Q1: 2022 saw many challenges: a slowing economy and an inflation-driven wipeout of stock market value. As you look back on last year, what key insights did you glean?
Never a dull moment in the world of investing! I think it’s important to look at 2022 in the context of a longer time horizon. Certainly 2022 will go down as a massively volatile and historically important year. Asset prices started the year on a positive note still propelled upwards by the tail-end of over two decades of loose monetary policy, and further exacerbated by the COVID-triggered stimulus. Starting with Fed Chairman Greenspan’s response to the dot.com crisis in 2000, through Ben Bernanke’s bail-out of irresponsible, too-big-to-fail banks in 2008/2009, to the more recent populist pandemic check-writing initiatives, “printing money” became the go-to solution for any crisis. Drunk on cheap money over that period, credit ballooned across all constituents from retail to corporate, to finally central banks. The Fed’s balance sheet under Jerome Powell ballooned from $3.78 Trillion at the beginning of the pandemic to a historic $8.97 Trillion in just 3 years.
The pandemic together with the Ukraine-Russia war, their related supply-chain disruptions, and a highly uncertain macroeconomic backdrop, created the perfect inflationary-storm. The interest rate policy reversal of March 2022 violently pulled the rug from under what seemed like a one-way market. Inflation, geo-political disruptions, and the first “hot” war in Europe (involving a nuclear power) since WWII meant that the blind, bullet-proof optimism had not only been stirred but fundamentally shaken. Instead, emotions whiplashed from party-mode to one of caution or outright fear. Armageddon-like predictions proliferated as did alternative and more subdued “soft” and “hard” landing” scenarios. Still others maintain a more contrarian view that recent Fed action is excessive, that a policy reversal is imminent, and that the current environment is presenting ahistorical buying opportunity. The jury is still out!
Q2: The game of the last five years—at least—is over. And no one really knows how to play the next one. What is the new venture capital playbook?
Where we land in 2023 is still unclear.The trial-and-error impact of short-term Fed interest rate policies is still playing out. The consensus (which is often incorrect) implies a Fed hiking cycle nearing the endgame with a 5% terminal fund’s rate. The intended crushing impact of these policies on demand and employment resiliency will at some point materialize. It would seem we may already be in the 6th or 7thinning of this hiking cycle.
As with all things, nuance is key. As touched on in my first answer, we see two plausible outcomes: a soft landing with the Fed miraculously getting it just right and applying the brakes on further interest rate hikes just before the economy skids into the proverbial ditch or, a hard landing where the brakes are applied too late. Regardless of which scenario unfolds, there will be attractive investment opportunities and reducing emotional noise is essential to making good decisions. We do this by following a rigorous, systematic, and data driven investment process.
We believe that the transformational nature of technology and the super-cycle of innovation will remain intact regardless of near-term economic volatility. We are being propelled into a world where Artificial Intelligence, Robotics, Quantum Computing, Bio engineering, and Blockchain/Web3 will dramatically alter the landscape of how we live, work, entertain ourselves, and evolve - possibly by the end of this decade. This means that the next Apple, ByteDance, Alphabet, Amazon, SpaceX, and Stripe are right there in front of us, hiding in plain sight. It is our mission to use a rigorous data-driven process to systematically invest into these still under-the-radar, high-potential private firms.
Q3: Venture capital has more dry powder than ever before. Are people waiting for valuations to further drop?
There are record levels of VC dry powder ($500B+; $250B+ in the US alone) and this will undoubtedly provide strong support for private market valuations. However, there is also a greater degree of discernment from investors now. 2022 demonstrated that not even the biggest and most reputed firms were immune to the buying frenzy that led to gravity-defying asset price multiples. This was limited to not just the VC world, but to practically every asset class from credit markets to public equities to real estate. Nowhere has this become more obvious than in the VC space, where some of the best-known VCs, Sovereign Wealth Funds, and Hedge Funds sacrificed proper due diligence and caution, at the altar of FOMO. VC has always been a game of probabilities where returns are generated from a handful of portfolio companies compensating for the other failed, or “zombie-like”investments. Today, the ability to identify winners from losers as opposed to“spraying and praying” is more important than ever and VC firms that can deliver top quartile returns in this more competitive environment will quickly ascend the performance hierarchy. Overall, we can expect an even higher degree of return dispersion between performance quartiles than observed over the past 13 – 14 years.
As with everything the devil is in the details. How much of that dry powder is earmarked for follow-on investments? Which segment of the private company life cycle is it mostly concentrated in (e.g. Seed versus Growth/Late-Stage)? And how is the demand for funds distributed within those segments? The key will be in determining which of these strategies presents the best opportunities, and who will be able to take advantage of them in a timely manner?
