In light of the current market meltdown, pending crisis, and litany of debates over the topic, there is bound to be a shift in corporate (and individual) investment psychology over the coming years. If we analogize the double digit “low risk” returns of yesteryear with sexy supermodels, then we may look to consider those single digit “no risk” opportunities ahead of us as the girls next door.
The sexy supermodel investment opportunities up until recently were made possible by massive amounts of leverage, off-balance sheet financing, complex financial engineering and syndication. These investments were conceived, underwritten, and sold to millions of investors around the world. A great many anticipated them with insatiable appetites, much like a typical male teenager who has discovered the Victoria Secret catalog.
Corporate CFO’s have had their pick of supermodels over the last few years, with Wall Street and its massive amounts of leverage seemingly able to offer an endless supply. Now, the music has stopped. Wall Street no longer exists in the same form it did as little as two weeks ago. Furthermore, the remaining investment banks will surely no longer be allowed even 15 times leverage let along 30 or 45 in their new forms as commercial banks. Post bailout, and after new regulations take hold, investors around the world may be forced to look at a smaller set of investment choices for their company’s and for their professional and personal portfolios.
What will the remaining insurance companies, regional banks and a host of other large institutions look to invest in? Will there be a new financially engineered product offering high returns with “little risk”. (How long would the disclaimers have to be on such a concept anyway?)
Since the beginning of the millennium, the field of finance and domestic markets have rewritten themselves despite antiquated regulations. Moving forward it is more than likely that future investment opportunities become simpler, easier to understand, and less interconnected regardless of new regulations. At least I’m hoping we go that way over writing longer and more complicated legislation. The opportunity set of investments is likely to be smaller, and despite all the reported losses, there is still a ton of cash out there looking for a home, particularly when T-Bill yields have turned negative at moments in time.
In any event, I am more than hopeful that not all investments will force us to take a loss, and to the contrary, given where we are today there will be a lot of opportunities moving forward. However, the concepts of wild leverage and massive syndication of complex instruments are probably at best on hold. In their place will be the need for us to look a little further, and work a little harder to make good investment decisions.
This brings me to my final point, with respect corporate investment. Corporate CFO’s without huge warchests are going to face new challenges. The opportunities to make acquisitions, to fund highly accretive but speculative investments with balance sheet, or to deploy large amounts of cash into major expansions are going to be rarer. With the hope that interest rates stabilize, and that they will remain low for some time though, the investment hurdles ahead may force more companies to look inward. In this environment a solid 7, 8 or 9% return may be enough to get CFO’s everywhere to smile. If this becomes the case, many investment opportunities may become inward verses outward, and corporations may be looking to rebuild infrastructure, efficiency and cost advantages.
One more lever in the case for investing more sustainable modes of business.
Treasury Prices Firm After Auction; T-Bill Rates Below Zero
Reuters, September 24, 2008
Larry Grafstein and Jim Millstein, The New Republic, September 26, 2008