RACING COVID'S CAPITAL CHASM
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EDISON EXCLUSIVE
September 2020
The prospects for capital markets,
equities and economic recovery
RACING COVID’S
CAPITAL CHASM
COVID-19’s capital chasm Preparing for the
Chapter 1 Chapter 3
capital chasm
The risks in equity Policy recommendations
Chapter 2 Chapter 4
capital supply and conclusions
Page 2 of 43
EXECUTIVE SUMMARY
While many companies have tapped the equity markets Although quantitative easing (QE) has inflated asset valuations, Demonstrating a strong
for money since the start of the pandemic, the process of it has, so far, provided an effective ‘crumple zone’ for the US and balance sheet will be
recapitalisation has only just begun. The needs of most UK economies. However, due to diminishing returns, QE is unlikely fundamental, while
are currently unmet and, as at September 2020, it is far to be sufficient to prevent the emergence of a capital chasm. investors are expected
from clear that supply will match demand over the next to be most responsive to
six to 18 months. What other actions should governments take? those seeking to grow,
improve pricing power and
The rate of equity capital raises in Europe has fallen by Further extending QE beyond its conventional mechanics, whose stocks will become
nearly 50% in the last decade. In the US, the average especially more forays into equity purchases, could be effective. more liquid after a raise.
number of IPOs has halved from 300 annually 20 years To prove optimal, however, a patient capital fund might need to
ago. There has also been a 31.5% year-on-year decline be larger than market expectations. To de-risk further, companies
in private equity sector activity in Q220. should be speaking to as wide
Further government asset purchases should also be bolstered an audience as possible by
There is, therefore, significant risk of a capital chasm by changes to tax incentives and regulations to encourage more looking further along the long
– a deep gap between the legitimate need for capital privately held capital to flow into SMID recapitalisations. tail of investors. As there is
and its available supply. This brings with it the potential a small number of very large
to rupture both the US and UK economies. To avoid falling down the chasm, we urge all SMIDs to raise institutions, investor relations
sufficient funds at the earliest possible opportunity. Those that efforts must be spread far beyond
Fidelity has already warned that institutions do not have yet to do so should begin planning and executing before the usual suspects, especially in
have sufficient capital for the task at hand and, with conditions worsen. the US where investor appetite for
other sources at a low ebb, the risk of a chasm must foreign stocks is often underestimated.
be deemed significant. Even if a wide capital chasm does not emerge, the flow of capital
may still be restricted to a tighter than usual cohort; investors will
Given investors’ likely flight to safety with any further be more exacting when picking smaller-cap stock recapitalisations
volatility, small- and mid-cap companies (SMIDs) are relative to larger ones. It is therefore important that all SMIDs in
most at risk – as well as up to a third of all employment. need of capital prepare to compete for funding.
Page 3 of 43
Ch.
01
COVID-19’S CAPITAL CHASM
While the process of recapitalising equities has begun,
the needs of most companies have yet to be met.
In the next three to 18 months there is a real risk of a capital
chasm emerging in the US and UK – demand may greatly
outstrip the supply of capital in both territories.
Small- and mid-cap companies are most at risk, but an initial
capital chasm may eat away at the entire economy and trigger
a capital black hole.
Large institutions have warned that they do not have sufficient
capital for the task at hand and, with other sources of capital
at a low ebb, the risk of a chasm emerging is significant.Page 4 of 43
CH. 01: COVID-19’S CAPITAL CHASM
THERE IS MUCH WE CANNOT CHANGE,
INFLUENCE OR EVEN KNOW
As long ago as April, Richard Staveley, fund manager However, the uncontrollable issues are not born With so many unknowns being faced, society
at Gresham House Strategic, made the point to only of COVID. The global financial crisis (GFC) continues to debate lives versus livelihoods
Edison that the length of a nation’s lockdown will of more than a decade ago is also acting as a and the most adept political responses to
affect what kind of recovery and what kind of magnifier in the economic environment on many balance tensions, loosen lockdowns and
economic environment it experiences as it emerges levels, most notably because interest rates remain take strides towards new normalities.
from the pandemic. It is perhaps telling that now, low and nations have not emerged from the low
in September, there remains significant global yield environment it imposed. No one can yet tell where all this will lead.
uncertainty ahead of us, with much anxiety about
the capacity to return to previous levels of It is also difficult to measure the impact – or even
employment and growth. gauge the implications of – the unrelenting pressure
that the pandemic is putting on our collective
We are still learning about and exploring the psyche. Its psychological footprint is magnified by
implications of many factors and constraints that its proximity to the GFC, which was still relatively
are beyond human control. We cannot currently fresh, if not raw, in most minds.
affect the mathematics of COVID’s transmission,
how the virus influences mortality and its ability
to mutate.
There remains significant
global uncertainty aheadPage 5 of 43
CH. 01: COVID-19’S CAPITAL CHASM
WE CAN INFLUENCE THE FLOW OF CAPITAL
Some things are within our control. Governments Capital is the lifeblood of all corporations and, We underestimate the lynchpin role of SMIDs
and central banks have responded to the collapse because demand is necessarily higher during times in our economies at our peril.
in economic activity by providing massive fiscal of economic stress, the availability and willingness
assistance programmes and quantitative easing of capital’s supply becomes critical – not just for A study by the ESSEC Business School and GE
to offset the liquidity crunch, aiming to avert corporates individually, but for the economy as Capital during the last financial crisis (2007–10)
otherwise inevitable large-scale job losses that a whole. of SMIDs in the UK, Germany, France and Italy
would exacerbate the looming recession. The Bank highlighted that while these companies represent
of England’s last Monetary Policy Report expects More specifically, the state into which we emerge a tiny proportion of overall commercial entities
unemployment to soar once the support from will be dependent on how large the capital chasm (between 1% and 2%), they generate one-third
government schemes end, moving from the is for small- and mid-cap (SMID) companies. of private sector revenues and one-third of the
current 3.9% to 7.5%. While larger businesses will use their scale to sit respective countries’ employment.
tight, attract capital and navigate into clearer
However, these programmes are a temporary fix waters, SMIDs are less resilient and have to work
and some of the funds will have to be repaid. harder than their larger-cap peers to access capital.
