Hunt for Alpha Succeeds if the Entrepreneur Attracts the Right Investors

Hunt for Alpha Succeeds if the Entrepreneur Attracts the Right Investors

From a speech given at the Olivetti day: “How to finance innovation and why it needs to be done.” Brescia, Italy, 16 October 2015

Italy is experiencing a period of extraordinary importance for its future.

If current developments have positive outcomes, a virtuous circle could be created with the potential to launch a new and much needed revival.

To draw on illustrious examples, such as that of the great Adriano Olivetti, should help to motivate concrete actions, as does the success of this gathering animated by entrepreneurs and young businesses.

The structural crisis erupted in 2007 – an epochal crisis whose faults are yet to be repaired. The relationship between capital and its deployment has undergone a derailment. Following a complete freeze, the flow of capital to enterprises and innovation remains stagnant.

Our small and medium-size companies, the engine room of the economy, have historically heavily relied on the banking system for their financing needs. For them, the effects of this monetary crisis have been devastating. The public – the Italian families – have suffered a lot.

The crisis has also resulted in the abnormal compression of the time horizon of the investments, down to the nanosecond, where enormous amounts of liquidity have been directed. This is a sign of the gravest evil of the century. What in fact can be created in a nanosecond?

Looking for yield, huge capital was directed towards wrong investments like raw materials and commodities, creating distortions and financial bubbles ready to burst. Very high additional liquidity offered by central banks to the banking system has been largely retained within it, and the levels of interest rates became negative, thus harming our nation of savers.

The paradox of “constipation of capital”, suffered by institutional investors who cannot find assets which offer a good return, became the other side of “the financial drought,” faced by small and medium-sized enterprises, who remain without sources of capital and funding.

This has stifled the necessary investments in technical capital, into research and development and into new opportunities, and has created a collapse of confidence. The average life of Italian manufacturing plants is now 20 years.

I hold out my analysis to include the necessary “cleaning”, and rationalization of the entire public administration, the development and revival of a common civic sense, restoration of the rule of law and observance of a common set of rules.

There is an opportunity here, and the country’s ability to meet this challenge depends on the various stakeholders’ ability to attract and employ the right capital resources for innovation. We must support the productive activities of small and medium enterprises, and through them we will support the real economy. An important contribution should come from our institutional investors and pension funds. Private savings would also be able to give a strong boost.

Italy, with little awareness, has great economic, productive and social skills that, despite serious damage suffered through this terrible period, remain the trump card for its economic and political success.

The ‘American’ economic and business model has promoted companies of abnormal size, impossible to manage, but which can dictate prices and markets and blackmail the states because the public pay for their failures, and their fraud. Volkswagen is only the latest in a long series that came to light.

Companies of huge size were in the past justified to some by the logic of economies of scale. Now our new technologies, the diffusion of free and immediate information, and interconnection of markets make those factors significantly diminished in their importance. A degree of vertical integration is now possible in many areas by companies of small and medium size. This calls into question the validity of numerous corporate mergers in various industrial and financial sectors.

Italy has many innate strengths: the average size of small and medium Italian companies; the presence of local economies based on local values; innate ability for creativity, innovation, and also for knowing how to make do with that which is available; a value in the social function of the enterprise; a fabulous international goodwill as a country full of history, top fashion, style, best food, and technical ability. These are the best ingredients to give rise to sustainable economic development, which can bring the country back to full employment, confidence in the future, and a new Risorgimento.

Nevertheless, the Italian companies have to make a leap of quality and gain a more extensive international presence. Not only to design and create new products, but to know how to benefit from their international spread and deployment. To do this is needed capital, and cultural development, i.e. good management; both essential to give our companies the opportunity, not only to innovate, but then also to reap the benefits of their ability to create new products and services, and then to follow the right path to internationalization, creating a host of innovations, and encouraging the development of others.

Moreover, despite the shift to a post-industrial economy heavily based on information, mankind will always need goods that require manufacturing, especially that of high quality, in all areas.

On this front Italy still has a huge legacy, despite strong damage, an erroneous tendency to manufacturing relocation, denial of our cultural enhancement and of our beautiful crafts, and failing to value manual labour. This legacy is a true competitive advantage to bring back into vogue those “Made in Italy” products that the world has so much appreciated, with the obvious benefits for the Italian economy.

For decades, the investor was searching for Alpha.

The hope was that, thanks to the ability of the investment manager, returns would be substantially constant over time, and not influenced by trends, and market volatility.

In reality, many managers have largely failed this goal, and have turned away more and more, not only from what they had promised, but in general from the real economy.

Today the answer to generate Alpha, is what I call “direct investments in the real economy”. This signifies a whole set of new tools and channels that fill in directly the gap between investors and entrepreneurs, with the necessary transfer of capital and equity investments.

