Fred Kittler, co-founder of Velocity Technology and Communications Fund, a hedge fund focusing on the high-tech sector that in 1999 was up 262 percent, after fees, is testing F. Scott Fitzgerald’s assertion that there are no second acts in American lives. Kittler, who, like Fitzgerald, attended Princeton University as an undergraduate, believes a relatively new investment sector called cleantech is about to take off, and with it the returns of his new hedge fund firm, five-year-old Palo Alto–California based Firelake Capital Management.
The firm’s Firelake Strategic Technology Fund is one of the first hedge funds to embrace cleantech — a category of alternative technologies in energy, water, transportation and manufacturing that delivers environmentally friendly products at lower costs than do current offerings. Of the 40 companies in Firelake’s portfolio, 15 belong to the cleantech sector — investments in privately held companies that Kittler believes have the potential to deliver enormous returns when they go public or are acquired. To balance the risk of such early-stage investments, cleantech investments constitute only a small portion of the portfolio, while the bulk of its funding is allocated to publicly traded information-technology stocks.
Kittler, 57, took a similar investment approach in his first act. In 1996 he and partner Andy Kessler, 47, both former analysts, launched Velocity Technology and Communications Fund, which also invested in private and public companies. The fund’s returns, aided by the soaring prices of virtually all technology stocks during the late ’90s, were fueled by investments in private companies, such as Seattle-based software company RealNetworks, maker of the popular RealPlayer media program.
By taking a hedge fund approach to early-stage investing, the pair were able to make bets on speculative companies that looked promising — but without having to make the lengthy commitments of traditional venture capital investors. Meanwhile, to offset the risk of those bets, they made the bulk of the portfolio’s investments in publicly traded technology stocks.
Using this strategy, the duo managed to parlay $100 million of investments into more than $900 million before starting to sell off the portfolio in November 2000, believing the sector’s valuations had become unnervingly high. By September 2001 they had completely liquidated the Palo Alto, California–based fund.
Kessler does not appear in this second act, though he is an investor in Firelake. Enriched by the millions of dollars he made at Velocity, he now pens books and articles for varied publications. In his place is Firelake’s co-managing director and co–portfolio manager, Martin Lagod, a Silicon Valley lawyer-turned-venture-capitalist who brings significant expertise in energy companies to his post. Lagod, 51, picks promising start-ups to back and then finds venture capitalists to sit on their boards and advise the companies.
Kittler, a futurist from his days at Princeton, where he graduated with a degree in architecture in 1971, says he chose to focus his new hedge fund on cleantech partly because “it was a big and important new field” that Wall Street did not understand.
But now Wall Street is also starting to believe cleantech may turn out to be the new new thing. Last year North American and European venture capitalists poured a record $3.6 billion into cleantech, more than double the $1.7 billion invested in the industry in 2004, according to Brighton, Michigan–based research firm Cleantech Venture Network. Just five years ago, Kittler says, no one would touch the industry.
In fact, Kittler has taken the same public-and-private-investing approach he used at Velocity because of the sector’s infancy. He is incubating its cleantech investments within a more traditional portfolio of computer and software stocks. Firelake’s biggest holdings of publicly traded high-tech stocks include Morrisville, North Carolina–based Harris Stratex Networks, a supplier of wireless transmission systems; and Mountain View, California–based semiconductor maker NetLogic Microsystems, which designs chips used for rapid access to the Internet, yet outsources the chips’ manufacturing.
“Because we had a portfolio of publicly traded companies, we could take our time finding really good private cleantech start-ups,” says Kittler. As with Velocity, he and Lagod started small with Firelake in 2002, launching with only $18 million in assets from friends, family and former Velocity investors. Firelake today has about $234 million under management; when the portfolio’s value reached $200 million, Kittler closed it to outside money — the same approach he took with Velocity.
Firelake’s strategy is to invest small and wait for high returns, says Kittler, who notes that its long-run approach to investing differentiates it from traditional hedge funds. It can short stocks but does not use leverage.
The fund’s cleantech holdings include companies like Pittsburgh-based Plextronics, an electronics manufacturer that makes photovoltaic cells — materials that convert sunlight into electricity — out of plastics; and Ann Arbor, Michigan–based Sensicore, a manufacturer of microsensors for water testing used by municipalities and companies to determine the purity of water within minutes.
Given such innovations and investment opportunities, Kittler believes Silicon Valley is once again leading a high-tech revolution. Unlike computers and the Internet, however, the nascent cleantech industry must deal with regulatory bureaucracy. Cleantech companies count major utility companies among their clients — customers who tend to be overly cautious and slow in adopting new technologies.
“Moving into this space requires understanding the regulatory drivers as well as the traditional business drivers,” cautions Joseph Desmond, a veteran of the alternative-energy industry who serves on the California Energy Commission under Governor Arnold Schwarzenegger. He believes getting old-guard utilities and visionary entrepreneurs on the same page will be challenging.
Still, Kittler believes cleantech solutions will erode utilities’ dominance over energy production and that the speed of innovation within the sector will mimic the computer industry’s. He notes that companies like transistor manufacturer Transitron Electronics were hot stocks in the 1960s, yet were obsolete only five years after the introduction of the integrated circuit. Cleantech, he predicts, is about to be the energy equivalent of the integrated circuit. “We’ve already seen this movie,” he says.
