Justin McGee-Odger, Second Squared
In the previous post we described patient capital as a way to leverage patience and time as tools on the path to long-term wealth creation. The patient capital investor is a warrior focused on winning the war, rather than each individual battle.
It may be easy to think of oneself as either a patient capital investor or not, but that is rarely the case. Often it is a question of allocation – determining how much of my capital as an investor is allocated as patient capital where I take a longer view, and disregard short term volatility.
In this second of four posts we look at this from the Investor’s perspective. What does an investor get out of a patient capital allocation?
There are benefits that only come from long-term investment horizons available for capture by the patient investor.Patience means shielding an investment from the short-term volatility of financial markets, preventing the loss of sleep over monthly, quarterly, or annual returns.
In its simplest form, patience translates to outperformance. Equity funds that hold assets for at least two years consistently outperform their more impatient peers by more than 2% annually.
Even in an illiquid environment, patience pays.
Of course, there is an inherent element of illiquidity that characterises an allocation of patient capital. Do not fret, as there is a return for this extra layer of risk. A study of 30 years of returns found that there is as much as a 7.5% annual return premium for the most illiquid investments compared to the most liquid ones. This 7.5% is termed the illiquidity premium.
Patient capital is built on loyalty. The patient capital investor is more than just a shareholder in a company. Their interest in the long-term success of the business evolves them into a stakeholder.
There is a clear distinction here. A shareholder’s only tool for influencing business direction is to exit. As a stakeholder, a patient capital investor has a voice. Their experience, expertise, and expectations are a driving force within the business itself.
Patient capital is also about risk management. The patient capital partnership gives an investor a clearer understanding the true value of their investment. When value is better understood, an investor can pull the right levers to ensure it is maximised.
Loyalty between investor and entrepreneur give them a competitive advantage in the marketplace. When an allocation of patient capital allows an entrepreneur to make decisions with a long-term view and with the support of stakeholders, it is the investor that reaps the benefits.
We discussed in the last post that there is a growing opportunity to the individual investor to seek out patient investments for appropriate allocation. The current environment presents a unique opportunity like never before.
Baby boomers are retiring. It is estimated that the market for private businesses held by baby boomers is north of $3.5 trillion in Australia. More than 70% of these boomers have no plan for what will happen with their business as they exit. With the ongoing COVID-19 pandemic, many business owners have also realised that the time for exit is now.
Many of these businesses are resilient, essential, and yearning for growth not exploited by ageing ownership. Pair this knowledge with the reports that patient capital is becoming scarcer, and the opportunity becomes staggering.
The allocation of patient capital is just one tool in the investor’s arsenal. How much that tool is used depends on the patience of the investor. It isn’t about whether you are a patient investor or not.
The question is: how patient are you?
Patient capital investors leverage patience and time to enable organisations to create value over the long term. These most powerful of warriors remain focussed on winning the war, not every battle. This is the Long Game. In the next posts we look at it from the perspective of Entrepreneurs and finally explore a way to harness this powerful strategy.