It presents an opportunity for investors, savers and entrepreneurs. The real Alpha can be achieved by selecting a diversified portfolio of industrial companies committed to innovation and growth, by investing directly into these, and by solving for the investor the problem of fragmentation and single risk

However, to attract this capital, companies have to accept a new function: to open their doors and make an effort with external communication and research to identify, attract, and select the investors that are most appropriate for its situation and goals. Suitable investors would be those who share a similar spirit and who have a time frame that will allow the enterprise to achieve its full potential.

It will be necessary to consider a new culture of the family businesses, and to offer these new forms of raising capital and financing.

The right professionalism will have to be employed to bridge the gap between the company and potential investors. We need new technical tools, forms of “light” listings, and new ways to attract the right capital. It will be relevant to open the company and offer investors transparency and a direct exchange of information. Yet, a successful company will never forget its corporate, social, ethical and territorial value, its origins and its strengths and responsibilities.

A golden rule is to have an accurate understanding of the capital market and all the available choices of capital, before having the need to use it. Therefore directors should undertake wide research in relation to access to capital, shareholders and partners of quality, before actually needing them.

In fact, when you require capital urgently, it is too late to find and select the right investor, the right partner, and to be able to obtain the right conditions.

In Italy there is a huge untapped potential for “direct investments in the real economy” to be deployed to increase the companies’ value.

Especially in this particular period of recovery, the entry of an investor of quality, the right investor, can increase the enterprise value, by the mere fact of this new presence, and also because of increases in its development potential – making future plans possible and opening up new avenues.

As a whole, this value enhancement is not only a strengthening factor in capital terms, but it offers independence, it opens opportunities for acquisitions of new technology and other businesses, and it is so able to elicit a productivity increase, markedly increasing export capacity, therefore increasing the Gross Domestic Product.

Together with the indispensable restructuring of the Italian public administration, this will make a difference, to jump-start the domestic demand, without which there could not be a full and sustainable employment.

Italy can and must accept this challenge.

Some of the companies participating to this initiative of the Olivetti Day were those that with pride and courage, have designed and successfully realized the manufacturing of the Tree of Life, perhaps the most illustrative symbol of the Milan Expo exhibition.

A renewed hope for the future of Italy. An example of great team playing, the ability to make great sacrifices, and to excel. These firms accepted a last minute call and managed to achieve a “Mission Impossible” task, showing that Italy can succeed and must accept the challenges that it is currently facing.

One Response to "Hunt for Alpha Succeeds if the Entrepreneur Attracts the Right Investors"

  1. A_Bruson   February 4, 2016 at 4:20 pm

    I believe, in my limited experience, that the financial crisis has not only been the result of an unsustainable economic model but also a somehow deviated application of technology innovation.

    During the last 10 years, we had appreciated a huge progress in computer technology and a narrowing, as you said, of the investment horizon. High Frequency Trading is the ultimate realization of this process, a purely speculative investment behaviour performed by automatic algorithms taking place in microseconds.
    During my Bachelor’s thesis on Predatory Trading, I spent some time studying the phenomenon and I understood its magnitude only when I discovered that the physical proximity to an Exchange could make the difference between profit and loss for them.

    I cannot deny a sort of appeal this phenomenon has for me since those algorithms are the result of unique and amazing mathematical minds but I also fully recognize a need for protection of the other market participants and a general limitation to the phenomenon since it has proved to be able to destroy the real economy, where we live.
    I think that the key for success in the next years is to enlarge again the investment horizon, forming a class of investors and analyst devoted to this aim, injecting capital in the real economy with a longterm perspective and, at the same time, reducing speculative behaviours especially in the sector of the economy requiring long-term commitment to succeed.

    It is undeniable that the American model promotes the formation of huge companies and enormous personal interests along with them but it cannot be forgotten that there is also another reality in that country, a reality starting from the bottom and moving up.

    I had the pleasure to appreciate some of his features when I took the E-Business course. This new model, born after the crisis, heavily relies on technology and on the passion of small entrepreneurs that exploit the connection given by technology to outsource everything that is not a core activity. This part of the “American model” fits our economy the most and it is the one we should follow.

    This phenomenon is already taking place in Italy but there is a risk we are going to face in the future and we cannot let it happen. During my internship, I had the chance to get close to this world of Italian start-ups and innovation from the bottom but I had the impression that the dominant expectation is to run the businesses until it is profitable enough to sell them to bigger companies. If this happens, we would fail to give our economy a new perspective since the general trend will again be the model of the huge company. I do not want to claim it to be the ultimate truth, just an impression I had from experience.

    I believe managers have sometimes used the alpha, the indicator supposed to measure their ability, to charge higher fees rather than truly prove their ability to make higher-quality investment decisions. Even if alpha might not be the right measure, I am sure we need to develop new ways to measure their ability and commitment to avoid disruptive behaviours.

    In short, if we take again a long-term perspective for investments, if we promote a class of entrepreneurs with the willingness to create and stay in the business together with long-run investment choices I am confident Italy and all western countries can make their way out of this crisis.