Tag / Investors

by Katie Bawden

Investment Attraction: An Asset Class Framework for Designing Investments

With budget short falls and the need to create jobs, investment attraction has become a top priority for governments. The private sector is increasingly being called upon to pay for and lead investments into a whole range of assets; as well as solve social and environmental problems. However, finding the right investor and structuring the investment can be a challenging task. Understanding investment asset classes and the investor’s requirements in each category is a critical first step.

 Investors

It is important to note that an investor that that works in one class/sub-class may not work in another and each investor’s preferences will differ. As Chen (2019) notes, investors “are not a uniform bunch”.

Investor is any individual or entity “(such as a firm or mutual fund) who commits capital with the expectation of receiving financial returns” through income or capital appreciation (Business Dictionary, N.D; Chen, 2019).

Investors use their capital for long-term gain and therefore are different to traders who seeks to generate short-term profits by repeatedly buying and selling stocks (Chen, 2019). In addition, some investors will also try to address a social or environmental need as well as make a financial return. This is an exponentially growing[1] field called impact investment.

Impact investment is investment that aims to achieve positive and measurable social or environmental impact, as well as financial return (Impact Investing Australia, N.D; OECD, 2015).

In order to select and commence negotiations with potential investors, investment opportunities need to be analysed and matched with investors based on asset class, risk, capital requirements, involvement and timeframes amongst many other factors (Chen, 2019; Nerd Wallet, 2012). Thus, before designing investments or approaching investors, it is critical to understand the major groupings of investments.

What is an Asset Class?

Asset classes provide a framework to categorise and analyse an investment opportunity, structure the investment and match it with interested investors. Asset classes perform either a growth or defensive strategy in an investment portfolio, depending on the underlying economic conditions at any given time. Most investors will have a mix of investments but will not invest across the spectrum of assets or sub-asset classes (Citi, 2016; Chen, 2018).

Asset class is a group of comparable investments that are grouped together based on having a similar financial structure and are traded in the same financial markets, subject to the same rules and regulations (CFI, 2019).

Sub-asset classes are segments that are grouped by more specific characteristics factors such as similar capital allocation, risk and return ratios.  For example, the asset class equity refers to an investment in a business. However, the equity ‘spectrum’ includes shares on the stock market, start-up funds (~$20,000), venture capital (~$2-5M) through to mergers and acquisitions (over $20M). In addition, risk and return and management structure of each investment are all very different (Feld and Mendelson, 2011).

Explaining Each Asset Classes

It can be hard to classify some investments into asset classes. For example, you can invest in commodities through a company on the stock market that produces commodities, purchase tangible commodities or purchase commodity derivatives such as futures or options. Another example is real estate investment trusts (REIT) that are held as equity (Equity REITS) or fixed income assets (mortgage REITs) despite both being derivative of real estate (CFI, 2019).  Additionally, there are always new segments such as venture capital and crypto-currencies (Chen, 2018). However, it is typically agreed that there are five main categories: cash, equities, fixed income, infrastructure and real estate and commodities. A final sixth category, alternatives, is used to reflect non-traditional investments (Frankenfield, 2019). Thus, general asset classes are as follows:

