State of the Industry – II, some comments for discussion. A good paper, but some perspectives to add:
On page 5 – you make the statement about securities markets having limited influence on capital formation and deployment. I think that is materially incorrect. One only has to look at some of the massive mis-allocations of capital that have occurred in the past – tech bubble of the 1990’s, resources in the 1980’s right back to the railroads in the 1800’s to suggest that the securities markets were probably the main motivating factor behind the misallocations of capital. I take your point that if the capital already exists in the listed markets it is what it is, however the behavioural impact on new capital from what is happening in listed markets can be very significant (and has been). Consequently, I think that you probably need to rethink that part and the assertion. If asset owners and investment managers had suitably long term time frames and invested accordingly, and all other market participants did the same (or where small enough to not matter that much) then you’d be correct and that would be a good thing. The impact from an asset owner’s perspective then is that those organisations (asset owners and managers) that chase shorter term outcomes exacerbate misallocation of capital.
Bottom of the same page the comment about the finance sector being too big – 100% agree, but I’d assert that the finance sector’s size is almost entirely a function of the leverage in the system. The greater the leverage the greater the size of the finance sector being the intermediary that issues the debt. The best way to limit the size of the finance sector is to limit leverage and debt creation. Perversely one could argue that the more debt an asset owner wants to hold in relation to equity, or to the extent they are willing to buy the equity of the finance sector and see it greater leveraged to capture higher returns, the more they encourage the growth in the finance sector (ignoring government and household debt).
Smaller asset owners vs larger asset owners – I think capacity is worth a mention here. Capacity to invest and capture returns from some sections of the securities markets are inversely proportional to size, and as such smaller asset owners are at an advantage over larger asset owners in this regard. Larger asset owners also have to appreciate that as they become larger and larger in relation to the aggregate size of securities markets, their returns must approach the average return of those markets.