Status Update

It’s an exciting time at Portico as we mark our first anniversary in business. It has been a great year professionally and personally. I’m grateful to all of you who opened your doors for a meeting, picked up your phones when I called, shared our research with colleagues, and last but certainly not least, engaged us as a client. Thank you!

It ain’t an easy road, entrepreneurship. I underappreciated both the amplitude and frequency of the journey’s highs and lows before I got underway, but it is genuinely gratifying to wake up each day and create something of value for other people.

The best part of this endeavor is demonstrating to my son, through actions rather than words, that he should never be afraid to assume some risk and pursue the life of his choosing.

A few highlights from year one:

• We assisted our clients through a variety of engagements, including strategy, fundraising, marketing documents and materials, pitchbooks, AGMs, custom research, and transaction advisory.
• Portico released two original research pieces—Is Emerging Markets Private Equity Dying? and The Mid-Market Squeeze—which have been viewed over 1,000 times, and opened doors with firms we’d not yet met. Thank you again for reading and sharing!
• We’re profitable with zero debt. At the outset of this adventure, I set a revenue target for December 2017. We beat it within 12 months of launch. Clear takeaway: aim higher and *get after it.*

All in all, it’s a great start out of the blocks, but we’re focused on staying humble, staying hungry, and identifying ways that we can deliver more value to our clients in the year ahead. I hope you’ll share the journey with us.

Alla prossima,
Mike

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The Societal Parasite that Is Facebook

Speaking of Status Updates, John Lanchester has a superb article in the LRB (“You Are the Product”) on the societal parasite that is Facebook. Lanchester’s article came out before the NY Times [disclosure: Mike is a shareholder] revealed the company’s role in facilitating the information operations that influenced the U.S. election. (Oops!)

Frankly, the entire tech sector is overdue for greater regulatory scrutiny and enforcement. Whether it’s Airbnb, Alphabet (fka Google), Amazon, Facebook, or Uber, the laundry list of unpaid taxes, unethical conduct, and outright illegal activities never fails to astound. Firms active in emerging markets often speak about a “social license to operate.” At what point do these firms’ licenses get revoked?

Parenthetically, will Uber be the biggest write-off in the history of venture capital?

On a related note, we’ve mothballed Portico’s Twitter account. It’s a channel that doesn’t deliver value for the company, so we will not spend energy on it.

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Who Will Make Money in EM Venture?

Henry Nguyen of IDG Ventures Vietnam made some thought-provoking comments at an AVCJ event in Ho Chi Minh City a few months ago. In a nutshell, he noted that the tech giants—Alibaba, Alphabet, Amazon, Facebook, and Tencent, among others—have radically transformed the venture ecosystem. Not only are these companies scouring the same landscape for deals as VCs, but they’re also doing so with the advantages of: 1) a longer time horizon; and, 2) a lower cost of capital.

These seem like … insurmountable advantages for an investor?

Intuitively, this might leave some space for early-stage investors to front-run their later stage and corporate venture peers; but, I do wonder.

What I don’t wonder about: whether entrepreneurs will build great companies, or whether economic value will be created. These are certainties. The question is: who will capture the value?

I suspect a number of LPs in EM venture funds are asking themselves the same question. Having seen individual deals rocket in value, LPs are seeing appetizing write-ups on paper, but they remain hungry for realizations (see below).

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This World Awash in Capital

Consider the following. Since 2006:

• Global central banks have expanded their balance sheets by more than $15 trillion;
• Pension fund assets in WillisTowersWatson’s “P-22” have increased by nearly $13 trillion;
• Gross domestic savings across the emerging markets have grown by more than $5 trillion; and,
• Total credit to the non-financial sector in emerging markets increased by $33 trillion.

We have been living amidst a transition from a world in which financial capital was relatively scarce to one in which it has become abundant. Bottlenecks remain, of course, and there’s ample room to expand access to finance for productive enterprises, particularly in our geographies. Nevertheless, this development has profound implications, and I’ve been pondering a few thoughts as of late:

• Corporations are asset managers. Thirty U.S. companies hold more than $800 billion of *fixed income* investments. This sum is greater than the combined AUM of Blackstone, Apollo, KKR, and Oaktree.
  
• Passive investing is a freight train. If capital is becoming commoditized, why should managers earn excess fees for investing it? Investors are voting with their feet en masse, with upwards of 40% of AUM now managed through passive vehicles. Vanguard’s AUM hit $4.4 trillion in the first half of 2017 (up from ~$1.6 trillion as of year-end 2011).Prices go up when there are more buyers than sellers. Therefore, in a world awash in capital, the biggest driver of performance is fund flows. If flows are channeling into ETFs and index products, then active managers that don’t buy the index will have a hard time outperforming, let alone justifying their fees (and most of them aren’t worth the fees to begin with). The passive trend is likely to end in tears, with a resurgence in fundamental-driven investment one day; but this freight train is leaving destruction in its wake.
• There is a scarcity of assets. The stock of quality, publicly available, investable assets is not keeping pace with the growth in global savings. To take one example, the number of publicly listed domestic companies in the United States has declined by 46% over the last two decades. Or, consider the rapidly growing pension schemes across emerging markets, whose asset bases are growing faster than investment managers can find places to invest it prudently.The relative scarcity of investable products leaves markets prone to bubbles and the misallocation of capital. The rise of passive investing and ETFs only exacerbates this problem.
• Private markets hold opportunity. Given their inherent inefficiency, private markets are likely to remain an attractive place to deploy capital (though not necessarily via traditional LP-GP structures). Technology-based platforms already exist to intermediate private transactions within the United States, and we should expect these to develop globally, as owners of capital climb further out the risk curve and get more hands-on with co-investment and direct investing.
  
• U.S. housing is a political time bomb. The stock of housing is neither keeping pace with the growth in population, nor accounting for the impact of cross-border flows on housing supply.For example, foreign buyers accounted for 10% of the value of existing U.S. home sales between April 2016 and March 2017, and they’re increasingly buying houses that are out of reach for most Americans. To wit, the average price for all U.S. home purchases grew at a CAGR of 5% from 2010-2017. Meanwhile, the prices paid by foreign buyers grew at 8%, and those by Chinese buyers grew at 10%. Moreover, while 50% of Americans can’t afford a down payment and 30% can’t secure a mortgage, 72% of non-resident foreign buyers paid all-cash (see below).

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From the Bookshelf

The world is always full of the sound of waves.

The little fishes, abandoning themselves to the waves, dance and sing and play, but who knows the heart of the sea, a hundred feet down? Who knows its depth?

— Eiji Yoshikawa, Musashi (Kodansha International: 1995).

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