Asset Class Framework

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  1. Cash and cash equivalents: refers to money or other liquid assets that can be a medium of exchange or mechanisms for payment. The main benefit for cash investors is safety as it is typically the safest form of investment. However, inflation and low interest rates can undermine the value of the asset (Frankenfield, 2019; Nerd Wallet, 2012).
  2. Equities: refers to ownership into a business and includes every things from traditional shares, trust structures, angel and venture capital. It is important to look at the capitalization, growth requirements, value and management structures when designing or investing in equities (Frankenfield, 2019; Chen, 2018; Nerd Wallet, 2012).
  3. Fixed Income: refers to lending money to a company or government for interest such as loans (debt), bonds, and certificates of deposits. While fixed income is similar to cash in that it tends to be a low risk-low return investment, it is also classified by the investment duration and credit rating (Frankenfield, 2019; Chen, 2018).
  4. Infrastructure and Real Estate: refers to property (i.e. bricks and mortar) where a return is made on the increased value or rental income generated. Infrastructure and real-estate may also be invested in when it helps to increase the value of other asset classes along that support supply chain development such as commodities (Frankenfield, 2019; Nerd Wallet, 2012).
  5. Commodities: are tangible natural resource commodities that have an end use. For example agricultural products such as grain or metals such as gold (Nerd Wallet, 2012).
  6. Alternatives: are investments that do not conform to the traditional financial securities including stocks, bonds or certificates.  While other asset classes such as real estate and commodities are sometimes added into this category, they should be separated as they have their own unique features.   Alternative assets therefore fall into two broad categories:
    • things people collect such as art and antiques that are regarded as having value to the investor. This sub-classes tends to be illiquid and value can be hard to determine; and
    • high finance such as private equity or hedge funds that give investors exposure a whole range of asset classes to balance risk (Chen, 2019; Zurich, 2019).

Why is it important to understand asset classes for investment attraction?

Understanding asset and sub asset classes allows governments and businesses to become more targeted in how they design investments and investors they engage with.  The following offers a list of preliminary questions to help design and attract investment opportunities:

 Investment design

  • How does the investor exit the investment?
  • How is the investment structured?
  • What are the standard industry/regulation terms?
  • How is the market performing overall in the asset class?
  • Where is the investment located?
  • what markets to you want to enter/expand into?
  • Are there any social or environmental goals associated with the investment?
  • What is the time horizon for the investment?
  • What time frame is the investor interested in?
  • Are there any tax advantages to the investment?
  • Is there a diversification element to the investment?

 Asset classification

  • Which asset class is the investment in?
  • Can it be classified into a sub asset?
  • What is the risk?
  • How liquid is the investment?
  • What is the reward? i.e. valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio or growth – market size?
  • What is the market capitalisation (how big is the firm and its tradeable stock)
  • Is there an income stream?

 Investor classification

  • Who invests in this asset /sub asset class?
  • Is the investor local, domestic or international based?
  • What scale of investment do they offer?
  • What other benefits does the investor bring? E.g. market assess/market knowledge/ growth knowledge
  • What level of involvement do you want an investor to have /do they want active or passive?

[1] In 2018 impact investment was worth six billion dollars in Australia (Uribe, 2018).

by Katie Bawden

Institutions and Incentives: A Guide for Policy Practitioners

Have you ever thought what stops some places from developing? Why is it hard for some places to implement progressive policy? What stops people from being more entrepreneurial? Well it can often be the institutions, the “legal and administrative organizations” that underpin society and they predict the ability of a place to prosper (World Economic Forum, 2015).

Institutions are a “consistent and organized pattern of behaviour or activities (established by law or custom) that is self-regulating in accordance with generally accepted norms” (Business Dictionary, ND).

Institutions “are the rules of the game in a society, […] the humanly devised constraints that shape human interaction. […] They structure incentives in human exchange, whether political, social or economic” (North, 1990, p. 4).

Why are institutions important?

Institutions are important because they form what is called the ‘enabling environment’ (World Economic Forum, 2015). Institutions move beyond the concept of an organisation to encompass social structures that guide “human interaction and activity” and include formal and informal rules. Institutions are important social structure as they “create stable expectations for the behaviour of others,” and create the incentives for economic and political development (Hodgson, 2006). Institutions therefore provide a framework for social cohesion and long term prosperity Bakir, 2009).

The four key sectors where institutions play the most effective role in promoting growth are “finance, education, justice, and public administration” and as a result, Institutions need to be a consideration for in policy and program design in both the developed and developing world (Paul, 2017).

In particular, strong institutions support economic development by:

  • reducing the costs of economic activity by lowering transaction costs such as search and information costs, bargaining and decision costs, policing and enforcement costs;
  • promoting a return on investment through common legal frameworks (e.g. contract terms and contract enforcement, commercial norms and rules);
  • reducing oppression, corruption and encouraging trust by providing policing and justice systems; and
  • Encouraging collaboration between public-private sectors to increase social capital (Bakir, 2009; Ferrini, 2012; World Economic Forum, 2015).

