8 ms·

For reliable excess returns, VC funds need 500 investments

80 points by dzink 6y ago

dzink 6y ago
Tail winds for YC and other diversified startup investors.
ry454 6y ago
My takeaways from the article: (1) VC is a casino for the rich and just like gamblers in casinos they have no idea what they are doing; (2) VCs have discovered that standard deviation shrinks like the square root of the sample size, however their understanding of stats seems to be just enough to run a monte-carlo simulation. Edit: the 3rd takeaway is advice to those who're considering to join a "startup" - if VC needs 500 investments to make a 15% return on average, you need 5000 years to get the sames returns as a line worker.
- andreareina 6y ago
  > if VC needs 500 investments to make a 15% return on average, you need 5000 years to get the sames returns as a line worker This doesn't necessarily follow. A "line worker"'s downside risk is the opportunity cost they pay for working at a startup, which has a different distribution than the investor's downside risk (the whole investment). At the extreme end I'd argue that e.g. WeWork's investors came out of it worse than the employees.
  - vkou 6y ago
    The downside distribution is more punishing on the low end. For people who need to pay rent, buy food, and pay medical bills, a 90% probability of losing half your wages is generally not worth a 10% probability of making 7x your wages. That's because the less money you have, the more valuable a dollar is.
    - chii 6y ago
      > a 90% probability of losing half your wages is generally not worth a 10% probability of making 7x your wages. this is a fairly bad expected value: 10% * 7 * wages - 90% * wages/2 = 25% * wages So you expect to lose 75% of your wages! Nobody is gonna agree to do that! A more realistic scenario is 10% * 100 * wages - 90% * wages/2 = 955% * wages
      - vkou 6y ago
        Your math is wrong. 0.5 * 90% + 7 * 10% = 1.15 average.
        Tomminn 6y ago
        For the record, the correct way of doing the first math, centered such that 0 represents no change to your wages, is as follows: 0.1 * 6 - 0.5 * 0.9 = 0.15. That is, a 10% chance of a 6 fold gain, and a 90% chance of a 50% loss (-50% gain), gives an expected value of a 15% gain. Your math is correct also, and has 1 represent no change to your wages instead.
        vijayr02 6y ago
        Actually, it's a bit more involved than that... The gain is a one time amount Wages are recurring income. So when wages fall by 50% you need to value an annuity with half the cashflows as before. The PV of your wage income stream over some time horizon can then be compared with the one time gain. Otherwise you are comparing a stock concept (wealth) with a flow concept (income)
  - yowlingcat 6y ago
    Correct. Another vehicle to display your point may be to consider the serial startup executive, who leapfrogs from growth stage startup to startup every few years, collecting 0.5%-2% of each in the process. For people who want to make returns from their stakes in startups, that seems like a better idea than going the VC route because it's easier to get better information and better deals as an insider. You can only make so much money from startups by gatekeeping how other people's money is invested. That skill does not an operator make. VCs with operating experience I think operate with a different toolset and underwriting criterion than lifers.
  - ry454 6y ago
    Investors lose only a small portion of their assets and most importantly they don't have to lose time. Whether 2% of my liquid assets is more valuable than 4 years of someone's life is debatable, but I can certainly say the loss of those 2% won't make any impact on my life, while that worker won't ever recover his 4 years.
- vmception 6y ago
  Correct, there isn't a distinction between positive expected value financial games, versus negative expected value financial games except cultural tolerances. There is also the exclusively state-level regulation of negative expected value games versus federal regulation of positive expected value games. There is also the liquidity. But any moral distinctions are arbitrary and unnecessary, based on culture. Today my colleagues on the federal open market committee and I made some important changes to our policy statement (brrr!)
  - thomasahle 6y ago
    > there isn't a distinction between positive expected value financial games, versus negative expected value financial games except cultural tolerances Why not? positive expected value games seem like a much better thing to post your money into.
    - vmception 6y ago
      Oh because they are just as much gambles as the other, there are several cultures that require a distinction between gambling and investing, and many cultures that don’t and won’t try to rationalize it just so they can sleep at night. The only reason positive expected value financial games exist is because there exist certain external cases that make them profitable almost all the time, such as inflation. But if your trade isn't sticking around for that, they aren't inherently positive expected value. I have pity for the people that feel they need to split hairs over this.... while paying for insurance.
    - throwaway2245 6y ago
      A national lottery with a positive EV would still make almost all players losers.
      - thomasahle 6y ago
        If you play at enough such lotteries with small enough bets, that sounds great. If the EV had been negative, not so much.
- compsciphd 6y ago
