ETF Edge - Investing in hot private tech companies 4/22/24

Episode Date: April 22, 2024

As more tech companies push off IPOs and stay private for longer, investors are hungering for ways to get in. Here’s two, but they’re not for everyone. Can the process be made more democratic?  ��    Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by InvescoQQQ, Supporting the Innovators Changing the World, Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds. You are in the right place every week. We're bringing you interviews, market analysis, and breaking down what it all means for investors. I'm your host, Bob Pisani. New funds offer ways for hungry investors to get in on private tech companies. but is it possible to democratize the process even further? Here's my conversation with Brett Witten, Chief Futurist at ARC Investment, Howie NIG, Head of Analytics and Investment Solutions

at Forge Global and Nicholas Colas from Dat Trek. Brett, I'll start with you. You and Kathy Wood launched the ARC venture fund in 2022. This is an interval fund. It also invests in private tech companies like SpaceX, OpenAI, and Epic Games, and it also owns public companies like Coinbase and Robbins. like Coinbase and Robin Hood.

Now you just published a paper that caught my eye claiming that this Interval Fund is a better way to invest in private companies. Can you explain why you think it's a better way? Yeah, actually, interval funds were designed specifically to allow everyday investors to invest in less liquid assets and the venture fits right into that idea. So with an Interval Fund,

you don't have to be an accredited investor, you don't have to be very, very wealthy, to invest in in venture exposures like Open AI and you get to invest at the net asset value so you can buy daily at the value of the underlying positions in the portfolio and then you can sell quarterly and so you have a quarterly window in which you can kind of sell your position and i want to this is a good educational moment to inform viewers what an interval fund is so with an interval fund you can buy at any time at the net asset value. That's the key. So there's no premium or discount. And you can sell to the company at set times on a quarterly basis. Am I right about that?

Exactly. And so that's why it's an appropriate vehicle for liquid assets because it allows for kind of the manager to prepare for the redemptions that come and make sure there's a pool of liquid assets that they can sell to meet those redemptions and those happen quarterly. So and you own private and public companies. Why does the fund own both private and public companies, like you owned Coinbase, for example? Yeah, the majority of the fund is in private companies, so roughly 80%. And then the public equities in the fund is to facilitate that quarterly redemption process. You know, frankly, it's an amazing time to invest in innovation. we think both venture exposures and public innovation companies are incredibly well valued today

to take a long-term investment over what's a unique decade in technological economic history. Okay, Howie, let me turn to you. Private funds for qualified investors are also available. Forge Global recently launched the Ford's Acuity Private Market Index. This is a market capitalization weighted index that tracks the performance of 60 late-state venture-back private companies for example like SpaceX and Epic Games and I know you told me this is already being used in a private fund tell us about this private fund who is qualified to invest in it right so as first of all as a data provider and as an index provider liquidity provided in the space we just

see all these different types of fund structure coming to the space which is very exciting and I think very similar to the interval of fund structure the The private fund is catering. It has a very similar redemption and contribution window. So you do transact a net asset value on a quarterly redemption basis. And I think for this fund, it is targeting institutional investors. So it's set up for to take contribution from qualified purchasers, which are $5 million of net worth and you just have to qualify to invest in the fund.

And what the, so qualified investors here are net worth of at least $5 million. What's the ticket size? I mean, it's totally institutional, right? The ticket size is $100,000 at this point. Down the road, they might get revised up. The idea about the private fund with qualified QP, qualified purchasers, is to target the institutional segment. I think for any kind of asset class to mature,

you're going to have retail players and institutional players at the same time. For this one, it's just the first step that we actually see index investing, and we're targeting the fund management. is targeting the institutional sector. Right. I mean, the obvious problem here with qualified investors is they cut out essentially the retail investors, right? I mean, I assume howie that was a conscious, obviously a conscious decision on your part, right? Yeah, it's definitely a conscious decision on the asset managers path, but if you sort of think about the next product and the next product and more products coming to the space,

the idea here is that now it's possible for you to invest like an index discipline just similar to the public market, right? public market, right? So this index is now launched for the first ever pure play institutional index fund. That's not to say down the world, we won't see products that actually cater to the retail segment, but it's still index tracking. So Nick, let me bring you in here. This is just, this highlights the fundamental problem here. Investors want access to these hot private tech companies, and it's really hard to do that. So isn't the solution here to get more companies to go public long term? I mean, you're the old wise man here. Tell us what what is your sense of watching

