In a world where industry giants often dominate the headlines, there’s an under-the-radar category of companies poised for explosive growth: micro-multinationals.
With turnovers ranging from $50 million to $250 million, these agile and innovative entities are bridging the gap between startups and established multinational corporations. Micro-multinationals present an unprecedented opportunity for the discerning investor to achieve stellar returns while diversifying internationally.
Micro-multinationals are mid-sized companies expanding beyond their home markets and establishing an international presence. According to an HSBC report, UK-based SMBs generate roughly 66% of their revenues outside their home market. That figure is expected to grow as 83% of SMBs cite overseas expansion as their top priority.
These companies are not just trading with international counterparts but are actively setting up operations in new markets, evolving from import/export entities into truly multinational businesses.
One of the defining characteristics of micro-multinationals is their agility. They are often faster to innovate and more adept at adopting new technologies than more giant corporations. This agility enables them to respond to market changes and capitalize on emerging trends quickly.
Plus, micro-multinationals tend to focus their value propositions around products or competencies where they have specialized expertise, allowing them to capture niche markets with precision.
Micro-multinationals offer a compelling opportunity for investors seeking higher returns and international diversification. Investing through private markets enables investors to access these high-potential entities with lower capital requirements than traditional investments in large multinational corporations.
Early-stage venture funds return average net annual returns of over 21%, compared to just 12.6% for late and expansion-stage funds. When companies are rapidly growing, their valuations can increase significantly in a relatively short period. Their innovative products or services often cater to a global market, and as they expand internationally, they can achieve economies of scale and access larger customer bases.
Also, micro-multinationals are often pioneers in their industries. Investing in these companies can reap the benefits of first-mover advantage. These companies may introduce new technologies or enter markets that have not yet been saturated, giving them an edge over competitors.
Of course, investing in early-stage micro-multinationals is inherently riskier than investing in established companies. These companies may not have a proven track record, and their success often hinges on the ability to execute their business model effectively. And, since they operate internationally, they are exposed to additional risks such as currency fluctuations, geopolitical tensions, and regulatory changes.
Given the high-risk nature of investing in early-stage micro-multinationals, investors must have a well-diversified portfolio. This can be achieved by spreading investments across different industries, geographic regions, and stages of company development.
Platforms like Gridline are making it easier than ever for investors to tap into the world of micro-multinationals. Gridline offers access to top-tier diversified opportunities vetted and curated by experts, providing investors with the tools they need to capitalize on this emerging international business category.
The classic investment disclaimer, “past results are not an indicator of future success,” is never more important than when considering established fund managers against emerging fund managers.
Venture capital is a space where strong early returns can reverse in a hurry. Nearly 18% of first-time funds nab an internal rate of return (IRR) of at least 25%, while later funds only exceed that number about 12% of the time, according to Pitchbook research.
Newer managers – defined here as having three or fewer funds under their belt- have some inherent advantages. They frequently have spun out of larger funds, bringing years of experience honing their craft at large firms. Additionally, these newer managers can bring innovative new ideas to the table by striking out on their own, helping recognize trends that more established funds may miss.
Here are four more reasons why emerging managers tend to hit home runs:
The IRR of early funds is a crucial indicator for emerging managers. High early IRRs help managers recruit new LPs, increase check sizes from follow-on LPs for future funds, and build out young organizations.
Emerging managers often leave secure, high-paying jobs to start their own funds, facing significant uncertainty. This only makes sense if those managers truly believe in the potential to generate outsized returns in their area of focus. Because these managers have an outsized personal and professional stake in Fund I’s success, those funds are more likely to outperform.
The math is more favorable for smaller funds. A smaller fund means smaller checks, which naturally makes generating higher returns a little easier. You’re more likely to exit at $100 million than something like $1 billion. When you scale up a fund size, you either have to invest in more companies or make bigger investments. The former stretches your human capital, and the latter could put you in a much different market from where you’ve found prior success.
We’re strong believers in actively managed funds, where fund managers don’t just give startups cash but they offer expertise through board seats or technical assistance to ensure venture-backed companies thrive. Gridline has a cohort of top-notch, experienced investors, and we’ve benefited from their active involvement, industry expertise, and network.
