retail investors: Lessons Learned: The collapse of SVB and what retail investors can do to protect their portfolios
Hindsight can give you the intelligence to smirk at that. But here’s the deal – the year and a half long bull run, after that massive Covid fall has wired investors in a way that is nothing but inappropriate for current market conditions. The markets first broke their winning streak in October 2021, and even after a war, the fastest and sharpest rate hike cycle, and the fastest rise and fall on the Forbes richest list, many of us, like the distressed founder, haven’t learnt enough!
Hopefully, SVB and the series of bank failures will shell out a few lessons for the stress yet to come. Here are three to start that process!
Hikes are meant to hurt
After the pandemic, cash-flushed start-ups deposited money with SVB. However, lending had come to a halt back then. So, SVB parked all that money up in government bonds. And then came hot and sticky inflation, which prompted the Fed to hike rates (hard, and fast). Funding winter arrived, and start-ups started withdrawing money. But the value of bonds SVB had purchased nosedived because of the rate hikes. To let start-ups withdraw, SVB would be forced to sell the bonds at a massive loss. Instead, it said nothing is wrong, and that it could raise more capital.
Unfortunately, that didn’t work, and start-ups rushed to withdraw their deposits. The bank couldn’t keep up and collapsed.
In the SVB case, the fifth-degree answer to all your whys will always boil down to rate hikes. The very purpose of rate hikes in an inflationary scenario is to slow the economy down, and consequent damage is a likely scenario. As a bank there was no point being placed against the tide either on expectations around liquidity requirements, or around the value and dependence of bond holdings.
As an investor, there is no point in betting against the impact of rate hikes either. Question some of your investments – bonds that are more sensitive to rate hikes (long-term bonds, low-rated debt), sectors that are closer to the war-zone (IT services), companies with high leverage, companies that are high on foreign debt or floating rate debt, sectors that are sensitive to interest rates, et al.
Real or notional – losses are losses
SVB had a classification choice on its bond holdings, thanks to accounting standards. If they’re AFS (Available-For-Sale), they’re available to be sold (of course) immediately, and meet requirements of withdrawal. However, they have to be marked-to-market, which simply means losses would have to be recorded on the balance sheet throughout this period. So SVB moved them to HTM (Held-To-Maturity), which means no recorded losses – yay. But when withdrawals hit, they would have been forced to sell and book losses.
Till the time SVB didn’t look at the sale of these ‘unrealised losses’ as the last resort to meet withdrawal obligations, HTM for them stood for Hide-Till-Maturity. And it could have sailed by had it not been for the increase in withdrawals, and the subsequent bank-rush.
It isn’t an uncommon story for investors to conveniently change their time horizon just because they’re making losses (when trades become investments). It takes one liquidity event to be forced to sell investments at a loss, or to liquidate that leveraged position which margin calls were feeding so far. Acknowledging losses (even notional) and providing for them is necessary during tough economic conditions.
The market isn’t in a mood for ‘chalta hai’
It took a few blinks for SVB to go from word of stress to a full-fledged shutdown. Customers, investors and regulators have all been unforgiving of lapses, and intolerant towards risk. The event triggered the collapsing of two more banks, raised questions on all other small banks, and even took Credit Suisse (CS) to a lifetime low.
Wait, are SVB and CS related? No. SVB’s failure didn’t lead to CS’s crisis. But it did expose how banks are vulnerable.
The markets have not only been harsh on what would have passed as ‘chalta hai’ in bull markets, but have also been flocking to safety at the first sight of risk. This week, there was an unprecedented rush to safety – (i) the yield on two-year Treasury notes logged the sharpest one-day decline since 1987, and (ii) while stocks of small banks halved in value, large banks ended up in the green.
As investors, it’s important to value safety right now, not just for your portfolio, but also because that’s what the market is valuing for now. Compare how value stocks (like ITC) have performed against the once-sexy growth stocks (name any listed start-up), and you got your answer. The market isn’t in the mood for high risks, missed expectations, inconsistent growth, failed plans, and more importantly poor governance (you know who we are talking about). Avoiding what could have afforded a deaf ear is what the current environment deems necessary.
The pace and intensity of events for SVB has been dramatic for it all happened within a week. Market cycles lately have been as quick and grave. The sharp Covid fall, massive bull run after, and ongoing stress have unfolded in a short span of three years. This makes it necessary for investors to rapidly re-wire.
Luckily each event provides an insight, which is useful unless you anchor yourselves to a dead past. In short, don’t buy something that has fallen 60%, especially when your finances are blocked at the same place!
(The author is WealthBasket Curator and Founder of Rupeeting)
