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The Changing Nature of Capital Markets

James Anderson | December 2017

In the last piece I wrote about the futility of daily life in the capital markets. But simply complaining about this is nowhere near sufficient. The point is to act differently.

At Scottish Mortgage, we can help shareholders by continually striving to keep cutting fees. We can contribute by trying to provide good stewardship to established companies and backing those that invest thoughtfully for the long term. But increasingly we see our most important role as backing, funding and encouraging young companies and especially young private (alternatively known as unquoted) companies. This is fundamental.

Our belief is that the near bankruptcy of purpose in the established equity markets, from London to New York to Tokyo and wherever else you care to mention, is gradually, yet ineluctably, breeding necessary alternatives and thereby leading to their own eventual downfall. If public equity markets function poorly then the probable outcome is that they will be replaced. For despite the real ability of a golden circle of cash generative digital giants to enjoy the independence which comes from relatively tiny capital requirements for future growth, even technological innovation cannot do entirely without financial backing or the liquidity events which may or may not lead to a traditional initial public offering (IPO).

The scale of venture capital financing may be dwarfed by the relentless secondary market trading volumes of public market capitalism but there is some hope. In America there is around three times as much new venture capital investment each year, as there is raised by companies which IPO on the public stock exchanges. Moreover, this is no longer just a US phenomenon. The percentage of US to global offerings has been falling in recent years.

Let’s be clear: we simply don’t truly know the value of a business in its early life. No one does.

Still better, whether in the US or internationally, these private companies are generally businesses that demonstrate ambition, take risks and aspire to better themselves rather than to institutionalise bureaucratic inertia. We even have some examples in the UK. Each year now we find many more worthwhile new investments in the unquoted world than in public markets. This is despite the damaging scaremongering amongst regulators and the media that somehow confuses the difficulty of pricing these companies on a day-to-day basis with the suggestion that somehow shareholders are being abused.

Let’s be clear: we simply don’t truly know the value of a business in its early life. No one does. That’s the point of risk-taking capitalism. This challenge persists for much longer than most investors are willing to acknowledge and is equally true, irrespective of whether they have become public or remained private companies.

We feel extremely fortunate that we have such good access to this brave new world. Although we cannot offer the detailed technological assistance or daily managerial assistance (or interference) that some venture capitalists can assuredly provide, we trust that we have compensating virtues. We would gently suggest that we do have some strategic advantages that others might find hard to replicate. We’re much less expensive for a start.

We want to be buyers in size at that time, not impatient sellers.

There’s been a tendency to belittle public investors when they visit the unquoted world. Traditional venture capitalists like to suggest that we are ignorant tourists who will run at the first sign of trouble. Time will tell if we are naïve, but we are not tourists. We’re quite the opposite. Already we have been a rare source of finance at times of difficulty. We believe that we should, in as many cases as possible, be able to finance a company round after round to self-sustaining profitability. Just as importantly we’re not looking for an exit. We’re indifferent as to whether our companies are quoted or unquoted, but we can assuredly offer more funds from more directions at greater size if a company decides to go public. We want to be buyers in size at that time, not impatient sellers. This requires scale. We regard the size of Scottish Mortgage as a virtue not a drawback in establishing our global connections and backing these ventures. It may be worth stressing that many unquoted companies in this era should not be confused with either smaller companies in public markets or the marginal players of yore. Airbnb, Spotify or Meituan are considerable companies already and could be amongst the great companies of the next decades. We’re delighted if we can be associated with them as early as possible and at scale.

Although we are still at a stage where Scottish Mortgage needs to freely, frequently and vigorously discuss the rationale for its unquoted holdings, we would hope that over time this becomes self-evident. Ironically, what we’d most like to see is that there becomes no difference between our private and public holdings – because all our public holdings are run with the same restless ambition and insouciance about daily market machinations that the private companies we hold routinely exhibit. We’re getting there, gradually.

The views expressed in this article are those of the author. Its express purpose is to highlight areas of intellectual thought and debate which inform the investment philosophy which underpins Scottish Mortgage, in the hope that they may be of wider interest. The author(s) therefore make(s) no suggestion that this article constitutes independent investment research and it is not subject to the protections afforded to such.

Further, it is not intended to be considered as advice or a recommendation to buy, sell or hold any particular investment. As referenced above, private companies may be more difficult to buy or sell, meaning short-term changes in their prices may be greater. Those considering investing in any of the areas highlighted in the article should undertake their own research, seek advice if unsure, and be aware that the value of any investment and any related income, can fall as well as rise, meaning that investors may not get back the amount invested. For those looking for information on Scottish Mortgage specifically, please visit www.scottishmortgageit.com