Six innovation trends best accessed via private markets

At Opto Investments, we genuinely think that private markets are an exciting place to put a client’s money to work. Private fund investors have exclusive access to private companies, which can present highly interesting (and potentially highly rewarding) opportunities.

Differentiated exposure to innovators

Investing exclusively in the public markets limits exposure to innovative early-stage companies, which are generally not listed so early in their development. Further, private companies are generally staying private longer, in effect at the expense of investors in public markets. This has resulted in public equities shrinking to represent an ever smaller slice of the overall universe of investable opportunities: Fewer than 15% of companies with revenue exceeding $100M are now publicly traded, according to S&P Capital IQ data.

Adding private investments therefore gives you access to a much wider range of companies than public markets alone, and in a differentiated, direct, and more selective way:

1. Differentiated, because private companies are not accessible via public markets and more innovative technologies are typically being originated by early-stage companies.

2. Direct, because private funds put money directly into selected companies.

3. Selective, because private funds invest in specific companies in which they have a high conviction. This selectivity is important in sectors where there are likely to be a few big sector winners but many more failures.

Venture capital (VC) in particular includes exposure to exciting new trends at a time when there is still significant growth potential. Put very simply, the earlier you invest in a company, the greater the potential upside. Even just one or two great investments - which can produce return multiples in the tens or even hundreds - in a venture fund could more than compensate for the greater number of investments that may not be successful. This unpredictability contributes to the wider range of outcomes from venture funds.

Compelling offerings for clients

For investors willing to tolerate this extra risk and assume some illiquidity, identifying trends with long-term growth potential and then finding the right managers to gain exposure to those trends can be a highly lucrative approach.

More practically for advisors, offering clients the ability to invest in an exciting secular trend - one potentially aligned with their values and worldview - rather than just an asset class, can make for a better story and a more compelling proposal.

Below we list six of the most interesting long-term investable trends, including how private markets may offer you differentiated access to them. We think investing smartly in these trends could deliver strong returns over the coming decade and beyond, which is obviously good for your clients, and by extension good for your practice too.

Six investable long-term trends

1. The spread of artificial intelligence & machine learning (AI & ML)

OpenAI’s ChatGPT is just the tip of an artificial intelligence (AI) iceberg, with the spread of AI and its cousin machine learning (ML) likely to be an era-defining development over the coming decades.

Technologies such as Large Language Models (LLMs) and the linked development of generative AI are going to impact numerous industries, including in the shorter term areas like enterprise search and various creative industries. But the sheer number of sectors that could benefit from the various AI and ML technologies offers enormous upside potential. You are unlikely to find a sector in which improved productivity is not worth investing in.

The global AI market is predicted to expand 37.3% annually in the period to 2030. Getting even a small slice of that growth could be very lucrative.

Gaining exposure via private markets

In a sector attracting such attention, it is important to not get caught up in the mania and remain strategic and selective.

Early-stage VC funds are the most direct way to invest in AI, allowing you to bet on and get access to the truly disruptive applications of AI that have the potential to change big industries.

You could, however, also gain some exposure via other asset classes. For example, rising demand for hardware infrastructure should provide opportunities for infrastructure and real estate funds to develop and invest in specialist facilities, such as high-performance computing data centers.

2. SaaS becomes truly ubiquitous

There are already many software-as-a-service (SaaS) success stories out there, including household names such as Microsoft, Adobe, Oracle, Salesforce, and Snowflake. SaaS companies are simplifying and automating workflows in areas such as accounting, customer relationship management, organizational processes, and monitoring and surveillance, among others. But there is a lot of room for further growth. 

Over the coming decade it is very easy to see high-growth “smart enterprise” SaaS companies expanding into hundreds of verticals. They are also well positioned to seize a lot more of the economic value within these verticals as more of the economy moves onto the cloud: 55% of businesses still rely on traditionally managed on-premises systems.

The global SaaS market is projected to grow by 25.9% annually from 2022 to 2028 to reach a value of $720B.

Gaining exposure via private markets

Publicly listed SaaS companies are well represented in most investor portfolios via tech-focused ETFs or mutual funds. Or even just through broad market exposure given the size of the tech sector: IT businesses accounted for 28.5% of the S&P 500 by market capitalization as of March 21, 2023.

VC funds can offer differentiated and more targeted exposure, and potentially greater upside given the stage at which you are investing. Competition is, however, fierce in the SaaS space, which means you should look for fund managers with a clear thesis, established networks, and rigorous selection criteria.

For example, for early-stage SaaS companies, managers should be looking more at gaps in the space, the potential for future expansion into similar or adjacent workflows, as well as assessing the strength of the team. For later-stage companies, there is normally an established product-market fit, so the assessment is more around how big that market is - or more importantly, how much it can still grow (referred to as “market pull”) - and whether the team is in place to really sustain that momentum.

3. BioTech innovation accelerates

Biotechnology is a fascinating and rapidly expanding industry in the US, benefiting from the confluence of a couple of major trends, namely:

1. The success and rise of cell therapy as a treatment option

2. The onshoring of manufacturing and research facilities due to trends putting pressure on international supply chains, exacerbated by the COVID pandemic

Innovations like the successful therapeutic use of CAR-T cells (specially engineered proteins that give T cells the new ability to target a specific antigen) and advances in personalized medicine clustered around gene sequencing, editing, and therapy have created huge momentum in the biotech sector.

However, there are compelling companies emerging in various parts of the sector, not just directly in therapeutics development. These include firms solving engineering problems, applying machine learning, leveraging informatics, and finding creative ways to use tech to push biology into new areas, while helping to speed data processing and accelerate research iteration cycles.

