(Click here to subscribe to the new Delivering Alpha newsletter.)

Lux Capital invests heavily in technology and science companies. They also make long-term bets against contrarians. The firm now manages $4 billion of assets over the past two decades. 

Lux Capital’s futurist fund manager Josh Wolfe leads the charge. His keen eye for technological innovations and scientific innovation is something investors need to pay attention to. Wolfe met with Wolfe. CNBC’s Delivering Alpha newsletterWe will discuss his outlook on investing and the best opportunities he sees right now.

The following video has been cut for clarity and length. You can see the entire video above.

Leslie Picker:Your wider market view is a great place to begin. Is this just a little bit of air being blown out the tires in certain key tech pockets and areas of growth or is it a complete revaluation?

Josh Wolfe:It’s not a mixture in all sectors. In some areas, you have a flat-tire. There is a possibility that we could be as high as 60% in March 2000, for an overvalued segment of the market. That means we will probably see an 18-month period of about 80% drop in the popularity rankings, from March 2000 to October 2001. That 80% decrease was achieved by just 50 basis points. It was about 1% drop over a prolonged period. There have been five, six years of buy-the-dip as the mantra. It worked. It’s not going to work anymore. You’ll see revaluation in specific segments, but mostly across high-growth technology and speculation.

Picker:This is what you are telling portfolio companies to do.

Wolfe: The three-word rule: Husband your cash. Keep the money you have raised. We’ve had companies that have gone public through SPACs, we’ve had companies that have done direct listings, companies that have gone public through traditional IPOs – the amount of cash that was delivered to balance sheets of Lux portfolio companies, and many companies around the world, is unprecedented. There are hundreds of million of dollars available for businesses that need it, like $10 million each quarter. You have maybe 10 years of cash. The most crucial capital allocation decision a management team or board can make is what to do with this cash. The most important thing that you can do for your cash is to make it work. If we are going into recession, investing now is like trying to spit against the wind. The cash will be better spent going after growth. Instead, make sure you have a fortress balance sheet, look at your weaker competitors, consolidate customers, technologies, positions, I think you’re going to see a huge M&A boom over the next year.

Picker: Silicon Valley’s capital circulation over the last five, six or seven years has been an important factor in valuation growth. Given what you’re seeing on the public markets, do you think that this trend will slow down? What will this mean for the company’s ability to obtain the right valuation and the amount of capital they can get going forward?

Wolfe: Yes, and yes. Now, I see it, there will be certain segments of the market that have plenty of cash. There have been a lot of investments. Six months ago we closed one-hundred and fifty million dollars. We had a lot more dry powder to deploy. Now the speed with which we’re doing that is going to be much slower than it was say, a year ago or two years ago…So I think that the next year you’re going to see LP indigestion, GPs slowing their pace, companies in the private markets seeing valuations come down, akin to what you are seeing predictably in the public markets.

Picker: There is usually a delay. We have only recently started to see reports that some companies may be willing to accept lower valuations due the current state of affairs. Many private companies have been able, at least in the last couple of years, especially during COVID. Some were even able double and triple their valuations. You might think that this is a different time. This will bring us back to 2002, when startup companies have to bootstrap for awhile.

Wolfe:The marginal price settingter sets the most recent valuation in the private market. In many cases that have happened historically, it was SoftBank. It could be large cross-border hedge funds doing private transactions. Then they basically stated, fairly randomly: “We are going to buy the winner.” Is it important what we pay for? It doesn’t, especially if you have excellent terms. … You’re in great shape if you are a senior preferred investor in these companies’ capital structures. In conclusion, I think you will witness a scenario where private companies experience a discriminating narrowing. Crossover hedge funds, early-stage growth investors and even early investors will all be much more discriminating. Und Des des all De Und All und Get get at Let A An set Alle an [it’s]Going to be dominated, let me give you an acronym. Instead of FOMO (Fear Of Missing Out), it’s what I call SOBS. It stands for the shame of being taken in. In this moment, people don’t want to be seduced.

