Thu. Jan 20th, 2022


The author is founder of Gesif, a media website for European beginners

Most of us have occasionally had a crisis of confidence over our career choices and cravings after becoming a ski bum or a Buddhist monk. Nevertheless, I was struck by a recent conversation with a seemingly successful venture capitalist, who cries that the impressive headline returns generated by his fund have outperformed the Nasdaq stock market over the past decade. Why work so hard to search the world for breakaway investments while you can make more money by buying an index tracking fund and sitting on a beach?

As my FT colleague Patrick McGee calculated, Apple’s stock market value averaged more than $ 700 million a day for the past 10 years. Even the best VC investors can not generate wealth on such a scale. In tacit recognition of that reality, the legendary Silicon Valley VC firm Sequoia has now declareded that his investments will no longer have “expiration dates”. This will enable Sequoia to break with traditional VC practices and stay invested in technology companies long after they have drifted towards an initial public offering.

Many successful start-ups – such as Apple – worsen their strategic advantage over decades, accumulating much of their value after IPO, Roelof Botha, a Sequoia partner, recently wrote.

Ironically, just as VC investors became increasingly jealous of the last-phase returns available in public markets, institutional investors further warmed up the attractiveness of earlier-phase private markets. According to a report by the computer company Preqin published this week, institutional investors in 2021 continued to pour money into VC funds and target private market transactions in 2021, attracted by an increase in more recent returns. Preqin’s venture capital index showed an annual return of 37.2 percent, outperforming most other asset classes. Over the past five years, VC funds have increased their assets under management from $ 547 billion to $ 1.7 billion.

However, as we are always told, past performance is no guarantee of future results. Given the oceans of cheap capital in the world, most asset managers have found it difficult to lose money over the past few years. But markets are growing weaker as higher inflation and the prospect of further interest rate hikes disrupt the investment calculation. Already this year, we have seen a huge rotation of publicly listed “speculative technology” stocks to value companies. Ark Invest, the high-profile fund managed by Cathie Wood, was particularly hard hit. “Spec technology is destroying,” as one investor said.

It seems only a matter of time before declines in public market technology valuations also infect private markets. The recent influx of money into the sector has pushed up valuations in unsustainable nosebleed. Rising interest rates will also make life more difficult for the VC industry. Institutional investors become more risk-averse and less willing to allocate money to VC funds in higher interest rate environments. The higher cost of capital also dampens the pace of new business formation and makes it harder for young companies to expand.

“I think there will be a correction. This is inevitable, ”says Josh Lerner, a professor at Harvard Business School who has researched the VC sector. He notes that much of the “madness” that accompanied the dotcom crash at the turn of the century has parallels today. “If we look at the movie from 1999 to 2000, it did not end well, especially for the ‘tourist’ investors who switched to arenas of which they did not know much.”

Although methodologies are controversial, there is growing evidence that, after deducting fees, VC yields were lower this century than those made on similar risky assets in public markets. But the sector’s overall returns hide a big difference in performance between the best and weakest such funds. We may be at that point in the cycle when smart judgment will make him money again over dumb luck. It will become all the more important to pick winners rather than flip through the market.

The argument for investing in VC funds is, moreover, that long-term technological trends will outweigh the short-term market fluctuations. As Prof Lerner says, there has been a fundamental change in the way innovation is pursued in many economies. VC-backed start-ups, rather than large corporations, have mostly proven to be the best innovation engines when it comes to exploiting new technologies and creating new industries.

My VC knowledge has good reason to stay off the beach.

john.thornhill@ft.com



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