Leveraging the Disconnect

To our Valued Investors:

Volatility in public markets has been extreme since February 2020. As of May 2022, only 10% of stocks in the Nasdaq 100 were trading above their 50-day moving average. For family offices and billionaire high-net-worth investors, the public markets have become a casino, where extraneous events that have very little to do with cash flow fundamentals can cause wild swings in portfolio values. So, the great exit has begun. Famed investor Charlie Munger, Vice Chairman of Berkshire Hathaway, forecasted in a recent discussion at the Daily Journal Conference that the market will deliver 0% over the next 10 years. What does Charlie Munger know that the street doesn’t?

The rate of change in the world is rapidly accelerating. If you’re wondering how these changes will affect your investment performance, you’re thinking correctly. What the elite players like Peter Thiel, Bill Gates, Tim Draper, Mark Cuban, and Mr. Munger know, and what may be behind Munger’s controversial forecast, is that unprecedented technology evolution will create significant wealth but will decimate many companies buried in the indices. Essentially, “buggy whip” companies are entrenched in the major indices. As these companies evolve or die, the indices are in for some volatile periods. Add the triggers and tremendous dollar flows of the large pension managers, and the public markets are no place to invest unless you’re selling gamma.

Artificial intelligence and blockchain are two technology movements that are rewriting the world as we know it. Electric vehicles will become increasingly prevalent over the next five years. By 2030, we’ll likely have fully autonomous EVs whisking us from point A to point B. We’ve seen how technology can change our lives, but the profundity of the change ahead will reshape economic norms. Unprecedented levels of AI-inspired innovation will result in disinflation, a concept that bewilders central banks at present. Cryptocurrency will disintermediate fiat or sovereign currency at an alarming rate. This isn’t futurism; these changes are taking place right now, and they explain why a lot of what we see in the financial markets is hard to understand. We’re already witnessing the early stages of singularity. How will this affect our investments? Perhaps the better question is, “what are some of the best ways to incorporate these technology-driven changes, proactively and defensively, into our wealth creation and asset allocation programs?”

First things first. What is “singularity”? The term was originally coined by John Von Neumann, a Hungarian mathematician. It’s “the hypothetical point in time at which technological growth becomes irreversible, resulting in unforeseeable changes to human civilization”. Improvements in quantum computing, for instance, are being generated through AI. In turn, improved quantum computing allows AI to solve increasingly complex problems. Given that this is where we are today, the growth of AI capability will be logarithmic, resulting in an eventual “intelligence explosion”.

Understanding the future requires an appreciation for the past. The iPhone was introduced in 2007, and in just 15 years, Apple and other smartphone manufacturers created a technology-driven ecosystem that restacked the deck in the top 10 S&P 500 companies, creating multi-trillion-dollar markets. We now pay bills, purchase groceries, and check on the kids, all from these powerful computers that fit in our pockets.

Leveraging The Disconnect Leveraging The Disconnect

To appreciate that statement, compare the S&P 500 from the pre-iPhone era to the second chart, which lists the top 10 S&P 500 companies today. Many of the iconic companies of 20 years ago aren’t even in the index anymore. General Electric was the largest company in 2003, with a market cap of $310 billion. Today, GE is relegated to number 125 with a market cap of $88 billion. Thanks to the iPhone, Apple now exceeds the combined market cap of 2003’s top ten S&P 500 companies by a staggering $650 billion!

The performance of the 11 sectors of the S&P 500 pales compared to the growth of the FAAN+ (Facebook, Amazon, Apple, Netflix, Alphabet, and Tesla). The primary reason is the index is diversified across many slower growth sectors, such as industrials. Invest in the index over the next ten years and you’ll own underperforming sectors that will tank your wealth-building potential. Remember that many disruptive technologies on the horizon will impact legacy companies. For example, financials comprise 11.5% of the index. Cryptocurrency-based banking alternatives will disrupt traditional banks.

Understanding and investing in the core technologies of the next ten years will generate another incredible opportunity in wealth creation. As a historical example, the semiconductor company Nvidia is another example of wealth creation through technology investment. In 1999, Nvidia went public at $19.69 per share. Nvidia stock increased in value 112x since that time — a $100,000 investment in 1999 is worth over $11 million today. Chances are you didn’t invest in these technologies. You’re not alone — most invested in the S&P 500 index and earned a respectable 15%. But that’s a far cry from 112x, and 15% isn’t going to create real wealth unless you were already very wealthy from the start. What strategies will put you in the position of the investor that put $100,000 or more into Nvidia at the IPO, and then had the vision to hold for 20 years?

