On October 23rd, the OECD Financial Roundtable (FRT) dealt with public SME equity financing with a special focus on exchanges, platforms and players. In today’s post, Markus Schuller of Panthera Solutions gives us his personal view on the meeting.
Let’s face it: the bulk of small and medium-sized entreprises (SMEs) are still financed mainly by bank credit. However, as bank finance is harder to come by in the current post-crisis environment, fostering non-bank financing alternatives may help closing an SME financing gap. The OECD has been looking into such issues, also with input from the private sector via its Financial Roundtables. After the one held in April that discussed SME non-bank debt financing, this one, held in October, explored impediments and possibilities for public equity financing for SMEs.
Banks represented at the discussion naturally pleaded their cause, namely for debt financing, some even arguing that there is no shortage of SME debt financing, but only of risk financing. I allowed myself to add that this insight comes rather late. Too late actually, to stop the BoE and ECB in rolling out their securitisation support (asset backed securities purchase programme and covered bond purchase programme) that may be pointless if the analysis that the Eurozone suffers mainly from a demand-side problem is correct – as we have been highlighting over the last three years.
But back to the actual Roundtable topic. The overall challenge was described as how to stimulate equity financing for a segment that is characterised by low survival rates and a large diversity of entities, the two main drivers that make it difficult to assess risk. The focus of the debate was more on analysing the current drivers of a challenging environment for SME equity financing and less on solutions.
The limitations in the ecosystem (exchanges, platforms, brokers, market-makers, advisors, equity research) necessary both for the development of SME equity finance and the maintenance of liquidity in such markets can definitely be named as impediments. Having said that, those are technicalities that can be resolved quickly by market forces, given sufficient investor interest in allocating to this segment. It appears to be a chicken or egg situation, but it isn’t. If investors are intrinsically motivated to seeking exposure in SME equity investments, the supply side will follow.
Let me focus on a more fundamental driver of an investor´s motivation to ensure a sustainable flow in SME equity investments: cultural change.
In my FRT contribution I highlighted the lack of a risk equity culture across Europe as an important obstacle. In Germany, only 13,8% of the population invests directly (7,1%, 2013) or indirectly via funds (6,7%, 2013) in listed equity securities. Compared with around 50% in the US (45% in 2008, ICI Survey / 52% in 2014, Gallup Survey). Both the US and Germany saw a slight deterioration in equity ownership from 2000 until today, explained by the long-term effects of the dot-com bubble during the 2000s and the pro-cyclical behaviour of retail and institutional investors, leading to a reduction in their exposure caused by the Great Recession.
On top of shying away from the volatility in asset pricing, equity exposure in Germany is significantly linked to the educational attainment of the individual. In 2013, investors with vocational baccalaureate diplomas achieved an exposure of 25,9%, with secondary school leaving certificate only 11,8% and secondary modern school qualification alarmingly 6,5%.
How to reverse this trend of sinking equity ownership in Germany and neighbouring countries? By reframing the question. Let’s analyse what drove the rise of equity owners in Germany from 3,9 million (1992) to 6,2 million (2000) and back to 4,5 million (2013). Two main factors can be named for the rise: pro-equity friendly sentiment in politics; and accessible home bias led to a low entry barrier for investors.
The dot-com bubble burst deformed the first. Since then politicians harvest low hanging populist points by stigmatising equity markets as too dangerous to get exposed to. The Great Recession acted as reaffirmation of their convictions. Some even enacted policies to forcefully dry up market liquidity as seen in Austria with its stock exchange tax.
The dot-com bubble also caused millions of Germans to divest their home bias. Home bias is a well-researched cognitive dissonance in behavioural finance, driven by both rational and irrational factors. Local bias in SME investments is driven by pride of local ownership; ambiguity aversion (investors are more likely to choose an option with known risks over unknown risks, and with fewer unknown elements rather than many); identification with product, service or entrepreneur; reduced information asymmetry through local knowledge.
Sourcing information globally on listed companies works well thanks to its digital distribution, identifying yourself with them doesn’t. Investors reject exposure to risk if they cannot judge the situation, or do not know the relevant risk drivers. This behavioural pattern can be traced back to the individual’s need for control (as von Nitzsch points out).
The affinity to an equity home bias for both institutional and retail investors can be used as entry point for changing the lack of equity culture in Europe.
The same cultural change was needed in Europe for SME debt financing. For corporate debt markets it needed the Great Recession and banks unwilling to or incapable of lending to trigger the change. Since then, starting with large corporations, a trickle down effect is starting – see German “Mittelstandsanleihen” and their friendly welcome by investors. In short, cultural change is possible.
A potential trigger for cultural change in equity markets can be found in the ongoing financial repression and negative interest on savings accounts. Less a carrot, more a stick.
In my profession as asset allocation advisor, I cannot recommend a home-biased portfolio as being well diversified. Scientific evidence opposes this view. My point is to only use this bias as an entry point for inducing cultural change. It needs to be followed by a further increase in sophistication levels of market participants, enabling them to properly invest in a risk factor diversified, global, multi-asset portfolio.
Which leads to my second FRT contribution, namely on calling for increased education regarding equity investments for all market constituencies (SMEs, individual investors and advisors alike). Only increased levels of sophistication allow a responsible extension of alternative equity financing options in the ecosystem – see the delicate, little plant called “crowdinvesting” for example.
As cultural changes and educational effects only pay a dividend in the medium term, I suggested at the FRT to leverage the activities of an existing EU institution, namely the European Investment Fund (EIF).
It acts under the umbrella of the European Investment Bank (EIB). The EIF is a specialist provider of risk finance to benefit SMEs across Europe, including equity financing via more than 350 privately managed private equity funds. Its equity activity encompasses the main stages of SME development. In total it runs a book of EUR 5.6 billion in outstanding commitments, leveraging EUR 20,7 billion from other investors. In 2013, the EIF committed EUR 1.5 billion to mobilize EUR 7.1 billion in other resources.
In its announcement of a EUR 300 billion stimulus package for EU28, the Juncker commission should increase the EIF allocation power by a multiple. Positive real economic effects are guaranteed.
Financial Market Trends OECD Journal