A CIO series conversation with Benjamin Gargui on venture capital
Below are some key takeaways from our webinar conversation with a notable institutional allocator:
1. Venture Capital (VC) is an asset class with massive dispersion in returns between managers
When looking at the industry as a whole and examining average returns across different types of private alternatives asset classes, VC looks like a very attractive asset class - averaging 16% annually in the data below. But when exploring the data further, you find a significant variance in returns between managers and realise that you only want to be invested in the top quartile of managers to seek returns in excess of 25%: It is a very skewed bell curve.
PRIVATE MARKETS: ASSET CLASS PERFORMANCE
Annual Returns of Key Alternative Investment Indicies Ranked in Order of Performance (2006-2020)*
2. Managers matter
Great managers will continue to do well. If you’re an entrepreneur, you want to be backed by the very best venture capital firms such as Sequoia Capital, Accel, and Index Ventures. Their brand will positively reflect your business, which will help when raising capital at later stages. This is a clear self-selection bias that contributes to the significant range in returns in the VC industry. The best managers remain in the top quartile for extended periods.
3. Appreciate the importance of diversification
You need to diversify your allocation to venture capital across strategies and vintages. Returns can take a long time, and vary year on year, so it’s important to be diversified across vintages. Different strategies perform better in different cycles, and all have different risk profiles. For example, pre-seed investing is far riskier than at a later stage as young businesses have a far higher failure rate. However, if you’re in a seed round for Twitter you can expect to make 1000x your money, whereas when investing in the later stages, the maximum expected returns are far more modest. Investing in a venture capital fund of funds allows a one off investment in VC to be spread across multiple vintages (usually 5 or 6) and multiple strategies.
4. Investing in VC is a relationship driven game
When investing in a venture capital fund you are really investing in the managers, and the individuals in that team to select the companies with the best growth prospects to deliver returns. This due diligence in understanding a fund’s team can be highly time consuming as this is an essential quality of the funds. What matters most is the ability to pick the winners because what they will deliver will outweigh the fees. It is vital to build relationships with the GPs responsible for the high returns, as these are the managers who will continue to perform (as explained in point 2). They will run the oversubscribed funds in future, which will be hard to gain a position in without a relationship. A fund of funds solution capitalises on this, with their fees justified by their ability to place their investor's money into the top decile funds.
5. VC is, in general, a longer term strategy than traditional PE
An observed industry trend is that private companies are now taking longer to exit. They are incentivised to stay private longer as the optionality for late-stage capital raising is widely accessible, with a large appetite for late-stage growth investing in the markets. The result is that it takes VC funds longer to realise returns on the investments in their portfolio companies.
6. VC fund of funds investing takes time for returns to be realised
Unlike traditional VC fund investing, investing in the asset class through a fund of funds (FoF) manager typically adds 2 to 3 years to the capital commitment term. This extra time is dedicated to doing due diligence on the VC fund managers and committing to partnerships with them.
ABOUT THE SPEAKER
Benjamin Gargui is a portfolio manager at EJS Investment Management, the investment company for the Edmond J. Safra Foundation, where he is responsible for hedge fund and private equity manager selection. Prior to this Benjamin was an Executive Director at Goldman Sachs Private Wealth Management. He holds a Masters from Universite Paris Dauphine and an MBA from The Wharton School at University of Pennsylvania.
Footnotes & Disclaimer
*Note: Morningstar Direct through 12/31/2020. The returns of the asset classes presented are based on the following indices: For Private Equity: Cambridge Associates U.S. Private Equity; for Venture Capital: Cambridge Associates U.S. Venture Capital; for Hedge Funds: HFRI Fund Weighted Composite; for Real Estate: NCREIF ODCE; for Senior Loans: S&P/LSTA Leveraged Loan TR; for Event Driven: Credit Suisse Event Driven. Past performance is not necessarily indicative of future results. There can be no assurance any alternative asset classes will achieve their objectives or avoid significant losses. The volatility and risk profile of the indices is likely materially different from that of a fund. The indices employ different investment guidelines/criteria than a fund and do not employ leverage; a fund’s holdings and the liquidity of such holdings may differ significantly from securities comprising the indices. The indices aren’t subject to fees / expenses and it may not be possible to invest in the indices. The indices’ performance has not been selected to represent an appropriate benchmark to compare to a fund’s performance, but rather is disclosed to allow for comparison to that of well-known and widely recognized indices. A summary of the investment guidelines for the indices are available upon request. In the case of equity indices, performance of the indices reflects the reinvestment of dividends. The indices are not necessarily the top performing indices in the given asset class and recipients should consider this when comparing the performance of any fund or investment to that of the indices. See “Important Disclaimer Information”, including “Index Comparison.”
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