Where the new breed of Unicorns will be found (hint: not in tech)
In 2013 Aileen Lee, a US based venture capital investor, coined the now popular term ‘Unicorn’ for private companies valued in excess of $1 billion. As of May 2022, it is estimated there are 1,100 unicorn companies worldwide with a cumulative valuation of ~US$3,671 billion, according to CB Insights.
Space X, Stripe, Klarna and Canva are four names you will find sitting on top of the pile of unicorns right now. The common denominator is that all of these companies broadly fit into the technology bucket that has performed so well over the last two decades. Another thing uniting these rare beasts is that investors, like you and me, rarely get a chance to participate in owning them.
Early-stage investing is the domain of venture capital, family offices and the ultra-wealthy. Right? However, according to Anthony Murphy, CEO of Lucerne Investment Partners, the playing field is starting to open up and select opportunities are becoming more accessible to everyday investors.
Murphy is an advocate for the alternatives bucket in investor portfolios, that’s effectively everything outside your traditional asset classes like shares, bonds, and property. He believes an allocation to alternatives provides a stabilising force to portfolios, especially in an environment where the tailwinds traditional asset classes have enjoyed appear to be changing.
I recently spoke with Murphy to learn more about what sits beneath the alternatives headline and why he thinks the next unicorns will be found in companies looking to solve the decarbonisation challenge. Murphy also shares two impact funds and one private Australian company that he has been introducing to Lucerne clients.
Gone are the days of Unicorns being in the technology space. That's been over the last sort of 10 to 20 years. Now it's really that decarbonisation thematic, says Anthony Murphy, CEO, Lucerne Investment Partners
But first a word of caution. In Aileen Lee’s 2013 article “Welcome to the Unicorn Club: Learning from Billion-Dollar Startups” she estimated that just 0.07% of software startups founded in the 2000s make it to Unicorn status. That’s why, as you’ll read below, Murphy is treading carefully in the decarbonisation trend and scouring the wave of ESG opportunities with a cautious eye.
Can tell me a bit about your philosophy and why you like alternatives?
In traditional portfolios, you have equities, bonds, cash and property, and would consider them your traditional asset classes. We consider everything else outside of that space to be in that alternative basket. This is why I think many investors out there and advisers see it as probably the most complex asset class to address. It can be so broad and forever changing, and also the most difficult to understand.
I think with a deep knowledge of investing in the alternative space, that's where you can generate systematic returns for your portfolio. Alternative assets also have the ability to complement those traditional asset classes. We're not saying that we don't believe in those asset classes. They have a position in the portfolio, but the weighting of that position is really dependent on where we are at in the market at any point in time.
If we think about the last 13 to 15 years post GFC, we've primarily had an economic environment that's basically been underwritten by the government and central banks. You're now starting to see a little bit of unrest and almost governments crying out and central banks crying out for economies now to stand on their own two feet.
When that happens, you'd see that there's generally quite a rotation away from that sort of passive style of investing, just owning the market or owning those traditional assets and investors still wanting to find a way to generate returns despite what economic conditions may be. And that's where we think alternatives have a real place to play.
So being forward thinking not backward thinking is where we are today and that's why we think alternatives really do have a place to play in a substantial position in investor portfolios.
How do alternatives perform in this environment where we're seeing effectively the drying up of liquidity or tightening style circumstances?
Investors tend not to have a risk profile when the market's going up, but suddenly everybody has a risk profile when the market's going down. And the reality is your risk profile or investment profile and appetite should remain constant. We all get caught up in herd behaviour in the market.
It's when you start to see large draw downs in the market and investors start to take stock and ask if there is an alternative out there? And I think there is.
How I really see alternatives in a nutshell is how investors actually like to invest and most people are wired this way. That’s that you actually want to realise reasonable returns over an extended period of time. Eight to 10% per annum is a pretty acceptable return, but you actually want to take the minimum amount of risk to generate that return and that's where Alternatives play their spot.
The ASX and global equity markets have done so well now for so long that I almost feel that people are flying into this trap and expect those returns going forwards.
You just don't have a lot of tailwinds in the market at the moment to continue those good equity like returns and that's why alternatives are starting to play a bigger space.
And what I mean by that from a performance perspective is using Lucerne Alternative Investment Fund LAIF as an example, back February, March 2020, where markets came off, a number of our investors still had that long on the equity exposure. We were able to stem the tide during that period with a good exposure to alternatives and only realise a drawdown of five to six in that period. Likewise the fund realised a positive return in January and now April this year when equity markets are correcting again.
That's by owning alternative structures or strategies that have the ability to be negative to certain sectors of the market. So, generate returns when those market sectors come off, but equally identify pockets in the market that do well in this economic climate.