They don’t have the same access to credit markets,
And so, we contend, there is one factor nation the same leverage on their lending banks and have
states can strongly influence that has not yet to overcome challenges in terms of liquidity and
reached popular understanding, and one that is sufficient equity research coverage. Andy Brough,
critical to the shape of our recovery. The extent fund manager at Schroders, points out that there
to which a capital chasm goes unbridged over are parallels to the last financial crisis: companies The extent to which a capital
the next 12–36 months will likely determine need funds to reach ‘escape velocity’ on their chasm goes unbridged will
the trajectory of our economic outcomes. journey back from crisis to growth.
determine economic outcomesPage 6 of 43
CH. 01: COVID-19’S CAPITAL CHASM
WE CAN INFLUENCE THE FLOW OF CAPITAL
In total, they contributed $1.5tn to GDP and while So now is the right time to evaluate their current
large companies in Europe lost 1.5 million jobs chances and ascertain how the capital might be
during the crisis, SMIDs added 280,000. provided, as the quality of these assesments will
dictate our eventual economic outcomes. We have
Yet we also know that this resilient potential for seen that policy can be swiftly implemented where
future job growth is strongly linked to the need the political will exists.
for capital and the health of the IPO market.
Data from the US from IHS Global Insight show that
92% of job growth occurs after a company lists.
As the extreme circumstances imposed by
lockdowns ease in the UK and across much of the
US, many SMIDs are in a race to cross their own
capital chasms. The most fortunate are not just
hoping to weather the pandemic, but to position
themselves and exploit the growth opportunities
the crisis has created.
92% of job growth occurs
after a company listsPage 7 of 43
CH. 01: COVID-19’S CAPITAL CHASM
NO OBVIOUS WAY ACROSS THE CAPITAL CHASM
Aside from the government, there are three main Given that the overall number of corporates has not According to PitchBook: ’Sellers pressed pause
sources of capital: banks, public markets and private changed significantly, we can unambiguously state on plans to offload portfolio companies, lenders
investment. By the mid-20th century, public equity that more chose to fund themselves without going focused on existing loans and deal makers assessed
markets had joined banks as the primary financiers public. In fact, equity markets were pushed into how best to revise their strategies.’
of global capitalism. second place by venture capital (VC) and private
equity (PE). The climate, therefore, does not seem to suggest
However, there have been significant recent changes. that a surge in private financing will cover a
One of the most significant capital market impacts As the reason behind the shift was the desire to potential capital chasm.
of the GFC was its challenge to the reliance of reduce reliance on bank-based financing, this turns
corporates on bank-based financing. With collective out to be somewhat paradoxical. In many cases, the If the last few months are indicative, COVID seems
opinion having lost faith in banks, policy makers closeness of the relationship between PE firms and to have reversed the preference switch from
and businesses spent more than a decade seeking banks facilitates much higher leverage. And, given private to public equity markets. The evidence for
alternative sources. current economic conditions, we suspect many of heightened capital demand is almost exclusively a
these financing structures will be severely tested public equity phenomenon.
This demand-led search did not show up in the in the coming months.
public markets and IPOs. European rates fell by
nearly 50% in a decade, from 380 per year between There is also good reason to doubt the appetite
1997 and 2007 to 220 per year between 2008 for new private financing in the current climate.
and 2018. In the US, the average number of IPOs PitchBook Data shows that PE deal volumes in
We suspect many private
has halved from 300 IPOs 20 years ago to Europe have fallen to the lowest levels since 2013,
150 IPOs today. declining 31.5% in Q220 on a year-on-year basis.
equity financing structures
will be severely testedPage 8 of 43
CH. 01: COVID-19’S CAPITAL CHASM
NO OBVIOUS WAY ACROSS THE CAPITAL CHASM
During H120, £55bn was raised in Europe through So will the public markets naturally emerge as the There are other reasons to be concerned about
IPOs and follow-ons, with London accounting for way forward? capacity more generally – US small-cap capital
43% of the total. This £23.7bn for H1 is 15% more raising is up year to date, but the public capital-
than the total raised across the whole of 2019. IPO There certainly seems to be deeper potential raising sector focus for US small-cap companies
activity has remained subdued, but since 1 March, following on from the initial reaction. And capital is predominantly biotech and special purpose
£17.4bn was raised in 249 follow-ons in the London raisings after the GFC amounted to £100bn in acquisition company’s (SPACs) dominant, with little
market as companies raced to recapitalise. the UK. activity outside these two areas.
In the US meanwhile, $136bn has been raised in However, the need for funding is greater and more So with banks remaining out of favour and unready,
H220. This is up a not in considerable $109bn for broadly spread now than it was during the financial private equity appearing to be caught in the
the comparative period in 2019. crisis – certainly much more than the £23.7bn raised pandemic’s headlights and doubts over the capacity
to date. And yet the direction of change in the of equity markets, there appears to be the very real
And while the volume of IPOs fell from 92 in H119 past 12 years does not support an argument possibility of a capital chasm – a shortfall in the
to 73 in H120, the reduction is perhaps smaller of for increased capacity in equity markets. funding needed to get us from the present day to
than we might have expected during a global For example, UK pension funds, which used to a brighter economic future.
pandemic. US IPOs raised $26bn and 59 of these absorb about 60% of UK new issuance, are now in
were for sub-$1bn market cap companies, raising de-risking mode and take up only around 20%
a total of $11.6bn. 556 follow-ons raised $110bn, of new issuance.
up from the $76bn raised in H119. Sub-$1bn
market cap companies represented 369 of
these follow-ons, raising $9.6bn in H220, $136bn has been raised in H220,
up from $7.9bn raised in H119.
up a not inconsiderable $109bnPage 9 of 43
CH. 01: COVID-19’S CAPITAL CHASM
NO OBVIOUS WAY ACROSS THE CAPITAL CHASM
This conclusion will not come as a surprise to some well-positioned commentators. Leading institutional As these comments implicitly acknowledge,
asset management leaders have already highlighted that their industry cannot cross this chasm alone: in determining how to cross the capital chasm
we should also remain very conscious that all
• Anne Richards, Fidelity International’s CEO, • Peter Harrison, CEO of Schroders, has stated sources of capital are part of the same ecosystem.
flagged that the asset management industry that companies need more equity, not debt to Corporates remain reliant on bank financing and
would struggle to provide sufficient capital secure jobs and promote growth. He has pushed the PE and VC industries need thriving equity
to fix the solvency issues which public for the UK government to create a £20–30bn markets to function as exit routes. The European
businesses face as they emerge from lockdown. patient capital fund to allow companies to IPO Task Force 2020 report makes a number of
She expressed concern that the scale of the cash maintain investment plans recommendations on how to achieve this, including
required to repay the public funding businesses and protect jobs. simplifying regulatory requirements, creating
have received will be so large that an equity culture in Europe, allowing retail to
it would depress recovery, and emphasised participate more in IPOs, improving tax incentives
that as businesses recapitalise it is important they for IPOs and promoting the provision of equity
are able to access as many pools of research on SMEs.
capital as possible.
