Steve started telling about his experience with British Blues, which he discovered while living in England some years back. He told how he was disappointed that he could not find any recording by these great artists here when he got back to the US. That got him wondering why the English could relate so strongly to what is generally considered a most authentically American musical experience. He got this answer from an Irish musician, who offered this view. In the UK, they have a class system that can feel as oppressive to those underclasses, as the American system of racial discrimination feels to the Blacks in America who express those emotions in the Blues.
That lead to a discussion of this idea about learning from educational philosopher Lev Vygotsky: Zones of Proximal Development. Art, among other things, is a philosopher of teaching and learning. Novelty must be close to what we already know. Otherwise, it is not novel. It is just noise.
Zones of Proximal Development is a powerful idea for Evergreen Private Equity, and this in two ways:
- As a guide to understanding the evolution of ownership structures for investment by stewards of perpetual trusts.
- As a guide to understanding the evolution of ideas and innovation, more generally.
People learn only along frontiers of what we already know. Development has to proximal to what we already do. Ideas that are outside the zone of proximal development are not novelties that are surprising and rewarding, like the novelty that makes great music great. They are just noise that has no meaning, and can be distracting and annoying.
So what is the history of proximal development for stewardship investing?
It starts with the republican democracy of corporate shareholding that gets transformed through the financialization of corporate shares into the temporary ownership of transient trading positions in perpetual enterprise. When financialized corporate shares are bought, held and sold by us as individuals, we are fundamentally time-limited as investors. So, there is a match between the temporary ownership for investment and the temporary nature of our capacity to invest.
The importance of this matching of ownership to investment horizons was not realized until pensions and other stewards of perpetual trusts became dominant participants in the financialized asset trading markets, beginning with the changes in the standards of prudence for investment by perpetual trusts that were made in 1972. Now, we have trusts that are perpetual becoming temporary owners of transient trading positions issued by enterprises that are, in theory, also expected to be perpetual. That is proving to be not such a good fit. Quite unsatisfying, actually.
The nearest zone for proximal development of a better experience has been the length of the perpetual investor's holding period. Private Equity has emerged as an alternative to Public Equities. In Private Equity there is no quoted price for the shares in an enterprise being invested in. It is not traded on an exchange. But the standard Private Equity paradigm is done on a managed fund structure with a ten-year limit to the life of each fund. That means that every investment made by any fund must be sold before the ten year anniversary of that fund. This is in many cases creates an artificial sell-by date. It has no directly engineered connection to the underlying economics for the enterprise being sponsored.
Experience has been mixed.
So, we are seeing a new frontier for proximal development being explored through the Canadian Model. Lead by bold innovators like Leo deBever at AIMCo in Edmonton, many Canadian pension funds are embracing the Private Equity construct, but letting go of the managed fund concept. Instead, they are investing themselves, directly. This eliminates the complications that arise with the artificial sell-by dates of the managed fund construct.
The experience thus far seems to be better. This seems to be mostly because of the cost-savings being realized by not having to pay fees to outside managers, but also because of the more direct connection being made in this way between capital and wealth creation.
However, this connection, while indefinite and open-ended, is still fundamentally time-limited. That is because the investment is still being made in reliance on exit-by-sale for return realization. At some point, the pension investor still must sell, in order to actually realize its return. The timing of that sale is more organic, which takes some of the stress out of the system, but still they bought to sell, and so at some point sell they must.
It is too early to tell if this will actually become problematic, but logically it should. It is still a temporary investment by a perpetual investor in an enterprise that is also expected, at least in theory, to be perpetual.
Will our experience with the bold experiments of the Canadian Model bring us to the next new zone for proximal development?
Will pensions and other perpetual trusts drop the exit-by-sale strategy, as well as the artificial sell-by dates, in favor of sharing directly in cash flows flowing to equity within each sponsored enterprise, in perpetuity? That would be a more complete alignment of perpetual investors investing perpetually in a perpetual enterprise, each realizing profits on an ongoing basis through wealth creation to the limits of commercial competitiveness.
This feel tight. It feels sustainable.
It does, however, sharpen our focus on the expectation that enterprise is perpetual. Maybe this will become the next new zone for proximal development?
But that's a topic for another post!