Is Regulation Good or Bad for Investing?

As we head close to an upcoming Presidential election in the US, there are lots of opinions being shared on business news on how the respective candidates will impact markets and how their policies will shape the economy over the next four years.

Winning or Losing Under New Government

Perhaps one of the main stories surrounding an election is whether certain industries or even individual companies will be winners or losers under the new government. Voters tend to congregate into two camps in the US.  Ones who believe the government should stay out of the way and seek to minimize regulation all the time.  These would traditionally be more right-wing Republican voters.  

The flip side are those people who like to see a lot of government intervention in the economy in order to perhaps level the playing field between the rich and poor.  These voters tend to like to see more regulations and rely on the government to rein in business owners whom they tend to mistrust.  These voters would traditionally be more left-wing Democrats.  

Of course in between the two extremes there is a whole spectrum of people who fall somewhere in the middle with their views. My general preference is for less regulation wherever possible, not because of any prevailing political view or affiliation but because it's my personal belief that the economy usually functions better with less government intervention.  

The Hammer of Regulations

As I've written previously, to a man with a hammer every problem is a nail.  The government's hammer is regulation and that's why we often get too many regulations.  In the best of cases these regulations are a drag on economic growth, but in the worst of cases they can be downright destructive.  Often these regulations are well intentioned but have far reaching and unintended consequences.  

For example, minimum wage laws, which are designed to protect low income workers, often in reality lead to a shortage of jobs for low income workers as companies cut back on staff as a result of the higher costs for their employees.  Thus the real world effect is the opposite of the intent.

Famed economist Milton Friedman wrote that he believed that the onus of proof should be on the government to show that the net benefits of a regulation outweigh the net costs.  He also said that it should also be incumbent on the government to show that a regulation is required because the private sector is incapable of regulating itself.  I think these are good rules for assessing government regulation and I wish they were employed more often.

So as you can tell, I am no fan of regulation, and often argue against it.  That being said, I do not believe that all regulation is bad.  In fact I think that proper regulation can actually be a very good thing that can unlock potential for a person/business/economy. All commerce is based on a baseline of laws which involve property rights, contract law, and a court system to settle disputes.  If we didn't have these things, it would actually be much harder to run the economy.  

Regulatory Framework and Enforcement Mechanisms

Think of the level of trust that you would need to have without these protections in place.  Everyone would come to business meetings with a gun in a holster, to make sure they didn't get stiffed on a business deal.  By the government providing a regulatory framework and an enforcement mechanism, business becomes a lot smoother (and a lot less violent!).

What's more, goods and people flow on transportation networks that are often paid for and maintained by government.  In fact all kinds of infrastructure which is necessary for business is either subsidized or solely funded by government because it would be uneconomical for any private entity to provide it on their own.  Without these things it would be much more costly and much less efficient to do business.

Because we have these foundational laws and regulations, there is no such thing as a true 'free market'.  In a true free market, only the threat of violence could protect your property rights and I don't think that is what most people who advocate for a free market actually want.  All markets are governed by a set of baseline foundational laws and regulations, and those markets function better because of that.

Oftentimes some of the best investment opportunities are where technological change and regulatory change actually overlap.  Without regulation to allow for traffic laws and government money to pave the streets, we would have no car industry and our world would look very different.  In some ways the same can be said about the Internet.  Without government regulation of the internet, it would be much harder to obtain the trust necessary for e-commerce to thrive because there would be no regulatory framework for resolving disputes.

Being Mindful of the Framework Businesses Operate In

How can investors take advantage of this?  Well for one thing, I think investors need to be mindful of the regulatory framework that businesses operate in.  This can be both positive and negative.  The Cannabis industry has taken off after legalization and regulation has come into effect in Canada and a number of US states.  This doesn't mean cannabis companies are all good investments, but there is certainly a better chance now rather then before legalization.  

On the other hand, Uber and Lyft are constantly bumping into regulatory problems including a potential re-classification of their drivers as employees in the state of California.  This could potentially kill their business model in the state and represents a huge regulatory risk.  Uber & Lyft could end up being case studies where technological innovation is not enough to overcome a lack of regulatory change, and that would be a harsh lesson for many investors to learn.

Interplay of Fintech and Blockchain Technology

Aside from Cannabis, what are some areas that could be ripe for regulatory change which would unleash huge investment potential.  Well one of the areas that I think is very interesting is the interplay of fintech and blockchain technology and what potential that could have for investors.  Banking and finance is obviously a very heavily regulated industry, and currency in particular is an area with a lot of government intervention and regulation.  

Often government endorsement of a currency makes it more acceptable for people to use broadly.  The seal of approval of your federal government is good enough for most people to accept fiat currency as valuable, even though it would otherwise be useless pieces of paper.  Now with new kinds of companies using technology to outmaneuver and outthink traditional forms of banking and currency, this could be an area where regulatory change is required.  

If governments do decide to get on board with blockchain, and decide to sanction it by regulating it, then I think this could be an area where there is huge potential for investors. This does not mean that I think you should go out and buy Bitcoins.  It's far from clear to me that Bitcoin will be a beneficiary of government regulation of cryptocurrency.  But I do think there are ways to invest to take advantage regardless.

Wealthsimple Brokerage App

One of the companies we own is Power Corporation of Canada.  They have a majority stake in a subsidiary fintech company called Wealthsimple.  Wealthsimple is a brokerage app for retail investors which also provides trading services and a robo-advisory service for clients who don't want a traditional advisor relationship.  

One of the things they've recently added is the ability to trade cryptocurrencies on the Wealthsimple app. Even though I don't invest in cryptocurrencies I do think this is a tremendous opportunity for Wealthsimple as this is an area of increasing popularity and has a lot of potential.  If we can profit from the popularity of cryptos without having to risk money in a cryptocoin itself, I'm all for that!  In addition, if there is future regulation of these cryptocurrencies which unlocks the industry and makes it more accessible to the average person, then Wealthsimple (and ultimately its shareholders) stands to benefit greatly from this.

This is definitely an area where a regulatory stamp of approval would go a long way to providing validity as well as structure to a new industry, and that could be the catalyst for big gains for investors.  If that occurs, it would be yet another example where regulation can be very good for investors.

- Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.