Companies need more equity, not debt,
to secure jobs and promote growthPage 10 of 43
Ch.
02
THE RISKS IN
EQUITY CAPITAL SUPPLY
Equity investors have, so far at least, been very supportive
of companies looking to capitalise on growth opportunities,
even in hard-hit sectors.
Moving forward, the potential for volatility is locked in;
uncertainty is the only certainty.
Further lockdowns and slower, flatter recoveries will
greatly increase the risk of a capital chasm emerging.Page 11 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
SEEK AND (SO FAR) YOU SHALL FIND
The initial evidence for the willingness and ability of The crossover point of capital raises in the hardest In healthcare, the London market raised £2bn
equity markets to supply capital to companies during hit sectors by companies looking to fund growth in 40 deals in H120. Not all of this was COVID
the crisis is positive. opportunities was particularly notable. Segro’s related, as the London Stock Exchange (LSE) noted
£680m raise supported European expansion and that only 11 deals – £278m of the funds raised –
As the epitome of contact reduction businesses, Supermarket Income REIT’s oversubscribed mentioned COVID. Synairgen raised £14m to fund
we might well expect the e-commerce cases from £140m raise was to add further grocery assets. its highly successful trial of SNG001, a respiratory
Ocado, Boohoo and ASOS, which raised £1.1bn in drug for COVID patients, while Oxford Biomedica
aggregate, to have been successful. Investors also backed raises such as Wetherspoon’s raised £40m, in part to fund its COVID vaccine
£140m ask where they saw an opportunity for development and manufacture as part of the Jenner
Yet companies in the sectors hardest hit by management to grow the company’s share in a Institute consortium.
COVID-19 – travel and leisure, real estate and retail declining market and thus improve pricing power.
– were able to raise funds as well. Sectors looking Technology was also well supported in London, with
to capitalise on potential growth opportunities – But perhaps more significant as an indicator of total 42 H1 deals raising £4.4bn. With changing market
gaming, e-commerce, healthcare and TMT – were investor appetite and the depth of pockets, there dynamics, many companies raised money to support
also well taken care of. were a number of rescue rights issues as well. Aston their acquisition activities – our notes on Boku and
Martin Lagonda, Ted Baker, easyJet and Kier Group Keywords Studios contain more details.
This success was consistent across all market all raised money to shore up their balance sheets
cap bands. and weather the downturn.
Companies in the sectors hardest hit by
COVID-19 were also well taken care ofPage 12 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
SEEK AND (SO FAR) YOU SHALL FIND
In the UK’s sub-$1bn market cap bracket, funds London
were quite evenly distributed between five sectors,
Number Total capital % of total
each of which benefited from 12–19% of capital- FTSE industry
of deals raised ($m) capital raised
raising volume, including healthcare with 14%.
Basic materials 45 260 7
In the US, the dominant sectors by far were financials
and healthcare, with the weight towards follow- Consumer discretionary 21 552 15
on activity. Together they represented 87% of Consumer staples 2 31 1
total capital raised and 94% of IPO capital raised
by smaller companies – the financials component Energy 19 129 4
being heavily driven by SPAC and investment Financials 44 707 19
fund IPOs.
Healthcare 33 607 17
We find these trends concerning when considering
Industrials 22 481 13
the potential for equity markets filling the
capital chasm. Real estate 7 447 12
Technology 18 290 8
Is the US smaller company capital raising
environment extremely narrow from a sector Telecommunications 2 7 0
perspective due to the lack of willingness in supply?
Utilities 4 160 4
Or have other sectors not been active in testing
investors’ appetites?
Source: London Stock ExchangePage 13 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
SEEK AND (SO FAR) YOU SHALL FIND
US (NYSE & NASDAQ)
Number Number IPO capital FO capital Number Total capital % of total
Market cap range
of IPOs of FOs raised ($m) raised ($m) of deals raised ($m) capital raised
Basic materials 11 45 11 45 0
Consumer discretionary 4 23 180 971 27 1,151 5
Consumer staples 6 113 6 113 1
Energy 5 101 5 101 0
Financials 32 14 8,483 354 46 8,837 42
Healthcare 17 236 2,458 7,003 253 9,461 45
Industrials 28 246 28 246 1
Real estate 1 2 102 171 3 272 1
Technology 5 33 373 463 38 836 4
Telecommunications 2 7 2 7 0
Utilities 1 13 1 13 0
Source: FactsetPage 14 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
UNCERTAINTY REMAINS THE ONLY CERTAINTY
We cannot predict how equity raises will be faring Alliance Bernstein provides a solid perspective of the (skewed) nature of the bounce. Aside from the primary
by the end of 2020 – too may significant factors driver of quantitative easing (QE) creating a vast supply of cheap capital, two trends stand out for stimulating
exist for a reasonable prediction to be made. There investor demand:
is a very large range of credible potential scenarios
– since the unlikely yet abjectly bleak emergence 1. The signal of stringency: 2. Animal spirits in retail, also known as the
of not just a capital chasm but a capital black hole Stimulus packages and the initial easing of Robin Hood effect:
sucking in the rest of the economy, to the far rosier lockdown tempted professional investors back Reports from Australia, China, Korea, Singapore,
situation where no chasm emerges. into the market, relieved to find the Q1 spasm the UK and the US have demonstrated the impact
was short and sharp. Market movement was of retail investors and their active participation
However, when planning for the next six months, then driven by the stringency of lockdown. in the market since March. Charles Schwab had
we can find distinct clues in recent patterns to help Exhibit 1 compares the stringency of lockdown a 126% increase in daily active trades in Q220
understand which situations are most likely to occur. based on an index published by Oxford compared to the same period in 2019, with the
Unpicking that knot is therefore worthwhile. University and the MSCI World Index. 1.62m active daily trades also ahead of the Q120
figure of 1.54m. This risk-embracing activity
Firstly, we must assume that the potential for has been seen around the globe, with platforms
astounding volatility remains. including the trend’s eponymous Robin Hood,
Hargreaves Lansdown, AJ Bell, Plus500 and
With a growing belief that valuations were already IG Group all reporting surges.
stretched, Q120 saw the fastest market drop in
history. Yet stocks then rebounded in Q2 on the
auspices of massive government stimulus packages. Risk-embracing activity has
The MSCI World Index was up 18.5% in Q220,
been seen around the globe
leaving it down 5.8% for H120.Page 15 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
UNCERTAINTY REMAINS THE ONLY CERTAINTY
As well as understanding why the demand occurred, it is also revealing to consider where it was strongest.