More specifically, institutions affect the level of production, adoption of new technologies, entrepreneurship and venture creation, environmental protection, ability to attract investment, property ownership, law enforcement, and levels of bureaucracy and red tape. Thus, institutions need to be a key consideration when designing policy and programs.

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Institutions and Policy

Often when transformational policy is required, consideration of the institutional framework is paramount. There are four different types of influences on institutions that practitioners should be aware, these include:

  1. Rational choice: where intuitions are influenced through ‘feedback’ that reinforces the decisions and actions to become norms. For example increasing returns on investments is a positive feedback that reinforces the norm;
  2. Organisational the adoption of common practices (i.e. imitation) and norm from other successful organisations and leaders;
  3. Discursive institutionalism is when self-interests and cognitive ideas are pushed until adopted as norms; and
  4. Historical institutionalism is a mix of the above three where logic and idea have amalgamated over time to become norms (Bakir, 2009).

Practitioners should examine the changes they wish to achieve against identifiable institutions.  Incentives or more specifically, pigouvian penalties can then be designed to help shift behaviours and actions in line policy positions.

Incentive: a moral, coercive or remunerative motive behind an individual’s particular course of action (Johnson, 2005). Incentives do not have to provide positive motivations.

 Pigouvian penalties: is a tax to deter or counterbalance market activities that generate negative externalities (the Economist, 1017).

 Examples:

  • Public transport: Policies to promote public or physical transport uptake may only become effective when society recognises that cars have a negative impact on the environment and are willing to change their behaviour to protect the environment. Policy practitioners may needs to consider the individual rational choice, self-interests and historic institutions that support people to drive cars. For example, if parking was increased in the CBD to support institutional change around driving, does it just push people in to suburban areas where driving is still more cost-efficient? Is advertising to change values and perspectives (self-interests) on driving required? Are additional services or upgrades required to change the efficiency of public transport in addition to car and parking taxes?
  • Welfare: Income welfare that supports disadvantaged people can be relatively ineffective in enabling long term dependents to transition into the mainstream economy when the alternative is low skilled and repetitive work. Thereby dis-incentivising people to transition to employment. Policy practitioners may need to consider if the community, formally or informally, agrees that welfare is a right? If individuals have intergenerational dependency and therefore share similar aspirations? And what are the real incentives that encourage employment and discourage unemployment? Otherwise actions that just consider capabilities will have limited impact.
  • Innovation and technology adoption: for societies wishing to promote innovation and technology adoption, it is also important to look at existing intuitions that may disincentive action. For example what are the red tape barriers (costs) to setting up a business and commercialising ideas? Are there any Government Trading Enterprises that crowd-out the private sector innovations? Are technology rebates and R&D subsidies promoted widely and easily accessed? Does the government have a consistent view and is their machinery (departments and agencies) progressive in their policies?

Finally, strong institutions may not ensure robust growth in the short term but in the long term, a society cannot expect to prosper without them. Thus the policy practitioners need to consider institutional environment when designing interventions.

North, D. C., 1990. Institutions, Institutional Change and Economic Performance, New York, Cambridge University Press.

by Katie Bawden

Part 3: the Innovation Ecosystem – Roles and Responsibilities

To drive an innovation-led approach to economic growth, it is essential to understand the roles of both the public and private sector, including academia; and how each can enhance to the ecosystem.

Innovation ecosystem: is the flow of technology and information among people, enterprises, and institutions central to an innovative process. It contains the interactions between the actors needed in order to turn an idea into a process, product, or service on the market (OECD, 1997).

PUBLIC SECTOR

The public sector has responsibility for creating an environment that ignites innovation and supports entrepreneurs. Yet, as Isenberg (2016), notes “there’s no exact formula for creating an entrepreneurial economy; there are only practical, if imperfect, road maps”.