In one of the wilder developments (pun intended) in the space, one firm is leveraging new DNA technologies to attempt to bring extinct animals back to life, such as the dodo and the woolly mammoth.

The global biotechnology market was estimated at just over $1T in 2021, and is expected to grow 13.9% annually from 2022 to 2030.

Gaining exposure via private markets

Venture capital again offers the most direct investment route, and venture investments in biotech have scaled new heights in recent years. But smart managers in other private asset classes, most notably infrastructure funds, should find ways to make money from financing the facilities and infrastructure required to manufacture or develop these emerging biotech solutions.

4. The energy transition

Elevated hydrocarbon prices have obviously had wide-ranging impacts over the last year or so. In the short term, higher prices have benefited oil and gas, both of which are highly profitable and remain a good potential source of income, yet with valuations at historical lows.

Longer term, recent volatility should accelerate the green energy transition, having dramatically highlighted the importance of energy security. This is likely to boost public investment in energy infrastructure and generate opportunities for private fund investors over the coming decade and beyond.

The US Inflation Reduction Act (IRA), for example, allocates approximately $370B through measures including rebates, grants, and tax credits to support investment in energy security and climate change mitigation. BlackRock estimates that the IRA will help boost capital spending on energy supply infrastructure by upwards of $600B relative to the prior spending path by 2035, and in aggregate unlock more than $3.5T in incremental spending over the same period.

Innovations in areas such as renewables, clean fuels (including fusion and fission technologies), carbon analytics and accounting, hydropower, and grid infrastructure could all support rapid value creation in private markets.

Gaining exposure via private markets

The most direct exposure to the energy transition will be via infrastructure and energy-focused funds. PitchBook data shows that most of the capital raised by real assets funds in 2022 was by managers investing in sustainable energy, the energy transition, decarbonization, and clean energy strategies.

However, investors can also access this trend via VC and impact funds. Many of the most disruptive energy-related climate solutions remain early in their development and inaccessible via public markets.

5. The modernization of defense procurement

The US defense acquisition framework has long been hampered by special interests and anti-competitive procurement methods. But there are positive signs of change to procurement policy, including a renewed focus on working with entrepreneurs and innovators on developing technology critical to US national security.

The full-year 2023 Department of Defense budget is $773B, including more than $130B just for research and development. These are substantial streams of reliable investment, and as more of that is directed towards innovators in the private sector, the upside for investors could be significant.

Gaining exposure via private markets

Given these positive procurement trends, VC funds may be a good way to get exposure to defense-focused early-stage companies developing modern solutions to modern threats, such as cyber warfare and drone attacks. Areas in which we see particular upside over the coming decade include: 

• Software-defined directed energy

• Electronic warfare and cybersecurity

• Logistics and supply-chain resiliency

• Autonomous systems

There may also be opportunities for private equity and infrastructure investment in areas of supply chain and logistics that are essential to defense.

6. The reimagining of logistics

The application of AI and ML (discussed above) could have a dramatic impact on the logistics industry, which as a sector benefits from tailwinds from the rise of e-commerce, among other factors. Ongoing onshoring of manufacturing - spurred by geopolitical frictions and anti-globalization trends and exacerbated by the COVID pandemic - are driving the modernization of and investment in domestic supply chains.

Logistics has long been dominated by less technologically sophisticated players, with high barriers to entry. But these new external challenges, as well as those created by innovation, are forcing them to adapt and adopt new solutions. Furthermore, the adoption is somewhat exponential: as more technology is used to collect and track data in real-time, other technologies become necessary to coordinate and work with that data to create even more efficiencies.

Software is helping drive improvements in areas such as risk management, visibility, and resilience.

Gaining exposure via private markets

We see opportunities via both VC and private equity. Venture capital funds are investing in the technologies that are being integrated into the logistics industry, while private equity funds are can buy more established players and find ways to make them function better, largely through technology, but also through consolidation and financial improvements.

Real estate and infrastructure funds with exposure to warehousing and supply-chain facilities more broadly should be able to find opportunities in the ongoing build-out of domestic warehousing. For example, Amazon set up a $1B fund to invest in companies developing supply chain, logistics and fulfillment technologies in April 2022, having already doubled its fulfillment network footprint in just two years from 2019 to 2021.

Not all funds are created equal

While these exciting trends are likely to create a lot of winners over the long term, there will be a significant number of companies that will fail to thrive - be that because of the wrong leadership or just poor product-market fit. However, the best time to access a mega-trend is before it goes mainstream.

As we have shown above, there are many ways to gain exposure to these trends. You should carefully explore each available approach to calibrate investments to the risk and return needs of your clients. It is clear, however, that VC funds tend to offer the most direct approach. It is important to reiterate that the range of outcomes can be very broad for VC funds, but there is strong evidence for persistence in performance among the top managers, often driven by better access to deal flow for previously successful venture funds.

This makes it vitally important to carefully select the right managers and funds, rather than just investing in those that are easily and widely available. These funds could, of course, also perform well, but advisors should not have to settle for anything less than the most in-demand funds, which are frequently oversubscribed and don't typically need to work with brokers.

This may necessitate finding a partner, given the intense competition to access these funds. Opto’s strong, established network and ability to make investments up front can help us access some of the most coveted managers in the industry. 

We’d love to talk to you about building custom exposure to these exciting, innovative trends - or any other trend you find compelling - to help you and your clients achieve your goals. Reach out to advisory-services@optoinvest.com to start a conversation.