This pattern provides particular insight into the likely immediate appetite of investors for capital raises
across geographies and economic sectors. And, in broad terms, these are the key phenomena:
1. US tech led the global charge: 3. Cyclicals outperformed defensives, 4. Healthcare and basic resources performed
The US’s tech-heavy indexes were rewarded for growth outperformed value: strongly in the UK and US markets:
hosting companies facilitating remote working, Exhibits 3 and 4 show cyclicals benefiting from Drilling down in the sectors, Exhibits 5 and 6
e-commerce, in-home leisure and non-contact the market recovery while growth continued show the top five and bottom five performing
digital products and services. to outperform value. The Global Industry sectors in terms of returns from 1 March 2020
Classification Standard (GICS) supersectors to 30 June 2020. Healthcare has been a strong
2. Smaller companies stood out: classify consumer staples, healthcare, telecoms beneficiary of investors looking for ’coronavirus
Despite the segment’s narrow capital raising, and utilities as defensives, while cyclicals stocks‘ while mining plays have been driving the
US small-caps were the best performing, ahead include technology, consumer discretionary and returns in the basic resources sector, in part as
of US large-caps. The UK has also seen smaller industrials. Value stocks include a large number investors look at the improving earnings and
companies performing strongly. While the of banks, where the outlook for lower interest fundamentals as the gold price hits new highs.
FTSE All-Share and the FTSE 100 indexes rates and higher defaults is contributing to the We will look at both these phenomena in
underperformed in Q220, the FTSE AIM All- underperformance. greater detail in subsequent chapters.
Share delivered a 29.5% return, coming close
to the NASDAQ Composite return of 30.6%.
The FTSE AIM All-Share
delivered a 29.5% returnPage 16 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
UNCERTAINTY REMAINS THE ONLY CERTAINTY
Exhibit 1: Global stocks vs lockdown measures Exhibit 2: US leading the returns while the UK underperforming
US Small-caps 25.4
MSCI World Index Value Countries easing lockdown measures (%) MSC
8,500 50 US Large caps 20.5
US Small-caps 25.4
SCI World Index Value Countries easing lockdown measures (%) MSCI World 18.5 MSCI World Supers
Easing
500 50 US Large caps 20.5
Australia 16.8
MSCI World 18.5
Easing
Emerging markets 16.7
0 Australia 16.8 1
China 15.8
Emerging markets 16.7 -
6,500 0 Europe excl. UK 14.7 12.5 1
China 15.8
500 Japan 11.3 -13.8 -3
Tightening
-50 Europe excl. UK 14.7
UK 10.2
Tightening Japan 11.3
-50
UK 10.2
4,500 -100 Def
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20
500 -100 Defensives Fina
Jan 20 Feb 20 Mar 20 Apr 20 May 20 Jun 20
Source: Alliance Bernstein, Lopsided equity rally Source: Alliance Bernstein, Lopsided equity rally
highlights growing market risks, 6 July 2020 highlights growing market risks, 6 July 2020
Health care Personal care, drug and grocery stores
Personal care, drug and grocery stores Media
Health care Personal care, drug and grocery stores
Basic resources Technology
re, drug and grocery stores Media
Technology Health care
Basic resources Technology
Telecommunications Basic resources
Technology Health care
Construction and materials Insurance IPage 17 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
UNCERTAINTY REMAINS THE ONLY CERTAINTY
Exhibit 3: Cyclicals outperforming defensives Exhibit 4: Growth outperforming value
MSCI World
MSCISupersector
World Supersector
returns (percent)
returns (percent) MSCIStyle
MSCI World World Style
Index Index (percent)
returns returns (percent)
12.5 12.5 11.3 11.3 19.7 19.7 26.6 26.6
2Q 2Q 11.8 11.8 24.6 24.6 9.0 9.0 18.9 2Q
18.9 2Q
-13.8 -13.8 -30.2 -30.2 -34.1 -34.1 -18.7 -18.7
1Q 1Q -26.0 -26.0 -14.2 -14.2 -14.7 -14.7 -14.5 -14.5
1Q 1Q
Defensives
Defensives Financials
Financials Resources
Resources Cyclicals
Cyclicals Value ValueGrowthGrowth
Minimum Minimum QualityQuality
volatility
volatility
Source: Alliance Bernstein, Lopsided equity rally Source: Alliance Bernstein, Lopsided equity rally
highlights growing market risks, 6 July 2020 highlights growing market risks, 6 July 2020
Segments
Segments
% of Index
% ofEarnings
Index EarningsKey companies
Key companies Key companies
Key companies
(index weight)*
(index weight)*
MSCI UKMSCI UK MSCI UKMSCI%UK
Seg % Seg
2019 2019
Wgt (%)Wgt (%) 2020 2020
2021 2021
Wgt (%)Wgt (%)
sector sector
Internationals
Internationals 59 59 49% 49%
62% 62%
57% 57%China China 15.8 15.8
6,500 6,500 -
Europe excl.
Europe
UK excl. UK 14.7 14.7
Japan Japan 11.3 11.3
Page 18 of 43
Tightening
Tightening
-50 -50
UK UK 10.2 10.2
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
4,500 4,500 -100 -100 Def
UNCERTAINTY
Jan 20 Jan
Feb REMAINS
2020 Feb
Mar THE
2020 Mar
Apr20 ONLY
20 Apr
May CERTAINTY
2020 May
Jun20
20 Jun 20
Exhibit 5: Top five and bottom five performing sectors in the UK Exhibit 6: Top five and bottom five performing sectors in the US
since 1 March 2020 since 1 March 2020
Health care
Health care PersonalPersonal
care, drugcare,
anddrug
grocery
andstores
grocery stores
PersonalPersonal
care, drugcare,
anddrug
grocery
andstores
grocery stores Media Media
Basic resources
Basic resources Technology
Technology
Technology
Technology Health care
Health care
Telecommunications
Telecommunications Basic resources
Basic resources
Construction
Construction
and materials
and materials Insurance
Insurance I
C
Automobiles
Automobiles
and partsand parts Travel and
Travel
leisure
and leisure F
Travel and
Travel
leisure
and leisure Real estate
Real estate H
I
Real estate
Real estate Energy Energy
D
FinancialFinancial
services services Banks Banks F
D
-50 -50 0 0 50 50 -25 -25 0 0 25 25 S
E
E
Source: Refinitiv Source: Refinitiv M
M-13.8 -30.2 -34.1 -18.7 1Q -26.0 -14.2 -14.7 -14.5
UK 14.7
pan 11.3
UK 10.2 Page 19 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
Defensives Financials Resources Cyclicals Value Growth Minimum Quality
UNCERTAINTY REMAINS THE ONLY CERTAINTY volatility
In retrospect, as ever, the above trends seem We already see this reflected in the earnings of earnings contribution to the index from
obvious. And, from a smaller-cap perspective composition of the FTSE 100, with large pre-COVID levels (2019) at the expense of
y stores of needing to raise equity capital, it is relatively international companies increasing their share domestically focused and energy companies.
