Bain and Company’s Macro Trends Group (32 page pdf) set out to understand how underlying capital trends will influence the longer-term global investment environment by investigating how the quantity and scale of assets on the world balance sheet have evolved over time. We discovered that the relationship between the financial economy and the underlying real economy has reached a decisive turning point. The rate of growth of world output of goods and services has seen an extended slowdown over recent decades, while the volume of global financial assets has expanded at a rapid pace. By 2010, global capital had swollen to some $600 trillion, tripling over the past two decades. Today, total financial assets are nearly 10 times the value of the global output of all goods
and services.
Their analysis leads us to conclude that for the balance of the decade, markets will generally continue to grapple with an environment of capital superabundance. Even with moderating financial growth in developed markets, the fundamental forces that inflated the global balance sheet since the 1980s—financial innovation, high-speed computing and reliance on leverage—are still in place. Moreover, as financial markets in China, India and other emerging economies continue to develop their own financial sectors, total global capital will expand by half again, to an estimated $900 trillion by 2020 (measured in prevailing 2010 prices and exchange rates). More than any other factor on the horizon, the self-generating momentum for capital to expand—and the sheer size the financial sector has attained—will influence the shape and tempo of global economic growth going forward.
1. Rethink hurdle rates.
A prolonged period of capital surplus will be characterized by persistently low interest rates, high volatility and thin real rates of return. Some big institutional investors, like pension funds, will face large gaps between the returns they will need to meet payouts to beneficiaries and what markets will generate.
2. Prepare for bubble risks.
Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles. The propensity for bubbles to form will be magnified as yield-hungry investors race to pour capital into assets that show the potential to generate superior returns. Because the global financial system has grown so large relative to the underlying economy, asset values can quickly reach unsustainable levels and remain inflated for months or years, tempting businesses to commit resources in pursuit of unachievable returns.
3. Actively manage the balance sheet.
Capital superabundance will require even the most traditionally stable businesses to operate in much the same way as many hedge funds do, by actively managing their mix of long and short positions to insulate themselves against a more volatile macroeconomic environment across their portfolio of business activities. For nonfinancial businesses, in particular, an extended period of abundant capital will change the balance sheet from an object of thrift, to be managed to minimum size, into an important strategic platform with defensive and offensive potential. Leading companies will actively use the balance sheet, using cash and financial instruments, among other tools, to stabilize and enhance their core business strategy.
4. Open investment channels to emerging markets.
The capital needs of the faster-growing emerging markets would appear to make them a natural destination for the large stock of financial assets that remain concentrated mostly in the advanced economies.
5. Look to the far horizon.
Capital superabundance will tip the balance of power from owners of capital to owners and creators of good ideas—wherever they can be found. But as yield-seeking capital increasingly crowds into all available asset classes, diversification will become even harder to achieve.
China will generate more capital than it absorbs
How big will China’s capital footprint become? Based on International Monetary Fund data, Bain projects
that China will add $87 trillion (calculated at fixed 2010 exchange rates) to the growth of total global
financial assets by 2020. That is more than four times the amount capital that will be generated by the Japanese economy and will surpass both the US and EU by some $25 trillion. From just $39 trillion in 2010, China’s contribution to the growth of global capital will increase at a 12% annual rate compounded to some $125 trillion through the balance of the decade, a threefold increase in its share.
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Brian Wang is a Futurist Thought Leader and a popular Science blogger with 1 million readers per month. His blog Nextbigfuture.com is ranked #1 Science News Blog. It covers many disruptive technology and trends including Space, Robotics, Artificial Intelligence, Medicine, Anti-aging Biotechnology, and Nanotechnology.
Known for identifying cutting edge technologies, he is currently a Co-Founder of a startup and fundraiser for high potential early-stage companies. He is the Head of Research for Allocations for deep technology investments and an Angel Investor at Space Angels.
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