Thursday, November 03, 2005
Capital Glut and Risk
VC blogger Fred Wilson writes about a problem of particular interest to me and to several of the guest bloggers on ZS. Economic theory predicts that capital should flow from where it is cheap and plentiful (the U.S., for instance) to places where capital is scarce (developing countries). Instead, we have a global scenario where capital actually moves from developing countries to the U.S. via those infamous currency reserves. But before going any further, here's a few extracts from a WSJ Page 1 story that Fred linked to.
What is the problem?
As Fred asks, why is it that this cheap capital is chasing after very risky opportunities when it could, theoretically, be invested in building infrastructure in developing countries or in developing non-petroleum based energy. The first part of Fred's question is what ZS bloggers are interested in. I had addressed this issue in an earlier post.
To investigate this further, I have put together a group of professionals in New York drawn from a wide variety of backgrounds (consulting, pvt equity, hedge funds, U.N., academia etc) who have an interest in the role of the private sector and capital markets in catalyzing economic growth. The International Private Enterprise Group (IPEG) currently has over 50 members, and we meet once a month to discuss specific issues, like, for example, the question that Fred poses. Our next meeting is on the 12th of November (next Saturday) and the speaker we have invited to speak is Rob Fogler, the founder of the Thousand Hill Venture Fund. THVF is the first for-profit, Africa-focused, mid-market VC fund that I know of. It promises to be an excellent meeting especially since we hope to discuss tricky issues like exiting from a mid-market fund, not to mention the risk involved in investing in Africa.
If you are interested in any of these issues and would like to pariticipate in our meeting on the Nov 12th meeting, send me a short note about yourself and why you'd like to attend. I need to know in advance because we need to know what sort of attendance we'll have before booking the conference room. We also run a moderated, low-volume mailing list to discuss these issues. So, if you're either interested in IPEG or the IPEG mailing list, shoot me a note and I'll be happy to update you.
There's an unprecedented wave of capital flowing around the world, with all of its owners anxiously searching for a better return. World pension, insurance and mutual funds have $46 trillion at their disposal, up almost a third from 2000. In the same period global central-bank reserves have doubled to $4 trillion, and other gauges of available capital have risen as well. Meanwhile, world central banks have kept short-term interest rates low, even after the Federal Reserve's latest quarter-point boost. That means investors who put their cash in safe money-market paper can net only a modest margin above inflation.
The result is that global investors are diving into a wide range of riskier assets: emerging countries' stocks and bonds; real estate and real-estate-backed debt; commodity funds; fine art; private-equity funds, which buy stakes in nonpublic companies; and the investment contracts called derivatives, including a kind structured to permit the sophisticated to take huge bond risks. For good measure, many investors use today's low interest rates to borrow money to amplify their bets. This "leverage," in effect, thus enlarges the already overflowing pool of investment capital.
What is the problem?
Policy makers increasingly see worrisome consequences of this global cash surplus. As the price of an asset rises, the income it throws off -- a stock's dividend, a bond's coupon, a building's rent -- automatically declines as a percentage of the asset's value. This means investors are demanding less compensation than usual for taking on the risk inherent in owning the assets. In the lingo of economics, the "risk premium" is low today.
...
But the concern is that, historically, very low risk premiums often presage a broad market decline that pushes down stock prices and pushes up what everyone must pay to borrow, hurting economic growth. "History has not dealt kindly with the aftermath of protracted periods of low risk premiums," Fed Chairman Alan Greenspan noted in August.
As Fred asks, why is it that this cheap capital is chasing after very risky opportunities when it could, theoretically, be invested in building infrastructure in developing countries or in developing non-petroleum based energy. The first part of Fred's question is what ZS bloggers are interested in. I had addressed this issue in an earlier post.
To investigate this further, I have put together a group of professionals in New York drawn from a wide variety of backgrounds (consulting, pvt equity, hedge funds, U.N., academia etc) who have an interest in the role of the private sector and capital markets in catalyzing economic growth. The International Private Enterprise Group (IPEG) currently has over 50 members, and we meet once a month to discuss specific issues, like, for example, the question that Fred poses. Our next meeting is on the 12th of November (next Saturday) and the speaker we have invited to speak is Rob Fogler, the founder of the Thousand Hill Venture Fund. THVF is the first for-profit, Africa-focused, mid-market VC fund that I know of. It promises to be an excellent meeting especially since we hope to discuss tricky issues like exiting from a mid-market fund, not to mention the risk involved in investing in Africa.
If you are interested in any of these issues and would like to pariticipate in our meeting on the Nov 12th meeting, send me a short note about yourself and why you'd like to attend. I need to know in advance because we need to know what sort of attendance we'll have before booking the conference room. We also run a moderated, low-volume mailing list to discuss these issues. So, if you're either interested in IPEG or the IPEG mailing list, shoot me a note and I'll be happy to update you.