cheering, added to which we must remember
Media
that, historically, small- and mid-cap stocks have
nology Segments % of Index Earnings Key companies Key companies (index weight)*
outperformed as the economy moves back into
th care recovery. While noting that SMID stocks were MSCI UK MSCI UK % Seg
ources Wgt (%) 2019 2020 2021 Wgt (%) sector
hit harder in the Q120 falls, we did see this in
urance the Q220 performance. Internationals 59 49% 62% 57%
Consumer staples 14 21 17 16 95 Diageo, BAT, Reckitt, Unilever
leisure Financials 15 14 15 13 93 AstraZeneca, Glaxo
estate However, given the depth of the economic Health care 8 13 11 8 83 HSBC, StanChart, Prudentia
catastrophe, there is a debate that this time it is Industrials 7 8 8 6 62 RELX, BAE, Experian, Ferguson
Energy
different. Small- and mid-cap outperformance Domestics 16% 15% 14%
Banks Financials 7 5 5 3 63 Lloyds, RBS, Legal & General
is predicated on a recovery and if this recovery
Discretionary 3 2 3 2 53 Next, Persimmon, Whitbread
-25is more protracted,
0 then as Tom25 Stevenson, Staple 2 3 2 1 73 Tesco
fund manager at Fidelity points out ’in a slower, Energy/Materials 27% 17% 21%
flatter recovery, investors will continue to favour Energy 16 3 10 12 100 BP, Royal Dutch
big reliable companies with pricing power. This Materials 11 14 11 9 77 Rio Tinto, BHP, Glencore, Anglo Am
argues for larger rather than smaller companies.’ MSCI UK 71
We conclude that until there are tangible signs of Source: Bloomberg Intelligence
a recovery, investors are likely to focus on pricing Note: Domestics have 70% of sales in the UK; Internationals have 70%+ abroad * Green companies
power, balance sheet strength and stock liquidity. have biggest contribution to estimated 2021 EPS growth. As of July 15, 2020Page 20 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
THE BASIS OF ONGOING VOLATILITY
While we can divine a broad list of favoured In fact, the pattern of Q2 returns suggests five clear sources of volatility in H220,
investment characteristics from recent history – with stark implications for the likelihood of the emergence of a capital chasm:
and smaller-cap companies in tech and healthcare
with a strong balance sheet, good liquidity and 1. The risk of a continued first – or even second – 2. Removal of government support:
US exposure have the most to be thankful for – wave, fuelling stringent lockdown: As employment and furlough schemes unwind,
nothing can fundamentally override the crisis There is no reason to believe the correlation as deferred taxes have to get paid back and as
situation and the potential for further extreme between market performance and lockdown interest payments start to kick in on government
volatility. There is no room for complacency. stringency will weaken. Nations which cannot support loans, we would anticipate further
control the virus without stringent lockdowns job losses with a resulting knock-on effect on
will therefore be less attractive for capital. consumer demand. All of the above lead to
While a case can be made to invest in some earnings growth being depressed. The global
of the sectors most affected by COVID economy is going through a major recession
at distressed valuations (hotels, airlines, and there are likely to be negative surprises as
restaurants, entertainment venues and retail companies come to report earnings in H220.
outlets) on the basis that consumer behaviour
has a short memory and by December you may
see a return to more normal levels of activity,
this is unlikely to be the case if we move back
into a more stringent lockdown in the winter.
Nothing can fundamentally
override the crisis situationPage 21 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
THE BASIS OF ONGOING VOLATILITY
3. A rush of earnings data: 4. Growth in concentration risk: 5. Changes in the way we do things:
Next, which we see as a role model in strategic As investors looked for liquid defensive names able Unlike the financial crisis, consumers’ habits and
assessment, set out in its earnings release a to grow and ride out the coronavirus impact, there preferences have changed during confinement
section on ’forecasting the unforecastable year‘. has been a crowded trade as institutional and and will leave some businesses stranded unless
With so much uncertainty, many companies have retail investors put money into the same stocks. they quickly develop new ways to meet their
withdrawn guidance and investors are without This is most apparent in the technology sector. customers’ needs. The challenge for both
the earnings data to make valuation assessments The largest five US stocks (Microsoft, Apple, corporates and investors is correctly predicting
and monitor earnings revisions. This will not end Amazon, Alphabet and Facebook) accounted for what the future might look like; do we start
well if investor assumptions are shown to lack 36.9% of the entire Russell 1000 benchmark as returning to our places of work, do we start to
sufficient imagination to capture the extent of at 30 June 2020. Our equity strategist Alastair fly as much as we used to, do we eat out as much
the downturn. George reflects that investors have responded by as we used to?
creating a new class of ’digital defensives‘ which
have strongly outperformed the overall market.
This in itself poses a risk as historically such
concentrations have reversed, and as Alastair
notes, the valuations for the technology sector are
at a five-year high on a forward price to book basis.
While these digital defensives have benefited
from the shift to working at home, they are not
immune to an economic downturn and if those
homeworkers start to lose their jobs. Investors are without the earnings
data to make valuation assessmentsPage 22 of 43
CH. 02: THE RISKS IN EQUITY CAPITAL SUPPLY
WHAT WILL THE FUTURE HOLD?
The only conclusion that can be drawn is that the For instance, given the level of uncertainty and the The question for SMIDs then becomes: ‘How could
risk factors and system complexity present in the very high stakes, a single dramatic academic paper we increase our chances of being in that cohort
current situation are such that even the near future could convince governments to withdraw support while markets are in the grip of a capital chasm?’
is impossible to predict. too early; or the winter might bring a renewed wave
of a mutated virus which will not be responsive And the question for governments is:
On the plus side, current levels of capital requirements to the vaccines or treatments about to become ‘How do we prevent or, as a last resort,
have been met. While high-profile names are going available; or earnings data could reveal that SMIDs fix the emergence of a capital chasm?’
into administration, especially restaurants and retail are less well-placed to survive the pandemic than
on the High Street, there has been no general collapse the market had been assuming.
in the availability of finance for viable businesses.