However, it is generally acknowledged that government have various tools at hand. Governments can create ‘demand factors’ for innovation such as policy, regulation and innovation targets the cause the market to change direction (this is essential to enable economic structural change). While Innovation ‘supply factors,’ may include research and development (R&D) credits, academic partnerships and university graduates.

In Mazzucato’s book, The Entrepreneurial State (2014), she argues that government has a bigger role beyond tax credits and the enabling environment. That is, government can also invest in transformational R&D where there is a public good, the risk is high and long term investment is. Marzzucato suggests that such investment by government often leads to transformational change that can create entirely new sectors and markets. Examples of these types of investment include the nuclear energy, the internet and GPS. For government to take this approach it needs to have a long term agenda for technology change; and work with in partnership academia and the private sector so they too can seize the opportunity along the way to add new information to develop spinouts.

Workforce development is also directly linked to the future of businesses creation and economic growth.  Government set the policy, run many of the programs and fund many academic institutions that develop skilled workforce essential to the capability to develop innovation commercialise but to also enable economic transformation when required (Fetsch , 2016).

Fetsch (2016), Moretti (2012) and (Sandbu, 2017) all argue that government can also drive immigration policy that supports innovation policy through three main factors:

  1. importation of skilled workforce to compliment or build a competitive advantage;
  2. immigrants “play a disproportionate role founding companies that make a big economic impact” because they are naturally risk takers having immigrated in the first place; and
  3. Foreign Direct Investment (FDI) flows often through the expat community to enable innovation and business growth

Isenberg (2010) provides a localised perspective and suggests that many government efforts focus too narrowly on building ecosystem determinants. Instead he suggests that government should focus on the following nine principles to “turbocharge venture creation and growth”. Isenberg’s principles include:

  1. Stop emulating Silicon Valley. Rather you can develop your own culture and practices that underpin entrepreneurship and innovation. Also see the ‘rules’ described in the Hwang and Horowitt (2012) book the Rainforest: the secret to building the next silicon valley;
  2. Shape the ecosystem around local conditions. Home grown solutions that compliment “local entrepreneurship dimensions, style, and climate” (Isenberg, 2010);
  3. Engage the private sector from the start. Reach out and understand industry needs;
  4. Favour the high potentials. This is through focusing on gazelles (high growth firms) and applying economic gardening approaches, as noted in Part 2;
  5. Get a big win on the board. Celebrate successes as success can spur more innovation and entrepreneurship;
  6. Tackle cultural change head-on. Governments can help to promote the benefits of innovation, the opportunities entrepreneurship through setting values that celebrate innovation and entrepreneurship, encourage collaboration and by building a tolerance of failure;
  7. Stress the roots. Let the market determine value – be careful propping up ventures;
  8. Don’t over engineer clusters; help them grow organically. Clusters occur naturally when an opportunity exists and are an important element of an ecosystem. However, government shouldn’t be picking winners, just backing them; and
  9. Reform legal, bureaucratic, and regulatory frameworks. Over regulation at all levels can stifle innovation and entrepreneurship. Examining the institutions and incentives is essential to ensure an ecosystem is guided by positive regulation.

 

PRIVATE SECTOR

The private sector is the main agent of innovation and value creation. They are the ones that take the risks, commercialise the products and services, and create jobs. Yet private stakeholders are often multifaceted, holding many roles along the innovation pipeline.

Entrepreneurs are the people with the ideas and are risk takers. In his book, Worthless, Impossible and Stupid, Isenberg (2013) notes that entrepreneurship is defined by an individual’s ability to perceive, create and capture extraordinary value.

A Start-ups is an early stage business that is beginning to scale rapidly. Angel investors “Incubators, accelerators, universities, and public agencies” typically provide the majority of help establishing the business in its early stages (Startup Europe India Network, N.D). Most start-ups die in their first two years in a period called the valley of death.

