The Triumph of Hope Over Experience ?

By Oliver Binette, CAIA and Preston McSwain, November 1, 2019

Many investors are increasing allocations to Venture Capital and other types of Private Investments.

Large investors are saying that “we need more of it, and we need it now” and some in Washington are suggesting that individual investors are missing out.

Before investing, though, investors might benefit from spending a little time on reports like ones from the Kauffman Foundation, outlining their 20 year history in Venture Capital, and a more recent report from the State of Oregon, which has been investing in Private Equity in scale since the early 1980s.

This what they found.

Kauffman Foundation Venture Capital Results

Only twenty of 100 venture funds generated returns that beat a public-market equivalent by more than 3 percent annually, and half of those began investing prior to 1995.
The majority of funds – sixty-two out of 100 – failed to exceed returns available from the public markets, after fees and carry were paid.
Only four of thirty venture capital funds with committed capital of more than $400 million delivered returns better than those available from a publicly traded small cap common stock index.
Of eighty-eight venture funds in our sample, sixty-six failed to deliver expected venture rates of return in the first twenty-seven months (prior to serial fundraises).
The cumulative effect of fees, carry, and the uneven nature of venture investing ultimately left us with sixty-nine funds (78 percent) that did not achieve returns sufficient to reward us for patient, expensive, long-term investing.

Kauffman Foundation Investment Committee Findings

Large LPs must invest in very large funds to put their allocated capital to work, yet big VC funds most often fail to generate market-beating returns
Investment decisions made based on seductive narratives such as vintage year and quartile performance, which rely heavily on internal rate of return measures that often are misleading and aren’t persistent over time.
Many VC funds last longer than ten years—up to fifteen years or more. We have eight VC funds in our portfolio that are more than fifteen years old.
Venture Capital returns haven’t significantly outperformed the public market since the late 1990s
Since 1997, less cash has been returned to investors than has been invested in VC.

State of Oregon Private Equity Portfolio Review

Private Equity has produced results broadly consistent with domestic public market indices over the past decade
The asset class has not generated anything close to the 250-500bps of target excess return over public equities for an extended period of time
- That level of excess return would have required nearly perfect fund selection or material fee reduction in all vintage years since 2005
Key industry trends that gained momentum in 2017 and over the last decade… represent an increase in scale, competition, and complexity for LPs (investors)

Some private investment opportunities have provided investors with solid returns, and we aren’t suggesting that investors shouldn’t keep an eye out for outlier opportunities.

The cover page of the Kauffman report states this, however, related to their Triumph Of Hope Over Experience and lessons learned from investing hundreds of millions into Venture Capital or private Growth Equity funds:

“We Have Met The Enemy… And He Is Us.”

Based on all the excitement and money “gushing into private capital funds,” is this often the case?

We think so.

Six Myths About Venture Capital – Harvard Business Review – 2013

Private Equity Presentations: Are Some Tall Tales? – CFA Institute – 2017

State of Oregon Investment Committee Review – 2018

Persistence That Just Ain’t So – CFA Institute – 2018

Private Allocations: Are We Baking with Bad Ingredients? – FWP Research Roundtable – 2019