The real issue isn't the asset class itself, but rather selecting the right VC. Unlike other asset classes, the return dispersion in VC is immense. VCs that adopt a gambling approach often drag down the median returns. In contrast, those with a structured and disciplined investment thesis can significantly reduce exposure to losing companies while enhancing their upside potential by investing the right amount at the right valuation. Achieving favorable returns in VC requires a programmatic approach: 1. Great manager selection and access: Identifying and gaining access to top-tier managers is crucial. 2. Consistency across cycles: Long-term commitment and consistency in deployments across various market cycles are key. This doesn’t mean investing the same amount each year, but maintaining a relatively stable investment pace where the VC is able to invest for value not just a trend follower. Many LPs tend to commit more capital during peak periods (e.g., 2019-2021) and scale back during tougher times. This natural psychological behavior often results in suboptimal outcomes. Peak periods can lead to behavioral changes and the inclusion of 'tourist' investors, ultimately affecting valuations and returns. It's all about dollar-based risk-adjusted returns. Selecting the right VC with a disciplined investment approach can make all the difference. Consistent, strategic investments, rather than reactionary ones, are essential for capturing the best returns over the long term. Thoughts?
A quote from a recent StepStone Group report on VC vintages around the concept of a “Vintage Power Law” is very interesting and highlights a point I often talk about. I’ve added the report in the comments. "Put differently, of the 23 vintage years assessed, 80% of returns come from just five to seven separate vintage years over the short, medium, and long term. Furthermore, 95% of returns come from six to ten of the 23 vintages measured over each time frame." Of course, investors won’t know which vintage years are power law until 7-10 years+ later. I often get the question of whether Venture Capital is a good asset class to invest in or not. The truth is that it depends. Unlike other asset classes, the magnitude of return dispersion in VC in massive. Benjamin Sun from Primary Venture Partners recently shared that the median seed fund returns of the last two decades were found (using a data set from a longstanding VC FoF) to be ~7% while mean returns were 50% (!). In other words, VC can be either a terrible asset class (as it is for many) or an incredible one. Putting aside strategic interests, this is speaking purely in financial terms. While a 50% return should never be expected (and presumably the FoF had great access and selection), it does mean that VC can be interesting only if done programmatically, which typically requires 1) Great manager selection and access 2) Consistency across cycles. The second point means that LPs typically need be committed long term across cycles and vintages --- as the Stepstone report highlighted (and be fairly consistent on deployments annually --- This does not mean the same amount each year, but variations should probably not be more than a single standard deviation or so). Unfortunately, looking at the data, it’s clear that many LPs go in heavy when times are the hottest (i.e. 2019-2021) and then retract completely during tougher times. This is primarily (not solely) a natural function of ingrained investor psychology. The problem of course is that peak times bring suboptimal outcomes due to behavioral changes (and the inclusion of tourists). It’s hard to know exactly where we are, but it’s clear that the majority of the market in no way resembles peak ZIRP.