The changes of the last 15 years, “the iPhone Era”, will pale in comparison to the next 10 years. It’s not just computer technology that will drive the change. Biotechnology was turned on its head in 2015 with the invention of a gene-editing technology called CRISPR. Armed with the complete human genome and the next generation of the original CRISPR CAS9 RNA template called Prime Gene Editing, our biology is now programmable. Computers speak in binary, 0’s, and 1’s, but biology is also programmed in the language of combinations of ATCG (adenine, thymine, cytosine, and guanine). Prime editing is essentially a bio-programming language specific to a single gene. This technology is so powerful that a cure for sickle cell anemia was “programmed” using gene-editing technology. So, theoretically, genetic predisposition to diseases will be eliminated by blocking the associated genes with “programming” or editing.

Gene editing covers genetic diseases, but what about drug discovery for other healthcare problems? Alphafold, a company within Alphabet Inc’s (Google) Deepmind subsidiary, has developed artificial intelligence that can predict the 3D shape of proteins with incredible accuracy in days. Before Alphafold, crystallographers used electron microscopes to study the shapes of proteins, and it could take years to understand complex proteins. This is significant because most drugs are proteins, and time is money. Until recently, drug discovery was a trial and error process, identifying and testing known naturally occurring proteins. But Alphafold’s custom proteins (essentially custom drugs) can be designed to interact with cell membrane receptors. As a result, we are no longer limited to naturally occurring proteins. We can create new protein structures to meet the patient’s therapeutic needs. Many new biotech companies will emerge with highly effective therapies. The effectiveness of therapeutics produced from these technologies will eclipse existing drug pipelines. This new class of biotechs will disrupt large pharmaceutical companies with legacy investments and legacy expenses. The age of cheap, readily available, and effective drugs is upon us. How this affects the S&P500 healthcare segment remains to be seen.

The common denominator between the major biotech advances and computer technology advances is artificial intelligence. AI is no longer science fiction. The semiconductor industry has relied on AI for over twenty years to create faster, more efficient processors. In fact, AI has now unified all data processing at the chip level and on a singular architectural framework developed by one company owned by Nvidia. In our daily lives, AI determines what we see on our streaming menu pages. It tells BTB sales companies which of their leads is most likely to close a sale. It is designing custom proteins for cancer therapies. It touches every aspect of our lives.

We are experiencing the earliest stages of singularity. The markets and the entrenched investment banks and financial institutions aren’t ready for this. You can see it in the composition of the S&P 500, in the confusion around interpreting economic trends like inflation, and in recent market performance. The entrenched financial institutions have ignored the top performing asset for 10-year, 5-year and 1-year periods: Bitcoin, which is a prime example of singularity.

Note the clear pattern. Artificial intelligence creates increased productivity. Increased productivity in equity is measured as better earnings and cash flow. The uptick in earnings and cash flow creates wealth. Just as we witnessed the incredible productivity increases over the last 15 years that resulted in Apple being worth more than the entire capitalization of the top 10 S&P 500 companies in 2003, AI is about to create the same effect. The impact is showing slightly in the public markets, but where the real wealth creation is happening is in the private markets. As evidence, last year the number of unicorns (private companies worth more than $1 billion) passed the 1,000 mark.

So, who are the lucky investors that fund these companies and experience wealth creation? They are the top venture capital companies like Tiger Global, Bessemer, Kleiner Perkins, Sequoia Capital, and about a dozen other top-ranked investors. The ultimate beneficiaries are institutional investors such as pension funds, endowments, and ultra-high net worth individuals. Investment at this level has several barriers to entry. For U.S. citizens, the Securities and Exchange Commission (SEC) requires that investors have accredited status. More challenging is the fact that these investments are in illiquid blind pools with a duration of seven to ten years. Finally, the minimum investment is usually in excess of $10,000,000. Meet those three criteria, and you can take a ticket and wait in line. This is a very exclusive club!

Asset allocation should be the cornerstone of any wealth creation program. Everyone’s circumstances are different. The percentage tech-equity component will vary based on many factors, and one should consult professional advice to understand if this is the right path to travel. But because of the singularity effect, technology is about to expand at a tremendous rate over the next ten years at a rate that will far transcend everything that we have seen over the last fifteen years. If you desire to create serious wealth, you may want to consider some of the ideas expressed here today.

Iron Edge VC sincerely thanks Karl Douglas, Chief Administrative Officer and strategic thinker of Covenant Venture Capital. Today’s newsletter was adapted from Karl’s research and writing. If you would like to learn more about the ideas discussed above, or about how you can take advantage of the opportunities in singularity, do not hesitate to contact us by clicking “Get in Touch” below.

If you have enjoyed this article, visit the Iron Edge Blog for past updates on our pre-IPO opportunities and for general commentary on investment in the private marketplace.

As always, shares of Iron Edge investment funds are available on a first come, first served basis.

All the Best,

Paul Maguire

Founder & Managing Partner

Leveraging The Disconnect

Paul Maguire

Founder And Managing Partner