That model doesn’t scale well when human capital is limited. Diminishing returns can be a real problem in labor-intensive tasks like building companies. Limited attention is one of the big drivers of the wide dispersion in returns you see across private equity, with investments underperforming substantially when firms have a large number of simultaneous investments.
Asset management consultant MJ Hudson noted in a 2018 report that while management fees for larger funds are falling, the size of funds has increased so substantially that these fees represent a “significant profit center.”
That can create misalignment between fund managers and their investors. Established managers raising mega-funds, who may have fees coming in from prior funds as well, may not feel the same pressure to hit a home run and cash in on their performance fee. They can return nothing to investors and still earn plenty, thanks to the size of the fund.
Emerging managers not only have a smaller share of their income coming from management fees, but they’re also trying to build a personal brand to justify bigger, successive funds. You can only do that with a strong performance.
Emerging managers are grinders, hungry for success the way a young underdog is against a perennial winner in the sports world. This tightly aligns their goals with LPs – a strong return means both the manager and their partners win.
As we edge towards 2024, the global M&A landscape is revealing a promising scenario. Purchase price multiples, a critical factor that impacts deal values, have been steadily declining, presenting a fertile ground for value-based investment strategies.
According to the Q2 2023 Global M&A Report, purchase price multiples are down by a significant 20% from their peak. This downward trend offers a compelling prospect for investors looking to capitalize on the opportunity to acquire assets at a discounted rate.
Historically, downturns have been strong M&A opportunities, with private equity firms that announced acquisitions during crises delivering over 7% higher returns than average in the following 12 months. This is central to the “buy and build” strategy, as cheap acquisitions can quickly expand operations and generate value.
Meanwhile, the coffers of private equity sponsors and corporations are brimming with unused capital, better known as “dry powder.” As per Allvue Systems, these reserves reached an all-time high of $3.7 trillion in 2023.
This colossal figure represents a double-edged sword. On the one hand, it underscores the immense financial firepower that companies possess. On the other, it emphasizes the pressure on firms to deploy this capital wisely to generate meaningful returns.
The existence of such substantial amounts of cash, paired with the declining deal values, makes for an intriguing scenario as we look toward 2024.
Traditionally, an Initial Public Offering (IPO) has been a favored exit strategy for many companies. However, the path to public markets has been increasingly fraught compared to pre-pandemic levels. A report by Lawyers Weekly suggests that IPOs have been difficult, leading to a significant decline in deal volume.
Plus, the tech sector, which has been a hotbed of IPO activity in the past, is experiencing a drought lasting over 18 months. This trend is not confined to the tech sector alone. Global IPO trends in 2022 showed a substantial slowdown, and in the first half of 2023, global IPO volumes continued to fall from already-anemic levels, with proceeds down by a whopping 36% year-over-year.
This slump in IPO activity may contribute to a resurgence in M&A deal activity. As public markets become less inviting, corporations and private equity firms with large cash reserves are increasingly likely to seek strategic acquisitions to drive growth and return capital to investors.
Given these trends, we can expect M&A activity to see a resurgence in 2024. Investors, particularly those in private equity, are well-positioned to capitalize on falling valuations and abundant cash reserves to make strategic acquisitions.
The current environment presents a rare opportunity for investors to acquire assets at lower prices, hold them through the period of market uncertainty, and potentially reap substantial returns when the market stabilizes.
The road ahead, however, will not be without challenges. While dry powder levels are high, there will be an increased emphasis on deploying this capital wisely. Investment strategies will need to be tailored to unique market conditions, considering factors such as sector dynamics, the competitive landscape, rate increases, the cost of capital, and the broader economic environment.
Gridline, an alternative investment platform, offers investors access to top-tier fund managers across venture capital, private equity, private credit, and real assets.
In recent years, private markets have attracted significant interest from investors seeking to diversify their portfolios and enhance their returns. The rise of private equity, venture capital, and other alternative investment strategies has highlighted the potential advantages of private market investing. Let’s explore the “game theory” perspective on private markets, illustrating how factors such as information asymmetry, reduced competition, aligned incentives, and long-term focus reinforce the advantage of private market investing with better returns than those offered by public markets.
