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August 18, 2013 4:32 pm
What happens when there is too much capital? It may be a good problem to have, but it demands solutions that the world currently lacks.
Measure capital as the sum of all financial assets and, according to the management consultants Bain & Company, global capital tripled between 1990 and 2010 – driven by financial wizardry, and increasing leverage. As financial services groups introduced new products, and populations looked for new ways to save, the supply of financial assets outstripped growth in the underlying economy.
The financial crisis slowed this growth, but the rising demand for savings products in China and other emerging economies will keep the supply of financial assets growing. Bain’s ballpark figure, in a report called A World Awash in Money , calls for a further 50 per cent rise to deliver capital of $900tn by 2020.
Assuming the consultants are right, the capital glut could create problems. We know what happens when too much capital is chasing returns. People grow uncritical, and bubbles form quickly.
So what do we do about this? First, investors must lower expectations. Pension funds must accept that returns will be lower than before, budget on that basis, and avoid the temptation to chase returns.
Second, we must be even more alert to the risk of bubbles. Companies need to recognise when returns are unrepeatable. And governments need to guard against the problems of overinflated asset prices.
One fascinating point made by Karen Harris of Bain is that company treasurers managing balance sheets will have to think more like hedge fund managers.
By this, she means that they must consciously assess risks of sharp falls in asset prices, while also attempting to use balance sheets as a competitive weapon.
Bain also suggests investors look to emerging markets, which is where fresh capital is being created, and where the lower level of development suggests that capital could be used most productively. It recommends seeking out “far horizon” investments, and sees five promising technologies on that horizon: nanotechnology, robotics, biotech and genomics, artificial intelligence and “ubiquitous connectivity”.
For Bain, pursuing such long-term investments “will not only be something businesses will ﬁnd possible to do; it will be the prudent thing to do.” With capital flooding into every asset class, pushing down yields and raising correlations, it grows ever harder to diversify risk. Hunkering down for the long-term becomes a way to avoid these problems.
The difficulty is that a focus on “far horizon” technology and emerging markets has contributed to spectacular investment bubbles in the recent past.
Looking ahead a decade or two, most emerging markets should outgrow the developed world, and investments in successful operators of those new technologies should work out. But exactly the same thing could have been said about the internet in 1999. Dominant internet brands just 15 years ago included names like Infoseek, AltaVista and Excite! Any of these might have turned into Google, but they did not.
In 1999, the result was an epic bubble, which did nobody any good. Not knowing who the winners would be, investors simply bought into every entrant at their initial public offerings.
The dotcom bubble cannot be dismissed as a one-off. In the middle of the last decade, alternative fuels enjoyed almost as drastic a bubble, with ethanol futures and stocks of ethanol producers multiplying many times over before collapsing.
As for emerging markets, China’s growth is amazing, but the bubble in Shanghai A shares that burst in late 2007 ranked with any other investment mania in history.
With so much capital seeking a home, do we need an alternative to public equities and initial public offerings?
Once the mania takes hold, it is easy to raise capital by launching a new company. But before any mania takes hold, there remains a bottleneck of financing for smaller companies – public markets are not good at funding them, while banks remain are reluctant to do so.
What alternatives are there? Putting more trust in governments through public-private partnerships is one option, although many will object to it.
A more radical and intriguing alternative lies in the emerging new finance based on peer-to-peer or “crowd-sourcing” models. Rather than go public too early, as happened in the dotcom bubble, companies developing new technologies can raise debt financing from crowdfunding lenders. This might even recreate some of the better features of old-fashioned banking, in which decisions are made by lending officers who know the businesses they are funding inside and out.
Crowds can of course go mad. But too much capital is seeking a home, and the risks of misallocation are clear. It is worth looking for new ways to guide that capital.
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