So when inflation is rampant, resources tend to do well, commodities tend to do well. So we bias the portfolio that way in this environment. And that's worked out very well for our investors. Equally digital assets, which has been a big thematic on your platform of late. We identified that theme in early 2020. So owning that theme, private debt, long short equities and convertibles.
I'm listing off a number of different alternative strategies here and that's because all of them in their own right have actually delivered returns for us in the past two to three years. When your traditional portfolio asset classes like equities, bonds and properties haven't necessarily in certain periods.
Well, let's get on to decarbonization. I'm going to share some results from a survey that we ran with our investors, just asking how they felt about the opportunity.
- Over 50% said, decarbonization is a mega trend you can't ignore.
- 37% think it's an opportunity but they're still getting their head around it.
- 10% are not convinced that it's worth chasing.
Where do you sit? What's your view?
It's interesting. Decarbonization, ESG overlay, green technology. The reality is it's becoming a very strong thematic in the market. What's quite ironic, probably the biggest question I'll got asked by investors 10 years ago now back in 2010, '11 was what ESG exposure do I have in my portfolio? Then I feel almost a thematic went away for sort of five to eight years. And I think that the market wasn't yet ready to start supporting managers or start supporting investment themes within that space. That's certainly changed in the last two to three years.
I also think there's a bit of greenwashing going on in the market that suddenly a number of these traditional equity managers or other institutions out there suddenly put a bit of an ESG overlay on their portfolio and make claims such as Microsoft and ESG friendly company. I don't consider that true impact investing, but the reality is that it is a theme that's getting a tremendous amount of institutional capital behind it.
And a number of market experts out there at the moment are saying that the next unicorns over the next 10 years are going to come in this decarbonization space.
Gone are the days of Unicorns being in the technology space. That's been over the last sort of 10 to 20 years. Now it's really that decarbonisation thematic.
I do think it's time for investors to think about having an allocation to this theme in their portfolio, and that's certainly something we've started to support.
In terms of the conversations you are having with your own clients and how it's represented in portfolios, what sort of allocations would you see in a portfolio?
We're starting to step into the theme at the moment as I still think it's emerging and I still think it's a relatively complex space. I'll take my hat off to the emergence of technology and financial services has allowed all investors, both retail, wholesale institution to gain exposure to this space quite efficiently.
At the moment, we're looking across the board in a traditional portfolio to have direct exposure to decarbonization and managers of that thematic, about 5% on a portfolio level.
Within LAIF at the moment, we're building that position out to about six to 10%, but we're doing that gradually. And we're really targeting managers and strategies that truly invest in impact investing because I think a lot of the greenwashing strategies out there and companies will be found out and there'll just be greater scrutiny put on businesses and companies that are truly providing a change to the environment through what they're doing. And that's why we're trying to bias our capital allocation that way.
We've done so recently for the audience's benefit with a manager called TT Global Environmental Impact Fund. I'd encourage them to look at.
They're targeting companies that truly provide a positive benefit to the environment, where over 50% of their earnings for that company has to go into a delta impact positive to the environment.
But in addition to that, they're targeting emerging economies, which when you think about decarbonization, it's often those emerging geographies that have a greater level of pollution than developed economies.
That's where we think there can be a greater level of impact made in this space.
A recent journal of finance paper did some analysis as a US based study over 20,000 funds and their Morningstar ratings. It found was that funds with a higher ESG rating didn't outperform lower rated funds. They attracted more money, but there was no noticeable or discernible difference in performance. And I think it sort of sings to the challenges that our investors are facing with the amount of noise and filtering. So what are some practical tips that you could share on how to filter the universe and find those funds that are true to label?
It is interesting. It probably backs the comment I made before that the market hasn’t been ready for it yet. To speak freely, at the end of the day, I think as humans, we want to do the right thing and want to support this thematic. But equally as investors, we want to make money. Otherwise, why do we invest? It's combining the two, which is providing a challenge.
That's why I tend to take with a grain of salt a lot of these managers out there and managers of capital that say, “we have an ESG overlay on our portfolio.” What does that even mean?
I think five to 10 years ago, ESG, tongue in cheek here, meant that provided you didn't have exposure to tobacco, firearms or pornography, you sort of tick that box. It's obviously a bit more rigorous today.
But you've got managers out there arguing that they can own BHP in a portfolio, but that still has an ESG overlay because BHP is becoming more environmentally friendly in their operations. But does that mean BHP is an impact investment? Of course it's not.
This is why we're encouraging investors to tread quite carefully with this thematic. And it might be as a result, you actually have to give up some performance early on, which sort of goes against our traditional investment ethos.