Valley of death: is a common term in the start-up world, referring to the difficulty of covering the negative cash flow in the early stages of a start-up, before their new product or service is bringing in revenue from real customers (Forbes, 2013)

While Small to Medium Enterprises (SMEs) are small businesses that have overcome the valley of death, tested the viability of their product of services, established a customer based and achieved growth that has allowed them to employ staff. Yet SMEs often lack the knowledge on how to scale-up and lack the resources to invest in innovation to fuel productivity and development (OECD, N.D). Once a business has gotten to this stage of its development, it has greatest potential to become a gazelle (see Part 2).

Investors are typically defined based on the capacity they can invest.  Most types of investors provide more than capital, also offering business support, networks and sometimes markets.

Typically early stage investors offer small amounts of capital and include business angels, incubators and accelerators[1], and some seed stage venture capital funds. As the start-up grows, it requires more investment to fund its expansion and will seek an investment from the venture capital investors who are considered growth-stage investors. Private equity investors and corporates are typically investors at a later stage business growth which may include business merges, stock market listing and buy-outs (Startup Europe India Network, N.D).

Hwang and Horowitt (2012) put forward a softer model in their analysis of the innovation ecosystem and identify:

  • Business leaders: who have a reputation of being innovative. What culture, process and strategy does individual business set to in place to innovate within their business to support innovation?
  • Keystones: individuals or businesses who serve as agents that connect people, ideas and investment to catalyse diverse action. Keystones can also exist in the private sector.
  • Stakeholders: anyone who is an entrepreneur, investor, support organisation or participates in the innovation ecosystem.
  • Role models – local entrepreneurs that are visibly successful in the community and offer examples of success and failure. They are people that promote a positive innovation and entrepreneurship culture. They challenge aspirations and values.
  • Community – the industry sectors, services providers and collective human capital that underpin an ecosystem.

 Industry: However ecosystems are also place-based, in that innovation, R&D and spill-overs are happen in a place, that is proximity is important for knowledge diffusion and is primary influenced by local innovation capacity (Rodríguez-Pose & Crescenzi; 2008). As a result a places industry base and industrial clusters become another important organising principle and stakeholder group for analysis.

Industrial cluster: “are geographic concentrations of interconnected companies and institutions in a particular field. Clusters encompass an array of linked industries and other entities important to competition. They include, for example, suppliers of specialized inputs such as components, machinery, and services, and providers of specialized infrastructure (Porter, 1998)”.

Crescenzi & Iammarino (2016) note that “economic and innovation trajectories do not depend exclusively on localised productive and knowledge assets but need to combine ‘local buzz’ and ‘global pipelines’”. Thus looking at a places external linkages through the lens of FDI flows, global supply chains and multinational corporations offers the opportunity to extract information and opportunities to leverage innovation, build capability and establish new markets.

Finally, academia, which provides an institutional framework for developing workforce skills and values that support and drive innovation and enable agglomeration forces which drive productivity. Academia can even compensate for some businesses that are not as well-equipped to do under take R&D through the production of skilled workers; public-private partnerships; and the generation of patents that diffuse into the local innovation ecosystem (Cauce, 2016).

CONCLUSION

No matter how you analyse your ecosystem, fundamentally what drives success it is how we join up and collaborate to create value. Hwang and Horowitt (2012) note that ecosystems “thrive because of normative culture that accelerates the evolution of human organisation into ever-increasing patterns of efficiency and productivity”.  In other words, we need to create value systems and networks that enable collaborative and symbiotic behaviours across all actors if we are to achieve well-functioning innovation ecosystems. No single individual or stakeholder group can do it alone.

 

Book References

Isenburg, D (2013) Worthless, Impossible and Stupid. Harvard Business Review: Boston.

Hwang, V. and Horowitt, G. (2012) The Rainforest: the secret to building the next silicon valley.
Regenwald: California.

Mazzucato, M (2015) The Entrepreneurial State. PublicAffiars: New York.

Moretti, E (2012) The New Geography of Jobs.  Houghton Mifflin Harcourt Publishing: New York.

 

[1] private incubators and accelerators are often owned by investors who use the structure as a mechanism to identify investment opportunities.