Why VC Is The Answer To Falling Returns
After ten years of continuous growth, the tide is finally turning in the public equity markets. Hedge funds, family offices, and pension funds have all sailed the wave of superior returns since 2009, making it the second longest period of economic expansion and market performance in history. Significant fortunes have been made along the way and, despite all historical evidence to the contrary, it’s tempting to believe that the markets will continue to deliver.
But last year was a wake-up call, as economic and political uncertainty sparked the biggest losses since the financial crash. Recent figures have shown that pension funds saw an average fall of 6.2% in 2018, with less than one in ten funds generating positive returns for investors. And as we settle into 2019, commentators are now split between those who believe the dip was just a correction – and therefore signaling a good time to buy – and those who believe this is the beginning of a much more prolonged dry spell.
Jeremy Grantham, the long-time investor and head of asset management firm GMO, is one of a number of economists and institutions in the latter category, predicting negative returns in developed market equities for the next seven years. That’s right – seven! And more recently, the outspoken investor, John Hussman – who has form with stock market predictions – has come out saying that the market is still trading at the “most obscene valuations in market history”.
As investors get nervous, even cash is in favor again, with Bank of America Merrill Lynch’s January survey of fund manager allocations showing that boosting cash was one of the more popular trades in the latter part of 2018. But, unless you have impeccable timing, the risks of holding onto cash could mean you end up losing out in the long-run as a result.
So rather than stashing your cash under the mattress, it’s at times like this that venture capital comes into its own. While it might be considered an ‘alternative investment’, if we drill down to the basics of what an investment is – it’s a conscious decision to deploy capital in the expectation of a reasonable return. And, more than ever, VC is able to compete in the risk-return balance, by taking a thoughtful and analytical approach to committing capital to transformative businesses at reasonable valuations.
As I argued in a recent blog, size is no longer the deciding factor in business success, with emerging technologies giving individuals and small teams the clout to take on the slow and risk-averse incumbents, who are struggling to adapt to change. While the big listed companies are failing to perform, new startups are ready to strike with new ideas, technology, and innovations. And venture capital is the best way of riding the back of that shift, by investing in the success stories of the future.
In uncertain times, VC offers the advantage that its performance is completely uncorrelated with public equity markets. Last year, both the US and Europe saw record VC investment, reaching over $99 billion and over €24 billion respectively. And at the other – perhaps more important – end of the equation, funds are delivering, with the US achieving $136bn of deals and IPOs last year – 33% up on 2017 – closely followed by Europe at a record-breaking $107bn. This included high profile exits such as Farfetch, Funding Circle and Zoopla.
If you’re used to picking stocks then VC is a different ball-game, requiring patience and a long-term approach, that could mean sacrificing liquidity for up to ten years. However, your patience won’t just be rewarded with potentially better returns than with traditional investments, you’ll also enjoy a front row seat to see the most exciting entrepreneurs and businesses shaping the future – and the knowledge that you’ve helped them get there.
A few pointers on how to get started with VC investing:
- Collaboration: Investing on your own is tough, so collaborate with an established VC partner who has a daily presence in venture markets and a long-term, hands-on approach.
- Flexibility: Aim to create diversification across a couple of fund managers – but no more. This allows for more meaningful relationships, more access to founders themselves and the potential to outperform the rest of the market.
- Shared interests: When choosing managers to partner with, check that they also have ‘skin in the game’, to show they’re confident in their own investments. Depending on the size of the fund, a commitment of 10 to 20% would signal a strong alignment of interests.
- Intimacy: Having an open and transparent partnership with your fund manager is vital and this is more likely with an emerging manager, as opposed to being a passive investor in a large institutionally-led fund.