Are the Banks Diversifying Too Much?

Unidentified Banking Shocks, there still out there…….

One of the main justifications that the investment banking community gave regulators, shareholders and the press when granting employees salary rises in 2008 of around 100% plus, was that it would reduce the drive to take undesirable risks with proprietary capital, dampening down a bonus driven culture.

Three years on and readers of last week’s column know that this is utter rubbish and later the same week, unless you were living in exile from all types of media you would have seen that a 31 year old employed by UBS, the Swiss banking giant, lost a couple of billion dollars on trades that just went wrong.

This in itself is no cause for panic, unless of course you work at UBS, which probably means that at best any bonus prospects have gone out of the window and at worse you’ll be out of a job by the end of the year. Unlike Barings that couldn’t absorb losses when Nick Leeson hid futures trades, UBS can, but it’s all about reputation, systems and controls, or in this case the lack of them.

In the wider banking community this couldn’t have come at a worse time, as the fallout from Sir John Vickers report is still reverberating around board rooms and even Bob Diamond at Barclays was right up until Thursday playing a game of double bluff by stating that he “welcomed”the report’s findings; yeah, of course he did!

When and if we ever hear the real truth about what went on and even though UBS stated that no client had incurred losses, it’s the fact that the rogue trader worked in a department involved in the fastest growing retail investment vehicle in the world.

Exchange traded funds at the most basic level are like trackers or passive investments which they’re sometimes referred to, in that they don’t do anything other than attempt to track an index, such as the FTSE 100 or S&P 500.

The beauty of ETF’s is that they tend to be low cost in terms of management fees and as the name suggests, can be traded on an exchange, which means investors can take much shorter term bets, sorry investment allocation decisions.

As is the norm for financial services, when so many clever people get together the creation of leveraged funds that amplify your gains or losses on all types of equity and bond indexes, commodities and currencies, was brought about, so opportunities to make a greater margin for the issuers (usually banks) occurred, but with this comes a higher risk profile for all parties.The big question that most banking executives will have asked themselves at the end of last week and over the weekend is “could it happen to us?”

I started off my career in banking as an internal auditor, whose job it was to look at trading operations and basically checking that the processes in place were watertight enough to stop any potential loss to the bank.

With that experience in mind and having quite a few stories under my belt, such as the time I was told by a PA to the Chief Executive of a once eminent British bank “not to bother leaving a report for her boss dear, as he never reads those things”, to a multi million pound option portfolio that no one knew how to value, I’m never surprised when banks lose money through negligence or fraud.

Stock markets stabilised over the last week and many of the worn, battered and bruised shares started to recover some of the losses incurred during August.

What we mustn’t forget is that the world remains a very dangerous place for investors and although as a client pointed out last week, that they could get nearly 10% by investing in high yield bond funds, that of course is for a reason.

If, as is looking more likely by the day, Greece is allowed to default on its debt, then this action and the then dismantling of the Euro experiment could create massive wealth destruction, not only in the countries directly affected, but globally, as countries who hold any assets in the single currency has the headache of unravelling the trade.

This of course is not a certainty, but I cannot personally see a way out, but I could be missing something fundamental. Greece needs overseas visitors who spend money on cheap beer and food. They need to be competitive when exporting, attract inward

investment and to be able to offer tax breaks, although as many people and businesses already unofficially have this, perhaps its attraction is limited.

As investors we have to remain vigilant and I would suggest no matter how juicy those yields on European equity or bond funds start to look, keep you money in pounds or dollars and just wait for the inevitable to happen.

Posted in Financial News

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