Wednesday 04 May 2016 11:41 am

Lack of long-term investment in early stage companies is damaging the economy

Lack of long-term investment in early stage and innovative companies is damaging the economy, leading fund managers have said.

“Our society has increasingly lost its way. Fund management should be doing rightful investment for the world and I think it’s a really serious problem [that they’re not],” says James Anderson, manager of the highly regarded Scottish Mortgage trust.

Anderson says output in the global economy is very closely linked to where investors channel their funds. It’s currently flagging, with most of the developed world’s economies limping along with little growth and hardly any inflation – and authorities are struggling to tackle this.

Investing in the next generation of innovations – and worrying less about the payback in the short term – will be crucial for getting the global economy roaring again.

Investors can “invent the future” through where they allocate funds, and by choosing to shy away from early stage companies, we are failing to create a vibrant economy.

“Why is capitalism failing? It’s because people are scared of doing this. It is an absence of finance,” Anderson says, adding that China and Asia generally are much better at supporting innovative companies.

It’s an issue the UK’s most successful fund manager, Neil Woodford, has also spoken out about recently. He says the UK is "doomed" unless we do more to create a thriving “knowledge economy”.

“We are failing as an economy to capture [the opportunity in science] and if we fail to capture that the economy is doomed,” Woodford says.

“The critical part of the jigsaw is that early stage science is what the UK economy does very well. And if the economy is going to succeed in the future we have to make the knowledge economy work,” he added.

He says the UK’s level of funding for early stage companies pales in comparison to the US, where both the number of investors and amount of capital on offer is much greater.

“The demand for capital is huge and supply is almost non-existent… We are producing great science but what we are not doing is turning great science into great business,” says Woodford.

Indeed, some say there's been an exodus of small businesses from the UK to West Coast America, where the more vibrant culture and greater funding mean chances of success are much higher.

IMPATIENCE

At the heart of the problem is the lack of patience most investors – both fund managers and private people – have.

Early stage businesses often require long-term commitment of capital. But fund managers avoid them because of the City’s obsession with short-term performance. Fund managers and their investors are so focused on the performance of their investments from month to month they tend to chase a quick buck rather than patiently invest capital in a business which may take a while to pay off – and can change society too.

“One of the historical problems was that if you are a start-up company and you were trying to sell your product to a FTSE company, they are not in a rush and you are. You need investors to fund you through to that commercial success,” says Moray Wright, director of technology investment specialist Parkwalk Advisors.

The issue of short-termism has become increasingly troublesome for investment markets, helped along by day traders and media focusing on businesses’ quarterly earnings statements.

“What bothers me is what we are doing in the financial services industry… We think what we are doing is a competitive game and that we have to report quarter by quarter, or even more often,” Anderson says.

PICKING THE WINNERS

Not only is backing early stage companies good for the economy, it’s lucrative for investors. “There’s a great investment opportunity here because nobody is really looking there,” Woodford says.

Anderson acknowledges that not all of these companies will succeed.

“You expect most of them to fail. What matters is that one of them is the next Alibaba,” he says, referring to China’s equivalent of eBay and Amazon rolled into one.

The company netted $25bn from investors when it listed on the US stock market at the end of 2014 in the biggest IPO the world has ever seen.

Anderson highlights biotech company Illumina as one with huge potential. It “has the greatest possibility of changing the world and will make the greatest impact in 10 years’ time,” he says. It’s developing a blood test to detect cancer through subsidiary Grail and has raised more than $100m from investors including Bill Gates.

Anderson also sees a big opportunity in companies which stay unlisted, preferring not to float on the stock market.

They’re a similar kettle of fish, as they’re often overlooked by professional investors. But unlike early stage companies, many of them don’t need the capital. Instead, the owners would rather control the company themselves than go public and leave themselves beholden to the whims of stock market investors.

The best opportunities are in founder-driven companies. “We regard the difference in motivation, vision and calibre of the management is, let’s be honest, huge compared to those [quoted] companies where the manager has three years to prove himself.”

Unlisted companies in the Scottish Mortgage trust

Airbnb
Dropbox
Palantir Technologies
Skyscanner
Spotify
Thumbtack
Udacity
Warby Parker
You & Mr Jones
ZocDoc