At Lucerne, we're happy to be really early and sort of take conviction. But not until you can filter through what is an ESG investment, find a true impact investment and then actually follow well renowned family offices and institutional capital into that space.
I think the appropriate approach to take rather than buying a green ETF or buying a manager with an ESG overlay is to spend that time on looking at for a true impact fund. As a result of that, that's when I think you actually are going to get those returns and outperform those Morningstar benchmarks.
Another strategy I'd encourage the audience to look at at the moment is a fund called Carbon and Growth. The fund trades in carbon pricing and looking at meaningful projects around the world that benefit from carbon credits. That's a fund that's done extraordinarily well since launching in July '21 last year, up nearly 80% since then. C
Compare that to your Morningstar table and you'll see the difference in a true impact fund versus an equities fund with an ESG overlay. And I'm being quite serious about that. Although it's a bit tongue in cheek, that just shows you the delta that you can realise when you find a true impact fund. That fund at the moment's about to launch their second series so I'd encourage investors to have a look at that as well.
Do you feel that direct investors and smaller investors are locked out of those direct opportunities to invest in this decarbonization trend?
Historically, yes, given how financial services was structured and platforms were structured, but today, no.
If there's a private asset in the decarbonization space that is only looking for a select amount of capital can go to one or two high grade institutions or family offices. Sure, but that's always going to be the case across most asset classes, right?
With the emergence of technology and the availability of funds these days, I think the average retail investor can get exposure to this thematic. Coming back to my point I was making before, how to carefully choose that exposure.
So using that example, before I go with TT Global, that's a retail and wholesale fund. You can invest in that for as little as $20,000 and that is a true impact investing option for investors out there.
I think once you move up to the sophisticated and wholesale into the market, and we all know that means tested, but those investors can actually still get access to some of these more, I guess, sort of pointed carbon funds and carbon trading funds as I mentioned one before. That is taking in capital of USD$100,000 whereas I think historically it was just for the bigger end of town with very large institutional checks coming into that space.
I think the market has progressed and now retail and sophisticated professional investors can get exposure to what was previously just limited to the institutional market.
Could pitch me an idea that you've uncovered and how you've uncovered it and why you like it?
We tend to back managers and back managers early out there. And one of our preferred managers out of Brisbane, a fund that you've interviewed before, James, Altor Capital. Dave McNamee brought us an idea that he'd seen, a company called Nu-Rock, which is a business that's been around for 20 or 25 years in New South Wales.
Their technology is fascinating. The biggest problem Australia has each year at the moment in terms of pollution and waste, annual waste, 22% of annual waste in this country each year is produced from coal power stations. And that's why you're seeing Canon Brooks, et cetera, bid for AGL overnight and trying to get involved. The waste from a coal power station is a real problem, but where we stand today, we still require coal power and probably will still require coal power in Australia for the next decade or two decades. So instead of ignoring that, how can we actually address it?
This business Nu-Rock, can take a tonne of fly ash, that's the waste produced from a coal power station, combine that with its knowhow and technology and produce materials for the construction industry.
So you think about that and it's really powerful. It's a sovereign economy, so it's our waste in our own backyard. It's a circular economy and it's also a complete carbon rebate. So 0% emissions on their process.
Now this is a business that's been around for 20, 25 years that the market has not cared about, but suddenly every major power company in Australia now wants this that has a coal fired power station.
And even AGL to give them credit, they've identified the issues within that business and they even announced their LinkedIn page the other day that they've signed a memorandum of understanding with Nu-Rock.
So here's a small, tiny Australian business that was started from a garage with a great idea that's now partnering with Australia's largest coal powered companies, energy Australia's Origins, your AGLs of this world and actually doing something meaningful.
Instead of complaining and being critical of the problem and the coal power, it's finding ideas and stories out there that can actually take waste and turn it into your next building down the road in a very, very cost efficient manner.
And I just love that idea of the circular economy. And that, James, hopefully gives you an example of what a true, I believe, impact investment is and how you've really got government and corporate Australia waking up to that and supporting some of these ideas.
It sounds like I can't actually wait to go and read up about that company. I love that idea of running out the challenge rather than running away from it.
Exactly. It's a very powerful story, one that we're really happy to be introduced to through one of our managers and one that we were really happy to support as a direct investment. And I think in the decarbonization thematic, you are going to find some of these private companies that do require you to do a lot of work on them, but then once we could do that due deal just over six months and really get under the hood, it was something that we were really happy to introduce to our investors.
Anthony, thanks very much for taking some time out to have a chat with me today. Really enjoy our conversation and thanks for being part of Livewire's 2022 mega train series on decarbonization.
A pleasure as always, James, and thanks to you and your audience.
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