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Chris Watson, SK Dhonsi: Why asset class disruption needs liquidity

Chris Watson, SK Dhonsi: Why asset class disruption needs liquidity

Disruption is the act of innovation and the evolution that displaces it. The first example of disruption can be traced back to the Oldowan stone tools of the Lower Palaeolithic period, some 2 to 3 million years ago, and their evolution to the devices we use today. No sooner had our ancestors grasped the ability to shape convenient tools had they begun the process of constant refinement. From the bronze age to the industrial revolution, and beyond, to the internet, robotics and artificial intelligence, pushing boundaries has been proven to be part of our nature.

The finance industry is no exception. It is hardly controversial to say that capitalism, through financial ingenuity and social inclusion, generally makes lives better. In a Ricardian sense, we are  better off than our ancestors. Our lives are more commodious, and, by virtue, easier. The smartphone you are probably reading this article on is proof of that. Smartphones are a shining example of innovation, having disrupted countless other technologies, including calculators, maps and cameras. It is also an example of financial disruption. It shouldn’t, therefore, be a surprise that Apple, with a market capitalisation of more than $830 billion, is now one of the largest corporates in the world dominating stock indices.

The rise of Apple and other leading disruptors within the Faangs acronym has coincided with the unprecedented rise of venture capital (VC) and private equity (PE) investing. Collectively part of the alternative asset class, the term itself is curious, given that as at June 2017, some $1.1 trillion of dry powder (the amount of cash available for drawdown) was available in commitments to VC and PE managers1. For perspective, as at December 2017, some $3.4 trillion was invested in exchange-traded funds (ETFs) 2.

It follows that total ETF investments were a mere three times larger than cash commitments to PE and VC funds. We understand that the amount being raised by investors and invested into private enterprise is at all-time highs, but the ratio of what is being invested verses what is being raised has never been lower. A consequence of this bottle-neck of dry powder has been that private corporates are able to remain private for longer and continue to be able to raise capital without going public.

As investments in private enterprise continue to grow, the traditional route to market is increasingly viewed as discretionary. If the best companies are not bought at fantastic valuations, such as PayPal buying payments provider iZettle for 20 billion krona following the company’s plan to list at an implied valuation of 10 billion krona3, more are taking longer to get to market. Companies with tremendous valuations, such as Uber, appear unlikely to list in the near future, and others, such as Tesla, apparently regret doing so.

While the nouveau riche remaining in private hands is not necessarily a new phenomenon, rising strategic decisions of companies to remain private are only likely to increase markets for secondary transactions in private securities.

Since the 2008 Global Financial Crisis, the liquidity premium across asset classes has been driven lower due to the unprecedented intervention of central banks, which has arguably made private markets more attractive to investors, allowing them to grow faster than public markets. However, as central banks abate, investors in private markets will increasingly seek an exit, and private secondary transactions will continue to become more prominent. 

Sources:

1.    PE Dry Powder - Black, G. (2018). The trillion-dollar question: What does record dry powder mean for PE & VC fund managers? Available: https://pitchbook.com/news/articles/the-trillion-dollar-question-what-does-record-dry-powder-mean-for-pe-vc-fund-managers. Last accessed 03 November 2018.

2.    Bloomberg as of 31 December 2017

3.    iZettle sale price - Terfis Group. (2018). Why did PayPay pay such a high price for iZettle? Available: https://www.forbes.com/sites/greatspeculations/2018/06/07/why-did-paypal-pay-such-a-high-price-for-izettle/#1c40f6a46860. Last accessed 3 November 2018.

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