The Capital Conundrum

The Wall Street Journal has a front page story today titled Huge Flood of Capital to Invest Spurs World-Wide Risk Taking (subscription required- ugh).

Reading this piece makes me wonder why all that capital isn't being applied to productive uses like building infrastructure in the developing world or finding new sources of non-petroleum based energy.

The Journal story suggests the capital is flowing into ever riskier and leveraged bets in search of returns.

I wonder if the globilization phenomenon combined with the ongoing transition to an information based economy from a manufacturing based economy means that the capital requirements of innovation and forward progress are going down, leaving excess capital sloshing around the globe in search of returns that can't be delivered.

Thoughts?

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Posted November 3, 2005 in Venture Capital and Technology

Comments

the global wealth creation over the past 30yrs will continue to be driven by the development of mortgage markets and release of capital from land. as we monetize land (the only truely limited resource) and seek new forms of investment these imbalances will work themselves out. people are building infrastructure - take a look at China and India and South Korea and Vietnam over the past decade. check out the best performing stock markets of the last five years (Egypt, Turkey, Dubai), the US scaring oil money from US investments back into their homelands at the time of its greatest profitability is just part of globalization and actually will be the best weapon we had in the war on extremism. thats because capitalist ideals will force democracy up. capitalism is unfettered and willl seek the lowest common denominator to exploit resources and people then rise up and use democracy as a function of capitalism to balance power and right the wrongs capitalism exploits.

Posted by: oliver | Nov 3, 2005 9:22:20 AM

I think everybody should invest in TEDSTOCKS, a very high risk, low return bond. In fact it's a no return bond, but you get a weekly newsletter that tells you how I'm spending your money, photos of me gambling on the Riviera, neat stuff like that.

Posted by: jackson | Nov 3, 2005 10:17:04 AM

I come from a different world of business - one where business owners tend to keep their companies for life. Successful ones make good to great livings but it comes from profit not cashing out their equity or doing IPOs. To this world, the whole concept of "capital" looking for something to do and the mechanism of VC workings smacks of opulent excess. Much like a fur upholstered Rolls Royce would look to the driver of your "average" Lexus.

In "Wealth & Democracy" Kevin Phillips makes the point that there is a historical pattern of societies moving from goods based to finance based economies, because once the basic needs for goods have been satisifed, more money can be made dealing in financial instruments. I was suprised to learn this pattern has existed since the 1500's. But according to him, the increase in wealth is accompanied by an increase in the disparity between rich and poor and this ultimately leads to the society at the top of the economic hill being supplanted by another. As the British Empire was supplanted by the Americans. The pattern played out in Dutch and Spanish empires before that.

Hard to say what effect globalization will have on this pattern, but parts of it are troubling.

Posted by: John Seiffer | Nov 3, 2005 10:36:42 AM

hey fred, i think maybe you posited a simple question -- if capital is abundant, why isnt it going to build infrastructure in the many places where such is obviously needed.

isnt the answer to that exactly what you say -- because capital these days chases returns where it is apparantly predictable or at least relatively easy and short term? in the 19th century, wild eyed risk taking VCs (of the time, say Carnegie and Stanford) and entrepreneurs (Rockefeller and Edison) poured money into infrastructure because it was the software and derivitaives of its time. there was little if any pure capital or security plays to be made. today, there are so many such opportunities, and the risks inherent in developing the undeveloped world feel so unquantifiable, that capital stays away.

think even a major league successful private equity investor like you could raise a fund to build infrastructure in africa?

also, isnt it the case that corporate capital *is* developing infrastructure in undeveloped parts of the globe? spearheading this, of course, is energy infrastructure development, e.g. the oil companies have invested hundreds of millions of dollars in the areas surrounding the Black and Caspian seas. politically incorrect perhaps, but constant and great risk/reward characteristics, and typically the door opener to all other sorts of infrastructure development, e.g. highways, airports, ports, housing, electrical grid, etc...

Posted by: steve | Nov 3, 2005 11:12:50 AM

hell, we'll take some of it.

Posted by: charlie crystle | Nov 3, 2005 12:31:39 PM

Low interest rates and global trade imbalances are the main reasons why there is so much excess capital floating around, particularly here in the US (and low interest rates are in fact fueled by the global trade imbalances, for that matter). This will come to an end sooner or later, hopefully sooner so that the global re-adjustment that Stephen Roach is always talking about will involve as little pain as possible.

Lack of infrastructure and other investment in the developing world is an issue of clean government and solid institutions that support property rights than anything else. This has been proven over and over again as countries with strong institutions that support property rights and clean government power ahead economically.

Lastly, it seems like everyone I talk to these days is somehow involved in alternative-energy investments - that definitely seems like a pretty hot sector right now.

Posted by: Stephen Bronstein | Nov 3, 2005 1:29:39 PM

read this if you get a chance

http://news.independent.co.uk/business/comment/article324370.ece

Posted by: Jezza | Nov 3, 2005 5:21:05 PM

Long-time lurker, first-time poster.

_Some_ of that capital _is_ being put into 3W infrastructure investments of various kinds, and there are lots of dollars invested in alternative investments, an increasing number as petroleum prices increase, whether there are "enough" so invested is another question.

But IMHO this isn't some sort of Marxian crisis of capital - it's an in-between state where we are reaping returns from technology investments, before the next tornadoes hit.