Picker:It’s a great acronym. It’s hard to believe that it’ll ever take root. I doubt that many investors are waiting for this acronym. Are you in agreement with this? Is it possible that people eventually leave the market altogether?

Wolfe:It’s true for every industry over time. It is common to see an influx of people, then rapid pruning. As the number decreases over time. The wise do what the foolish don’t. These things happen within the investment sector. So you saw this, you know, 2002 to 2007, with the rise of activist hedge funds or active long short hedge funds, then there was a pruning post-crisis…There will be survivors. This market will see great investment opportunities, new companies will emerge, and there will also be significant culling. Within the next few decades, between 50%-75% of private investors today would disappear.

Picker: Do you have capital available to put into work? Or are you content to watch the outcome? Are you looking for the long-term?

Wolfe: We have strong balance sheets for existing businesses and are telling them: “Consolidate you position. Don’t be too quiet, don’t make it loud, just do what you’ve been told to do.” We are becoming more selective about the price of new investments. Auctions are not something we participate in. There are 40 term sheets available so we won’t do deals that close in one day. We are in the long-game. It’s possible to invest in advanced science and technology areas that are not well-known. There are no 500 competitors in the area we invest. Many times, we invest in sectors where only one, two or three companies exist. Capitalizing that company means you have the right team of management to ensure you are able to withstand the changes in macroeconomics for the next five, six or seven years. Indexes are not something we buy. We are not passive investors. From inception to completion, we help these businesses grow by providing their talent, competitive insight, future financing, and risk mitigation.

My motto is “It’s like trying to choose the best food on a meal menu.” After you have chosen the perfect restaurant and the best location in your best state, you are about to begin to bite into the delicious dish you selected. But then, Godzilla shows up and attacks the restaurant. It is not a virtue to ignore the macro. Attention must be paid to the macro context, including inflows and price settings, where money flows, as well as what the Fed does. Many people don’t pay attention to this kind of information. In the past, we have always incorporated a small amount of macro analysis and the current global situation into micro investments. We also make security selections about the entrepreneurs that we invest in and the businesses we build.

Picker:Is there a specific opportunity that interests you now?

Wolfe: There are two main themes we really want to capitalize on. We generally say that we are ready to strike. One of these is hard power, and the other is soft power. Both relate to geopolitical instabilities. On the geopolitical level, there’s a revanchist Russia as well as a rising China. There’s also a Cold War between these two superpowers, with a division of financial and surveillance systems, along with internet technology. So on the side of hard power, we believe that the U.S. needs to have cutting-edge technology in every aspect of defense and aerospace. There have been 20 years worth of Zeitgeist, where many people were reluctant in this military industrial system to supply cutting edge technology for the soldiers and women who serve on the frontlines, including Special Operations, Air Force, Space Force, Force, Force, Army, etc. We are therefore very keen to provide technology via many of our investments for the defense industry. 

You’ll see some of the next-gen primes, people and companies that will compete with Lockheed, Raytheon, General Atomics and others. in air, space, land and sea – autonomous systems, artificial intelligence, machine learning, cutting edge tools and technologies that are very expensive, very risky and in many cases, people have been loath to only focus on a government customer like the Department of Defense or the Pentagon, or allies. We’re entirely comfortable doing it and we think it’s geopolitically important…You’ve got north of 14 sovereigns that are now racing to get to space…and so there’s a lot of competition to launch things into space, have satellites, antennas, communication, lots of technologies that were invested in across [those]Space platforms can be literally launched from anywhere. 

On the soft power piece….we’re convinced, and people have not really picked up on the steam yet, but what we call the tech of science, there’s going to be a huge boom and demand globally, but particularly for the U.S. pharma companies, biotech companies, academics, U.S. government labs, for the technologies that improve science and give us a competitive advantage to win on the global stage, what is really prestige, globally.