this? People want these things and they can't get to them. Yeah, it's funny because IPOs, the IPO window is what we call it on Wall Street when a company can go public, even the hottest company can go public, but even smaller ones. It opens and closes over time. The IPO window was last opened at the very beginning of 2022 and then it shut hard and it hasn't reopened since. We've only seen a couple of interesting IPOs this year. There were very few last year. So as you said, there's a between investor interest in owning public companies and the ability of companies to actually go public in a relatively productive way. And that mismatch is exemplified by needing these kind of products. So, Howard, you said you're going to, you imply somehow there's going to be something coming down the road catering to retail investors.

What is it? Is it an interval fund like Kathy has and Brett has here? What's going to come down the road that you have, plan? No, I think the interval fund that Kathy has is actually a very, sort of reasonable next step, you know, other than these close-end exchange trade a close-end fund, which is the fund that you're referring to at the outset. So I think interval fund is definitely a possibility. And downward, there might be other ways to access this spot before we even get to, say, like a 40-eat ETF wrapper.

Brett, this is an ETF show. And so I know the viewers are wondering, why can't we just deal with this problem and create an ETF that holds the shares? of these private companies. It seems in terms of how you want to do this, that'd be the best way to address the issue. Why can't we do that? Well, it comes down to the kind of liquidity and ability to access the underlying exposure.

So you can't just invest in a private company without getting the permission of the company to invest in it. And that's an area where we do a lot of work and actually we have an advantage because we're so well embedded in the technology community. to be able to approach these companies and both provide them with information and then, and then, you know, invest direct on the cap table of these companies. And so if you had an ETF that had to accommodate daily inflows and outflows,

it would be, you know, very difficult to actually have those assets be automatically deployed into the exposures that you are promising to your end investors. So there's the problem, you know, I mean, to me, as an ETF guy, gee, wouldn't that solve the problem? But there's not enough liquidity to be able to pull that off and you've got to go to the companies and invest in the shares. You can't do it. So long term, you're the wise man here. What do we do to get these companies to stop sitting private for so damn long and go public so people can access? People want to get access to SpaceX and, you know, the company sits out there quite happy. Yeah, I'd say two things. The first is when

you're a stable market for the rest of the year and there'll be more IPOs. SpaceX may go next year. Who knows when OpenAI goes or maybe there's a liquidity event, but it's going to be a runway. There's going to be, it's going to take some time. The second is I think the public is now so much more in tune with understanding the power of disruptive innovation that the next raft of companies will come right behind these. Once these go public, we'll get excited about the next ones. So I think this is going to be a perpetual problem because these companies won't go public as soon as people want to own them.

And Howie, you're sort of one of the experts. I talk with you often about IPOs. What will force more companies to go public? Is it higher interest rates? I mean, most of these, a lot of these companies sitting around 10, 15 years, all of these, already, they're middle-aged, essentially. What is your thoughts on that process? I think very similar to see the market situation

of the public market. I mean, first of all, I do think that companies are actually staying private longer. So like it or not, there is going to be like, your guest was just saying that it's going to be a new batch of company that's going to fill the spot of the SpaceX of the world that I've actually gone public. So I think the trend of companies things private longer

is definitely there. Now, the company's moving on to the public market and therefore sort of enjoying. enjoying or the benefits of the public market is largely a function of how the public equity market is actually behaving. What kind of valuation can be fetched the interest of environment, the macro environment to your point? Brett, is this a structural problem by structural? I mean, do companies want to stay private longer, not just because they get in funding, but because they don't want to deal with the regulatory burdens of going public? They don't want to deal with the scrutiny, the quarterly

reports, is there a problem with the way the market, the legal requirements of going public? I'm trying to figure out other reasons besides, oh, interest rates are too high or we're happy because we're getting funding or the market's not right. Is there another reason that's preventing all these companies sitting out there for years and years from going public? Yeah, I mean, there are compliance and kind of like legal burdens to being in the public markets. I think that actually most public shareholders are not long-term enough focused, and that serves as both unneeded near-term pressure on companies and can sometimes distract them from what they should be doing to differentiate themselves over the long-term. And so we as a manager, both in the public and private markets, our emphasis is that we are investing in innovation over the long-term and going to support management teams, even as they make their way into kind of the public market,