In any of these and innumerable other scenarios,
All of this points to the very worst scenario remaining investors may swing behind the relative safety of
possible but being unlikely. And the same can be larger stocks and be highly selective on the capital
said for the very best outcome. However, some of funding requirements of SMIDs. It might not be that
the seemingly more likely outcomes in between the supply of capital would dry entirely, but it might
the extremes do include a capital chasm for SMIDs. be so constricted so as to be only available to a very
There is a plethora of circumstances that could act tight cohort.
as a trigger.
Even the near future is
impossible to predictPage 23 of 43
Ch.
03
PREPARING FOR
THE CAPITAL CHASM
The most effective way to avoid the chasm is to raise The surest way a SMID can avoid the risk of a capital chasm is
equity capital as soon as possible. to raise sufficient funds at the earliest possible opportunity.
Ocado and dozens of others have clearly demonstrated how
With high demand for equity capital, it will be important to find
to execute such a strategy.
less well-known pools that other businesses will not exploit.
The US is the world’s largest equity market and is therefore However, many smaller businesses in other sectors were unable
of particular importance – it has the deepest pool of investors, to make such a positive and immediate response. Given this,
with long-tail distribution across both geography and scale. how should they now go about it?
The most successful equity stories are likely to emphasise The first task is to understand the investor and market
pricing power and stock liquidity. landscapes we are facing into.Page 24 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
HITTING THE RIGHT MARKET
The London Stock Exchange’s Alternative Investment Exhibit 7: Average market capitalisation Exhibit 7a: Market capitalisation distribution
Market (AIM) and the US Nasdaq have historically at IPO ($m) – June 2020
supported smaller, growth businesses in the UK
and US. As AIM celebrates its 25th anniversary, it is AIM Nasdaq AIM Nasdaq AIM Nasdaq
important to understand and exploit the changing
market conditions and dynamics between them. 2015 95.92 504.88 $0–5m 123 14 15% 1%
2016 100.63 504.24 $5–10m 94 52 11% 2%
A key structural difference is their orientation.
Nasdaq has a strong bias towards larger companies, 2017 103.69 450.12 $10–50m 266 430 32% 16%
whereas AIM - despite a modest increase in the size
2018 112.17 846.84 $50–100m 127 261 15% 10%
of companies completing IPOs – remains focused
on smaller businesses. 2019 140.72 1,089.95 $100–500m 172 838 21% 31%
$500m–$1bn 25 306 3% 11%
$1–5bn 21 527 3% 19%
$5–10bn 1 113 0% 4%
$10bn+ 0 204 0% 7%
Total 829 2,745 100% 100%
Source: Dealogic Source: London Stock ExchangePage 25 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
HITTING THE RIGHT MARKET
Despite this difference, AIM and Nasdaq are often Of course, both AIM and the Nasdaq have Key, therefore, to maximise benefit from an existing
thought of as competitors, whereas they are in fact drawbacks for Small-mid capitalised companies listing on either market, especially when looking
entirely complementary. AIM is the sweet spot for (SMIDs). Unattractive valuations and a lack of for a follow-on, is to reach far beyond well-known
companies valued between $30m and $500m. liquidity leave some frustrated with AIM. holders of AIM and Nasdaq stocks. SMIDs should
It serves as a bridge to larger, more liquid indices Nasdaq, meanwhile, is relatively expensive also be focusing on less well-accessed pools of
such as the London Main Market or Nasdaq. And and more heavily regulated. Its investor base equity capital.
AIM’s attractions should be carefully considered. also has a reputation for being rather fickle,
With less burdensome regulatory requirements, with retail holders always hungry for positive
it offers small issuers the benefits of a longer-term, news to justify holdings.
buy-and-hold investor base that understands
smaller companies.
In the US, by contrast, the abundance of Venture
Capital (VC) and Private Equity (PE) investment
means companies typically list on Nasdaq later in
their business cycle, and at much larger valuations.
As Exhibit 1 shows, the average market cap of a
Nasdaq IPO was just over $1bn in 2019.
AIM and Nasdaq are in fact
entirely complementaryPage 26 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
MAPPING OUT SOURCES OF EQUITY CAPITAL
To access as much capital as possible, it is vital to have Exhibit 8: Ownership of London-listed stocks, 2018
a map of the territory being searched. Yet comparing
the equity landscape across European countries and Charities
the US is challenging. The data sources are compiled Banks
with different lag times, actual beneficial ownership Investment trusts
is masked by nominee accounts and there is no Private non-financial companies
like-for-like standard across these two territories.
Public sector
To provide a picture of equity ownership, we focus
Pension funds
on the UK and draw some comparisons to European
and US data. Insurance companies
Other financial institutions
Unit trusts
The map of stock ownership in the UK
Individuals
The latest release of data from the UK’s Office for Rest of the world
National Statistics (ONS) shows ownership for the 0 10 20 30 40 50 60
year 2018 (see Exhibit 2) and covers incorporated % of UK equity ownership 2018 2012
companies listed on the London Stock Exchange.
Source: UK’s Office for National Statistics
In terms of making sense of what this means for capital
raising activities ahead of the potential chasm, there
are several trends to note. Three segments are on US holdings of foreign equi�es (US$tn) It is vital to have a map ofUS$bn
the
the up proportionately, while two are in decline. 10 territory being searched50,000
9
8 40,000Page 27 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
MAPPING OUT SOURCES OF EQUITY CAPITAL
London is a deeply international market: Retail investors matter: Institutions are persistent and rather consistent:
There is a significant and increasing flow into UK UK-based retail investors account for 13.5% Institutional ownership, an aggregate of unit trusts,
stocks from international investors, both institutional ownership. This has also been growing, up from investment trusts and others, accounts for 19.1% of
and retail. ONS data has international ownership 10.6% in 2013, with platforms such as Hargreaves overall ownership, up just 1.3% from 2012, and shows
at 54.9%, with the US and Canada accounting for Lansdown, AJ Bell and Interactive Investor no particular skew for large-cap or SMID equities.
