VCs have dominated private funding and the start-up space for decades, while hedge funds focused largely on publicly listed companies. The reason for this is simple: hedge funds prefer to invest in stocks such as Google (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) that will offer them high returns on investment (ROI) in a short period of time.
As mentioned in the Securities Exchange Commission (SEC) issue on Hedge Funds, these funds largely invest in public equities with the goal of building a diversified portfolio and practicing managed risk.
It is easy to make wagers on well-established companies than it is to find the next industry giant that is just starting up today. However, hedge funds are now focusing more on private funding, where they are investing billions of dollars in progressive businesses.
Fund managers are supporting businesses that use cutting-edge technologies to provide solutions ranging from healthcare to fintech.
2021 was a big year for hedge funds
Hedge funds have been pouring money into fintech start-ups since the financial crisis of 2008, as new technologies continue to reshape the banking and financial sector.
Fintech-based businesses are still at the top of the investment list, but marketing solutions, social media, communication, and business management systems are also receiving attention.
In 2014, hedge fund Coatue Management participated in Snap's (NYSE:SNAP) $50 million round of fundraising, making it the first significant hedge fund investment in a non-fintech start-up.
Even though hedge funds have always been around, their presence was more prominent in the last year with Tiger Global leading the private market investments—not traditional VCs. According to Crunchbase, Tiger Global made 335 investments in 2021 and landed some of the year's biggest venture capital deals such as Patreon, a subscription platform for content creators, Hinge Health, a healthcare business, and Side, a real-estate tech firm.
Some hedge funds also have programs to host and assist startups. With a growing number of startups with potential breakthroughs and evidence of profitability in investing in startups, there’s no wonder that hedge funds are drawn to the private equity industry in the hopes of making enormous gains on investments.
While there are many reasons for entering the private equity industry, one of them is that the number of public companies has reduced by half in the last two decades, while private companies have expanded rapidly before debuting on stock exchanges. This growth provides hedge funds with good exit opportunities, as with the IPO of Roblox (NYSE:RBLX).
Few industries will be big winners
Given the changing hedge fund investing trends, it would be reasonable to assume that high-flying business sectors, such as cryptocurrency, fintech, digital health, Artificial Intelligence, and big data sectors will attract hedge fund investments in the future.
With cryptocurrency making headlines, some hedge fund managers have already entered this new industry to capitalize on the market potential. Despite being a risky and unregulated asset class, these digital tokens continue to attract new supporters.
Not only has an interest in digital assets grown gradually, but the number of hedge funds focused on cryptocurrencies has also grown significantly. According to PWC Crypto Hedge Fund research, there are between 150 and 200 active crypto hedge funds managing more than $1 billion in assets under management (AUM).
Investing in young industries is deemed to help fund managers yield above-average returns in the future as these investments will serve as a foundation for the global transition into a more digitalized and connected future.
This will provide hedge funds with a long-term competitive advantage as they fund future developments and discoveries in these fields. While the number of hedge funds investing in start-ups grows, so does the number of start-ups with groundbreaking solutions, from financing to marketing.
Young companies to watch
Many start-ups are working to offer advanced and secure solutions in response to the growing interest in digital assets and cryptocurrencies. Because the digital transformation has resulted in a significant shift in the way people invest and transact, stock exchanges, marketplaces, and trading vehicles have come under tremendous pressure to keep up with the changes.
Current financial institution infrastructures still lack transparency and are slow compared to blockchain and Web 3.0, which are gaining traction due to the ease of access to transactions, as well as faster transaction speeds.
As financial service providers lack adequate solutions to keep up with the rapidly changing and expanding marketplaces, companies like Exberry, an Israeli startup, offers exchange and trading technology expertise to exchanges, banks, digital securities houses, and marketplaces.
The company provides a deep-tech trading infrastructure for exchanges, banks, digital securities, and marketplaces that trading platforms can use to quickly create new digital asset trading platforms without needing to start one from scratch. Exberry is a classic example of a company that could attract the interests of institutional investors in the future.
As the investing world evolves, one company is working to modernize the commercial real estate financing industry. LoanBase, founded in 2020, provides cutting-edge technology that connects borrowers and lenders while also allowing direct communication between parties for maximum transparency.
This enables clients to find the best financing solution for their property in a fraction of the time and cost associated with traditional financing methods.
Aside from the investment world, technology is having a strong influence on marketing. While many companies offer design and marketing tools, Walnut offers a no-code platform that automates and customizes the process of creating sales demos.
Since its inception in 2020, the company has enabled customers to quickly create customized product demonstrations, integrate demos into their sales and marketing processes, and then generate insights from the demos to improve the sales experience.
The platform is claimed to be fail-proof because demos are done live, even when the real product is unavailable, and the drag-and-drop solution speeds up the demoing process by giving sales reps full control.
Since the last Series A funding, the company's yearly recurring revenue has increased 700%, and it currently has approximately 100 SaaS customers, including Adobe (NASDAQ:ADBE), Dell Technologies (NYSE:DELL), Medallia (NYSE:MDLA), NetApp (NASDAQ:NTAP), Treasure Data, Funnel, People AI, and ContractBook.
Takeaway
Companies that achieve significant revenue growth and international expansion do so in the private stage, and there could be little upside when these companies go public.
This is exactly why hedge funds are bucking the trend of waiting until young companies go public to invest in them. In the recent past, many renowned hedge funds have come under scrutiny for their lackluster performance despite their hefty fees, and this underperformance can be traced back to their lack of investments in private companies.
To alleviate these concerns and to attract new clients, many hedge funds are beginning to invest in startups and early-stage companies, which is a trend that could help not only hedge funds and their shareholders, but also the global economy.