  one doesn't work at startups to maximize your earnings. you work at a startup because the pay is sufficient for your goals and its work you want to do (ex: because you really believe in the product, you feel you can grow in ways you couldn't in large companies / have impact or control in ways you can't in lage companies or perhaps others). If either of those 2 things aren't true, you probably shouldn't choose to work at a startup over a large established company.
- threeseed 6y ago
  > just like gamblers in casinos they have no idea what they are doing I follow all of the VCs on Twitter and it's very clear from their many, many tweets that they have a far superior intellect than the rest of us which allows them to divinely predict the future. And between them and their diverse network of other 40 year old, white males they have a rich, deep understand of the customer's wants and needs. And from that they 'select' the startups that best aligns with this understanding. I even believe that one day VCs will realise that they don't need founders and can just invest in each other. Keeping the prosperity moving.
  - Toenex 6y ago
    It's a similar phenomenon to media celebrities who clearly have access to special information that makes them a good choice for Tv interviews on just about anything.
  - senko 6y ago
    > And between them and their diverse network of other 40 year old, white males they have a rich, deep understand of the customer's wants and needs As a 40yo white male, I resent this generalization. You should have qualified that further with "...living in the Bay Area".
  - robert_foss 6y ago
    ಠ_ಠ Not sure if this is sarcasm or not. I'm leaning towards sarcasm, but if there ever was a place where someone would say this with a straight face it would be HN.
    - adwn 6y ago
      > Not sure if this is sarcasm or not. It almost certainly is. > if there ever was a place where someone would say this with a straight face it would be HN. This is not my impression of HN at all. It might have been true, what, a decade ago? but contemporary HN is pretty sceptical of VCs and VC culture.
    - deleted 6y ago
      [deleted]
- cryptica 6y ago
  I disagree. VCs are great; they are the backbone of our economy and are responsible for creating millions of jobs. A good VC is a huge value-add to any startup and provides valuable advice to aid the value-creation process and streamline the value chain.
  - yowlingcat 6y ago
    > A good VC is a huge value-add to any startup What does a good VC add that would be hard to get otherwise? The obvious counterpoint to your argument is that good VCs play primarily passive roles in comparison to the good operators they invest in, by a very wide order of magnitude.
- 1e-9 6y ago
  > VC is a casino for the rich and just like gamblers in casinos they have no idea what they are doing Except that the VC expected return is positive. They just need a sufficient number and diversity of bets to lower their variance to a small value relative to their expected return, which most of them don’t do.
- silexia 6y ago
  VC's are predators. Avoid them like the plague. Get your funds from friends, family, and fools unless you are building a nuclear power plant. Even successful businesses will be destroyed by VC's demanding leverage and higher returns and quick exits.
greesil 6y ago
Takes a lot of samples to converge to the mean of a fat tailed distribution.
- zeroer 6y ago
  If ever. The Central Limit Theorem requires the distribution to have finite standard deviation.
- arthurcolle 6y ago
  you should read Taleb's new book "Statistical Consequences of Fat Tails"
  - spekcular 6y ago
    I realize this is a bit off topic, but no, the parent poster should not. It's a mish-mash of poorly explained introductory probability material. There are numerous other textbooks on statistical aspects of heavy-tailed random variables that would be far more insightful.
    - dannyw 6y ago
      Taleb is a great writer, but not a great teacher.
    - arthurcolle 6y ago
      I enjoyed it, but I can see why someone might get that impression. Care to share other reads?
      - spekcular 6y ago
        Didier Sornette, Critical Phenomena in Natural Sciences: Chaos, Fractals, Selforganization and Disorder. Springer, 2nd edition. This covers the mathematics of heavy-tailed distributions and a lot of fun applications, and also touches on some other interesting, Taleb-esque topics (fractals, renormalization group). For financial stuff in this vein (heavy tails), Bouchaud has some books with various coauthors (e.g. Theory of Financial Risk and Derivative Pricing: From Statistical Physics to Risk Management). Admittedly I have only browsed them, but what little I've read has been good. Also, on a tangent which may interest you, Charles Martin and Mike Mahoney (of UC Berkeley) have some recent work which uncovers heavy-tailed laws in neural networks. You can get started here and follow the citations: https://arxiv.org/abs/1901.08278 https://arxiv.org/abs/1901.08278.
maxekman 6y ago
On the upside, that means a lot more founders are given the chance to test out their ideas. That should hopefully lead to more experimentation and faster iteration of ideas in general.
ackbar03 6y ago
I think this is pretty much what PG and YC have discovered from reading their essays. They're not really concerned about the idea of a startup, if anything they would like there to be more startups to invest. The exponential nature of growth means averaging over large numbers seem to still provide decent returns and all they have to filter for are teams that are really serious about getting something done.
lpolovets 6y ago
