I interviewed James Anderson, the lead manager of the Scottish Mortgage Investment Trust, last week. The trust (which I hold in my Sipp) specialises in investing in innovation. If there is something out there that might change our world, Anderson is working on getting a piece of it.
But as we were talking he mentioned one of the big frustrations of his world — the difficulty of buying into growing companies. It used to be reasonable to assume that a growing company would always be in need of capital and would therefore make its way to the equity market to raise that capital sooner rather than later.
That isn’t the case any more. That’s partly because technology companies don’t need much capital. If all you need to get going is a couple of servers (which you can rent in any case, so there’s no need to buy them), some excellent programmers and a 20-something who gets digital marketing, you just don’t need equity markets to grow.
Instead, you use them to cash out once you’ve enjoyed the best of the growth. When Chinese e-commerce group Alibaba listed in the US last year, its market capitalisation topped $220bn, making an instant stockmarket giant. On a list of companies ranked by market cap it came just between JPMorgan and Procter & Gamble.
But that’s not the only reason why growing companies aren’t listing. More just want to avoid the pressures of being a listed company. They don’t want to deal with regulation and shareholder demands for constantly rising profits and reliable forecasts of more of the same.
They see being private as being a competitive advantage: one that allows them to use the capital they raise privately to invest heavily without thinking about market valuation metrics.
Uber, which allows you to use an app to call taxis to wherever you are, is a classic example of this, says Mr Anderson. It has raised not far off $3bn so far, but that money has not come from from the stockmarket.
It’s come from the likes of Google, Jeff Bezos (the founder of Amazon) and from various private equity, sovereign wealth and hedge funds. The surge in concentrated wealth around the world has meant that there are deep pools of private capital available to convincing start ups.
As a result, the ordinary private investor no longer gets a look in. This was a subject that also came up when I interviewed tech investor Jim Mellon recently. When I asked him how readers short the $100m or so needed to get in the innovation investing game might access growth these days, he said “just buy into Google”. Why? Because their investment arm is buying everything else.
There’s another more troubling side to this story. This bit is all about debt. As Andrew MacNally points out in his neat new book Debtonator, How Debt Favours the Few and Equity Can Work For All of Us, this works for the banks. If companies raise equity finance (which is by definition very long-term capital), the need for regular refinancing is largely gone. With equity comes stability.
That’s the last thing a banker needs. They would prefer that companies raise debt, because that way they’ll be back in a few years to refinance. It works for companies as well. Issuing debt rather than equity means less dilution for existing shareholders, who are often managers. Plus, they get tax relief on debt.
Across the West, companies get to write off debt interest against their taxes, something that makes debt rather more “financially efficient” than equity.
This goes some to explaining why, between 2001 and 2005, equity issuance across 51 countries came to 1% of GDP, but debt issuance was “around three times that”. It also gives us a starting point to explain why equity markets are shrinking, not growing.
In 2013 and 2014, US companies raised about $300bn selling new shares into the market. But in 2014 alone they spent $553bn buying back their shares. Much of that repurchasing was financed by the issuance of corporate bonds. Goodbye equity. Hello debt.
All this matters much more than you might think. It matters first because debt goes hand in hand with instability: it is the debt-financed who go bust in recessions. But it mostly matters because it is really bad for capitalism. Mr MacNally explains how the shift to debt has left ownership of the most productive wealth there is, shares in companies, in the hands of the few; if you aren’t issuing equity, your company’s growth isn’t shared, it is kept close.
Look at it like that and you might begin to understand some of the rise in inequality in the West in the past few decades and the existence all that private wealth. Debt doesn’t share wealth and keep people engaged with capitalism. Equity does.
I’d also say that this is possibly more important than it has been in the past for the simple reason that our ageing populations need access to equity growth. What’s the point of pensions freedom if all there is to invest in over the coming decades is a heap of overpriced corporate bonds?
There have been discussions about shifting the balance back to equity by taking away the tax breaks on debt in the US as well as in the UK, and pre-Budget my colleagues and I dreamt that George Osborne would make a move towards it before the election.
But nothing has happened yet and there are obviously super strong vested interests working to make sure it never does. Something for the nation’s retired and soon to be retired to start campaigning on, perhaps? We all need to participate in wealth creation. But right now, they need it most.
• I wrote last week about how much I loathe the lifetime allowance on pension tax relief. In the spirit of engaging to create a better world I have written a petition. It is now up on the government website until March 30. I would love it if you would humour me (and perhaps make your own retirement more satisfactory) by signing it.
• This article was first published in the Financial Times.