The case for ‘engaged’ capital
Policymakers and financial investors need to work together to encourage engaged capital and investment in productive assets, argues Jonathan Oppenheimer
The Covid-19 pandemic has forced governments and companies to radically question long-standing assumptions about their actions and their respective roles in society. The pandemic provides an opportunity for financial investors to do so too.
The UN’s International Labour Organization estimates the pandemic will eradicate the equivalent of 435 million full-time jobs in the first half of 2020. That figure is not difficult to believe considering that the United Kingdom’s furlough scheme announced in March already counts 7.5 million on its payroll and that more than 36 million Americans have filed for unemployment since the outbreak. But this is not just a developed markets issue.
We have witnessed similar impacts in South Africa first-hand. In just the first few weeks of operation, the South African Future Trust and its six partner financial institutions have provided interest-free loans to protect the immediate livelihoods of more than 80,000 small and medium enterprise employees. From the number of additional applications made by South African SMEs, we know that demand for income support greatly exceeds supply.
UNDESA estimates Africa alone accounts for 29 per cent of the growth in the global working-age population today. By 2030 Africa will account for more than half and by 2040 three-quarters of global working-age population growth.
Failing to address pandemic-related unemployment and the growing job creation burden in emerging markets threatens not just economic livelihoods but longer-term political stability.
With so much at stake, we must ensure that the recovery is sufficiently strong to get people back to work when the disruption from the pandemic eases. There is only so much that public balance sheets and charitable organizations can do to ensure a recovery. If we are to see a return to strong growth, then the post-pandemic recovery must be driven by private investment. But what will it take for this to happen while the outlook remains so uncertain?
To raise investment, we must transform the relationship between financial investors and the companies they invest in. This requires a radical change in the mentality of financial investors.
More engaged capital – which involves a partnership between financial investors and company managers, with a shared long-term horizon and a focus on maximising sustainable value – is needed. Engaged capital investment requires patience, tolerance of risk and scale, all of which are key to ensuring company managers can make sound decisions to invest in productive assets in the pursuit of long-term value.
This is crucial to securing a strong, stable and sustainable recovery.
Company managers face real constraints in balancing corporate finance decisions and financial investor expectations. Short-termism and dividend yield often win out over long-term value creation. That BT’s share price was punished on management’s decision to cut dividends to ‘create capacity for value-enhancing investments,‘ is but one recent example of these dynamics at play.
We need more engaged capital if we are to increase investment in job-creating productive capacity globally. The majority of financial investment is currently in the form of passive funds that track indices and take a relatively hands-off approach to company management or transactional capital deployed by traders who are focused on technical factors rather than the fundamentals that create long-term value.
Engaged capital implies a different relationship between financial investors and company decision-makers. Informed and committed financial investors are more able than anonymous traders or passive investors to encourage company managers to focus on long-term value.
Providers of engaged capital, who through analysis and dialogue, understand and support – where merited – the strategy of a company, are more likely to see through short-term fluctuations in share prices. They are also more likely to see long-term growth opportunities arising from pandemic-related disruption.
Policymakers and financial investors need to work together to encourage engaged capital and investment in productive assets. Policymakers must strip away overly restrictive regulatory barriers to investment in productive assets and reduce political and regulatory uncertainty. Financial investors need to reassess existing practices that inhibit engaged capital, including how fund managers or company managers are rewarded and the impact of dividends and share buybacks on productive investment.
Both need to reassess together the factors that are leading to an excessive focus on quarterly earnings at the expense of long-term value and a narrow focus on market depth that is driving up transaction volumes without contributing to genuine value discovery.
It would be naïve to expect all financial investors to provide engaged capital, particularly in the current climate where many have suffered losses and feel forced to be more defensive.
But equally, we must recognise the consequences of a failure to ensure a strong recovery, driven by private investment, both for long-term value and for political and economic stability. Covid-19 has forced governments and companies to radically rethink their practices. It is time financial investors do so too.
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