It’s No Myth: You Can Corral Moneymaking “Unicorns”

For investors, unicorns are far from being mythological creatures. These private companies have a history of generating huge profits for investors lucky enough to get in on the ground floor.

As a retail investor, you may think you’re locked out of these unlisted companies, but there are easy ways to gain exposure. Below, I show you how.

In the fairy tales that I read to the kids in our family, a unicorn is a magical horse with a single spiraling horn projecting from its forehead. In the world of finance, a unicorn is a private company that lacks an established record of solid operating results but boasts plenty of potential. The company’s estimated valuation is $1 billion or more and investor buzz is such that the unicorn appears on track for an initial public offering (IPO) or acquisition.

The term was coined in a 2013 article by venture capitalist Aileen Lee, founder of CowboyVC, a seed stage venture capital fund based in Palo Alto, California.

Lee discovered that the start-ups that made the most money for venture capitalists often hit the $1 billion threshold in valuation while they were still private companies. Because of their relative scarcity, she dubbed these companies “unicorns.”

According to new data released on May 26 by CB Insights, a research firm that tracks venture capital activity, there are 197 private companies worth $1 billion or more around the globe, up from 154 at the start of the year (see chart). Combined, they have raised about $142 billion. There are 76 institutional investors with at least 5 unicorns in their portfolio, up from 70 in 2016.

Unicorns: The Growing Herd*

*Number of unicorns at the beginning of each year. Source: CB Insights; SEC data

SoftBank plays hard…

Unicorns tend to be start-ups in the technology, mobile telecommunications and information technology sectors (often at the nexus of all three).

Sometimes a unicorn’s expected IPO turns into a surprise acquisition, as occurred in January when Cisco Systems (NSDQ: CSCO) announced its buyout of software developer AppDynamics for $3.7 billion, one day before the latter was scheduled to sell shares to the public at a valuation of less than $2 billion. The acquisition was completed in March.

Investor interest in unicorns is heating up. SoftBank Group (OTC: SFTBF) and Saudi Arabia announced on May 20 the first round of capital commitments for the largest-ever technology investment fund. SoftBank founder and CEO Masayoshi Son is eager to finance cutting-edge technologies, whereas the Saudis are intent on diversifying into other sectors besides oil and gas.

With an annual gross domestic product (GDP) of $1.8 trillion, Saudi Arabia’s petroleum sector accounts for roughly 80% of budget revenues, 45% of GDP, and 90% of export earnings. The desert kingdom wants to create a more tech-oriented economy that’s less dependent on fossil fuels.

SoftBank’s tech investment fund so far has raised a staggering $93 billion from several deep-pocketed backers, including Saudi Arabia’s Public Investment Fund, Apple (NSDQ: AAPL), Qualcomm (NSDQ: QCOM), and other Silicon Valley tech titans. SoftBank is spearheading the funding efforts, with the goal of reaching $100 billion within the next six months.

SoftBank will base the fund’s operations in London, from where it will invest in the hottest tech trends — and a huge chunk of this money is likely to get plowed into the most promising unicorns.

Plenty of horsepower…

Igor Greenwald, chief investment strategist of Breakthrough Tech Profits, asserts that technology’s momentum has plenty of horsepower left:

“I’m happy to report investors’ yearlong love affair with tech stocks just won’t quit. As noted last month, it’s a relationship cemented by cold, hard cash flow as much as promises of a happy ever-after…

No one can know when the next selloff will hit. But odds are excellent that this isn’t the top of this bull market.”

Much of the tech sector’s mojo stems from entrepreneurial unicorns that are upending the status quo in their niches. Ride-sharing service Uber, online hospitality exchange Airbnb, and aerospace rocketry firm SpaceX are well known unicorns that grab headlines.

Alphabet’s (NSDQ: GOOGL) Google Venture division, founded in 2009 as an early stage venture capital investor, has major stakes in several unicorns, including Uber.

These unicorns are unlisted, but here’s a way to gain exposure: by acquiring shares of exchange-traded funds (ETFs) that are participating in the private funding rounds of unicorns. By investing in these companies, the funds are giving a shot of steroids to their returns.

Pre-IPO tech stars…

The Fidelity Contrafund (NSDQ: FCNTX) was one of the equity funds that owned Facebook (NSDQ: FB) in advance of the social media pioneer’s 2012 IPO and has since accelerated its private investments in pre-IPO tech stars.

Contrafund’s lead manager William Danoff has invested in several of the best-known unicorns, including Uber, Airbnb, Pinterest, Dropbox, and SpaceX. (For more on Elon Musk’s SpaceX, see my March 17 issue: Space Exploration’s Return to Glory: How to Profit).

With net assets of $110.6 billion, Contrafund also owns stakes in Apple, Alphabet, and Microsoft (NSDQ: MSFT). Year to date, the fund has generated a total return of 13.1%. The fund has posted one-, three- and five-year returns of 18.5%, 11.4%, and 13.1%, respectively. The fund returned 10% in the first quarter of 2017. The expense ratio is 0.68%, less than the average of 1.14% for its peers.

Hartford Growth Opportunities (NSDQ: HGOAX) counts Uber as one of its top holdings, at 2.7% of assets. Lead manager Michael Carmen is constantly on the prowl for other promising unicorns.

With net assets of $4.2 billion, Hartford also owns major stakes in Facebook, Amazon (NSDQ: AMZN), and Netflix (NSDQ: NFLZ) — all unicorns in their early days and now publicly traded tech sector behemoths.

Hartford has generated a total return of 12.6% year to date. The fund also has racked up one-, three- and five-year returns of 15.9%, 12.2%, and 14.5%, respectively. The fund returned 10.1% in the first quarter of 2017. The expense ratio is 1.14%, in line with its class.

Looking to invest like the big-shot venture capitalists? It’s possible to supercharge your portfolio with unicorn exposure, but still enjoy the safety of a diversified ETF.

Drop me a line if you have any comments or questions. I’d also like to hear how you’ve fared with the recommendations made by my newsletter: — John Persinos


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