The Bottoms-up Economy
As investors seek higher returns than index funds, they tend to have their money managed in alternative instruments and by professionals. Two of these prestigious institutions are Venture Capital and Hedge Funds. However, the search for the best returns in evolving from the way it used to be.
Venture Capital
We’ll used Venture Capital (VC) to talk about investing in private companies and Hedge Funds (HFs) to talk about investing in public companies. As a company matures, it seeks different kinds of investors with differing skill sets. In the diagram below, we see the changing funding sources based on the companies’ age.
As you go higher up the ladder, although there is more money to be invested, there are fewer providers of that money. The reason being is because angels cut smaller checks. They are people, not funds, after all.
So how do you get the personal touch of an angel without having to deal with the selectiveness of a VC, but still get access to VC sized checks?
AngelList is website where “the world meets startups.” It initially started out as a posting board of what a private company was working on. Then it evolved into a job board for open position from those companies. And now it rolled out a feature called Syndicates. With Syndicates, you can invest along side a notable angel on his/her deals. Because certain angels have a prestige or a unique skill set that a company values, they can bring all that — plus the money. This ultimately turns the syndicate lead into the VC and his syndicate into LPs.
This removes the traditional route of raising money of heading to Sand Hill Road. In this way, you can communicate with the angels on AngelList, and raise your round at the comfort of your home.
Hedge Funds
Hedge Funds had the same approach to VCs as to raising money. They would raise from their connections in either larger banks (Merrill Lynch, Goldman Sachs) or retirement funds (CALPERs) or endowments funds (Harvard, Yale). Now those institutions need more than a handsome guy in a $4k Zegna suit to raise a few hundred million from them.
Estimize brands itself as “crowdsourced earnings and economic estimates.” What the real interesting byproduct of their site is the curation of top analysts in varying sectors. The metric that everyone is trying to predict is EPS and quarterly revenue of stocks. And the point is how close these analysts can get to the companies’ real number.
In theory, this is the way for large funding sources and accredited investors can go and cherry pick who should be managing their money. So now we go from wooing tactics like expensive steak dinners and gentlemen’s clubs to a leaderboard.
But this no barrier to entry/ “let my trades do the talking” is nothing new. Dr. Michael Burry, which was popularized in Michael Lewis’s “The Big Short,” got his start that way. His fund went on to return 726% over an eight year period, while the S&P was only able to return only 2% over the same time frame. Lewis writes:
Late one night in November 1996, while on a cardiology rotation at St. Thomas Hospital, in Nashville, Tennessee, he logged on to a hospital computer and went to a message board called techstocks.com. There he created a thread called value investing. Having read everything there was to read about investing, he decided to learn a bit more about “investing in the real world.” … A few people grumbled about the very idea of a doctor having anything useful to say about investments, but over time he came to dominate the discussion. Dr. Mike Burry — as he always signed himself — sensed that other people on the thread were taking his advice and making money with it … He was working sixteen-hour shifts at the hospital, confining his blogging mainly to the hours between midnight and three in the morning. On his blog he posted his stock market trades and his arguments for making the trades. People found him. As a money manager at a big Philadelphia value fund said, “The first thing I wondered was, When is he doing this? The guy was a medical intern. I only saw the nonmedical part of his day, and it was simply awesome. He’s showing people his trades. And people are following it in real time. He’s doing value investing — in the middle of the dot-com bubble. He’s buying value stocks, which is what we’re doing. But we’re losing money. We’re losing clients. All of a sudden he goes on this tear. He’s up fifty percent. It’s uncanny. He’s uncanny. And we’re not the only ones watching it.” In the beginning his readers came from EarthLink and AOL. Just random individuals. Pretty soon, however, they weren’t. People were coming to his site from mutual funds like Fidelity and big Wall Street investment banks like Morgan Stanley. One day he lit into Vanguard’s index funds and almost instantly received a cease and desist order from Vanguard’s attorneys. Burry suspected that serious investors might even be acting on his blog posts, but he had no clear idea who they might be. “The market found him,” says the Philadelphia mutual fund manager. “He was recognizing patterns no one else was seeing.”
In the past, Venture and Hedge Funds raised money on relationships, credentials and word-of-mouth referrals. Now, in an age of distrust and group think, investors are looking to de-risk their investments and letting the numbers do the talking. Marketplaces with no barriers to entry, the complete opposite of the Harvard Clubs and Davos’ of the world, is where the best opportunities are emerging.
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