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In the changing landscape of venture capital, a once-general-enough investment approach faces significant challenges. With the rapid pace of technological advancements and societal shifts, venture capitalists must adapt to stay ahead of the game. In addition, new research from S&P Global on venture capital funding for the second quarter of 2024 found that funding rounds declined in deal value and volume, suggesting that investors are becoming more selective and cautious, which may signal the need for more targeted investment strategies.
As a result, a new paradigm is emerging in early-stage investing, in which the practice of venture capital is being overhauled from the ground up. This paradigm shift is not just a trend; it’s a strategic evolution that promises to enable venture capitalists to tap into the next wave of disruptive opportunities.
Shifting to a new business paradigm can significantly improve an investor’s ability to identify high-potential opportunities, align with long-term trends, and achieve sustainable returns. The first principle of this shift is thematic investing.
Related: Here’s what you need to know about the changing face of venture capital
The New Paradigm: What is Thematic Investing?
For decades, the VC general investment style dominated. This approach, characterized by a broad, diversified portfolio, relies on the hope that a few big wins will offset numerous less successful investments. This method often leads to a superficial understanding of each industry and a lack of deep specialized knowledge. As a result, general VCs may miss marginal opportunities and fail to predict long-term trends, leading to suboptimal investment decisions. The inherent risk and inefficiency of this model are becoming more and more apparent, forcing investors to look for more reliable strategies. A contrasting approach that my company has succeeded with is a thematic investment strategy.
What is thematic investing? Unlike general or sector-specific investing, the thematic investment style emphasizes the importance of focusing on enduring economic, technological and social trends to drive innovation and generate sustainable returns. By examining long-term trends, thematic investors can focus on opportunities with higher potential for sustainable growth. Thematic investing is based on the belief that certain macro trends will shape the future, and by aligning investments with these trends, VCs can achieve greater success.
This approach contrasts with other strategies, including impact, sector and thesis-driven investments. Impact vs. thematic investing is a key differentiator; impact investing prioritizes creating measurable social and environmental benefits alongside financial returns, while thematic investing focuses on identifying and capitalizing on long-term social, technological and economic trends.
When comparing thematic investing vs. sector investing offers a broader but more precise approach to thematic investing. Sector investing limits its scope to specific industries and potentially misses the cross-sector opportunities that thematic investing can capture by focusing on cross-cutting trends affecting multiple industries. Difference Between Thematic Vs. thesis-based investing further emphasizes the benefits of thematic strategies. While thesis-driven investing is based on a specific hypothesis about the market’s future trajectory, thematic investing emphasizes a broader examination of enduring trends. This allows thematic investors to remain flexible and adaptable, constantly refining their strategies based on the evolving economic, technological and social environment.
By understanding and exploiting these differences, venture capital providers can better navigate the complexities of modern markets and adopt thematic investment strategies that align with their goals.
Related: Do you want to build an impressive investment portfolio? Here’s what you need to know.
How to build for a new paradigm
Based on this fundamental principle with effective operational structures, the emerging manager can create a strategy, processes and portfolios that are significantly different from the status quo. Follow these steps:
1. Create a rigorous thematic research framework
A successful thematic investment strategy requires a careful and structured research framework. This approach starts with building an engineering investment foundation based on first principles, which involves hypothesizing potential investment themes and rigorously testing them. At Ascend, this process involves reviewing over 500 companies per month, resulting in over 30,000 reviews to date. Such an exhaustive flow of deals enables early identification of promising investments. We also limit each fund to a maximum of 10 companies to ensure each business receives significant support and resources.
A robust research framework should include ongoing market analysis, trend monitoring and data validation. This strategy involves subjecting hypothesized themes to rigorous testing, evaluation and refinement, focusing on their impact on monetary returns. The use of scientific methodologies to manage and use funds increases the accuracy and efficiency of investment decisions, leading to a higher success rate compared to other approaches. This higher hit rate then allows for smaller, more concentrated portfolios.
The framework must also be designed to be adaptable, allowing adjustments based on emerging trends and new information. This flexibility is essential to stay ahead of market shifts and ensure that the investment strategy remains relevant and effective. By adopting such a strategic, research-intensive and highly targeted approach, you can significantly increase your success rate and uncover transformative opportunities that are often overlooked by traditional investment styles.
2. Target transformation companies
Use unique qualification criteria to identify companies that traditional VCs might pass on. For example, my company’s approach to thematic investing specializes in data-centric technology that enables future states of rapidly changing industries. By targeting businesses that align with deep-rooted economic, technological and social trends, you can identify significant growth potential and drive innovation in their industries.
One such enterprise is REFASHIOND OS (rOS), a comprehensive operating system for the fashion industry that connects and manages the entire value chain from fibers to finished products. The company is transforming supply chains and laying the foundation for a unified system similar to the advent of computer and mobile operating systems.
3. Build a diverse and advisory investment team
A critical component of an effective thematic investment strategy is assembling a team with expertise in various areas relevant to the identified themes. This diversity increases the ability to evaluate opportunities from multiple perspectives and provides a more comprehensive understanding of emerging trends and potential investments. Recent research by Korn Ferry found that diverse, inclusive teams make better decisions 87% of the time.
It is also beneficial to introduce a blind founder selection process, which eliminates biases and allows virtual providers to focus purely on the potential of the business idea and its alignment with the chosen themes. This ensures that investment decisions are based on the viability and transformative potential of the origin rather than the background of the founders.
However, assembling a diverse team and founding group is only the beginning. It’s also important to ensure your team can provide real advice to the companies you invest in. At Ascend, we go the extra mile for founders by offering a wide range of strategic, operational and educational guidance throughout the life of our investment. Our commitment to white-glove interaction, personal attention and strong relationships ensures that we support modern disruptors comprehensively. This approach enhances the success of our portfolio companies and strengthens our investment strategy by closely aligning with their evolving needs.
Fostering a culture of continuous learning and adaptation within the investment team is a critical component. Encourage team members to stay abreast of industry developments by attending relevant conferences, participating in webinars and engaging with thought leaders. This ongoing education helps the team stay ahead of thematic trends, equipping them with the knowledge to make informed investment decisions and providing valuable advice to founders.
Related: What are the strengths and risks of thematic investing
The field of venture capital is evolving rapidly, and thematic investing is becoming a critical strategy for staying ahead in a world marked by technological advancement and societal change. By focusing on long-term trends, venture capitalists can uncover transformative opportunities that traditional approaches often miss. The shift from a general to a thematic investment strategy requires a rigorous research framework and a diverse, constantly learning investment team. Adopting this paradigm promises not only to boost innovation and support sustainable returns, but also to position venture capitalists at the forefront of the next wave of disruptive opportunities.