Editor’s Note: One of my greatest joys is reading bedtime stories to my twin eight-year-old grandsons. These tales are often full of mythical creatures and fantastical adventures. A favorite of ours is The Unicorn and His Friends, which tells the story of a magical unicorn that learns to fly.

For investors, unicorns are far from being mythological creatures. These private companies have a history of generating huge profits for investors lucky enough to get in on the ground floor.

As a retail investor, you may think you’re locked out of these unlisted companies. Think again. Below, I pinpoint an easy but effective way to tap the growth potential of unicorns, with mitigated risk. But first, some context.

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What Is a Unicorn?

In the investment world, a “unicorn” refers to a privately-held startup company that is valued at $1 billion or more. The term was first coined by venture capitalist Aileen Lee in 2013 to describe these rare, highly successful startups.

Lee discovered that the startups that made the most money for venture capitalists often hit the $1 billion threshold in valuation while they were still private companies. Because of their scarcity and nearly mythical aura, she dubbed these companies “unicorns.”

Unicorns are associated with high-growth industries, particularly technology, and often receive significant venture capital investment to fuel their rapid expansion. They tend to get a lot of coverage in the financial press, making them “story stocks.”

Unicorns typically operate in innovative sectors such as technology, fintech, biotech, or software, and they often disrupt traditional industries with their unique business models.

The best unicorns receive multiple rounds of funding from venture capitalists or private equity firms, enabling them to scale quickly and sometimes operate at a loss in the short term while building market share. Many unicorns eventually go public through initial public offerings (IPOs) or get acquired.

For venture capitalists and other early stage investors, putting money into unicorns can be risky due to the uncertainties in their business models, but they also offer the potential for outsized returns if they succeed.

The combined value of the world’s unicorns currently hovers at $3.8 trillion, more than the gross domestic product (GDP) of India. The following graphic depicts the most valuable unicorn companies in the world, as of October 2024:

There are over 1,200 unicorns around the world. Well-known former unicorns include Airbnb (NSDQ: ABNB), Facebook parent Meta Platforms (NSDQ: META), and Google parent Alphabet (NSDQ: GOOGL). Today, six of the 10 most valuable unicorns are based in the United States.

The mania over artificial intelligence (AI) has waxed and waned this year, but it still represents a huge magnet for investment capital. Case in point: Following the success of ChatGPT, San Francisco-based OpenAI has emerged as the third most valuable unicorn.

OpenAI announced on October 2 that it had raised $6.6 billion in new funding, bringing its post-money valuation to $157 billion. “Post money” is a company’s estimated worth after outside financing and other capital infusions are added to its balance sheet.

On October 4, OpenAI announced that it had set up a $4 billion revolving credit line with several banks, further enhancing its financial firepower.

The Fed Boosts Growth-Oriented Sectors

The Federal Reserve recently provided unicorns with a powerful tailwind. At the September 2024 Federal Open Market Committee (FOMC) meeting, the Fed slashed interest rates by 50 basis points (0.50%), easing monetary policy for the first time in four years.

The Fed felt comfortable making a jumbo-sized cut, due to progress on its dual mandate of sustaining employment while curbing inflation. This lowered the central bank’s interest rate target to a range of 4.75% to 5%.

When interest rates decrease, borrowing becomes cheaper for companies. Growth companies, especially tech names, often rely on external financing to fund research and development, expansion, and innovation. Lower interest rates reduce their cost of capital, allowing them to invest more aggressively in growth initiatives.

Tech stocks, in particular, tend to be valued based on future earnings and cash flows, which are discounted to their present value using interest rates. When interest rates are cut, the discount rate is lower, making future earnings appear more valuable. This leads to higher stock valuations.

As bond yields drop, investors are willing to accept lower returns from stocks, driving more capital into the equity markets, especially in sectors where innovation and growth drive returns.

My Favorite Play on Unicorns

Perhaps you’re itching to invest like a big-shot venture capitalist. Why should billionaires have all the fun? It’s possible to supercharge your portfolio with unicorn exposure, by purchasing shares of mutual funds or exchange-traded funds (ETFs) with ownership stakes in the startups. Anyone can buy shares and liquidity is high. These funds hold a diversified portfolio of unicorns, which reduces risk through diversification.

In my view, the best-of-breed fund to leverage the promise of unicorns is the Renaissance IPO ETF (IPO). This ETF primarily focuses on newly public companies, many of which were previously unicorns. While it doesn’t exclusively invest in unicorns, it provides exposure to many companies that started as unicorns before their IPOs. Through this indirect but well-researched exposure, you can avoid a lot of the hype surrounding many unicorns.

With net assets of $156.7 million, the Renaissance IPO ETF tracks an index of U.S. and international IPOs, generally holding these companies for two years after their listing. This approach captures the early stages of public trading, often when growth potential is highest.

Companies within the Renaissance IPO ETF come from a broad spectrum of industries, including technology, health care, consumer goods, and financial services. This ETF dynamically adjusts its holdings, adding newly public companies on a quarterly basis while removing those that have been listed for over two years.

The ETF offers exposure to some of the most innovative companies worldwide. Its top five holdings, in order of portfolio percentage, are Nu Holdings (NYSE: NU), which provides digital banking platforms; Kenvue (NYSE: KVUE), a consumer health company; Arm Holdings (NSDQ: ARM), a chipmaker heavily involved in AI; Robinhood Markets (NSDQ: HOOD), a financial services provider with a focus on cryptocurrency; and Rivian Automotive (NSDQ: RIVN), an electric vehicle (EV) maker.

By providing access to a diversified portfolio of recent IPOs, the ETF allows average investors to benefit from the potential upside of companies making their public market debuts, all while managing risk through diversification and expert selection.

The fund has racked up a year-to-date return of 11.02% and a one-year return of 36.82%. The expense ratio is a reasonable 0.60%.

As interest rates fall, economic growth gains traction, and technological innovation accelerates, the Renaissance IPO ETF is poised for a banner year in 2025…and beyond.

Read This Story: How to Beat Wall Street…Under All Investing Conditions

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John Persinos is the editorial director of Investing Daily.

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