The language of the equity markets over the third quarter of 2018 has been dramatic and sensational. We’ve heard of implosions, the global financial system at breaking point, the crumbling markets and ructions across the globe. All of this in a month that was referred to by commentators as Shocktober.
And there’s not a sector that hasn’t felt these shockwaves. Tech stocks are bruised amid issues of trust with Apple, Google and Facebook all making unwelcome and unexpected disclosures, leaving share prices floundering. Apple plunged by more than 25 per cent over a month as investors reacted to the company’s latest results on 1 November, in particular gloomy sales figures of the much-hyped iPhone XS. This is a tale that’s typical of the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) who had previously been the ring-leaders for growth in the S&P and Dow Jones Indices. The iPhone XS seems to have brought this crashing down.
The ASX’s top ten tech stocks have grown by 83 per cent on average in the last year, but in the last three months are down approximately 12 per cent. Tech stocks had been priced according to growth but with risk to those growth factors now realised, the markets have had a reality check.
Investors who are planning to ‘ride it out’ had best be prepared for a very, very long ride with many analysts predicting sluggish growth and low yields from equities over the next 10 to 15 years. So, amid the gloom, doom and despair are alternatives – the alternative? If we look to the US, we are seeing alts, alternative investments, taking a greater allocation in the portfolios of institutional and high-net-worth individual investors. Allocations to private credit, infrastructure, hedge funds and private equity – including venture capital – are all increasing as investors seek refuge in uncorrelated alternative asset classes.
Before the rot even sets in for tech stocks, other asset classes had started to come into bloom. According to AVCAL’s 2018 yearbook, assets under management held by private equity and venture capital fund managers in Australia exploded to almost AU$26 billion in 2017 with venture capital accounting for almost $6.9 billion of this AUM. There are now at least 30 Australia-based PE and VC funds in the market.
This is strengthened by a recent AVCAL report that showed VC investment in start-ups and early-stage companies is also increasing with around $1.5 billion in investment spread across 204 deals in the 18 months leading up to June 2018. There is both a healthy appetite for investors in PE and VC funds and a willingness for PE and VC firms to part with their cash.
And some are VC firms are very willing. An Australian fintech start-up has raised $45 million in capital. It hasn’t even launched to the market and has only been trialled with 50 family and friends, yet it was still appetising to a VC firm and super fund, Hostplus. The latter added a slice of this start-up to their reported existing $1 billion venture capital investment portfolio. And just last week, Sydney-based workforce management software provider Deputy raised $111 million in Australia’s largest Series B funding round to date.
With VC investment becoming more mainstream, many investors are questioning how performance stacks up. Well, measurement can be tricky with many VC funds holding investments for upwards of eight years, returns are on paper and cash may not have been returned to investors yet. But the figures look promising. In numbers recently released by Cambridge Associates, PE and VC delivered pooled horizon returns of 17.36 per cent for FY18, compared to 11.82 per cent in FY17.
With an estimated 700+ start-ups opening for business every year, and many failing to make their first anniversary, a VC fund with a portfolio of at least 20 early-stage companies with exposure to different sectors and themes is optimum. Diversification and volume within the portfolio is key to managing risk. Some start-ups will inevitably fail while some will take off, so a carefully constructed portfolio is essential.
For those of us making the decisions on which early-stage companies to invest in, it’s clear that the opportunities are abundant and VC is undercapitalised. There have been a number of new VC funds that have been very successful in fundraising and this shows that investors are developing a stronger appetite for innovative companies at the expansion stage.
Benjamin Chong is partner at venture capital firm Right Click Capital, investors in high-growth technology businesses.
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