Who allocates capital these days?

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The Economist recently put out an epic on the future of asset management. Some of the conclusions were fairly obvious and well-known (albeit still important) but a couple of others struck me as under-appreciated.

Who allocates capital?

When you strip asset management back to its core societal purpose it’s about allocating investors’ capital to the best opportunities. Or is it?

Modern markets are challenging this paradigm for a few reasons:

Intangibles. Today corporate investment is all about intangibles (research, brand, know-how) which now represent twice as much investment as traditional capital investment (factories, plant). This means companies have less need for capital and indeed many large companies can self-fund their requirements and don’t really need to go to the markets for capital. In this world decisions are taken more by corporate management such as debt-profile management, buybacks and dividends.

Passive investing and private markets. It would surprise no-one that The Economist identified the rise of passive investing as a big theme. More interestingly though, this theme also sows the seeds of it’s own antithesis: active private markets investing. As passive investing makes the largest public market stocks more and more liquid, so the bar for listing has become higher and higher, resulting in far fewer firms going public and, through mergers, fewer public firms existing now than 30 or 40 years ago. This has made the public markets less relevant for capital allocation, but who has picked up the slack? Key stages in a firm’s journey now happen in the private markets – making those markets the key areas where capital allocation decisions are now taken, not public markets.

Schroders recently put out a good piece which does challenge this narrative a little: while money raised in new issue IPOs on the London stock market has dried up over the last decade money raised in secondary issues has grown and is still very significant. This has been particularly evident this year as some listed firms have sought to raise capital to shore up their finances through the pandemic, Rolls Royce being a notable example. These raisings often don’t represent good investments for the shareholders, but do demonstrate the public markets still playing some role in capital allocation.

Savings glut. The classical notion of capital markets has the allocators as the holders of the “keys to the kingdom”, allocating out their scarce capital to only the best and most deserving entrpreneurs. Today’s world turns that idea on its head- there is an excess of global capital chasing a small number of good investible opportunities, shifting that balance. The cost of capital for most businesses is lower than ever. Asset owners and managers are in hot competition for the juciest opportunities.

From Allocation to Stewardship

One other consequence of passive investing has been a mindset shift toward the portfolio being the core investing building block, rather than the individual stock, in the eyes of the end investor. but does this mean that the end owners are less engaged in the affairs of their end holdings?

In a world dominated by passive investing the obvious question is – who controls companies?

In the idealised capitalist system corporate management and boards are answerable to their shareholders. But when an increasing proportion of these shareholders are passive funds who won’t sell their holdings, and one step removed from the ultimate asset owners what does this mean? Are these “zombie” owners?

The answer lies in stewardship. More and more now passive managers acknowledge that they still need to be active owners of the companies and that they can be a powerful force for corporate change – a recent example being pushing fossil fuel companies to increase their climate disclosures and commit to net zero targets. In 2019 passive managers co-filed a succesful shareholder resolution calling on BP to set out a business strategy that is consistent with the goals of the Paris Agreement on climate change.

Stewardship means exercising their votes and taking a view on key shareholder resolutions, perhaps in coalition with other more activist investors. Consultants who help clients select asset managers (like LCP, who I work for) are increasingly taking stewardship practices into account when forming a view on a manager’s suitability. In the UK it has also recently become mandatory for pension schemes to report annually on the votes being taken on their behalf – putting a spotlight on this area.

Ok, boomer

A final conclusion of the Economist piece, which I wholeheartedly agree with is the asset management industry as a relic of the baby boomer generation. The industry in its current form came of age in catering to this generation as it accumulated, and now spends, it’s wealth. This is all well and good but leaves the industry woefully underprepared to cater to today’s growing generations who will soon surpass the boomers in terms of wealth and have vastly different expectations of their investments and the interactions with those investing on their behalf. Apps like Robinhood, youtube channels like this one and twitter accounts like tiktok investor give you a sense of what the future might look like but the big issue is that a large part of the fund management industry spend energy actively mocking some of these approaches rather than seeking to understand and cater to them.

A big issue highlighted by author Laura Whateley is the lack of relatability of people who talk about investing and money to younger generations. Hence the popularity of investing accounts run by young people and particularly young women. And no, in case you are wondering, young people don’t want to be told they could buy a house if only they bought less coffees and avocados.

Plenty then to pick over on the Future of Asset Managment. I wrote my own epic on this back in 2016 and it’s interesting to look back and see what has changed in 4 years, in some ways not so much and we are still waiting for the themes to take off. This sort of change pattern reminds me of Ernest Hemmingway’s famous description of how one of his characters went bankrupt: “two ways: gradually, then suddenly”. We tend to overestimate change over short periods and underestimate over longer periods. 2030 is not so far off and that is likely to be quite a different world for asset management. What an interesting time to be a part of the industry!

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