I'm No Economist #4 ⚙️: Software Ate The World - But Already Spat It Out, Why I'm Going Into Hardware, Mercer 2022 Top Considerations for Private Markets
Take no advice from me. I'm No Economist.
Welcome to another edition of I'm No Economist. I'm super happy to announce that the last edition reached a record 60 views! 🎉
Most of these views come from finance and investment professionals. And according to the last edition, if they're still investors, they're the good ones that weren't wiped out from the market.
If it's your first time and you're not used to my foul mouth and acid humor, here are the ones you missed:
#1: Overture, My Portfolio & Investment Strategy for 2022, Returns so Far
Make sure to share I'm No Economist with your friends and say “I told you so” in a few months’ time. You won't want to miss the next chapters of the current market scenario
Software Ate The World - But Already Spat It Out
"If I only had an hour to chop down a tree, I would spend the first 45 minutes sharpening my axe" - Abe Lincoln.
Right now it's hard to look at the market and filter what's a good opportunity. However tough it may be now, I reckon it'll be better than the past couple of years.
On high liquidity, high greed market, everything's a no-brainer. It's tough for you to pass on an opportunity because investment competition is in its all-time high euphoria.
Now, saying "no” will be easier, simply because saying “yes” is too risky. It's in times like these that geniuses are really made. On a bull market, everyone's a genius.
In my humble opinion - like everything else in this newsletter - it got too easy because, as a society, we got too comfortable with investing in incrementality.
We narrowed investment decisions down to solving niche problems. And although that is the right mentality from a problem-solving perspective, builders stopped there.
While "software is eating the world” was the 2010's decade motto, I believe it's that time of the cycle for us to focus more on hardware to have a higher impact on societies' evolution.
Why I'm Going Into Hardware
I'm investing in hardware from now on. That's what is going to be the next one or two decades’ focus if investors really want to make a positive impact and build long-lasting value.
All the problems we have to solve are related to creating the right hardware solutions, if you think about it: climate change, energy supply, logistics, and countless others.
Let alone the inflation issue. I remind you that in edition #3 of this newsletter I pled the case of investing in real estate and other deflationary assets such as precious metals and Bitcoin.
Now, all you have to do is ask yourselves the right questions.
Do we really need another productivity app? I mean need, need. Probably not.
Do we need renewable energy sources applied at scale? F* yeah.
My thesis is that doubling down in hardware for the next 20 years is going to get us ahead as a society.
It will be hard because making investment decisions was pretty easy for the past decade. But now, saying “yes” should be hard.
There's a whole generation of people that are hooked on making easy stuff, copycats, and calling a new productivity feature a company.
I call on all LPs out there that want to make sure they're building for their next generations, that they grow a conscience, and make sure to invest in solving real-life problems.
And GPs, that's what it means to really add value. Let's make it happen.
Mercer 2022 Top Considerations for Private Markets
While I was studying economic cycles to write this newsletter, I stumbled upon the 2022 Mercer report on their top considerations for private markets.
One of the things I found most interesting is that the word “inflation” appears 67 times in 26 pages. 6 of those times on the first page. Maybe it's something on the top of their minds. Who would've thought, huh?
TL;DR, some of the most important topics they cover:
Natural resources: on their point of view, natural resources are a tactical allocation in times of inflation, as commodities can out-perform due to their correlation with an inflationary scenario;
Infrastructure: how investing in hardware can bring on a positive impact on climate change;
Real estate: how investors choose real estate sectors due to the new demographic trends brought by the pandemic;
Venture capital: "a provocative overview” of how the rapidly entering of emerging managers can be a sign of a market top. This topic comes as a warning to LPs to choose their GPs well.
Natural resources
There's no doubt that inflation is not transitory. Brazilians are used to high inflation and currency depreciation. We're not proud of it, but we understand it pretty well.
Mom and dad taught me to buy groceries as soon as the paycheck comes. Buy it for the month. Even though inflation is not annually triple-digit like in the 80s, that's something it passed on to the next generation - yours truly.
But that's not how I see U.S. citizens dealing with it. I bet their consumption habits have not followed a high inflation scenario. Because investment hardly does, and that's what moves economies.
They are under the impression that their central bank can really tame inflation by hiking interest rates. I'm skeptical.
When it comes to investment allocation, natural resources are a great way to maintain your purchasing power. Here's evidence of that:
Infrastructure
According to the report, the infrastructure capital raised in 2022 could exceed 2019 US$ 129 billion. But the pandemic created this uncertainty weather for this asset class.
Merce believes that the most resources will be deployed into climate change open-ended funds, as liquidity is something that is really important in times of inflation and due to the recent black swan events such as the pandemic.
Although recently the US Senate and House of Representatives approved the Infrastructure Investment and Jobs Act (IIJA - an approximately US$1.2 trillion legislative bill that includes approximately US$550 billion of incremental infrastructure spending - there's still too much uncertainty for this asset class.
There are a lot of paradoxical elements to this part of the report, that I believe are expressed well by the excerpt below:
"[…] although they are inherently unpredictable, they paradoxically should continue to be expected. For investors, this means being more aware of climate change as it relates to the potential impact on current and future infrastructure investments, as we have seen the impacts extending across subsectors within the asset class to varying degrees.”
Real Estate
This asset class is one of the preferred when everything else is uncertain. Not only this is a deflationary asset, as land is extremely scarce, but it also gives a sense of yield and cash-flow predictability that's important to investors in an inflationary scenario.
Capital allocation within this asset class may be different due to the pandemic and the new trends that surfaced with using real estate. Structural changes in how individuals live, work, and how tech advanced are the aspects that may have impacted it the most.
Venture Capital
This is my favorite part of this report. How LPs should see non-traditional investors as a top sign of the market.
Who are non-traditional investors? Investors that are only investing when there's a clear sign of liquidity - because money is all that they can offer from a value generation standpoint.
Those investors are always present when there are signs of irrationality.
In recent memory, during the 2000 dot-com bubble and 2008 GFC (global financial crisis), those investors were heavily spotted in there.
Recently, this data is also scary:
"Per PitchBook (as of Q2 2021), we have seen a record level of nontraditional investors participating in venturebacked company financings in 2021, particularly in the later stages. Of all VC investments in the US, 34% were from nontraditional investors — a percentage that increases to 50% at the late rounds. For mega rounds (the very late and pre-IPO rounds), nontraditional investors represented a remarkable 88% of all participants.”
While Mercer suggests that this is not advice to LPs to not invest in venture capital, they make it clear that it is LPs’ responsibility to make sure they choose GPs wisely when allocating their capital in this asset class.
Your feedback is more than welcome!
It's been a little rough to keep up with consistency and bi-weekly frequency for these newsletters. They take a lot of time and consideration to make sure there is added value™ being generated by these texts.
I really appreciate the feedback and I'm working on having more updates in different kinds of publications. Maybe a weekly roundup on the markets via Twitter threads or via Substack, really.
I'd love to hear your opinion on the kinds of content that you'd like to read, so reach out to me and we'll make it happen!
Coming soon
I updated my portfolio but I would love to have better metrics to measure it. For the next edition, I'll be working on a more accurate measurement tool such as TIR.
It takes a little more time and effort, but bear with me and we'll get there.
Thank you very much for the read!
Talk soon,
L.