(I'm a VC.) I'm skeptical of simulations like this one because they typically assume that every startup has the same statistical distribution of returns, and whether you pick 15 or 500 startups, each startup will have the same expected value and variance. But in practice it doesn't work like that. A full time VC might see 2000 pitch decks per year, meet with a few hundred of those companies, and end up investing in 5. So they are picking what they perceive to be the top .25% of all pitches they see. If they invested in 20 companies, it would be the top 1%. If they invested in 200 companies, it would be the top 10%. But because these companies are ranked, the expected outcome distribution of the VC's #1 company should be a little better than the #10 company, and a lot better than the #200 company. The further down the list you go, the worse the expected value -- even though some of the lower ranked companies may turn out to be amazing. So you can't just 40x the number of investments you make and say "expected value is the same but variance is now much lower!!1!" because you would be lowering your bar a lot by expanding the # of investments. And your variance would go down considerably, but so would your expected value.
- zzleeper 6y ago
  (PhD Finance here) Even classical 70s-era finance is against this article: Rich investors don't need their VC to be super diversified. They can just invest into multiple VC funds and get diversification that way. Also, it doesn't matter how much risk is in a given VC fund, what matters is how investing part of my porfolio in that VC fund affects the risk of my portfolio!
  - Tomminn 6y ago
    This was the first thing that occurred to me. Why do they need the VC firms to change from an investment perspective? Just buy the asset class as a whole. The lesson is VC funds are more like individual stocks than index funds from an investment perspective. Which is fine. In fact VC funds as a class are like a great class of individual stocks, from an investment perspective. The problem isn't from an investment perspective at all. It's from the VC perspective. VC's which invest in small numbers of companies are trusting the future of their fund on the role of a dice. That is risk they might want to eliminate for their own good.
darawk 6y ago
> How big is diversified enough? Classical portfolio theory says that in public equities, reasonable diversification effects can be expected when one combines 20 to 30 stocks, while more detailed recent studies set this number at 40 to 70. Lol, what. No. Diversification is about correlation, not stock count. If you buy 40 different tech companies, you are not diversified. If you buy 3 etfs, you may be extremely well diversified. > Analysis shows that this handful of successful deals is responsible for around one-fifth of the total cash returned by the industry. To reliably access the excess returns generated by one in 250 deals, a fund size of more than 500 investments is needed. Anything less risks having a portfolio without any mega-winners. This only matters from the perspective of the fund manager, not an investor. From the perspective of the investor, investing in 1 big fund with 500 companies is equivalent to investing in 2 small funds with 250 companies. > This counterintuitive result is further validated by a recent Kauffman Fellows study, which says that at the seed stage, “indexing beats 90 to 95 percent of investors picking deals.” In VC as a whole, it seems from Figure 2 that indexing beats 50 to 75 percent of investors picking deals, since indexing gives second-quartile result When will people stop saying this trash? Indexing beats lots of things. Indexing beats cash, it beats bonds, it beats CDS. But all those things still exist. And they exist because they are uncorrelated asset classes, just like venture capital. Diversifying your portfolio across uncorrelated asset classes elevates your long term CAGR assuming each returns stream has positive expectancy. This is why people invest in things that have lower expected returns than stocks - those things have less risk, and more importantly, uncorrelated risk. All of this is finance 101, and yet, publications calling themselves 'institutional investor' still don't seem to understand portfolio theory. I guess then they can't write clickbait articles about the great mystery of venture capital. There is no mystery in VC. Investors diversify across VC funds. If you are thinking about investing in a VC firm, what you care about is uniqueness of the return stream. You want to be able to pick and choose manages who will themselves make diversified bets, so that your overall portfolio is diversified both across companies, and across perspectives. The system as constructed makes complete sense.
- xorfish 6y ago
  Is venture capital or private equity really uncorrelated to the general stock market? It is also difficult to evaluate the volatility of an asset if the price is evaluated infrequently. Imagine how good the stock market would look, if you only get the price every 5 years.
siruva07 6y ago
This validates what VC Dave McClure has said since 2010. He literally named his firm “500 Startups.” https://www.slideshare.net/dmc500hats/investment-thesis-fundamentals-april-2016 https://www.slideshare.net/dmc500hats/investment-thesis-fund...
mensetmanusman 6y ago
Sounds like a Ponzi scheme :D But in all seriousness, we all know lots of companies would not exist without VC.
deegles 6y ago
You can rephrase the headline: For reliable excess returns, startup employees need to correctly choose one out of 500 companies.

