The Deepwater Frontier Tech Index
2024 was a rewarding year for investing in disruption via our Deepwater Frontier Tech Index. We believe we are still in the early stages of the potential opportunity to make outsized returns in AI (~65% of the Index) and it will remain a core investment thesis within our frontier tech investment discipline. Other investment themes include Fintech, Autonomous & EVs, Robotics, and Ambient Computing.
In 2024, the Magnificent 7 (Apple, Amazon, Google, Meta, Microsoft, Nvidia, Tesla) drove the market, contributing approximately three quarters of of the Nasdaq 100’s 25.6% performance. This underscores the large concentration of risk in the Nasdaq as passive flows continue to be directed into these names. Our Frontier Tech Index only invests in companies with a market cap below $500B.
Our valuation-aware discipline aims to identify emerging and disruptive technologies early, helps us identify those companies that may have asymmetric upside. We also leverage insights from our venture capital strategies with the objective to select a focused portfolio of leading public disruptive tech companies.
The Deepwater Frontier Tech Index has only a 4.0% overlap to the Nasdaq 100 Index as of Dec. 31, 2024, with a minimum market cap of $250 million and maximum of $500 billion.
We think 2025 is an opportune time to add some diversification to investors’ growth portfolios away from the Mag 7 concentration.
One way to gain exposure to smaller companies that are enabling AI, automation, robotics, ambient computing and fintech is through the Deepwater Frontier Tech Index.
Our goal is to give investors exposure to cutting edge tech companies outside of the megacaps. This Index is designed for investors who believe in tech innovation but already have megacap exposure. Our median market cap in the index is $38B as of Dec. 31, 2024.
Ways to Invest in Disruption
We believe that disruption-focused funds, including the ones listed above, tend to come in three clear flavors in accordance with our investor archetypes:
- Gunslingers: Disruption at any price.In our opinion, these funds represent disruptive technology well, but they ignore rational consideration of generating future cash flows to justify current prices. Instead, gunslinger funds tend to optimize for the most disruptive companies in the most attractive disruption themes. In our view, there’s nothing wrong with the gunslinger approach. As we describe in our archetype overview, gunslingers that understand technology and get in early can potentially do quite well if they also accept supply and demand. Eventually, we believe that all equity assets need to rationalize on cash flow generation, so the trick for the gunslinger is to get out when demand for the asset is highest. It’s hard to time this correctly.
- Indexers: Indexing all disruption at any price.We believe index approaches to disruption come in two types. First, many disruption indices take significant positions in the Mag 7. While those mega cap tech favorites are driving disruption, nearly every investor already has significant exposure to those names just by owning the QQQ (Nasdaq Index) or SPY (S&P 500 Index). The idea is funds that emphasize the inclusion of Mag 7 names are essentially closet- indexing the broader market as opposed to looking for outperformance. The second index approach to disruption is to hold hundreds of companies that fit into the disruptive category without consideration for valuation. These funds offer exposure to disruption, but they don’t optimize for the most attractive companies on a price/technology basis.
- Concentrators: Curated disruption at a reasonable price.Valuation-aware disruption investors seek to combine a deep knowledge of emerging technologies with a respect for how much growth is already priced into companies pursuing such technologies. This is Deepwater’s approach, and we’ll describe it in more detail here:
Disruption at a Reasonable Price
Our goal at Deepwater is to invest in disruption at a reasonable price so we can sleep well at night.
We’ve done internal case studies on the stock performance of several of the most successful tech companies in the world — the ones that now make up a significant part of the S&P 500 and the Nasdaq. Those studies demonstrated that if investors paid prices that accurately reflected the tremendous future growth of such companies throughout history, the returns from those investments would have historically trailed the broader market despite the disruptive power of those companies.
Our view is paying any price for a company simply because it’s disruptive doesn’t work. If you pay for all the disruptive power of a company upfront, you’re likely to be disappointed by the long-term result.
Investing in disruption helps us sleep well in the midst of a rapidly changing world, but paying any price for disruption makes us sleep poorly. We believe that a company eventually needs to justify its price through future cash flow generation. To be a great investment, in our view, an equity asset needs to generate far more in cash flow than is implied in its price. We believe the point of any investment strategy should be to generate attractive returns, not just to bring exposure to a category.
Howard Marks described the investing game better than anyone: To generate extraordinary investment results, you must do something different than everyone else. If you act according to consensus, you’ll get the same result as everyone else — regardless of whether consensus is right or wrong. If you do the non-consensus thing, and you’re wrong, you get terrible results. If you do the non-consensus thing, and you’re right, you achieve the extraordinary.
The most contrarian viewpoint in investing in disruption is to emphasize future cash flows — not technologies, market sizes, or optionality. We believe all those aspects of disruptive investing only matter to the extent that they generate incremental cash flow above and beyond what’s already priced into a stock.
A respect for valuation is intentionally built into how we construct the Deepwater Frontier Tech Index so that we seek exposure to disruption at a price that gives us a chance to generate strong returns.
Variant Perception
We believe there’s a persistent interest in disruptive companies because disruption has the potential to drive outsized investment returns. Disruption has the potential to create the next Mag 7, the next Tesla, Nvidia, or Bitcoin.
The problem is that most of what’s considered disruption consists of things that are obviously disruptive. Tesla was a great investment when no one believed in electric vehicles. Now everyone sees EVs gaining large market share. That doesn’t mean Tesla still can’t generate attractive returns, but it’s mathematically and economically harder for them to do so compared to their valuation many hundreds of billions of dollars ago.
With a market full of investors seeking disruptive tech, we see three contrarian ways to find disruption at a reasonable price:
- Be earlier than everyone else.
- Understand a much bigger opportunity than everyone else.
- Look where others aren’t looking.
We believe each of these strategies can be effective when applied appropriately, and we use each in our investment approach.
We strive to be early not only because you potentially benefit from the tailwind of excitement that benefits the gunslinger but also because future cash flows may not be fully priced into emerging disruptive tech. Understanding an opportunity bigger than everyone else has been the story of AI infrastructure over the last two years with Nvidia, TSMC, Vertiv, etc.
But the excitement around disruptive tech means that it’s hard to get ahead of a trend for very long, and it’s hard to find opportunities that aren’t fully appreciated.
Looking where others aren’t is likely the most difficult of the three options. We believe our early -stage private market Venture Investing business gives us early insights into those technologies that will shape the future of innovation and disruption, and we use those insights to inform our public market investing when selecting companies to add to the Deepwater Frontier Tech Index.
For more information on our Frontier Tech Index, please contact Brian MacHale at bmachale@deepwatermgmt.com.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended and/or purchased by adviser), or product made reference to directly or indirectly on this Website, or indirectly via link to any unaffiliated third-party Website, will be profitable or equal to corresponding indicated performance levels.