FANews
FANews
RELATED CATEGORIES
Category Investments

Tackling concerns about rising debt levels by way of a rugby analogy

22 October 2019 Andrew Williams Investment Specialist, Equity Value at Schroders

A course of action that might be entirely rational for an individual to follow – such as taking on cheap debt – can be entirely irrational if it is pursued by a wider group

With the Quarter-Finals in the 2019 Rugby World Cup now completed, four countries remain in the competition with the dream of winning the coveted title still alive. In that spirit, then, imagine your preferred team has made it all the way to the final in Yokohoma on 2 November – and, what is more, you are among the 72,000-strong capacity crowd to cheer them on.

At a particularly exciting point in the match – almost inevitably – the person in front of you stands up to try and obtain a better view of the action. It is irritating but also predictable – as is what happens next: you stand up and the person behind you and the person behind them … Before you know it, thousands of people are on their feet – and, in aggregate, nobody is any better off than if everyone had stayed sitting down.

Granted, using the Rugby World Cup final as the setting for this upcoming analogy may be a little opportunistic –– hoping it illustrates an important behavioral science lesson: a course of action that might be entirely rational and beneficial for an individual to follow can be entirely irrational and detrimental if it is pursued by a wider group.

According to Andrew Williams, Investment Specialist, Equity Value at Schroders, this is particularly relevant for investors because of the way so many businesses have behaved as a consequence of the benign economic environment of the last 10 years. “Given the historically low interest rates of this period and the resulting slew of income-hungry investors seeking any kind of yield, it makes a lot of sense individual companies would issue cheap debt – but what does that mean for the system as a whole?”

Williams refers to an article by economist Hyman Minsky - Worrying picture, where he put forward his hypothesis on financial instability – that “the illusion of stability of the system will, over time, create its own instability”. In essence, what happens here is a benign environment encourages businesses to take on additional leverage and risk and these twin triggers combine to create instability.

Increasing amounts of leverage is a topic that has been addressed on a number of occasions – both in the context of lesser-known debt instruments, such as covenant-lite bonds and mandatory convertible bonds, and at a more mainstream level. At the start of this year, for example, the growing proportion of corporate bonds rated just one step above ‘junk’ status was highlighted.

Williams says, “Each time we highlight these investment ‘red flags’, we express concerns about the cumulative levels of debt in the system but it should be acknowledged that, for individual businesses, their directors and their advisers, any deals they are doing may make perfect sense.” Taken as a whole, however, it all serves to increase risk as any future financial or economic shocks will reverberate far more strongly in a highly-levered system.

“Investors need to be aware of this risk and guard against it – by steering clear of companies with excessive levels of debt. Such businesses are ill-prepared to face the broad range of economic scenarios that could occur in the coming months and years. Having stood up with the rest of the crowd, they could easily find themselves knocked off their feet.” concludes Williams.

Quick Polls

QUESTION

In terms of vicarious liability, damages should not be borne by companies in all conditions, but only in those circumstances which it is reasonable for them to do so. Do you agree?

ANSWER

Yes, damages should only be borne by companies in those circumstances which it is reasonable for them to do so.
No. If there is a sufficiently close link between the employee’s acts and the purposes and business of the employer, the employer should be held liable for delicts committed by their employees.
As long as the employee is acting within the course and scope of his or her duty… the employer will be held liable.
A E fanews magazine
FAnews October 2019 Get the latest issue of FAnews

This month's headlines

Non-disclosure - a question of fairness
Level of insurance regulation notably tightened
The cost of treating cancer
Employee Benefits… an untapped opportunity
Bound to NHI… whether you like it or not
A stormier world for marine insurers
Examining the application of reinstatement clauses
Subscribe now