In private markets, there is often less information available to the general public than in public markets. In fact, the annualized return for PE was 11.0% over a 21-year period, compared to 6.9% for public stocks over the same time, thanks to informational advantages.
This information asymmetry creates opportunities for investors with superior knowledge, expertise, and access to information. By leveraging their informational advantage, these investors can identify undervalued assets and achieve higher returns than their counterparts in public markets.
Public markets, with their accessibility and liquidity, have a broad appeal, attracting millions of investors. In 2022, 58% of American adults invested in the stock market, amounting to approximately 150 million people. This immense level of participation can result in a highly competitive environment where information is quickly assimilated and asset prices are driven toward their true value, leaving fewer opportunities for investors to capitalize on inefficiencies.
Moreover, the number of public companies has been shrinking. In recent years, there have been around 4,000 companies listed on public exchanges in the United States. Further, private markets have a significantly smaller investor base. In 2016, there were an estimated 12 million accredited investor households in the United States: A small fraction of the 150 million American stock market investors.
Adding to this dynamic is a vastly larger number of private companies. There are approximately half a million private companies in the United States. In 2020, there were around 4,500 private equity firms in the United States, backing approximately 16,000 private companies. This landscape of far more companies and fewer competing investors in private markets presents a fertile ground for identifying and investing in undervalued assets.
A crucial factor contributing to this abundance of private companies is the decline in the number of IPOs. Companies increasingly opt to stay private for longer periods, allowing them to avoid the pressures and regulatory scrutiny associated with going public. This trend has resulted in an expanding pool of private companies ripe for investment, presenting many opportunities for discerning investors.
In public markets, the interests of investors (principals) and company management (agents) may not always be aligned. This misalignment can result in agency costs that reduce overall returns.
In private markets, investors often have more direct influence and control over the companies they invest in, which can help better align interests and improve returns.
Further, public markets are often characterized by short-termism, with investors and companies focusing on quarterly results and stock price fluctuations. Private markets tend to have a longer investment horizon, allowing for more strategic decision-making and potentially higher long-term returns.
In recent years, private markets have attracted significant interest from investors seeking to diversify their portfolios and enhance their returns. Game theory provides valuable insights into the dynamics of private markets, illustrating how factors such as information asymmetry, reduced competition, aligned incentives, and long-term focus contribute to better returns than those offered by public markets.
Gridline, a digital wealth platform, aims to provide individual investors and their advisors with access to professionally managed alternative investment funds in private markets. Through its institutional-grade process for identifying and evaluating top-performing fund managers, Gridline offers a curated selection of funds that enable diversified exposure to non-public assets with lower capital minimums, lower fees, and greater liquidity.
Information asymmetry, the phenomenon where one party has more or better information than another, has long been a subject of interest for economists and market participants.
Recognized by George Akerlof, Michael Spence, and Joseph Stiglitz with a Nobel Prize in 2001, information asymmetry has significant implications in the world of investing. In private markets, this disparity in information can lead to lucrative investment opportunities for savvy investors who can effectively identify and capitalize on these inefficiencies.
Let’s see how investors can leverage information asymmetry in private markets to gain a competitive advantage and ultimately achieve superior returns.
Unlike public markets, where companies must disclose financial information and comply with strict regulatory requirements, private markets are characterized by a relative lack of transparency.
Nonetheless, private capital AUM grew from $4.08tn at the end of 2015 to $8.90tn at the end of 2021, representing a compound annual growth rate of 13.9%. Further, Preqin predicts that global AUM for the alternative asset class will increase to $23.21tn by 2026. This growth can be attributed, in part, to the potential for higher returns and diversification benefits offered by private markets.
Information asymmetry in private markets can arise from various factors. One key contributor is the limited financial disclosure of private companies. A report by Preqin revealed that 59% of private equity investors cited a need for improved fund transparency to improve the alignment of interests.