about half of this. There is a general consensus that reporting growth in account openings and inactive
UK stock prices, held back by concerns over Brexit, accounts reactivating. Retail investors are more What is notable for the small- and mid-cap sector
have looked increasingly attractive from overseas. active in SMIDs, and hold 25% of AIM, c 20% of in the UK is concentration. Citywire data has
While the ownership is skewed towards larger stocks non-FTSE 100 stocks on the Main board and yet a total of 425 UK equity funds, with 323 fund
– with international holders of the FTSE 100 at only 11.3% of the FTSE 100. managers. For small-caps, there are 52 funds
57.1% – AIM and the non-FTSE 100 Main board and 63 managers and for mid-caps there are 17
also have c 48% of their stock held overseas. However, UK retail is underweight to other markets. funds with 18 managers. Mergers (Premier and
The average for Europe (including the UK) is 15.6%, Miton) and closures (Woodford) are expected to
the ASX reported 31% retail ownership in 2017 lead to further concentration. By contrast, in the
with growth in younger investors in particular, US mutualfund.com reports on 521 US small-cap
while the US has individuals owning 37.6%. The funds and 393 US mid-cap funds.
pattern of shifting away from financial brands to
self-investing since the financial crisis is thought
to be one driver of the growth. The growth in
retail participation during the COVID-19 crisis
is expected to grow this share further globally. UK retail is underweight
to other marketsPage 28 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
MAPPING OUT SOURCES OF EQUITY CAPITAL
Pension funds’ shareholdings are dwindling: The map of stock ownership in the US Dominance from longevity and scale:
UK pension funds have been reducing their exposure The US has 45% of the $46.7tn global regulated
to UK equities, with their share falling to 2.4% in The US equities market is, by some margin, the funds market, according to the International
2018, down from 4.7% in 2012. Pension funds look largest in the world, accounting for c 40% of total Investment Funds Association 2019 yearbook.
to match assets to liabilities and, as the baby boomer world market capitalisation. With this scale comes Mutual funds have been available since the 1920s
generation starts to retire, there has been a switch a culture of owning equities; over 50% of US and the regulatory framework in place since 1933.
from equities to bonds. households own equities and there is a rich Funds growth has also been stimulated by 401(k)
ecosystem servicing the market. And it is important plans, a wide and available pool of funds (eg ETFs)
Insurance companies are withdrawing: for SMIDs to bear in mind that US investors are alongside stock market growth and
increasingly looking to diversify from the home dividend reinvestment.
Insurers have also been reducing their exposure
market. Today c $9tn of their holdings are in non-US
to UK equities. Their peak equity ownership was
equities, with the 12% UK share a disproportionately The long tail of capital pools continues to grow:
in 1997, when they accounted for 23.6%. By 2018,
large percentage relative to GDP.
their share of overall ownership was at 4.0%, While the US represents an unparalleled breadth
down from 6.2% in 2012. Changes in the insurance and depth of overseas capital opportunity for UK
These are the key US trends to note:
company solvency regime have put equities at a and European stocks, it does not follow that it is easy
disadvantage; they have to take a 39% charge to to access. The market operates across a large, ever-
own shares in listed equities, while they only take a changing and highly fragmented landscape, which is
15% charge for debt instruments and no charge for complex to map and difficult to reach en masse.
treasury bonds issued by eurozone member states.
Changes in the insurance company solvency
regime have put equities at a disadvantagePage 29 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
MAPPING OUT SOURCES OF EQUITY CAPITAL
For instance, single family offices are in the ascendency. The rise of retail continues: Exhibit 9: Private wealth breakdown by state
Campden Wealth reports a 41% increase between US retail AUM is significant. SEC Chair Jay
2017 and 2019, with 3,100 offices and an average
Charities
Clayton outlined in a speech in 2018 that
Other
AUM of $852m. This suggests a total AUM of $2.6tn
Banks 43 million US households have a retirement California
in the segment,trusts
Investment with 38% allocated to equities. account and 53 million own at least one New York
Based on data from Barron’s, we estimate that the
Private non-financial companies mutual fund, with regulated advisors having Illinois
US private wealth managers segment has AUM of a total AUM of $15.6tn. There has been very
Public sector Texas
c $3tn. In comparison, UK private wealth AUM is active participation in the market by retail Georgia
c £1.1tnPension
based funds
on 2019 data from Compeer. investors since markets sold off in February
Insurance companies Florida
and March. There has been significant account
The
Other geographical
financial presence of these pools of capital is
institutions
opening at retail brokers (Robin Hood, Schwab,
New Jersey
also more Unit
dispersed
trusts across the US than is generally E-Trade, Interactive Brokers, Ameritrade) as Massachusetts
realised, as shown in Exhibit 9. And with c 3,700
Individuals retail investors actively participated in buying Pennsylvania
FINRA registered firms with c 156,000 branches in
Rest of the world sold-off stocks in April and May, with 4.5m Ohio
the US and c 29,500 registered investment advisors, new accounts
0 10 20 30 40 50 60opened in the first half of 2020. Connecticut
it becomes clear that capital is not only concentrated In a recent2012
interview, Philip Berlinski, COO of
% of UK equity ownership 2018 0% 5% 10% 15% 20% 25% 30%
in the traditional financial centres. Global Equities at Goldman Sachs, made the
point that if you examine the baskets of stocks
Source: Edison Group
that the retail investors have been buying,
most of the activity is in small-cap names.
