The fundraising challenges facing the Canadian venture capital (VC) industry are well known and widely acknowledged. Institutional investors and retail investors alike have been shunning the asset class, causing governments to step in and fill the gap.
Less recognized is the glaring absence of the significant pools of capital that are to be found in Canada’s wealth management industry – mutual funds, investment counsel firms and portfolio management firms.
Canada’s mutual funds alone, according to the Investment Funds Institute of Canada, have more than $1 trillion in assets under management. This compares to the $775 billion in assets held by the top 10 Canadian pension funds in 2013.
As Sir Arthur Conan Doyle had Sherlock Holmes remark in his famous tale: “Why didn’t the hound bark?” So too one might ask: “Why hasn’t the wealth management industry stepped up to the plate?”
If we cast our eyes south of the border, what do we see? What is evident in the U.S. is wealth managers that are increasingly playing a role in VC. As the National Venture Capital Association‘s president and CEO noted in a U.S. market report in October: “The emergence of non-traditional investors, including hedge funds and mutual funds, is contributing to the increase in venture investing this year.”
In some cases, as with Fidelity Investments’ Fidelity BioSciences and Fidelity Growth Partners Europe, funds have been active for forty years. Examples include such notables as Black Rock, T.Rowe Price, Janus Capital and Wellington Management.
U.S. firms like Fidelity are also beginning to make incursions across the border, with direct investments into Canadian companies.
In contrast, Canada’s wealth management industry has largely elected to bypass VC, despite following the lead of public pension funds into other alternative asset classes, such as infrastructure, private equity and private real estate.
For instance, both AGF and Sun Life Financial have recently established infrastructure vehicles, following in the footsteps of CPPIB and the Caisse de dépôt et placement du Québec. VC has been largely ignored, despite wealth managers’ professed focus on a long term, buy-and-hold approach – a focus that would seem ideally suited to the characteristics of venture capital.
Why has this happened?
There are a number of reasons that can be identified.
Firstly, wealth managers chase past returns and the returns of Canada’s VC industry have been quite weak both in absolute terms and relative to other investment opportunities.
Wealth managers recognize that one high-performing asset category in one time period is very likely to underperform at a later date and vice versa. VC under performance should signal that at some point it will return to a position of strength.
The challenge might be that wealth managers’ investment time horizons are out of sync with the VC industry. Wealth managers seem to look at year-over-year performance numbers for potential investments: How large-cap Canadian equities did in the previous twelve months vs. emerging-market bonds vs. European small caps, etc. Venture capital, despite marked vintage year performance variations, moves in long-term waves that can last a decade or more.
In a related manner, the growing presence of U.S. wealth managers in venture capital may simply reflect improving U.S. VC returns, which are still not fully evident in Canada.
Secondly, there is some history between the two Canadian industries that has adversely affected the view of VC held by wealth managers. Labour-sponsored venture capital corporations (LSVCCs) have competed with mutual funds for retail dollars since the late 1980s. Some large mutual funds, like Mackenzie Financial, had formal ties with LSVCCs, but may not have had positive experiences in those relationships.
Thirdly, wealth managers have been increasingly courting institutional clients who themselves have been wary of venture capital. Large mutual funds have also been poaching senior investment staff from public pension funds, which may have helped reinforce the distance between them and the VC industry.
Lastly, there may be structural reasons for this ongoing mismatch. Investing in VC funds can lock those investors into vehicles for up to 10 years, which may be challenging for wealth managers to accept in the post-2009 world, where liquidity comes at a premium.
Additionally, technology companies have not been popular in IPO markets, despite some very visible U.S. exceptions of late, and there has been no secondary private placement market for trading in the securities of privately companies (though this may be changing).
Bridging the Chasm
How can the gulf between the wealth managers and VC be bridged? Is there a role for public policy in facilitating this outcome?
The VC industry could take steps to market itself to wealth managers. Representatives of the two Canadian industries could also sit down and discover ways of meeting their mutual requirements. To start with, a joint summit of mutual fund and VC industry leaders could readily be organized and might actually lead to a meeting of minds.
Government could play its part by offering wealth managers an HST rebate on their products in return for investments in VC funds or in venture-backed companies. Notionally, government could return to the wealth managers $2 of HST owing for every $1 invested in a VC fund.
That way, a win-win-win scenario can take hold:
• VC gets more capital and broadens its investor and co-investor base;
• Wealth managers pay less HST, a major sore point for the industry, and better enables mutual funds, for instance, to compete against financial products on which HST is less burdensome;
• Government indirectly funnels more venture capital into Canada’s budding technology companies, enabling them to match the financial resources available to their international competitors.
Richard Rémillard heads Remillard Consulting Group, a firm that specializes in research-based solutions to public policy issues affecting the financial services industry. He has over two decades of experience with financial trade associations, including the Canadian Venture Capital and Private Equity Association and the Canadian Bankers’ Association.
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