On 21 February, the ASX will launch the S&P All Technology Index.
Or the S&P AllTech for short.
This new index is to be a smaller version of the US’ famous Nasdaq index.
The Nasdaq is the premier exchange in the world for technology company listings. And the Nasdaq index tracks the performance of the world’s top tech stocks.
The AllTech index will track the performance of tech companies listed on the ASX, hoping to provide liquidity and raise the visibility of the local tech scene.
The ASX hopes to find an unserved niche in the late-stage venture capital space.
So, companies that are too small, or not far enough in their progress to list on the Nasdaq, can come to Australia to try and raise investment funds on the ASX instead.
At face value, I’m a fan of this idea.
After all, new and innovative technology is the kind of thing Australia needs if we’re going to survive the future of tech-led disruption that now seems inevitable.
However, I think you need to approach this with eyes wide open too.
There are huge risks for the unprepared.
How should you deal with it?
Let me explain my thinking…
Follow the wisdom of Groucho Marx
There’s an old saying in the IPO (initial public offering) business.
As you probably know, an IPO is when a company lists on an exchange to raise new cash. At the time, a prospectus is sent out and new investors are invited to submit bids to take part.
Allocations of new shares are then made to successful bidders.
Here’s where the old industry saying comes in.
‘The only IPO you want to be part of is the one you can’t get stock in…’
It’s a play on the famous Groucho Marx quip that he’d refuse any club that’d accept him as a member!
The thing with IPOs is that getting hold of new stock isn’t a sure thing.
A network of interconnected broker relationships exists to make sure the best IPOs are reserved for them and their clients.
Which means if you do manage to get a stock allocation in a new IPO, it can sometimes be a bad sign.
Think of the ‘Mum and Dad’ investors that loaded up on Telstra stock back in the late 90s, for example.
I’d say to you, to be wary of any new tech offerings coming though this new mini-Nasdaq hype.
Remember, these are companies that can’t get listed on the Nasdaq, so they’re very likely to be pretty high risk, even by tech standards.
At best, they’ll be good but risky bets on companies with a chance at glory.
At worst, they’ll be cash grabs from directors and founders with a story to sell to you.
How can you separate the two?
In my experience, hype is the perfect reverse indicator. If something has too much hype (a little is OK), it’s usually a bad sign.
So, if the spruikers are out in force, you should steer clear.
But I don’t mean to put you off this area. It can be a great place to find good investments too.
Australia has actually produced a decent number of tech success stories in recent years.
Check out the below:
Companies like Xero Ltd [ASX:XRO], Afterpay Ltd [ASX:APT], Nearmap Ltd [ASX:NEA], and EML Payments Ltd [ASX:EML] have shown that Aussie tech can battle it out with the best of them. Not just in Australia, but globally too.
Indeed, technology is an area I spend a lot of my own time looking for investment opportunities in.
It’s the one part of the stock market where you can find stocks with exponential prosects ahead.
You just need a smart system to uncover them…
Think like a VC
If I could give you one piece of advice today, I’d say this:
Never bet the farm on any one stock opportunity.
That goes for small-caps and large-caps alike. But especially in small-cap stocks, diversification is key.
I know it can be tempting to load up in one small-cap stock when you get excited about its prospects. You can easily convince yourself you’re onto a sure thing.
And sure, you might get lucky.
But that’s like saying you might win the lotto. It could happen, but you wouldn’t risk your life savings on it, would you?
A smarter way to invest in speculative small-caps is to borrow from the venture capital playbook.
Venture capital lives by something called the ‘Power Law’.
It means that they accept that rather than making 10% on a bunch of investments, they’re happy to make 10-times returns on a just a few superstar plays.
Check out the below chart:
Source: Hacker Noon
This shows the returns from one of the most successful VC firms in the past two decades — Andreessen Horowitz.
It shows that over 50% of their investments lost money. And it was just 6% — the superstars — that produced over 60% of the gains for the fund.
It seems counterintuitive, but you need to lose money a lot in early-stage investing in order to win in the end.
As long as you land on a couple of those moonshots, you could potentially make very good returns investing like this.
It takes guts and it’s important you go into it with your eyes open.
And I’ll admit, it’s not for everyone. That’s fine.
But for those who have the stomach for it and can make it work, in my opinion, it’s the most exciting way to potentially make money in the markets.
Editor, Money Morning
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