Current Banking Crisis Shows Why You Must Diversify
Key Takeaways
Banking crises have occurred many times over the decades.
These crises have almost always been a result of over-investment and speculation in the dominant high growth industry of that period.
Silicon Valley Bank’s (SVB) collapse can be attributed to its aggressive exposure to the technology and startup space and poor management of their risk, deposits, and loans.
Is my money safe?
At GYC, the bulk of the portfolios are held in a subsidiary of DBS Bank, which has a very healthy capital ratio.
Separate custodian arrangements within the portfolio and funds ensures that a banking collapse would not bring it down.
As diversification is one of our core investment philosophies, your exposure to the affected banks are less than 0.1%.
By being globally and broadly diversified, your investments are unaffected by sector or country specific crises.
You must be diversified enough to survive bad times or bad luck so that skill and good process can have the chance to pay off over the long term.
The recent mini-market meltdown caused first by Silicon Valley Bank (SVB), then Signature Bank made headlines all around the world. Chances are just 2 weeks ago, it was unlikely that you had heard of these two entities, let alone have known that there were over 4,000 different commercial banks in the US alone.
Fears of another banking crisis then spread to other US regional banks and also onto Credit Suisse — which has been beleaguered for some time after being exposed to various scandals, for example:
Losing US$10B in invested funds after the collapse of Greensill — a British firm selling corporate loans.
Losing US$5B due to exposure to the hedge fund Archegos.
Fined US$475M after being caught up in a bribery scandal in Mozambique.
Exposed by the Organized Crime and Corruption Reporting Project to have held US$8B in bank accounts related to criminals, dictators and rights abusers.
Failed in its fiduciary duty and lost over US$500M in a trust related to former Georgian prime minister Bidzina Ivanishvili and fined for being involved in money laundering related to a drug network.
Over the recent weekend, it was reported that UBS has agreed to bailout their rival at SFr 0.76 per share. Credit Suisse’s shares just over a year ago were over SFr 7.00. In addition, the takeover means a complete write down of the US$17B in Credit Suisse’s convertible bonds. Ouch!
Banking crises are nothing new and the world has been plagued by a lot of them. However, there is always a similarity between all of them — over-investment, speculation, and high concentration in a dominant high growth industry; these often has led to the collapse of key players in the financial ecosystem which led to widespread panic, a scramble to preserve capital, and the eventual bailout (or buyout) by regulators or competitors.
Here are a list of major crises over the years:
1840s Banking Crisis
Over-investment and collapse of railway companies.1860s Banking Crisis
Over-investment and collapse of railway companies (again).1900s Banking Crisis
Over-investment and overleverage in commodity companies (copper and steel).1920s Banking Crisis
Over-investment in agricultural land and farms.1980s Banking Crisis
Overexposure to mortgages.2008 Banking Crisis
Overexposure to housing and mortgages (again).2023 Crisis?
Overexposure to technology and startup firms?
Quite simply, bank runs occur when everyone heads out the door at the same time. The bank just doesn’t have enough cash on hand to disburse out to all its depositors because it uses these assets as part of its daily activities, like giving out loans. Imagine this — there are nearly 1,000,000 registered vehicles in Singapore. If EVERYONE decided to get into their car/bus/truck and drive out at the SAME TIME, our roads would cease to function. In a similar vein, if everyone with a gym membership decided to appear at 9am to get a workout, you probably won’t be able to fit through the door. These systems work because most of the time our collective activities are staggered.
Let’s take a look at SVB
A quick peek into SVB’s structure in terms of deposit and loans highlights a huge exposure to the technology and startup space and a lack of diversification into other industries. Over 70% of its deposits and loans made out were to firms from the same sector and industry. Rising rates and how such firms typically burn through cash at a very rapid rate were part of its demise.
How Safe Are The Other Banks?
Another reason for SVB’s demise was poor risk management and improper duration matching between their deposits and loans. Banks typically hold some bonds on their balance sheet at different durations to match some of the deposits and loans they give out. The quick rise in interest rates last year created paper losses on these bonds. Normally, it would not have been an issue — as bonds would go back to par at maturity. However when many depositors demand their money back, the bank has no choice but to sell the bonds at losses to meet these demands. SVB just managed this very poorly.
The left chart shows the unrealised losses on the bonds held by banks with deposit insurance with the FDIC.
On the right, it shows the impact of those losses on the Tier 1 ratios of some of the US banks. Tier 1 ratios are the highest quality reserves on a bank’s balance sheet (which had been increased post-2008) which is meant to absorb losses without destabilising the institution. You can see that SVB was in a league of its own after accounting for bond losses.
How Safe is My Money?
Your portfolios with us are mostly held with DBS Nominees — a 100% subsidiary of DBS Bank. DBS Bank (as of 3Q 2022) had a Tier 1 ratio of 14.5% and a very healthy 80% loans to deposit ratio. Each of the funds that comprise your portfolio also have separate custodian arrangements that hold the individual stocks and bonds - meaning that a banking collapse would not bring your portfolio down.
Diversification is one of our core investment philosophies and it works wonders during stressful times. For a 100% equity portfolio like our VaR 16 or Everest 16, the exposure to the affected banks such as SVB, Signature and Credit Suisse was around 0.075%. For investors who held bonds like a VaR 10 portfolio — the exposure would be less than 0.04%.
Contrast this to some other funds out there with a larger exposure to SVB and the broader bank sector below;
In another example, the United G Strategic fund — which is a very diversified core equity fund in many of our portfolios, held up well during this period compared to the broader bank sector which has been under tremendous pressure over the past two weeks. This can be seen in the diagram below where the red line represents the performance of US Regional Banks (KRE), and the blue line, our core equity fund (United G Strategic). Diversification may not get you supercharged returns, but it really helps keep you from going bust.
In short, the current banking crisis and past panics share many analogies. Overexposure to a rising and dominant industry attracted large-scale investments, and ultimately exposing the financial sector to significant risks. These parallels underscore the importance of diversification, prudent regulation, and vigilant risk management — not only where you invest, but in all the other operational aspects in financial and investment planning.
If you have some investments which are experiencing higher volatility, are unsure what to do in this environment or simply would like to find out more, come and have a chat with us.
