compared to the fascinating world of making money, but it sure will go a long way after next week’s FOMC.