A bunch of interesting insights today about the future of tech investing.
First-up fund analysts at Numis report today that CNBC has released its ninth Annual Disruptor 50 list highlighting the private companies coming out of the pandemic with business models and growth rates aligned with a rapid pace of technological change. The article highlights that the majority of companies on the list already have billion-dollar valuations with 34 being unicorns (>$1bn valuations). The table below is fascinating and shows UK-listed fund’s exposure to these businesses. To have exposure to 13 out of 50 is a real achievement for the UK market and shows far and how fast the idea of public VC has come. I note with interest the lack of Draper Esprit on the list.
Next up we go to the excellent Nicholas Rabener and his Factor Research platform which recently carried a brilliant analysis of VC investing.
I’ve long wondered why VC can’t adapt to the passive model. Here’s my reading of the concept.
We’re told that stock picking is a difficult exercise but public markets provide huge information flows. If that information isn’t as readily available in private markets, why should active managers be any better? Ah, the VCs say, we have asymmetric information flows and can access data that isn’t widely available to inform us to make better decisions. OK, I say, but in reality, I suspect that most VCs are in fact data-poor. Sure, they can assess a business plan but in truth, their knowledge of the wider market context is inadequate and poor.
Also, in truth the old adage holds true – money follows money, success follows success. Many of the most successful start-ups are run by people who already have amazing track records. So, if you can jump onboard these express trains you stand a better chance of succeeding but in truth, there’s only limited seats available and most VCs can’t clamber aboard. So, in sum VC investing is pretty much like a crap shoot in which case go passive and equally eight through a diversified portfolio of assets.
Nicholas has taken this idea and run with it – you can see the analysis (Portfolio Construction in Venture Capital) here: https://insights.factorresearch.com/research-portfolio-construction-in-venture-capital/?mc_cid=d0e6e0f735&mc_eid=d8376c4e49
In order to test this thesis, he’s used a near approximate: US-based biotech stocks. He has then simulated an equal weight strategy “using biotech stocks in the US and contrast an equal-weighted portfolio with a market capitalization-weighted one.”
The results are below in the chart, and they are exactly as we would expect if you believe my thesis. Go passive!
But Nicholas – like me – does accept that “some venture capitalist funds are still able to generate high excess returns with consistency. However, this is explained by the managers of these funds having such a reputational pull that they have a proprietary deal flow that allows them to generate stellar returns. Although this is great, it only applies to a few individuals, who are mostly based in Palo Alto. The average venture capital fund generates the same returns as a technology index like the Nasdaq. For first-time venture capitalists who are building their personal brand and are unlikely to have access to the best start-ups, there is a substantial risk of missing the winners and generating less attractive returns than public equities. It might be better to invest in certain themes but then allocate equally across these as much as possible. “
I agree. So, I ask again why aren’t there more passively structured VC vehicles? Is it just because of manager economics ?
Last but by no means least I thoroughly recommend reading the Astral Codex Ten newsletter on substack. It’s a strongly libertarian publication but its discussion threads are always absolutely fascinating and thought-provoking. A recent thread focused on a book review of The Accidental Superpower – which is a compelling book by the way. You can see the review and thread here: https://astralcodexten.substack.com/p/your-book-review-the-accidental-superpower#comment-2024902
Anyway, if you dig around in the thread you come to the following section from a reader Peter Robinson. This makes a fascinating point. China is fast emerging as the new Germany of the globalised markets – an expert in precision manufacturing in a technological age. The idea that China can simply be contained and ignored is laughable and the embedded expertise being built up in the delta upstream from Hong Kong is indispensable. China will turn into a modern Japan and South Korea and we should absolutely fear a wave of higher value imports.
This all comes courtesy of the following quote from Tim Cook on why the iPhone continues to be manufactured in China – and its not because of labour costs.
“China has moved into very advanced manufacturing, so you find in China the intersection of craftsman kind of skill, and sophisticated robotics and the computer science world. That intersection, which is very rare to find anywhere, that kind of skill, is very important to our business because of the precision and quality level that we like. The thing that most people focus on if they’re a foreigner coming to China is the size of the market, and obviously it’s the biggest market in the world in so many areas. But for us, the number one attraction is the quality of the people.”
“There’s a confusion about China. The popular conception is that companies come to China because of low labor cost. I’m not sure what part of China they go to, but the truth is China stopped being the low-labor-cost country many years ago. And that is not the reason to come to China from a supply point of view. The reason is because of the skill, and the quantity of skill in one location and the type of skill it is.”
“The products we do require really advanced tooling, and the precision that you have to have, the tooling and working with the materials that we do are state of the art. And the tooling skill is very deep here. In the U.S., you could have a meeting of tooling engineers and I’m not sure we could fill the room. In China, you could fill multiple football fields.”
“The vocational expertise is very very deep here, and I give the education system a lot of credit for continuing to push on that even when others were de-emphasizing vocational. Now I think many countries in the world have woke up and said this is a key thing and we’ve got to correct that. China called that right from the beginning.”
Turning a room full of tooling engineers into multiple football fields. Keep that image in mind when you imagine competing with Chinese manufacturing.”