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So there’s a story about the firm Jacob Rees-Mogg has equity in supposedly profiteering from COVID 19. I just wanted to do a quick thread about how equity markets work and why it’s not perhaps as outrageous as it seems.
When people think of profiteering in a crisis, they think of things like hoarding essential supplies and selling at an obscene markup. That’s deeply immoral, and I agree that a government profiteering tax wouldn’t be unreasonable on profits from that kind of activity.
That’s not what’s happening here in terms of people buying up “real” resources. All investment management firms basically make their money by purchasing financial assets (shares, loan certificates, derivatives), and receiving payouts on them / selling them for more than they paid
I am grossly oversimplifying, but that’s basically what they do. If I run the Joe Miles fund, I basically have to tell my investors I will make a certain return. Eg if they give me cash of 100 and I promise 10% return, I have to turn it into cash if 110 (more or less).
This is an oversimplification because most funds have a minimum lock in period, requirements about what kind of assets they will and won’t hold etc, but that’s largely what I’m doing. The way I make that money is by buying assets, collecting payments (eg divis/ interest)...
... and then selling them. Now what I should note is that, unless I participate in an initial share or bond listing, my money doesn’t go back to the company that issued the shares or debt. I’m normally buying these shares or other financial instruments from other investors.
If I’m willing to buy shares in a company at a price someone else is willing to sell them at, there’s a reason why they might not want to hang on to them (eg need to free up cash to repay exiting investors or change of fund strategy).
However, one factor that can really drive this is if the investment professionals in my fund think a stock or debt is trading at less than it’s worth and think it will be worth more in future than the current owner does.
None of this involves anyone being dishonest! Assuming that insider dealing isn’t involved, people genuinely make different judgement calls as to how companies will perform and what that will do for their future earnings potential (which is largely how stocks are valued).
Now in the current financial climate there is a *lot* of uncertainty about future earnings profiles. It’s genuinely really hard to know what companies are going to be worth in a few years time. Some previously healthy ones could go bust.
Equally, there are some companies struggling before Covid 19 that might actually make quite a lot of money as we adjust to the new economy. What’s important to investment managers is that there’s no way to know in advance which is which.
So investment management firms like JRM’s effectively take a gamble (well, a best estimate based on their assumptions about how the market will work) about what shares they think will perform well in the next twelve months.
Equally, the investors selling stock to JRM’s firm might think the stock is a complete donkey based on their (different) estimates using their own judgement, and be glad to sell.