Unlike their public counterparts, private firms are not mandated to release detailed financial information, making it challenging for investors to assess their true value. Further, investors with specialized knowledge and industry experience may possess information not readily available to others, enabling them to make better-informed decisions. Lastly, investors who have built strong networks and relationships within a particular industry can gain valuable insights and access to opportunities others may not be privy to.
While information asymmetry in private markets presents opportunities for investors to achieve superior returns, it also poses unique challenges. The lack of transparency and limited financial disclosure can make it difficult for investors to accurately assess the value of potential investments, leading to a higher risk of loss or underperformance if the hidden risks are not appropriately accounted for.
This underscores the importance of a rigorous approach to investment selection, due diligence, and risk assessment.
Leveraging information asymmetry in private markets offers numerous benefits. One of the most significant advantages is the potential for superior returns. Investors can achieve higher returns than those attainable in more efficient public markets by capitalizing on market inefficiencies.
According to a study by Cambridge Associates, investments led by section specialists across four sectors generated a 23.2% gross IRR, outperforming generalist investments at 17.5%. A rigorous approach to investment selection is needed to uncover these opportunities.
A data-driven approach also helps investors to uncover mispriced assets. A report by Broadridge found that 60% of asset managers believe that leveraging data and analytics is essential to gaining a competitive advantage in the market.
Moreover, a deeper understanding of a company or industry can help investors more accurately assess risk and make better-informed investment decisions. This knowledge-driven approach can ultimately lead to enhanced portfolio performance and risk mitigation.
Gridline, an alternative investment platform, effectively navigates the challenges of information asymmetry in private markets by providing rigorous analysis, expertise, and access for investors. By leveraging its deep industry knowledge, proprietary data, analytics, and strong networks and relationships, Gridline uncovers hidden opportunities, mitigates risks, and ultimately helps investors achieve superior returns.
The recent failures of Silicon Valley Bank, Signature Bank, and First Republic Bank have thrown a wrench into the gears of an otherwise strong bear market rally.
Amidst the chaos, large banking institutions such as JPMorgan Chase are capitalizing on the situation, scooping up smaller regional banks to strengthen their foothold. However, not just the big banks are seizing opportunities in these uncertain times.
Private investment firms are also closely examining the loan books of these struggling banks, seeking valuable assets that might fit well within their credit portfolios.
To better understand the scale of opportunity for private markets, let’s take a closer look at affected regional bank loan books.
Signature Bank’s commercial real estate loans totaled $33.1 billion at the end of 2022, primarily focusing on multifamily assets, commercial assets, and acquisition, construction, and development financings. Silicon Valley Bank, on the other hand, had $2.6 billion in commercial real estate secured loans, with a total loan book worth around $74 billion. First Republic Bank’s real estate loans alone amounted to $73.4 billion.
The regional banking crisis has created a sizable–and potentially growing–opportunity to take yield opportunities from the banking system to private markets, further diversifying portfolios. That opportunity has contributed to the resiliency of private equity, even amidst broader market turmoil.
Several prominent private investment firms, such as Blackstone Group, Apollo Global Management, KKR, Ares Management, and Carlyle Group, are eyeing the regional bank loan books for potential acquisitions.
With $246 billion in assets, Blackstone is contemplating purchasing some of SVB’s larger loan portfolios and considering bidding for the entire loan portfolio outright. KKR, Carlyle, and Ares are also conducting due diligence on loan asset purchases from SVB. With $550 billion under management, Apollo is actively reviewing the SVB loan book, seeking assets that complement its credit unit.
Another player, Oakmark Fund, bought up shares of Truist Financial during the first-quarter banking fiasco, while equity group Stone Point Capital bought up 20% of the firm’s insurance brokerage business. Leading private equity investors note that there’s no “spiraling fundamental problem” with many regional banks, which are largely stronger than they were during the Great Financial Crisis.
In tandem with these developments, leading private equity firms purchase the debt of their portfolio companies from banks at deep discounts, sometimes as low as 60 cents on the dollar.
The appeal of this strategy is twofold. On one hand, purchasing debt at a discounted rate allows private equity firms to achieve higher investment yields. The lower acquisition price increases the potential return on investment while minimizing downside risk.
