From The Chair: Why do we need early stage investing?

Most fund managers avoid investing in start up/early stage/smallcap companies - in the UK small for this audience equates to a £100M market cap. However, people who take this view ignore the Kondratiev cycle, an economic phenomenon identified by Nicolai Kondratiev, a Russian economist who was born in 1892 and died in 1938. His theory was that economies have long term (50 to 60 years) cycles of boom followed by depression, with the turning points being related to major changes in technology facilitating step change improvements in productivity, for example:

  • 1st Industrial Revolution - steam power
  • 2nd Industrial Revolution - application of science to mass production
  • 3rd Industrial Revolution - use of computing power to automate production

We are now in the early stages of the 4th Industrial Revolution, which is characterized by a range of new technologies that are fusing the physical, digital and biological worlds - examples are new tools emerging for analysing the huge amounts of data associated with the development of therapeutics and thereby enabling better treatments to be developed more quickly and cheaply.

Turning to the theme of early stage investing, if we imagine the time when steam powered transport in the form of railways started to emerge, there would have been a huge infrastructure to support horse drawn transport, e.g. coaching inns, carriage builders, wheelwrights, farriers, horse feed suppliers, horse breeders, bridle makers etc. However, as railways started to be adopted as an alternative to horse drawn transport, the various trades associated with horse drawn transport started to see their markets shrink and the trades associated with rail transport start to grow.

The above illustrates the challenge for investors in that at the heart of capitalism lies a long term process of creative destruction resulting from finding better ways of doing things - the latter generally emerge via newer and smaller companies based on harnessing new technologies - larger companies have generally responded by acquiring the latter, but that means that those larger companies which fail to both make such acquisitions and also leverage the acquisition successfully will ultimately fail - this process does not happen at an even pace over decades but conforms to the Kondratiev cycle

We are currently seeing examples of long-established sectors currently experiencing turmoil due to changes in technology, such as retailing and vehicle manufacturing, demonstrating that when fundamental technological change is under way, being large is not necessarily an indicator of ongoing commercial success.

In the context of the Woodford events, the media generally advocates that retail investors' money should be invested in lower risk investments. Against the background of the above, I regard this as risky advice unless the investor is selecting companies capable of prospering in the landscape of the 4th Industrial Revolution - I am a fan of B2B businesses operating in growth markets and which compete on value not price, with a business model which generates growing recurring income (SMARTCOs). Aspremont develops earlier stage SMARTCOs and is working with Crowdcube to help private investors access such opportunities. All investors should remember to construct barbell portfolios in order to proactively manage risk - barbell portfolios will be the subject of another blog.