The demographic trend that matters most is not what you think

When most of our clients hear ‘demographics’ they think of aging populations in Japan and Europe, digital native millennials in the U.S., or the working-age population boom in Africa and South Asia. Rightly so.

But what is overlooked is perhaps one of the most important demographic trends for investors: the dramatic change in the lifespan, dynamism, and behavior of companies, not individuals. These changes matter for investors since more than half of a typical portfolio is comprised of corporate debt and equity, either publicly traded or privately held.

I would argue that firms today are evolving more rapidly and radically than ever before, with profound implications for their growth, profitability and returns.

For starters, take Schumpeter’s famed engine of capitalism – creative destruction. Measures of business dynamism have seen quite a remarkable secular decline in the U.S. and Europe over the last decade, a trend that even Silicon Valley isn’t immune to. According to the U.S. Census Bureau, the new-firm entry rate has declined in the U.S. from over 15% in the late 1970s to 10% today. At the same time, the firm exit rate has gone from 13% to 9%. 

Or take public equity markets – the heart of a vibrant capitalist economy – where fewer firms are going public, especially in the U.S. and Europe. The number of listed firms in the U.S. has dropped from over 8,000 firms in 1996 to fewer than 4,500 by the end of 2018. The Wilshire 5000 Total Market Index now only has 3,538 listed names.

Finally, a host of disruptive innovations are leading to the emergence of new business archetypes that are altering the very nature of the firm:

1. The Weightless Firm: Firms are shifting away from physical capital to a “capital-light” model centered on investments in intangible assets like R&D, software, and design. Intangible assets as a share of market value have more than doubled in the U.S. since 1985, to represent nearly 85% of the S&P 500’s value (Exhibit 1).
2. The Superstar Firm: Firms are leveraging technology, proprietary data and network effects to build scale and dominate in an increasingly concentrated, “winner-takes-all” environment. In 1975, half the earnings of U.S. public corporations came from 109 firms; today, that same share of corporate earnings is generated by fewer than 30 firms.[i]
3. The Purposeful Firm: Companies are increasingly measuring themselves by more than just financial profit and loss. Customers, employees, regulators and shareholders are holding them accountable to a broader set of community values that go well beyond maximizing quarterly earnings.

The investment implications of the shifting demographics of companies are significant. To pick three areas:

• Weightless firms are staying private for longer. Investors seeking to participate in the new economy, in particular technology-forward companies in developed markets, will want to evaluate shifting allocations from public markets to private markets.
• With rising firm concentration, fewer new entrants, and expanding “kill zones,” successful investors will need to identify potential superstars with strong staying power relatively early on. Evaluating sustainable advantage, increasing returns to scale, and the ability to capture network effects will be key, as will be the ability to monitor rising regulatory scrutiny.
• Investors looking to incorporate ESG factors into their portfolios, and actually even those that don’t, will need to evaluate what the purpose-driven firm of the future will deliver in terms of private investment returns and social returns. It will be important to recognize that there is no “one size fits all” set of ESG metrics that matters for all firms across all industries, and a sophisticated, active approach is essential to make meaningful purpose-driven investment decisions.

My colleagues and I address these and other implications of the evolution of the firm in our new research report, “The Future Means Business: The Investment Implications of Transformative New Business Models.”

I invite you to read the full report here.

[i] Gross, Peter M.J., “Investing in a Winner-Take-All World,” CFA Institute, October 25, 2018. <https://blogs.cfainstitute.org/investor/2018/10/25/investing-in-a-winner-take-all-world/>