On the other hand, acquiring the debt of their own portfolio companies allows private equity firms to exercise greater control over the financial restructuring process. They can negotiate more favorable terms, streamline operational efficiencies, and even convert debt into equity to strengthen their position within the company.
This crisis makes it clear that when one door closes, another opens. The regional banking drama has opened the door to loan book opportunities for private investors. With platforms like Gridline, individual investors can step through this doorway to access high-quality alternative investments, building diversified portfolios that can weather any storm.
In the public equity markets, top-performing and bottom-performing managers provide returns within a relatively tight band. For example, the 5th percentile of managers returns around 5%, and the 95th percentile is around 10%. Further, persistence is almost non-existent: the top-performing managers in one year are unlikely to repeat their performance in subsequent years, and neither are the bottom performers.
In contrast, the dispersion of returns is much wider in the venture capital (VC) industry. The 5th percentile of managers lose money, and the 95th percentile returns over 40%. Further, persistence is strong: the top-performing VCs in one year are likelier to repeat their performance in subsequent years than the bottom performers.
One study finds a correlation of nearly 0.7 between a VC’s return in one year and its return in the next year. This research isn’t alone; Morgan Stanley points to “other researchers, using different data and methods, [who] find continued evidence of persistence.”
This means that the best VCs are much more likely than the average public equity manager to generate significant outperformance. Fund selection is critical in VC and worth paying attention to a VCs track record. That said, there are many other factors at play in VC—the stage of the company, the industry, the quality of the management team, and so on—so fund selection is only a part of what goes into a successful investment.
There are a few possible explanations. For one, VCs invest in entrepreneurs, and entrepreneurs with a track record of success are more likely to be successful again. In fact, Harvard research shows that a successful VC-backed entrepreneur has a 30% chance of succeeding in his next venture, while first-time entrepreneurs have only a 21% chance. Accessing these serial entrepreneurs is a key to successful VC investing, and the best VCs have a network of them.
Another explanation is that early VC success “leads to investing in later rounds and larger syndicates,” which means that top-quartile VCs have greater access to deal flow. This preferential access gives them an informational edge, leading to better returns. Access-constrained funds, or those with greater access to privileged opportunities, outperform across the board.
Further, a recent Oxford Journal paper theorizes that “successful funds receive continuation contracts that tolerate investment failure and encourage innovation.” In other words, the best VCs are given more leeway to take risks, which leads to more success.
The simplest explanation is that top-quartile VCs are better at what they do. They have a superior understanding of the startups in their portfolio and are better at working with entrepreneurs to help them grow their businesses. These advantages compound over time, leading to better and better performance.
This isn’t to say that all VCs are created equal; the best have a rare combination of skills, experience, and networks. But if you’re looking to invest in VC, it’s important to consider persistence. The best funds have a strong track record of delivering superior returns and are more likely to do so in the future.
Gridline considers all these factors when curating a selection of professionally managed alternative investment funds for individual investors. With lower capital minimums, fees, and greater liquidity, Gridline is the most efficient way to gain diversified exposure to non-public assets.
Headlines purporting the demise of VC and private equity markets are overblown and fail to appreciate the historical resilience of private markets. A closer examination of the industry reveals a much more optimistic reality, with significant growth in retail investment, exceptional PE performance, and rapid expansion of sectors like private debt.
This article will also explore the factors contributing to private market outperformance, such as the liquidity premium, M&A opportunities, a larger investment universe, and longer-term orientation.
Private equity has consistently outperformed other asset classes. In fact, McKinsey research shows that the median net IRR for 2009–19 PE fund vintages were 20.1 percent, surpassing the top-quartile return of all other private asset classes by over 200 basis points. Top-quartile PE funds have been particularly impressive, with net IRRs reaching 29.8 percent or higher.
Another area of significant growth within the private market landscape has been private debt. Private debt has experienced the fastest growth among all private asset classes. Global fundraising reached a new high of $224 billion, marking a 2.1 percent year-over-year increase and the fifth consecutive annual rise. Since 2013, annual fundraising in private debt has more than tripled, growing at an impressive annual rate of 12 percent.