journey to make long-term decisions that are in the best interest of the company and the long-term investors. And I think that's a real challenge. A lot of public market investors don't have that long-term view. You're certainly right about that. But my point is, I remember the 1990s, and a lot of companies went public very fast. And the criticism was, oh, they were credibly volatile because they didn't have much of a track record. And yet, given a choice of having that, I would rather have that than this, where we have companies that are middle-aged that are still the, you know, look how old Reddit was before it went public. You know, that's a long, long time to sit in the private market. Another explanation could be that the challenges these companies are solving require a lot more capital than the dot-com bubble companies did.

And so they require a lot more capital. It's much easier to go to a VC and have them write a bunch of checks as a series C, series D, and keep the company growing rather than go to the public markets and say, okay, do an IPP. then do a secondary two years later and do another one two years after that. It could just be these company managements prefer the structure of going to the venture capital community who, as Brett said, do understand the challenges, do understand you've got to hold for a couple of years and are going to be patient through their process rather than going to the public markets and ask for those continuous rounds of fundraising to get to the end goal. So Howie, you're sort of an expert on what's going on with venture capital.

Where are all the VCs? Are they at the point where we've got to get these companies? out there we need more dry powder we need to cash in or are they able to do some you know buy out where the company itself or other venture capital we will essentially buy them out of early stage investing where are we in this whole game I think we definitely have been seeing things have started to turn around because if you're focusing on the late stage pre-IPO set of companies if you look at the fourth private market index you know one indication is that we have started to trend positive this year the last

two years have been negative so I do think that you're seeing to see interest going back into the private market. As companies starting to go public, there will be new companies to rep replenish the inventory, so to speak. So things are definitely turning better, and access to capital is actually becoming easier. Brett, just let me go back to the ARC Venture Fund. Give us a sense of how you pick the funds here,

the stocks here, the companies. I see Epic Games, 8%. Free Gnome, Relation Therapeutic, 6%. Anthropic, there's an AI play, 5%. SpaceX is about 5%. Databricks is about 4%. How do you and Kathy sort of come up with this stew of companies and how do you decide which is weighted more or less?

Yeah, so we believe that this is a unique time in technological economic history and that there are five major technology innovation platforms that are entering the marketplace at the same time. Robotics, AI, multi-oemic sequencing, public blockchain and energy storage. And that's the framework by which we approach these companies. So our analysts are, I think, best in the world on technology.

And then we select the companies we want to invest in and talk to them and then write checks. And can you explain the fee structure for this? Because sometimes it gets a little complicated. When you own this, what's the fee structure? Well, I'd refer you to the prospectus. It's 2.75 in the prospectus. and investors paid more than 2.9%. Okay.

Where do you think this is all going to go? What are you, I mean, besides just whether SpaceX, we can speculate whether SpaceX is going to go public this year or next year, what's going to happen, who knows what Elon Musk is thinking right now. But where is this ultimately going to go? My hope is this is it that we are seeing IPOs starting to come and we're going to get a flood of IPOs this year. We've had a billion to $2 billion in the last few weeks.

going to get the next few weeks. It's almost like 2019 again when things were really opening up. Who knows? This could all end at any moment. But that's my hope. What's your? No, you're right. Because ultimately, the reason all this is important to public market investors was these companies drive future returns. If you look at what drives returns over any 10 or 20 year timeframe in the SB 500, for example, it's really a handful of companies. And it's usually disruptive technology companies. So it's very important to get these companies public if you're an index investor. This is not an academic discussion because it's just private markets. This is super important to get these companies public. So I also hope we get a raft of

new IPOs and these kind of products continue to fund innovation and get the next raft of companies going that are going to go public in five or ten years. It's a very important process. It's very important dynamic that only U.S. equity markets really enjoy. This is not a phenomena in Europe or Asia as much as it is here. That's why U.S. stocks have performed is because of this dynamic. And RUB. Howie, Rubrics slated to go public Thursday, right? Behind me here at the New York Stock Exchange, they're going to raise, on a lot of the United States. know, 750 million or so, but they're not profitable. So to me, this is an interesting test. Here's a big, well-known data company that's going public that's not profitable. So how is the

