Businesses are hurting the economy by playing it safe

Companies are taking less risks, and that’s making the economy perilous for every one.

According to Luke Hickmore, co-manager of Aberdeen Asset Management’s Strategic Bond Fund, a monumental shift in investing behaviour is beginning to weigh on the managements of companies, impacting the way they think about building their firms.

In turn, a more cautious approach to investing is holding back the global economy from achieving higher growth.

The shift in investing is something we’ve highlighted before. As traditionally “safer” investors move from relatively stable assets like government debt to corporate debt and dividend-paying equities, they are taking on more risk in order to get the same return.

Hickmore said that this long-term distortion of investor behaviour is now seeping into boardrooms.

“These investors that are used to returns through bonds are looking for that yield and in some cases getting into equities,” Hickmore told Business Insider. “They want these companies to reward them like a bond, but also be safe like one as well.”

The symptoms are showing up in how companies allocate capital. Instead of investing in long-term capital expenditures, companies are instead raising dividend payouts and buybacks in order to reward yield-starved investors.

On the one hand there is a push effect towards buybacks and dividends.

“If I’m a company manager and I go on a roadshow or to a shareholder meeting, it’s more likely that I’m going to hear a desire for more of these shareholder-friendly moves,” said Hickmore. “These people, the shareholders, are quite literally the owners of my business, why would you not listen to their demands?”

On the other hand, there is a pull effect. When companies announce buybacks and increased dividends, there is typically a solid stock prices response. In turn, companies could notice this and attempt to do more.

This in turn only creates returns for shareholders instead of more jobs or capital that can drive long-term growth and demand.

While pressure from return-focused investors isn’t the only reason for the shift, according to Hickmore, he said that cheap financing for debt among other factors have played a role as well. This rabble rousing, however, has certainly contributed.

This sort of allocation, however, isn’t just hurting the broad economy said Hickmore, but also making it more dangerous for those in the C-Suite.

“With lower growth rates from companies but leverage still high (often to pay for those higher equity payments) the risks of a management misstep are likely to be magnified with the very real potential of rising equity market volatility,” said Hickmore in a recent note.

“This will only act to ensure the tourists insist on even more conservative management of their companies and again lower growth.”

So the vicious cycle of conservatism and instability goes round and round. Hickmore’s suggestion for solving it? Get bond yields up through higher interest rates and these bond investors back to their usual ground.

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