The surge in private debt can be attributed to factors such as increased demand for alternative sources of financing, regulatory constraints on traditional lenders, and the search for yield among institutional investors.
Now that we have explored the growth and performance of private markets, let’s briefly highlight the key drivers that contribute to their outperformance.
One of the most significant contributors to the outperformance of private markets is the liquidity premium. Private market investments often come with higher returns due to the illiquid nature of these investments. Investors are rewarded with a premium for the additional risk of reduced liquidity. This premium encourages them to commit their capital to long-term projects that may offer higher returns.
Another key driver of private market outperformance is the ability to capitalize on economic downturns by seizing M&A opportunities, restructuring distressed assets, and investing in companies at discounted valuations. This ability to act decisively and strategically during challenging economic periods allows private market investors to enhance their portfolios and generate value over the long term.
Further, private markets have access to a broader range of investment opportunities, including small and medium-sized enterprises that are not publicly traded. This larger investment universe allows private market investors to be more selective in their investments, targeting companies with strong growth potential that are not yet accessible to public market investors.
Moreover, many companies are choosing to remain private for extended periods, allowing them to focus on long-term growth and avoid the short-term pressures of public markets. This trend provides private market investors with a larger pool of high-quality investments and the opportunity to work closely with management teams to unlock value and drive growth. By collaborating with companies prioritizing long-term objectives, private market investors can better align their interests and maximize returns.
The same McKinsey report highlighted earlier shows that the retail investor market is worth $45 trillion, but allocations to private markets range only from 5 to 6 percent. This untapped source of funds could significantly bolster VC and PE investments, providing a promising avenue for growth and demonstrating the resilience of private markets.
As retail investors become more aware of the potential returns in private markets, we can expect their allocations to increase, leading to a greater inflow of capital and supporting continued growth in the sector.
The resilience and strength of private markets stand firm, despite headlines suggesting otherwise. With retail investment on the rise, private equity demonstrating exceptional performance, and private debt experiencing unprecedented growth, there are strong reasons to be optimistic about the future of private markets.
With Gridline, these opportunities are now available to individual investors. Gridline provides a curated selection of professionally managed funds that enables access to non-public assets with lower capital minimums, lower fees, and greater liquidity.
A key part of the startup ecosystem went up in flames with the sudden collapse of Silicon Valley Bank (SVB). When the Federal Reserve began hiking interest rates, it started a chain reaction that led to the bank’s demise, largely due to its complete failure to hedge interest rate risk.
The higher interest rates put pressure on tech stocks, eroded the value of SVB’s bonds portfolio, and caused venture capital to pull back. After SVB announced that it would sell $2.25 billion in new shares, panic and fear spread among venture capitalists, and SVB stock started to decline rapidly. Within 48 hours, a run on SVB to the tune of $42 billion had taken place, forcing regulators to intervene and shut down the bank. Soon after, the FDIC moved to guarantee deposits beyond the standard limit.
Despite this guarantee, the investment community is worried about the current state of VC. With one of the major banks in the industry gone, there is a fear that venture capitalists will become more cautious with their investments.
SVB has done business with nearly half of all US tech startups backed by venture capital, and, likely, VCs will now be more risk-averse. This could mean companies will have a harder time getting funding as VCs become more selective. Further, VCs may also demand more in terms of equity for their investments as the risk of investing in startups increases.
Unlike the collapse of FTX in 2022, SVB is an FDIC-insured institution, which is why the federal government stepped in. Still, the Fed’s backstopping of SVB doesn’t extend to investors in the banks themselves, only to the bank’s depositors. So, some investors lost significant sums of money in the collapse, which could also have a dampening effect.
Two other large banks failed recently as well: Silvergate and Signature Bank. Regional banks are considered to be particularly vulnerable to higher interest rates, and some experts fear that more bank implosions could be in store, especially if interest rates continue to climb.
If the Fed chooses to pause rate hikes or even reverse course and cut interest rates, then it is possible that today’s inflation of 6% won’t revert back to 2%. In this case, the banking industry, startups, and venture capital ecosystem could all be jeopardized.