market going to greet that right now? I mean, any thoughts? I'm trying to get this opening up story going in a little more detail. Right. I think Rubek will be a very interesting thing to watch because the last two IPOs you actually had companies that, you know, were somewhat profitable and they're actually a lot more profitable than, say, for example, Rubrik, which is in most growth-oriented company. So I do think it is interesting to watch what the market reception is when it comes to rubric. Do people continue to optimize for growth? And that's about earnings per share in profitability.

So we'll see. And Brett, you're going to continue to invest in early and late-stage companies. You want to drop any interesting names outside of the obvious SpaceX names on us that you're particularly interested in these days? Sure. I mean, we just invested in Figure AI, which is a human-red robots company. And amongst all the technologies we look at, kind of our robotics forecast has moved forward the most because of the acceleration in artificial intelligence and the capability that that covers.

So we think it'll be an exciting business cycle for profound innovation that will change everybody's lives. Sounds like an ArkInvest pitch to me. Oh, wait, you are Ark Invest. Thank you very much. Appreciate that. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Market's 102 portion of the podcast. Data Tracks.

Nicholas Coles continues with us now. Nick, thanks for sticking around. I wonder if you can give me your thoughts on earnings. We're going into the heart of earnings season. And what I have been saying to people is it's important to note the multiples are coming down. But so far there's not earnings estimates. The actual dollar value of these earnings estimates are not. not coming down yet. Would you agree with that? And how do you assess the state of things right now?

Yeah, no, it's entirely accurate. We have not seen analysts cutting estimates at all. They've been bumping them up a little bit in some quarters and cutting others, but overall, they're still very steady and very good. Earnings growth for the year running 8 or 9 percent. So there's really not any fear we're going to see a sudden earnings decline. And the first batch of earnings that we saw last week showed us that companies are beating by a little bit more than they average, so that's good. They're not beating revenues by quite as much. So they're doing a good job on cost containment, is good. It means that yes they see revenues perhaps only in line with the expectations but earnings are still beating by an average amount. That means

companies are being very sensitive to keeping their cost structure under control and again that bodes well for the rest of the year. And cost cutting is a logical reaction when perhaps your revenues are not growing as much as you want to keep the margins up but nothing beats revenue expansion. That's not quite happening if you want to complain about something. That's a little bit on the weak side. Absolutely but it does set up for a very good back half of the year because if revenues do begin to re-accelerate, then the cost structures are now very modest, and you get even better upside earnings surprises later on in the year. And it's important to understand

the fundamentals here. The reason earnings are holding up is because the economy is still strong. Is that right? Entirely. Yeah, we're looking for maybe two and a half percent GDP growth in Q1 when that number comes out later this month. The economy is still in good shape. Initial jobless claims are still low. Unemployment is still good. Wage growth is still good. All the basic metrics we all look at are still quite nice, quite strong. And do you feel the, um, The main thing, of course, right now is simply Treasury yields. 4.6% on the 10-year. People are complaining, perhaps understandably, about 6% and 7% mortgage rates.

But isn't that more normal? That people thought 3% mortgage rates were normal, and they're not. Historically, they never were. And now there's all sorts of stories people don't want to move because they have 3% or 4% mortgage rates. Well, do you think the mortgages are going to go back to 3% or 4%? Well, let's put this. We hope they don't.

Actually, I'm getting a lot of feedback in my. Sorry. Go ahead. So let's, let's, I just pop it out. Go ahead. So let's hope mortgage rates don't go back to 3% because it'll mean something very bad has happened. The economy or geopolitically, and that rates are come down a lot.

The current level of mortgage rates, I think, are quite healthy. People can still buy a house and they can find one that they like. The prices are higher, the rates are higher, but people have the money to spend in order to afford them. And so net net has not really been an impediment to economic growth. Yeah. What I say is, I used to be the real estate reporter here 30 years ago.

