Investment Matters

Venturing across the S curve

Venture Capital. It’s a word tied at the hip to “innovation”, “disruption” and other futurist buzz words of today.

But this wasn’t always so. Not too long ago it was the esoteric domain of a handful of foolhardy mavericks, including Eugene Kleiner.

An engineer and technology wildcatter, Kleiner went looking for investors to put their chequebooks behind a new type of transistor in the late 50s. This was at a time where many still clung to the safety of government-issued securities.

The eventual funding of eight traitorous engineers from Bell Labs (the Traitorous Eight) was the genesis of Fairchild Semiconductor. Although a relative unknown today, the company went on to produce the first silicon transistors. These building blocks, having passed through the hands of countless tinkerers, innovators and dreamers have been transformed into the Silicon Valley of today and sparked the creation of a wide range of industries, products and services.

As for our visionary (at least, a posteriori), Kleiner would go on to found venture capital firm Kleiner Perkins. Synonymous with Silicon Valley, the firm has been behind on to a who’s who of Fairchild’s progeny including Apple, Google, YouTube, Instagram, PayPal, Zoom and WhatsApp.

This underscores what has now attracted many to invest in early-stage companies. Their growth potential is not only vast. It can be world-changing.

First Samuel clients own their little slice of this entrepreneurial spirit through an allocation to Venture Capital within Alternative Investments.

We are pleased to announce that one of these investments, the Acorn Capital Expansion Fund saw a 16% uplift in its value last week. Our investments in the fund between 2019 and today have generated a return of 20% p.a.

What did early Venture Capital firms like Sequoia Capital, Kleiner Perkins and others see in venture capital investing that other didn’t?

We explore venture capital investments and the role they can play in a portfolio.

Where does it all fit in?

Why does Venture capital funding exist?

If you were to ask Bell Lab’s Traitorous Eight in the ’50s and the answer would be simple. They needed capital, and there simply was no one else.

Companies like these are often birthed from the intellectual wellsprings of government institutions, university research programs and, like Fairchild Semiconductor, renegade offshoots of large corporations.

But great ideas need capital. And not everyone shares their vision (particularly so early on!).

Venture Capital fills the void between an inventor/innovator bootstrapping (a polite term for scrounging for funds) and traditional, lower-cost sources of funds such as public markets, large institutions, and banks.

This gives investors a chance to be part of the highs (and lows) of being on the frontier of the out of the box thinking, innovation and technology that will shape the world of tomorrow.

Examples of early-stage, Venture Capital style investments in clients’ Alternatives sub-portfolios include:

Camplify (Part of the Acorn Capital Expansion Fund)

The AirBnB of campervans, Camplify is one of Australia’s leading peer-to-peer (P2P) digital marketplace platforms, connecting recreational vehicle (RV) Owners to Hirers.

Camplify has built a platform that delivers a seamless and transparent experience for consumers and potential RV Hirers to connect with RV Owners and SMEs with a fleet of RVs. A wide variety of caravans and campervans are available on Camplify.

Camplify flow

 

Source: Camplify

Elitic (Sourced by First Samuel through industry relationships)

A US-based machine learning company that harnesses the power of artificial intelligence to read, analyse and interpret radiographic images (X-rays, CT scans, MRIs, etc).

Its software has the potential to significantly improve the screening, triage, and interpretation of radiographic images, including the identification of subtle, rare and incidental abnormalities.

Enlitic x ray

Source: Enlitic

Hemideina (Sourced by First Samuel through industry relationships)

Hemideina is a medical device company that is developing a novel cochlear implant. The device is a compact, wireless earbud that aims to provide superior hearing through a novel strategy of stimulating the cochlear.

The novel stimulation methods proposed have the potential to significantly improve the quality of hearing for the hearing impaired.

Hemideina hearing

Source: Hemideina

From little things…

Given the role that Venture Capital plays, investments are often made in companies that are much earlier in their company/industry life cycle (or “S curve”).

A stylised version of this life cycle is shown below:

Company lifecycle

The companies that receive Venture Capital firms exist on the left end of this curve.

Their growth is driven primarily through the establishment and adoption of new industries. products and services, as well as disrupting and reshaping existing industries.

Companies can exist at different points on the curve, with risks and rewards generally commensurate with their level of maturity. This can be shown through the placement of the investments in client portfolios on the curve above.

How does this differ from owning those on the ASX?

Many listed companies (particularly within the ASX300) are often in industries in a more “mature” phase of the S curve. Mature companies are often battle-hardened, having survived an onslaught from competition during their industry’s most rapid growth phase to carve out a largely stable market share.

As such, these industries are often more reliant on growth in the overall economy or population than rapid growth within their industry, and most exhibit growth largely in line with movements of GDP.

Examples of such industries include the Telecommunication industry – which after decades of rapid growth has consolidated to a handful of carriers playing a tit for tat game for market share.

Why Venture Capital investments can make a sensible addition to some portfolios

There are always risks involved in allocating capital. What is important is the ability to select and diversify amongst these risks.

Venture Capital broadens the buffet of opportunities on offer to investors whose Investment Program can absorb the risks of the individual investment when held in a diversified portfolio.

Why? Just like diversifying across industries, venture capital allows diversification across the industry life cycle.

From a risk perspective, the success or failure of Venture Capital investments often has less to do with movements in the broader economy than many mature companies.

It resides more in the success of products and services they provide or the growth of the new markets they are participating in. Thus, elements of macroeconomic risk are traded for more “idiosyncratic” commercial risks: including those around the success of research, development, and marketing.

From a return perspective when these investments work – the payoff can be large (sometimes many multiples of the original investment). In portfolio lingo, this provides “positive skew”.

Camplify provides a good example, to date has returned more than 3 times clients’ initial investment.

But equally, the probability of downside can be higher (although ultimately limited to the capital put in).

Thus, sizing these investments appropriately within a portfolio is important. Furthermore, some of this can be mitigated by spreading venture capital eggs amongst a number of baskets. Exposures are often spread across many companies in a range of industries.

We have looked to achieve this through small positions in exciting companies, as well investments in diversified Venture Capital funds such as the Acorn Capital Expansion Fund, which provides broad exposure to early-stage companies across several industries.

Ultimately, the combination of lower correlated risk and high positive skew means that Venture Capital investments can make sense for many portfolios (although not all).

Where appropriate, we are looking to add more of these kinds of investments to clients’ Alternative Portfolios in the near term. Watch this space.