We’ve written several times about the historic difference in valuation between small and large companies. There’s a number of ways investors could take advantage of this–small cap ETFs, small cap funds, or for the enterprising investor, picking your own individual small cap stocks. Today though, we’re introducing a new, unique opportunity.
In the coming month, TAMIM will be offering access to a venture capital (VC) fund focused on the Start Up Nation. We believe this opportunity has incredible long-term growth potential. This is the second venture capital investment we have offered to our investors, with the first fund launched at the start of 2020. The first fund has done exceptionally well to date and we believe the environment today is even more conducive to launching a venture capital fund.
We’ll provide much more detail at the upcoming launch, but given Israel’s incredible history of innovation, the dramatic changes to public share markets over the past several decades, and the limited opportunity that investors have to access to private markets, we believe it’s a particularly enticing offer.
Israel: A Beacon of Innovation
While Israel is a small nation, covering just 22,145 square kilometres and with only 9 million people, it certainly punches above its weight. It ranked 18th on the 2022 global innovation index and excels in the technology space. Tel Aviv ranked fifth in a study (by U.S. research firm Startup Genome) of the world’s most attractive ecosystems for startups and innovation–behind only the powerhouses of Silicon Valley, New York, London and Los Angeles. In fact, the Chairman of Google’s parent company Alphabet (NASDAQ: GOOG) is quoted as saying “Israel has the most important high-tech centre in the world after the U.S.”
For those new to the Israeli investment world, Tel Aviv has its own stock exchange founded in 1935, which has performed admirably–the TA 125 (the largest 125 stocks by market capitalisation on the Tel Aviv exchange) has returned shareholders more than 5x their money over the past 20 years. Yet it’s a mistake for investors to think that the opportunities to gain exposure to the best Israel has to offer are limited to investing directly on the Tel Aviv exchange (which might be difficult due to an investor’s brokerage platform or investment mandate).
The NASDAQ exchange in the U.S., for example, is home to several highly successful Israeli-based companies. These include the likes of:
Even the U.S.-focused Warren Buffett is no stranger to the opportunities in Israel. In 2006, Berkshire Hathaway paid $4 billion for an 80% stake in Iscar, an Israeli metalworking business headquartered in Migdal most known for precision carbine metal working tools. Such was his delight with Iscar, the Oracle of Omaha purchased the remaining 20% for a further $2 billion in 2012–double the original valuation. Yet Buffett has had no regrets, with sources close to the company suggesting that Iscar had returned between $5 billion and $6 billion back to Berkshire over the decade ending in 2019.
These are already large and well-known companies though. While they might continue to generate healthy returns for shareholders well into the future, they’re unlikely to generate the multi-bagger potential that comes from smaller, more unknown startups.
Venture Capital: What is it and Why?
Companies that undertake an initial public offering (IPO) to list on a stock exchange are typically larger, more mature businesses that usually have strong market positions and positive cash flows that allow them to invest in their own expansion and return capital to their shareholders (through dividends and share buybacks). Smaller companies on the other hand, usually need capital–particularly startups. This is where venture capital comes in.
Venture capital (VC) is another form of share ownership for small and startup companies. These businesses typically have very high growth potential, but their products are in the early stages of adoption or they are competing with larger, established players. Because it is higher risk (or at least, more uncertain), it is generally restricted to more sophisticated investors (Marc Andreessen for example). Although it’s a bit different in reality, the television program Shark Tank provides a decent glimpse into the startup and venture capital world.
Unless you’re a professional investor or in the industry, rarely do retail investors get the opportunity to invest in promising startups–which significantly reduces an investor’s universe.
The Shrinking Universe
The share market, both in Australia and internationally, has provided investors with huge opportunities to generate long-term wealth for decades. We think it will continue to do so for decades to come and fully support investors developing a long-term, diversified portfolio to support their financial goals. However, one of the challenges with investing in the stock market is the shrinking universe of available investments. A 2017 study by Credit Suisse found that while around 2,500 companies were added to the U.S. stock exchanges between 1976 through 1996, the number of listed companies fell by 3,650 after 1996–a whopping 50% of companies disappeared in the next 20 years!
Part of this is due to regulation. The Sarbanes-Oxley Act of 2002 created a host of new standards for listed companies (regarding the Board of Directors, management teams, accounting firms, etc.), which noticeably increased the cost of being public for small companies. There’s also more scrutiny on public companies, such as the pressure to hit quarterly earnings targets, ESG requirements and the like, leading to frustration amongst management teams that they’re not able to focus on the company’s long-term strategy. Mergers and acquisitions have also increased, leading to more concentrated industries with fewer large companies (anti-trust regulators have been increasingly concerned by this).
Overall, these factors (among others) have encouraged companies to stay private for longer. In fact, CB Insights believes that there are currently more than 1,200 unicorns–private companies with a valuation of more than US$1 billion, many of which would have been listed on a stock exchange in times past. The IPOs of late have been of extraordinarily large private companies, such as:
This has led to endowments, superannuation funds and other sophisticated investors gaining better access and increasing their allocations (and ad higher allocations to alternative investments–including private equity and venture capital.
Rare Opportunity to Diversify Your Portfolio/Favourable TIming?
The valuations of high-growth companies, including listed technology and private venture capital businesses, soared during the coronavirus pandemic. Investor participation surged, interest rates and the cost of capital plummeted, and the investment community wildly extrapolated that a bigger proportion of the economy would shift online than has proven to be the case.
While valuations for most of these businesses have since moderated, the so-called “megacap” stocks have rallied back to near-record highs. Nvidia and Microsoft are the poster children, fuelled by the recent artificial intelligence announcements, including ChatGPT. Smaller companies, however, have not seen the same rally, and we’ve written before about the huge discount of international small cap stocks relative to their history–currently at the biggest gap since the dotcom bubble.
We’re optimistic about the outlook for small companies and believe now is a great time to offer this unique VC opportunity to Australian investors to get in on the ground floor of Israel’s next wave of innovation.
Markets & Commentary
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.