The purpose of investment

In a recent article, the Wall Street Journal stated that Alphabet (Google’s parent company), Amazon and Microsoft had collectively spent $31.5bn on capital expenditure and capital leasing in 2016 – up by 22% on the equivalent figure from 2015. The bulk of this was directed towards so-called hyperscale computing, which enables rapid access to heavy duty processing power on demand, and is vital to the tech behemoths’ pursuit of dominance of the cloud. From a financial point of view, the remarkable aspect of this vignette is that the firms were able to deploy this amount without tapping equity markets.

The above seems to be an extreme case of a clear global trend in developed economies: new share issuance to fund capital expenditure is on the wane. Bond markets appear more buoyant, with new issuance hitting record levels in 2016 – although much of this has been used to fund takeovers as industries such as pharma, retailers, consumer staples and airlines look to consolidate – consistent with the dramatic reduction in the number of listed US entities over the past 20 years. Companies are also using surplus cash to fund share buy-backs.

So what exactly is going on? There was a time where the purpose of the investment industry was acknowledged to be the efficient allocation of capital. Financial courses teach how capital projects are assessed in terms of expected internal rates of return, and are funded in descending order of profitability. This may still be true. The big difference now is that these decisions are happening at a corporate level, most notably by industry ‘winners’ to whom capital has gravitated, rather than by asset managers. Money directed to an equity portfolio is predominantly applied to buy ownership rights in the secondary market – we’ve talked about this before. (As a brief aside, the accumulation of large pools of internal capital seems to be an evolutionary phenomenon, and is far more noticeable in developed than emerging markets, where equity is still a major source of financing for new capital projects.)

If equity investors are no longer performing the role of capital allocation directly, does the investment industry still have a de facto purpose? I would argue that, rather than becoming irrelevant, the investment industry should now be assessed as fulfilling a different function (or range of functions) on behalf of its clients and society. The obvious candidate for this would be stewardship and engagement with management on behalf of shareholders. Again, though, with ownership being so fragmented much of this potential influence has been diluted. It appears then that the principal value proposition to end clients is in providing exposure to the multiple facets of economic activity. End investors, through the actions of the investment industry, are able to participate in the listed parts of the economy, and hence harvest returns on account of owning rights to a share of profits. Gaining diversified exposure to the ‘private economy’ is harder.

This reorientation of the ultimate purpose of investment has several implications for the intermediaries acting on behalf of investors. For one thing, if exposure to the economy is paramount, this would seem to be inconsistent with the pursuit of quarterly alpha, which is more a reflection of short-term market sentiment. Instead, investors are best served by a focus on the following activities:

  • Engaging with management on the best ways to generate sustainable long-term growth, and manage the risks that might impair a company’s prospects (so stewardship and engagement do have a fundamental prominence).
  • Allocating investors’ assets in a way that provides them long-term exposure to those sectors and companies that are best-placed to benefit from the evolution of society’s needs – the ones most likely to capture a growing share of overall consumption. With this reframing, it is reasonable to expect new investment solutions to emerge and existing ones to evolve.

This would seem to be a worthwhile purpose for an industry – facilitating participation in prosperity, thereby ensuring that the average investor, whose income might not be growing at the same speed as the return to capital, is at least able to deploy their personal savings in such a way that they are not left behind.