This is why I'll never make a living as a pundit or a reporter - my first reaction to these "big revelations" is "what's the big deal?

Posted by: Ray | Nov 3, 2005 5:59:24 PM

Fred,
You pose a question that a bunch of us have asked for a very long time and are trying to find a reasonable answer to. Economic theory predicts that capital should flow from where it is cheap and plenty to where it is not (developing countries). Instead, we currently have a global scenario where money actually flows from developing countries to the U.S. (those infamous dollar reserves). So yeah, there has to be a damn good reason why a lot more of this cheap capital is not being employed to build infrastructure in Asia or S.E.Asia, where the risk is arguably lower than in sub-Saharan Africa.

I will probably ask you for your thoughts once we organise some of these ideas into a research paper or some such. In the meanwhile, you (and your readers) could check out the Thousand Hills Venture Fund (www.thvf.com/), the first for-profit, Africa focused V.C. fund that I know of. It was founded by a friend, Rob Fogler, and will start by making an investment or two in Rwanda in the next couple of months. Heaven knows if it'll work, but at least it's a good start.

Posted by: Reuben | Nov 3, 2005 9:14:05 PM

Interesting. Fred, what investment(s) is your fund looking at making for building infrastructure in the developing world or finding new sources of non-petroleum based energy? Have you seen any good plans for this lately?

Posted by: Scott | Nov 4, 2005 1:37:08 AM

I come from South Africa where property has shown almost 300% returns over 5 years ... some-one is investing in & reaping returns in Africa (mostly Europeans) ... but as SA has shown, you have to remove the risk first. In terms of S.African potential though, its just the tip of the ice-berg & Moz. and Bots. seem poised for massive growth.

More investment is going offshore today than ever. Over the course of 18 month in 2003/4, I saw neon strip-malls and roads replace dusty rubbish-heaps in Delhi, India - the economic rise of that country has been fasinating & I guess China looks the same. Reminder: within the next decade, the US will no longer be the world's #1 super-power & that aint happening without infrastructure.

Spreading Capitalism to the 3W is an indirect investment in its Infrastructure more effective than any direct investment in its governments could ever be. And its happening today on an unprecidented scale.

If the US VC community wants to contribute to the global economy, all it needs to do is keep investing in great companies but drop the fear of travel & invest outside of their zip-code - I'm convinced that you can't both invest in a niche and a geography anymore - at least not if you want to pick the winners! (?skype?)

Posted by: David Gibbons | Nov 4, 2005 12:58:19 PM

Fred,

This is certainly a very interesting topic. I for one, am on the planning stages of building part of the infrastructure for India. We are teaming up with the Indian Institute of Technology, which as the best minds in the country.

It might have been mere coincidence, but the topic of investment and funding has been the focus of discussion at the moment.

If your firm has an interest in investing on such projects or if you know of any firms that do so, I'd be interested in hearing about it. Thanks Fred.

Posted by: Vijay Anand | Nov 4, 2005 1:21:07 PM

In the western countries, the requirement for capital in IT industry will become even smaller:

a) Open Source & high-perf commoditized servers allow to build very large IT/web companies with investment at 1/10th or even 1/100th (1/1000 th?) of what it costed 10 years ago (Google invest in machines below 1'000 USD, fully open-source equipped - Of course, they have more than 100'000 of them but the resulting 100 millions bucks are nothing, just 20% of a current quarter of net earnings...)

b) now think about web 2.0: Google Adword, Maps and other web 2.0 services will even drive those investments lower: the infrastructure that new companies need to create internally by themselves will tend to be close to nothing. They will generate their added-value on top of remote services not on top of software and hw that bought and included in their infratstructure

That means that those new companies will require few capital to create their infrastructure. Their balance sheet will become very thin on tangible assets. Their gross margin will also probably decrease as they need to purchase more services "in real-time" rather generate their value from the sw/hw (bought through investments) in their internal infrastructure.

But, their net profitability will get much bigger as they got rid of all (now) superfluous internal infrastructure & organisation

The issue that I can see for VCs: those companies will operate on lower scale, ie. in very specialized niches probably meaning that VCs will need more companies in their portofolios to allocate their funds. That also means more attention (and bigger teams ?) from their side....

Are my toughts (trend for smaller investments) backed up by official statistics of the VC branch?

didier

Posted by: d.durand | Nov 5, 2005 12:55:54 PM

you'll notice that sovereign risk is a common factor amongst places that aren't getting infrastructure development.

I have a great plan to invest $15B in Venezuela. With your MBA hat on, you'll notice that investing in a country with a president who is promoting his socialist revolution is a bad idea. Spielberg isn't doing major business in Cuba either, despite his admiration for Fidel.

Ask why people aren't investing in big projects in Russia. Lots of infrastructure plays there, in terms of roads, oil, etc. But strangely, not so many people looking to invest. Why?

Governments that want to nationalise wealth and redistribute assets to "the people" (also known as friends and family of the president), or where such a government is likely, do not engender investment. But you are so blinded by your politics that you forget your MBA analysis.

Keep thinking that it's the evil capitalists and Rethuglicans that are doing this.

Posted by: whats | Nov 7, 2005 9:48:30 PM

A VC

Musings of a VC in NYC