S holdings of foreign equi�es (US$tn) US$bn Households Capital is not only concentrated
Ins�tu�ons
0 50,000
in the traditional financial centres
9
8 40,000Other financial institutions
Unit trusts
Individuals
Page 30 of 43
Rest of the world
0 10 20 30 40 50 60
CH. 03: PREPARING FOR THE CAPITAL CHASM % of UK equity ownership 2018 2012
MAPPING OUT SOURCES OF EQUITY CAPITAL
Exhibit 10: US equities dwarf other markets by capitalisation Exhibit 11: The growth in non-US stock ownership
US holdings of foreign equi�es (US$tn)
10
Australia
9
Other developed markets
8
Canada
7
UK
6
Hong Kong
5
Japan
4
China
3
EU27
2
Emerging markets
1
US
0
0 5,000 10,000 15,000 20,000 25,000 30,000
2018 market capitalisa�on US$bn 2004 2006 2008 2010 2012 2014 2016 2018
Source: World Federation of Exchanges Source: Federal Reserve Source of Funds AccountsNew Jersey New Jersey EU27 EU27
Massachusetts Massachusetts Emerging markets Emerging markets
Pennsylvania Pennsylvania US US
Page 31 of 43
Ohio Ohio 0 5,000 10,000 015,0005,000
20,00010,000
25,00015,000
30,00020,000 25,
Connecticut Connecticut 2018 market capitalisa�on
2018
US$bn
market capitalisa�on US$bn
CH. 03: PREPARING FOR THE CAPITAL CHASM
0% 5% 10% 0% 15% 5% 20% 10%25% 15%30% 20% 25% 30%
MAPPING OUT SOURCES OF EQUITY CAPITAL
Exhibit 12: Households are one-third of equity participation Exhibit 13: Foreign ownership by country
US$bn
Households Ins�tu�ons
Households Ins�tu�ons
50,000
40,000
Other Other 16 16 Cayman Islands Cayma
Netherlands Netherlands 34 34 United Kingdom United
30,000
12 12
20,000
Germany Germany % % Japan Japan
France France 10 10 Canada Canad
3 3
4 6 4 6
10,000 Ireland Ireland 5 5 5 5 5 5 Switzerland Switze
0
2009 2010 2011 2012 2013
2009 2014
2010 2015
2011 2016
2012 2017
2013 2018
2014 2015 2016 2017 2018
Source: Federal Reserve Source of Funds Accounts Source: US Department of Treasury
US$bn
Households Ins�tu�ons
Households Ins�tu�ons
50,000
40,000Page 32 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
USING THE MAP FOR CAPITAL RAISES
Knowing where capital can be found is obviously A successful equity story must, therefore, include Many of the investors we talk to – especially
a distinct advantage. But it is far from sufficient to a clear and confident view of the balance sheet those who have participated in recent capital
ensure an optimal capital raise and avoid the impact on a pre- and post-money basis. And all financial raises – report that successful equity stories
of the capital chasm. projections must be supported by credible revenue are emphasising how the finance will be used to
and cost models that demonstrate how the consolidate and improve a business’s pricing power.
SMIDs would be well-advised to take other preparatory business will perform in the current environment. Markets are also proving responsive to the idea
steps as well. The next primary building block is Companies should anticipate many questions: that by virtue of the stock becoming larger and
crafting the right equity story. What advantages does the business have during more powerful, its liquidity will improve as well.
the pandemic? What adaptations have been proved Given that market power and liquidity are two
To create the most compelling narrative, listed to work and will continue to be strengthened? underlying reasons why investors may rush away
companies must put themselves in the position of the What other changes have yet to be made to from SMIDs and towards larger equities, being
investors they will be courting. What is it they need? produce the projected results? What contingency able to demonstrate these properties may prove
What’s their motivation to buy any particular equity? and mitigation plans are in place if further particularly critical.
headwinds are encountered? What are the
Right now, as the emergence of digital defensives remaining risk factors?
has demonstrated, the baseline need for investors is
companies with business models and balance sheets
that will emerge strongly from the COVID-19 crisis.
The primary building
block is crafting the
right equity storyPage 33 of 43
CH. 03: PREPARING FOR THE CAPITAL CHASM
USING THE MAP FOR CAPITAL RAISES
Another trend worth considering is the environmental, However, all of this may still prove insufficient.
social and corporate governance (ESG) narrative. Once validated, the equity story has to reach the
Ahead of the crisis there seemed little doubt that many right screens. Financial PR certainly has a role
investors were moving towards ESG methods of to play here but given the scale of the potential
investing, not least because the trend was delivering investor universe, the extent to which it is scattered
above average rates of return. And as attention and the speed with which the equity story needs to
moves beyond the sole focus of COVID-19, we be communicated, investor relations (IR) is the key.
expect ESG to re-assert itself forcefully, not least
because it is considered a proxy for both resilience And clearly your IR team needs to be armed with a
and growth potential. detailed global capital map, with contacts reaching
far beyond large institutions and particularly strong
Having created an attractive, credible and deliverable representation in the US, UK and EU. We expect
equity story, the next step is to have the work many SMIDs will make the mistake of targeting
validated. Any stock that is not well covered by too narrow a pool of capital.
traditional brokers – and many SMIDs now suffer
this fate – will need to find alternatives. It is
needless to say that Edison, as the originator
of the issuer-funded research model, is one
such alternative.
We expect ESG
to re-assert
itself forcefullyPage 34 of 43
Ch.
04
POLICY RECOMMENDATIONS
AND CONCLUSIONS
Quantitative easing (QE) has inflated asset valuations and dampened
price as a signal of underlying value, but has been very effective
in acting as a ‘crumple zone’ for the US and UK economies.
However, QE in its present form is likely to be insufficient
in preventing the emergence of a capital chasm.
The extension of QE to equity purchases, especially at larger
than expected scales, could prove effective.
Changes to regulations, tax incentives and other government policies
– especially towards equity capital – should also be used to
increase supply.Page 35 of 43
CH. 04: POLICY RECOMMENDATIONS AND CONCLUSIONS
QE HAS PROVEN EFFECTIVE SO FAR
Before we consider further policy recommendations, The Fed has also added corporate bonds to its stock Given the BoE is allowing its asset buying programme
it is important to acknowledge that the fiscal response of asset purchases – maxing out at 10% from a single to undershoot targets by £50bn, many are hoping
of most central banks and many governments has been issuer and 20% of ETFs with a broad portfolio – that an additional £100bn – which some commentators
sufficient so far. When looked at in the broadest of and is focusing heavily on forward guidance. It has expect to arrive in the autumn – is indeed forthcoming.
terms, it is clear that quantitative easing (QE) has indicated that it is willing to tolerate inflation moving
been effective in keeping the capital taps turned on. above its 2% target and has created expectations that
close-to-zero interest rates will persist for five years.
It is also true to say that QE has inflated asset
valuations and dampened price as a signal of Others have followed this lead so that, across most
underlying value to investors – with implications major economies including the UK, US and EU,
that are only now starting to play out. However, we expect continued support and relatively stable
given the scale of economic collapse triggered by implementation of the policies already set out.
the pandemic and lockdowns, these side effects
are entirely preferable to the malaise. In the UK, as of August 2020, the Bank of England’s
(BoE) asset purchase target was at a smidge below
The US has led the world with its entirely emphatic £750bn, with interest rates being held at a record
response, convincing general consensus that enough low of 0.1%. The British picture is perhaps tinged
has been done to avoid domestic deflation. In the with slightly more risk than the US – the level of
process, federal debt is now set to exceed 100% of enthusiasm on the part of policymakers for QE, QE has inflated
GDP and the Federal Reserve (Fed) has increased its despite the UK economy sustaining more damage asset valuations
total assets to $7tn, up by $3tn since the start of 2020. than most, appears lower than that of the US – and dampened
and the EU, with its joint €750bn borrowing plan
price signal
on top of national schemes.You can also read
