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March 21, 2022

Letter from the Portfolio Manager

Portfolio Manager, Ben Hensman, Introduces the Global Tech Fund

Ben Hensman

December 1, 2021

Letter from the Portfolio Manager

Portfolio Manager, Ben Hensman, Introduces the Global Tech Fund

Ben Hensman

We believe that the most attractive businesses in the world are increasingly tech businesses. This is driven by the enormous, multi-decade impact of tech adoption in every facet of life and commerce. We also have the view that backing the businesses that can compound at high growth rates through this period requires specialist insight.

Why Square Peg?


Over the past decade, Square Peg has built a successful track record backing founder-led tech businesses from the earliest stages through to scale, delving deeply into the themes, business models and teams that are driving change.

This front-line exposure to change gives us a unique perspective on the defensibility and durability of later stage, listed tech businesses. It puts us in a differentiated position to identify the large, important tech companies of tomorrow and back them when they’re still early in their listed journey. We combine this with our venture investing DNA and mindset.

So, what does this really mean?

  • Genuinely long-term: Understanding that the most attractive way to build capital is to compound it in the highest growth businesses over time.
  • Focusing on what can go right: Bringing deep rigour and understanding to our investing, while remaining focused on what can go right and looking for asymmetric upside.
  • Concentrated investing style: Investing substantially in a set of businesses that can really move the needle and where we have high conviction – not going broad for the sake of exposure or diversification. Much like our venture funds, this means holding 10-20 businesses in the portfolio. In a listed setting, this means high volatility in the short term. While we need to be thoughtful about risk management, we do not see volatility itself as a risk. The primary risk we seek to avoid is the permanent impairment of capital.
  • Alignment: We align with our investors by investing meaningfully in the Fund and tie incentives to long-term performance. Like our investors, we seek to compound our own capital at high rates of return over the long term.

What do we look for?

When we talk about what can go right, we are looking for the building blocks of long-term success and the ability to continue scaling at high rates of growth.

There are four key building blocks to our investment philosophy and what we look for in businesses:

Theme

  • Our venture investing helps us focus on and understand key tech themes and trends that will play out and generate substantial value over time – we dig deep to find the specific beneficiaries.

Team

  • We focus on outstanding founder-led teams who maintain many of the important characteristics that underpinned their success as an early-stage business – long-term mindset, clarity of vision, alignment.

Moat

  • We are most excited about businesses with strong defensive moats or accumulating advantage that can enable longevity of high growth over many years.

Model

  • We look for highly efficient, scalable business models where financial success is closely linked to the success of customers and solving problems for them over time.

Beginning with theme, we’re currently focused on three key thematic areas:

1. Fintech

  • Traditional institutions still command the vast majority of revenue and profits within financial services – we believe we’re very early in seeing a large shift to non-traditional providers, such as software and ecommerce companies with close proximity to the customer and the transaction flow.
  • We are also seeing an unbundling of products from large institutions, allowing the reimagining of entire product categories, such as the full homeownership lifecycle.

2. Enterprise cloud and infrastructure

  • The cloud software market is still very early in its adoption cycle. There are multiple catalysts and drivers to deepen that adoption over the coming decade, such as ”no code” applications that minimise complexity for users, deep vertical specialisation of software and the democratisation of capability around AI and machine learning.

3. Healthcare

  • Health system costs have long been decoupled from inflation and are unsustainable. A number of trends we’ve observed can help solve this problem.
  • These include decentralised models of primary care that are highly patient-centric, proactive and utilise devices and community support. This also includes process improvement (especially in decision support for clinicians) using AI techniques.

I’ll unpick our building blocks further through the lens of a current portfolio company that aligns closely with our philosophy:

The first component of our philosophy is the theme. We aren’t simply looking for exciting tailwinds. We seek out businesses where there are specific reasons why they will benefit disproportionately from change. Take DLocal, which is a local payments and FX infrastructure provider in emerging markets, with a focus on LATAM. These markets are far earlier in their migration to ecommerce and digital payment methods compared with more developed markets like the USA and Europe. They’ve built a complex infrastructure network that enables international merchants to easily sell and payout funds into these markets using highly localised payment methods without being a local regulated entity.

One of the factors that make successful start-ups so special is their founders and the mindset they create throughout the organisation – looking for these types of teams is the second component of our philosophy and a cornerstone of our venture DNA. DLocal’s founders, Sebastián Kanovich, Andres Bzurovski and Sergio Fogel, are deeply connected to the problem they’re solving. Founded in 2016 after spinning out from a previous LATAM payments business, they’re renowned for their customer centricity and for working hard to achieve the best possible customer outcomes. It is a highly technical product that presents interesting and impactful challenges for the team. This culture will be critical as they seek to become a very large global business.

Thirdly, we love businesses with strong defensive moats. This goes beyond being “sticky” and difficult for customers to turn off. We look for moats that can be entrenched to benefit the prospects of customers, rather than to exploit them. DLocal’s moat is two-fold. Barriers to entry from the incredible complexity of payments infrastructure they’ve built and continue to expand, as well as an accumulating advantage in understanding customer needs. Within that comes a depth and variability of data that allows their product and data teams to solve more problems for customers through building more specialised and focused products than competitors. Perhaps the clearest example is recognising unusual fraud patterns across multiple geographies and being the most effective in driving up approval rates and conversion at the point of transaction. In other geographies, we’ve seen this data advantage evolve into the ability to start addressing other needs, like credit risk, as well as deeper accounting and tax automation.

Finally, we look for highly efficient, scalable business models. We focus on tech business models with low incremental costs for each dollar of revenue that can generate high incremental rates of return on capital deployed in an expanded opportunity set over time. We look for businesses with multiple levers of growth. DLocal has a land and expand model where a customer will often start with just a single payment method in one country. Over time, they seek to grow the number of countries and payment methods used. They also seek to add products, like card issuing and fraud to solve additional customer problems. This allows existing customer revenues to typically grow at net rates of 50%+ at very low incremental costs. This can only come from deep investment in customer relationships and understanding of their needs.

Together, these building blocks should allow DLocal to continue scaling at high rates of growth, creating a large and important payments infrastructure company over time.

On markets

Financial markets are replete with lessons for investors, and these will always be front of mind in the Global Tech Fund. Three stick out for me among many.

The first is the need for humility and intellectual honesty in what we do and don’t know, and to continually assess where we have conviction and what can undo that conviction.

The second is that the presence of liquidity and volatility in public markets leads to an abundance of shorter-term thinking and reactive decision making.

The combination of these leads to the third key lesson, which is that markets can be a poor judge of high incremental returns for a company over a multi-year time horizon. For us, this provides an opportunity to back businesses with this dynamic over the long term, resulting in extraordinary investment outcomes.

Lastly, a word on valuations and markets. We are in an environment at the moment where there are a lot of macro influences on markets. It is difficult to understand the precise path that the macro environment will take.

Our focus is on what is realistic and achievable for the businesses and teams we choose to back. In some cases, we will struggle with the financial expectations implied by valuations. In others, we will need to be very thoughtful about how quickly we establish positions and exercise patience in the companies where we have high conviction. In all cases, we will be looking for asymmetric outcomes skewed to the upside over the long term.

Thank you

Thank you for your interest in the Global Tech Fund. We will be disciplined, thoughtful stewards of your capital and look forward to a long-term partnership as we seek to compound your capital by partnering with extraordinary founder-led tech businesses.

Ben Hensman & Team Square Peg