Questions like the above are precisely what we try to answer via our quantitative analysis. Data from the public markets suggest that historical averages for the growth segment are still too high relative to value stocks and hence a further sell-off in growth-oriented companies is a possibility. Many private companies have not yet fully priced in an equivalent drop because they continue to hide in the shadows. Privately held firms that don’t have an immediate need for VC-financing will perhaps avoid theTechCrunch article announcing their down-round, but behind the scenes, these firms will see their share prices drop in the secondary markets (as we’ve seen first-hand over the past 6 – 12 months). Motivated sellers in need of liquidity will provide at worst fairly priced shares, and at best extraordinary entry levels for firms like ours in the secondary market.
There is no doubt that the 2022 (undeployed), 2023, and 2024 funds are going to be strong VC vintages, but who will be able to pick out the winners from the losers? Who will find the needles in the haystack, and how do their respective strategies empower them to do so?
Q4: The market moves quickly. How can investors be ready when the market turns around?
As with any market, trying to pick the bottom of the market is rarely possible. However, competitive entry pricing remains one of the most critical contributors to returns. Based on several factors including the extreme multiple compression observed in public growth companies, the massive supply-glut in the private secondary market and the consequential drop in prices, now is likely a good time to begin allocating to VC again. Many venture-backed companies are being valued far lower than their 2021/early-2022 valuations, in some cases the “baby is being thrown out with the bath water” with several great companies staring at 50% – 75% price reductions compared to their 2021 peaks. The growth in transaction volumes and number of companies trading in the direct secondary market is transforming the industry and allowing for a greater degree of price discovery. Motivated sellers whose IPO timelines have been stretched are eager for liquidity solutions and are providing buyers with highly attractive entry levels.
Q5: How does EQUIAM differentiate itself from the other VC firms?
We believe that applying a systematic and data-driven investment process to the growth and late-stage VC space is not just another type of investment strategy, but potentially a superior one. We are convinced that systematic investing will permeate the entire VC space over the next decade. This investment methodology is not new, it is just new to VC.Venture Capital hasn’t fundamentally changed its investment processes in 70years. If we are to take stock from what happened in the public markets over the past 2-3 decades, some of the most successful and best returning investment firms in public markets, as well as macro players, have relied on a data-driven and systematic approach to investing and alpha generation.
Increased deal-flow in both the primary and direct secondary VC markets has delivered a tremendous amount of new data that was not previously available. This has allowed us to develop an approach that marries data science with VC investing. We leverage 90+ proprietary investment signals, allowing us to pursue a rules-based approach to investing. Computing power and data-availability are transforming investment methodology across all asset classes; however, VC investment methodology has lagged. We aim to be major innovators in this space and are well on our way to executing on this goal.
Q6: Let's shift gear a bit. How exactly is the relationship between public and private markets changing?
We believe that the line between public and private markets is blurring. The onerous cost of going and staying public, as well as the tyranny of quarterly reports has dissuaded many a private company from going public. The fundamental role of regulators is to protect the retail investor so it’s unlikely these requirements will diminish any time soon. As a result, this will continue to encourage private market participants to invent alternative solutions to liquidity and develop an entire liquidity ecosystem that includes marketplaces; custodians; data-providers; and even derivative markets. Crossover investors such as Mutual Funds; Hedge Funds; FamilyOffices and SWF’s have entered the fray and will bring their own investment processes and technology to the space. We predict that over the next 5 years, the private growth and late-stage VC markets will start operating more like a private capital market than what it’s been to-date—an information-asymmetric, opaque, and oligopolistic market.
Q7: Let’s assume the economy slows further in 2023. Do you think it’s risky to be a buyer in the tech sector?
I believe it’s risky not to be an investor in Tech. It is also misleading to speak in terms of Tech as a sector, every sector is infused with technology and those that are not, will not survive. We are sector agnostic and are looking for the companies disrupting existing paradigms and driving the next major wave of technological innovation. There are companies that fit this profile within just about every sector. Data is the fuel of innovation, and everyone must use it to thrive. The perceived“riskiest” portion of the investment spectrum: crypto, tech, growth etc. have been punished more harshly that the rest and perhaps justifiably, but as things stand today, if the markets are anticipating slower Fed rate hikes, innovation and, more broadly, technology companies have traditionally rebounded much faster and more strongly than the broader market.
The availability of historic dry-powder levels will provide additional cushion to any market correction. Money will flow back into public equities and fixed income (which finally again pays a yield), and then make its way back to the growth stocks in the private space.Private market access is only possible, for most, through VC funds and these funds tend to have a 3-4 year deployment period, so if you are not already allocated to private markets and, in particular, VC, you will most likely be somewhat late to the party.
During times of high volatility, it is essential to adopt a highly disciplined approach. Certainly, there are exceptional VC firms that through the robustness of their networks and the expertise of their partners will continue to deliver spectacular results with a traditional approach to investing. However, we see an enormous opportunity driven by two key factors: 1)the proliferation of private market data & 2) the rapid maturation of the private direct secondary market. For the first time in private market history, a quantitative, systematic approach to investment is possible. VC-firms that can continuously scan, filter, and force rank a universe of several thousand investment targets at the push of a button, will be at a decided advantage compared to their more traditional peers. We’re excited to be at the cutting edge of this revolution.