Thanksgiving or Black Friday?

Over coffee last week, a thoughtful and sophisticated investor friend and I discussed how we should deploy capital. He talked about the exciting long term growth prospects engendered by technology and innovation. I worried about the relatively high prices of equities, particularly in the US, and the long in the tooth economic expansion. Who was right, the long term bull or short term sceptic?

In fact, we both agreed about a lot. We agreed that valuations for equities, particularly in the US, looked pretty full, particularly now that there was a positive real interest rate. We know that when expected returns on risk free rates start to get near the expected return from stocks, we can expect an unhappy time for risk assets and their soon to be even unhappier owners. Put another way, if you decide you want to sit out the next two years, to take an investment holiday, you can buy two year US Treasuries and still have some change after paying for inflation and custody.

And we both also agreed that we lived an extraordinary and exciting time when the list of technologies we are going to develop only gets longer. It does feel an historically unparalleled time when the list of things we are going to master grows faster than the rate at which we can tick off the things we have done. It’s going to be a long time before we run out of species to DNA sequence. We are going to master driverless technology. We are going to develop replacement organs. And, and, and. In sum, the world, in aggregate, is going to keep getting richer.

Moreover, we agreed too that this is not without cost. There will be business losers as well as winners. Intermediaries everywhere will continue to suffer. Take drivers. They are intermediaries, moving people and things from A to B. In my more reflective moments, I wonder if much commercial real estate is not an intermediary function. We know what is happening to retail space. With remote working technology and employee monitoring, office space is only needed when people have to be co-located to work effectively and that is not true of all employees. And logistics warehouses solve the clumsiness of factory to home distribution but with localised 3D printing…?

We agreed too that just because a society is getting richer does not mean that all members are getting richer or feel that they are. What will be the jobs that will be taken up by those displaced by all this wonderful technology and innovation? We were sanguine that there was a happy ending to this great unwinding but the dramatic arc of this story might be quite steep. If society is how a people organises itself to cope with the economic realities of its time, then there is a lot of societal adaptation a-coming: creative destruction.

That, though, is the long run for society, what about the here and now for investors? Surely if the future is clearly heading in one direction, you want to be on the right side of history, own high growth businesses and ride out the ups and downs of stock prices. Well, yes, but it depends. It depends on temperament, of course. Some people are just more comfortable with risk than others. Some folk do free fall parachuting for a hobby; others play golf.

It depends, moreover, on circumstance. If you have bills to pay, you do not want to have to pay them by selling stocks that have just fallen in price. Debt is a particularly troublesome bill. Beware borrowing money to own high growth, high risk assets. Illiquidity was a more common cause of death in 2008 than insolvency.

It depends too on the price you have to pay for something now compared to the price in the future, the longitudinal rather than latitudinal choice. Our view is that you should continue to own growth but own a little less of it than before and own a bit more cash than before. Cash allows you to buy things cheaply in the future.

It’s like shopping around Thanksgiving. There are some things you just have to buy like food for Thanksgiving and perhaps that special present for your special person but the rest? Wait for Black Friday. It’s coming and stuff will be cheaper.

As we have observed above, the technological change to come is important, and thrilling. But before we get there, we anticipate some damage done to investors, in the medium term by the likely assault on risk asset pricing that will result from the potential coming correction and in the slightly longer term by the social dislocation caused by some of these new technologies.

As investors, our job is to keep an eye on the long term whilst steering around the obstacles in the short and medium term. Investors who want to hitch a ride on the technology wagon need to understand how to achieve these long term gains without being wiped out by asset price collapse or political tumult in the mean time.

In that context, we take the view that venture capital funds are not the best way to capture the gains to be made in technology. The potential upside per single technology investment is huge if the technology in question turns out to be transformational and to have huge barriers to entry – but the likelihood of any one investment being that one smash hit stock is so tiny that success is largely a matter of chance. Venture makes sense for individual investors with knowledge in particular sectors who are able to differentiate between opportunities within the same space. For those without that knowledge, venture funds basically offer the opportunity to roll the dice a few times but they offer very little in terms of resilience or ability, as an investor, to be nimble.

However, we observe with interest some recent cases where collaboration between unlikely partners has fostered some genuine innovation, opening up new investment themes. A traditional high street bank recently joined forces with a group of “upstart” fintech direct lenders. The former recognised that its legacy business model was not capable of meeting the needs of an increasingly tech-orientated SME customer base requiring flexible and fast financing decisions. The latter had the technical firepower to readily meet those customer service requirements, but not the sheer capital base to fund that lending volume. But with the bank acting as the sponsor to further its own business ends, these technologies had a much better chance of reaching the end consumer. Investing in a traditional high street bank may lack the glamour of a direct investment in a technology business but if that bank is nimble enough to host and monetise technological innovation, and has enough heft to weather some political storms, then arguably it is the better investment opportunity.

One would not typically look to a high street bank to be an important incubator of tech – indeed over the past two decades their main activity appears to have been flogging useless products to unwitting customers and then having to launch mass compensation schemes to correct the mess. But the more recent examples demonstrate that established businesses with a nimble approach to tech may be a more investable vector for technological innovation than a venture fund with a load of interesting ideas but no way of embedding these ideas into people’s lives.

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