And at that time, in the late 1980s, early 1990s, mortgage rates were in 11%, 10%, 9%, and now people are bitterly complaining about 6% or 7%. That's much more normal historically and healthier. Plus treasury yields, we were down at 1% at 1 point, 10-year treasury yields. Who's going to lend the government money for 10 years at 1%. That made no economic sense to me at all. At 4.6% is a positive real yield. That makes some sense to me. Now I can see you being an investor in treasury bonds.

Not at 1% though. Yes, you're right. It's a much healthier market. Having a positive cost of capital is the way capital is supposed to work. You're supposed to get paid for your capital. Even risk-free, you're supposed to get something. Real rates were just back now to where they were in 2005,

six, seven. So we're back to normal levels. We're not at absurdly high levels like in the early 80s. We're back to normal pre-financial crisis levels. It's taken us a long time to get there. But we're here now. I think we're going to stay here for a long time. You're one of the best data analytics people I know.

And for those of you who don't know, data track folks, it's one of the great market reads. I read it every day, and I get a lot of stuff that I don't read every day. So I think very highly of your work, Nick. Artificial intelligence, where do you see that going? You know, in my business, I've been dealing with artificial intelligence for a number of years. There are firms out there that will scrape the data, the economic data, or home sales, for example, right off of the website for the federal government,

and we'll spit out a paragraph on what it's doing in a sub-second interval. And when I look at this stuff, I think to myself, you know, if I only had one paragraph to describe home sales, actually I'd write exactly what this thing is writing, writing and it's an artificial intelligence. Now it doesn't have deeper analytical skills that I might have but you know that's not far away. So I see myself as a financial journalist for 30 years thinking to myself a lot of this of what I do is already being done by an A and more of it will be done in

the coming years. What is your thoughts about how AI is going to impact the financial services business? Yeah it's definitely having effect what I would call it the low end so if you're a rookie journalist it's going to be tough because AI can be competitive with you. Where it then rewards you is for thinking. It records the human for actually doing the deeper analytical work that the AI can't do because it hasn't seen all the things

that you and I have seen over the past 30 years. So from that perspective, I think it's very healthy. Broader speaking, AI has to improve productivity growth in this country. That is the central issue. Productivity growth has been very low for the last decade. It's picking up a little bit now, just remembering sub 1%, and that's no good.

A country can only be as wealthy as its labor force growth and its productivity growth. If we can improve, the second one, We've got better economic outcomes. Explain that to people because people somehow think, I just want to raise without being able to explain productivity growth to people. We had spurts of productivity growth right in the 1980s,

the 90s when we had the internet, we had better software as a service program starting to come in. And do you think AI can provide the same spurt that those other developments provided? Yes, and you're right. If we look at the way computerization came in, PCs came in the early 90s, we have a spur of higher productivity growth all through the back half of the 1990s, more than 2% productivity

growth per year. Excellent results. But since then, we haven't had anything close. And why is that? You know, there's a bunch of theories. The technologists say we don't measure GDP right. I kind of disagree. I think the central issue is a lot of technology went to entertainment purposes, streaming and games, and that doesn't improve productivity. Now if we get AI actually in the workplace working to focus on improving productivity, then labor force productivity can finally improve again. But that is the critical issue for AI. If it just proves to be nothing, then we're not going to get that growth. I remember software as a service in the 90s and the 2000s, particularly, when they came in, I mean, it just replaced a lot of back office functions that were redundant. People actually

had, you know, accounting books, literally books, that all got automated, essentially. And that was a huge productivity. Yes, it really, it went very strong from 95 to 2002. Ironically, it went right through the dot-com bust. All the technology spent was actually well spent, for the most part. But since then, there's been very little incremental productivity growth. Well, it certainly is a worry that everyone's spending too much time on gaming. I mean, boys in, you know, 20-year-old, 25-year-old boys, 30-year boys, have spent a good part of their life, essentially gaming. And I know people are very worried about that for social purposes. On the other hand, I spent a lot of time in I was in 165 watching bad science fiction movies from the 50s as a kid, and everybody said my brain was going to rot out.

And I don't think it did. I don't know. Maybe some people do, but it's a tough game to play. Thank you, Nick. Always a pleasure. That does it for this week's ETF Edge, the podcast. Thanks for listening. Join us again next week for another edition of ETF Edge.

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