A famous Warren Buffett quip is often cited in economic trouble: “Be fearful when others are greedy, and be greedy when others are fearful.” While the collapse of Silicon Valley Bank brought chaos in the short term, it also presents a unique opportunity for savvy investors.
The fear, disruption, and instability have caused some venture capitalists to retreat, leaving money on the table. Smart investors can take advantage of this window of opportunity, especially as uncertainty about Fed rate hikes persists. VCs who can capitalize on market dislocations by deploying capital more strategically can find value and catalyze more stability in the market.
One resource potential investors can utilize is Gridline, a digital wealth platform that provides access to professionally managed alternative investment funds at lower capital minimums and with greater liquidity than ever before. Instead of relying on traditional financial institutions and their limited options, modern investors can use Gridline to more efficiently gain diversified exposure to non-public assets at lower costs now.
In finance, a theme is an investing style or strategy in which an investor seeks to profit from companies benefiting from specific secular trends. Thematic investing is a popular and growing approach to active investing, as it allows investors to target investments based on their preferences and views about the future.
A thematic approach can help you identify companies well-positioned to capitalize on megatrends. For example, the Energy Select Sector SPDR Fund (XLE) tracks the 23 energy stocks in the S&P 500. XLE gained 64% in 2022 as high inflation, supply chain constraints, and the war in Ukraine caused commodity prices to soar.
Another ETF, Simplify Interest Rate Hedge ETF (PFIX), used creative OTC derivatives to benefit from rising interest rates. PFIX gained 94% returns in 2022 as the Fed turned off the printers and hiked rates. With generative AI and the metaverse well into the Gartner hype cycle, some investors are looking at the WisdomTree Artificial Intelligence and Innovation ETF (WTAI) and the Roundhill Ball Metaverse ETF (METV) to capitalize on these themes.
MSCI offers a large suite of thematic indexes across four categories: Environment and resources, transformative technologies, health and healthcare, and society and lifestyle. If you’re interested in thematic investing, here’s a guide to get you started.
On the risk side, portfolios focused on a few trends may be more volatile than traditional portfolios. We can see that, for instance, the ARK Innovation Fund had abysmal performance in 2022. And since these investments are based on long-term structural changes, they may take longer to play out, or they may not play out at all.
On the return side, well-chosen thematic investments can offer the potential for higher returns than traditional investments. They can also offer diversification benefits since they often have low correlations with other assets.
Research shows that from April 2018 to March 2022, eight of MSCI’s nine thematic indices outperformed the benchmark ACWI index. Cybersecurity was the top-performing index, with a 22% CAGR, or double the ACWI benchmark’s 11% return.
The universe of available publicly-traded companies limits Thematic ETFs. Private companies are staying private for longer and are, therefore, off-limits to traditional ETFs. Even some publicly-traded companies are opting to return to private ownership.
This presents an opportunity for investors interested in thematic investing. Private companies often have a longer runway to execute their growth plans and may be less affected by short-term market volatility, quarterly earnings pressure, and other factors. They also provide an illiquidity premium or, more aptly, a complexity premium.
To access these opportunities, investors can consider private equity and venture capital funds, many of which have a thematic focus.
Private market investments have historically outperformed public markets in bull and bear markets. In fact, the average VC fund generates a 19% internal rate of return (IRR), compared to an 11% IRR for the S&P 500.
These differences become particularly pronounced in downturns. Ten years following the dot-com crash, private equity maintained a 7.5% average, compared to 0.08% for the PME index.
Not all themes are created equal. Some megatrends may be overhyped, while others may be under-the-radar. It’s important to conduct your own research and consult with experts before making any investment decisions.
In addition, it’s important to consider your risk tolerance and investment timeline. Thematic investing can be volatile, so it’s not for everyone. If you’re investing for the long term, though, a thematic approach can offer the potential for higher returns.
Diversification helps smooth out the ups and downs of individual investments, so it’s important to build a diversified portfolio. This can be done by investing in Gridline’s Thematic Portfolios, which allow investors to benefit from diversification across a mix of funds based on asset type, sector, stage, and geography. Gridline selects 5 to 10 underlying funds to build a diversified holding based on a specific investment thesis.