The first research produced within the Thinking Ahead Institute, State of the industry, concluded by contrasting five likely futures with more desirable versions of them – the argument being that ‘we’ the organisations within the system could, if we wished, create a different and better future. One of these was the likely future of ‘modified market fundamentalism’ contrasted with the more desirable (our view at least) ‘inclusive capitalism’. Standing on stages and trying to convince asset owners of $1bn or so that they had the power to shape the future of capitalism was a tough sell. To attempt it, I argued that the economy was akin to an evolutionary search engine – in this case business models were being selected rather than genetic traits. When a buyer chooses between competing business models, one is rewarded and gets access to more resources, making its future selection more likely. Roll forward through enough iterations and the makeup of the economy reflects our multiple selection decisions. I therefore argued that no matter how small an asset owner’s portfolio, their selection of agents still mattered – and therefore they should choose wisely, mindful of long-term consequences.
Moving this thought piece to the present, we have recently hosted a topical day during which we explored whether the investment industry was an ecosystem. In essence we were testing whether my above intuitive argument had any substance. While we have no definitive proof, my assessment is that the attendees finished the day more convinced of the ‘ecosystem hypothesis’ than they started. What we can say definitively is that there was overwhelming support for continuing this line of research.
A couple of lines from the day seem worth pondering. The first was the statement that the number of listed equities in the USA had fallen from over 7,000 to under 4,000 (see The Incredible Shrinking Universe of Stocks, Credit Suisse, March 22, 2017 – PDF widely available on the internet). The second related to the possible growth in allocation to private assets given the return imperative many asset owners are under. Is it a co-incidence that the USA has the most developed private equity industry in the world, and appears to be the only market in the world with a shrinking number of listed equities? Is it possible that asset owners of the past (say 30 years ago), by selecting ‘2 and 20’ private equity business models, have shaped the current ecosystem – where current asset owners are faced with a listed equities market where the industries are more concentrated and the average listed company is bigger, older, more profitable and more likely to return cash? [Aside: ‘2 and 20’ is in quotes to refer to the whole business model, not just the fee rate – a separate debate could be had on whether the fee model implicitly selected has delivered net value.] Are the prospective returns on such a listed market lower than for one comprising smaller, younger, less profitable, higher retention of earnings companies? And, if yes, is this understood intuitively and does it act as a reinforcing mechanism to increase the size of the private bet? But if asset owners continue to allocate more to private equity, shouldn’t we expect the number of listed equities to continue to fall? This doesn’t have to be a bad outcome – however, the fact that a security is listed communicates a lot of information to an investor regarding transparency, controls and governance. Which suggests that when selecting private equity business models, asset owners should opt for those that offer the transparency, controls and governance that they would like to see as the ‘status quo’ five or 10 years hence.