David Robinson on how distrust raises the cost of speculative investment activity
The world’s investment capital is increasingly concentrated in large institutional pools. The top five pension funds in the world today hold about US$ 2.5 trillion in wealth. In 2011, the estimated total global pension fund wealth exceeded US$ 27 trillion, and sovereign wealth funds add another US$ 2 or 3 trillion to this number. Moreover, this concentration is increasing over time: the growth in assets among the largest 20 or so funds far exceeds that of the next 100 in size.
As investment capital becomes increasingly concentrated, it becomes increasingly disconnected from high growth, high impact investment opportunities in the entrepreneurial sector. Because the minimum size of an investment grows more or less proportionally to the size of the assets under management, large funds such as the Abu Dhabi Investment Authority and the China Investment Corporation find it prohibitively burdensome to write small cheques. Just think about the administrative costs of overseeing a US$ 200 billion fund: allocating capital in US$ 100 million increments, they would have over 2,000 individual relationships to manage. And because overseeing investments in young, high-growth companies is an extremely labour- and talent-intensive affair, US$ 100 million chunks of capital are too large for all but the biggest firms.
On the other end of the spectrum, many opportunities for investment in projects with high economic and social growth have a number of unappealing features, at least from the perspective of large, institutional capital. Often, social impact is hard to quantify; therefore, it is hard to present in an objective manner to outside investors. The early-stage nature of many high-growth opportunities makes the investments highly speculative in nature. Ultimately, many of these projects offer high returns because they require investors to bear high risk.
This “size disconnect” between large capital pools and the small investment opportunities that have high financial and social impact creates a drag on growth around the world. How can we reconnect capital?
Financial markets have a knack for seeking out profitable investment opportunities, so reconnecting capital is really about removing impediments and creating catalysts. The problem is that there are a number of systemic challenges to improving the flow of capital from large-scale sources to small-scale uses.
At the centre of the problem are trust, information and transparency. Throughout the world, there is profound distrust of many financial market actors. Regardless of the root cause, distrust raises the cost of speculative investment activity, especially when important parts of the investment return are difficult to quantify. Improving trust in financial institutions is critical. This cannot occur without greater transparency. And, of course, greater transparency cannot occur without more information throughout the investment value chain.
Author: David Robinson is Professor of Finance, William and Sue Gross Research Fellow at Fuqua School of Business, Duke University, USA and is a member of World Economic Forum’s Global Agenda Council on Financing & Capital
Image: A man watches stock market monitors in Tapei REUTERS/Nicky Loh