When FTX imploded, some of the largest investors including OTPP and Temasek Holdings issued public statements to disclose their full write-downs of the investment. Unfortunately these two entities fall under relatively more heavy scrutiny not because they are huge, but more so because of their source of funds. These are either the state coffers or life savings of relatively financially unsavvy civil servants and decent few who make an honest living out of making a real contribution back to society.
To know that millions of dollars have been lost due to the apparent oversight of a few fund managers is unacceptable. At the end of the day, someone has to be held accountable.
This is not to say that privately managed funds that have raised money from accredited and sophisticated investors can get away with calling caveat emptor. Regulators and the financial system exist to protect the interests of those who may not be equipped with the analytical skills to make sound investment decisions i.e. stupid money.
The state of capital markets today
Stupid money doesn't necessarily refer to mom and pop money. It could be a hundred million dollar fund moving ahead with the decision to invest largely based on the fact that a well known name in the market like a Temasek or BlackRock is backing the deal.
The underlying notion is that: if a large financial institution managing billions of dollars is putting money in this company, the due diligence is probably airtight.
These institutions are also supposedly staffed with the brightest minds hailing from the best business schools. The investment process has probably also gone through numerous rounds of review under the scrutiny of multiple eyes.
So what can go wrong?
This is apparently not what it seems as highlighted in an article published by the FT recently, highlighting that in due diligence processes:
"The hands-on work usually fell to the youngest lawyers, consultants and bankers. Today’s 20-somethings have no meaningful downturn experience so were less experienced at judging the adequacy of controls and clauses that only matter when money starts to run out."
And so it somehow feels that even at the largest and most prestigious institutions, the decision to move ahead with a deal does not involve the knocking of experienced heads at the conference room table, instead it all comes down to endorsement. The endorsement of branding, track record and taking comfort that a 'rocket scientist' has crunched the numbers.
That's essentially what today's capital markets has come down to.
Talk to anyone in equity sales. Chances are that he or she will be an excellent story-teller. Don't bore them with the mechanics, and the nuts and bolts of the transaction, they'll almost always refer you to the deal team.
Those in sales tend to have a condescending attitude towards execution work and often a lack of appreciation for details and protracted deal processes.
In the world of equity markets, you (investors) have been conditioned to make that decision to invest almost solely on subscribing to the "equity story".
Buying a share in a business equates to buying a bet on its future, and not its past. Sure enough you can "diligence" the historical numbers, ask about existing customers, next year's revenue, cost structure, profitability, cash flows, etc. But at the end of the day, chances are that owners of the business will insist on being valued based on its outlook. I have even seen some companies who turn away potential investors that ask too many questions.
What kind of crazy world is that?
But stupid money seems to be important, a lot of stupid money is born out from FOMO and FOMO is exactly what drives people to do stupid things.
The final equity "takeout"
There is nothing wrong with a fundamentally sound business with a good equity story. Ultimately, we just need to remember that a significant part of what supports the valuation narrative hinges on sufficient stupid money being in the system i.e. liquidity. And liquidity is a big part of what drives financial markets.
For what initial public offerings are worth, they essentially represent the final destination for all stupid money i.e. the final equity takeout for all seed investors to series A,B,C investors, venture capital, private equity funds and cornerstone investors - the whole lineup of "smart" institutional money waiting for their payday. This is the unfortunate truth.
Can you imagine any decent institutional investor taking out a huge block of primary shares of a to-be-listed business that has an incredibly low free float? Portfolio managers also frequently turn down follow-on offerings of companies that have a low daily trading volume. The main idea here is that should there be a need to sell down their stake one day, they need to get comfort that those shares can be sold in the shortest amount of time within the open market.
Liquidity basically gives investors the ability to transfer risk quickly to another party.
So the next time you hear fund managers talking about "sufficient liquidity", what they are really saying is that they want to see enough stupid money circulating in the system for the investment to make sense.