Not many things seem obvious at the moment. But one thing that does, is the likelihood that companies will need more cash from shareholders. Historically, the stockmarket was a mechanism for raising capital for uncertain trade ventures into uncharted territory. Starting with the Muscovy Company, the first Joint Stock Company in 1553 expedition round the top of Norway to find a trade route to Moscow and The East.
Joint Stock Companies
The problem that the original JSC’s was designed to solve was: what happened if a merchant needed money before the voyage returned? The answer was that rather than each merchant trading for his own account, it made sense to separate control and ownership. Then divide the ownership into shares which were freely transferable. Hence if a merchant needed money before the successful voyage was completed, he could sell shares in the market and convert an uncertain future gain into money today.
By 1579 the Muscovy Company had signed a trade agreement with Ivan the Terrible’s Moscow, but also reached as far as the Caspian Sea, Bokhara, Turkestan and Persia. Soon other Joint Stock Companies were set up to exploit trade ventures to other parts of the globe: The Eastland Company of 1579, The Turkey Company established in 1581. In 1600 the East India Company was formed.
But that is the history, Professor John Kay has pointed out that, with the obvious exception of banking shares, in the last 20 years the amounts taken out of the stockmarket through share buy-backs and dividends have exceeded the amounts raised through new issues. “The stock market is no longer a means of putting money into companies, but a means of taking it out” he says.
The interesting question seems to me – now that the stockmarket is likely to revert to it’s original role of capital raising mechanism:
how will capital raisings work when so much of the stockmarket is now owned by quant funds, ETFs and index trackers?
These investors will need to make qualitative judgements on which companies to back. In general most of these funds will be almost fully invested, to put new money into a company will require selling shares in other holdings. And this assumes that the amount of money these funds are managing remains constant, in reality investors are asking the funds themselves to return their money, and that Assets Under Management are shrinking. The Financial Times reported that investors pulled €22bn of funds from European ETFs in March alone.
Getting it wrong will be expensive mistake – as the example of Royal Bank of Scotland shows.
Before the financial crisis Royal Bank of Scotland had 3.2bn shares outstanding according to the Group’s 2006 Annual Report. Following the acquisition of ABN Amro, the financial crisis, investors were asked to fund a £12bn capital raising in the first half of 2008, but it quickly became obvious that even £12bn was not enough to save the bank and management had to ask for government support in September 2008. Following the first rights issue and then Government rescue the shares outstanding grew to 107bn shares (of which 51bn were government B shares). More than a decade later, the Government still owns 62% of the bank.
Unlike Lehman Brothers, Royal Bank of Scotland “survived” the financial crisis. But if investors took up the original rights issue, they would have likely lost more than their initial investment and then had to wait ten years until dividends resumed. Those dividends have now been cancelled. This seems like a case of throwing good money after bad. Sometimes it is better for investors to recognise a loss than keep funding a business that looks unlikely to make a return any time soon.
While traditional fund managers have not covered themselves in glory deciding which capital raisings and new listings to back: companies loaded up with debt and sold by Private Equity to public stockmarket investors seem to have fared particularly poorly. It now seems that quant funds and index trackers will need to develop some new strategies to cope with some difficult decisions.
We are in uncharted territory.
Source: The Stock Exchange Story – Alan Jenkins, first published 1973