80 points by dzink 6y ago

Tail winds for YC and other diversified startup investors.

My takeaways from the article: (1) VC is a casino for the rich and just like gamblers in casinos they have no idea what they are doing; (2) VCs have discovered that standard deviation shrinks like the square root of the sample size, however their understanding of stats seems to be just enough to run a monte-carlo simulation. Edit: the 3rd takeaway is advice to those who're considering to join a "startup" - if VC needs 500 investments to make a 15% return on average, you need 5000 years to get the sames returns as a line worker.

andreareina 6y ago
> if VC needs 500 investments to make a 15% return on average, you need 5000 years to get the sames returns as a line worker This doesn't necessarily follow. A "line worker"'s downside risk is the opportunity cost they pay for working at a startup, which has a different distribution than the investor's downside risk (the whole investment). At the extreme end I'd argue that e.g. WeWork's investors came out of it worse than the employees.
- vkou 6y ago
  The downside distribution is more punishing on the low end. For people who need to pay rent, buy food, and pay medical bills, a 90% probability of losing half your wages is generally not worth a 10% probability of making 7x your wages. That's because the less money you have, the more valuable a dollar is.
  - chii 6y ago
    > a 90% probability of losing half your wages is generally not worth a 10% probability of making 7x your wages. this is a fairly bad expected value: 10% * 7 * wages - 90% * wages/2 = 25% * wages So you expect to lose 75% of your wages! Nobody is gonna agree to do that! A more realistic scenario is 10% * 100 * wages - 90% * wages/2 = 955% * wages
    - vkou 6y ago
      Your math is wrong. 0.5 * 90% + 7 * 10% = 1.15 average.
      - Tomminn 6y ago
        For the record, the correct way of doing the first math, centered such that 0 represents no change to your wages, is as follows: 0.1 * 6 - 0.5 * 0.9 = 0.15. That is, a 10% chance of a 6 fold gain, and a 90% chance of a 50% loss (-50% gain), gives an expected value of a 15% gain. Your math is correct also, and has 1 represent no change to your wages instead.
        vijayr02 6y ago
        Actually, it's a bit more involved than that... The gain is a one time amount Wages are recurring income. So when wages fall by 50% you need to value an annuity with half the cashflows as before. The PV of your wage income stream over some time horizon can then be compared with the one time gain. Otherwise you are comparing a stock concept (wealth) with a flow concept (income)
- yowlingcat 6y ago
  Correct. Another vehicle to display your point may be to consider the serial startup executive, who leapfrogs from growth stage startup to startup every few years, collecting 0.5%-2% of each in the process. For people who want to make returns from their stakes in startups, that seems like a better idea than going the VC route because it's easier to get better information and better deals as an insider. You can only make so much money from startups by gatekeeping how other people's money is invested. That skill does not an operator make. VCs with operating experience I think operate with a different toolset and underwriting criterion than lifers.
- ry454 6y ago
  Investors lose only a small portion of their assets and most importantly they don't have to lose time. Whether 2% of my liquid assets is more valuable than 4 years of someone's life is debatable, but I can certainly say the loss of those 2% won't make any impact on my life, while that worker won't ever recover his 4 years.
vmception 6y ago
Correct, there isn't a distinction between positive expected value financial games, versus negative expected value financial games except cultural tolerances. There is also the exclusively state-level regulation of negative expected value games versus federal regulation of positive expected value games. There is also the liquidity. But any moral distinctions are arbitrary and unnecessary, based on culture. Today my colleagues on the federal open market committee and I made some important changes to our policy statement (brrr!)
- thomasahle 6y ago
  > there isn't a distinction between positive expected value financial games, versus negative expected value financial games except cultural tolerances Why not? positive expected value games seem like a much better thing to post your money into.
  - vmception 6y ago
    Oh because they are just as much gambles as the other, there are several cultures that require a distinction between gambling and investing, and many cultures that don’t and won’t try to rationalize it just so they can sleep at night. The only reason positive expected value financial games exist is because there exist certain external cases that make them profitable almost all the time, such as inflation. But if your trade isn't sticking around for that, they aren't inherently positive expected value. I have pity for the people that feel they need to split hairs over this.... while paying for insurance.
  - throwaway2245 6y ago
    A national lottery with a positive EV would still make almost all players losers.
    - thomasahle 6y ago
      If you play at enough such lotteries with small enough bets, that sounds great. If the EV had been negative, not so much.
compsciphd 6y ago
one doesn't work at startups to maximize your earnings. you work at a startup because the pay is sufficient for your goals and its work you want to do (ex: because you really believe in the product, you feel you can grow in ways you couldn't in large companies / have impact or control in ways you can't in lage companies or perhaps others). If either of those 2 things aren't true, you probably shouldn't choose to work at a startup over a large established company.
threeseed 6y ago
> just like gamblers in casinos they have no idea what they are doing I follow all of the VCs on Twitter and it's very clear from their many, many tweets that they have a far superior intellect than the rest of us which allows them to divinely predict the future. And between them and their diverse network of other 40 year old, white males they have a rich, deep understand of the customer's wants and needs. And from that they 'select' the startups that best aligns with this understanding. I even believe that one day VCs will realise that they don't need founders and can just invest in each other. Keeping the prosperity moving.
- Toenex 6y ago
  It's a similar phenomenon to media celebrities who clearly have access to special information that makes them a good choice for Tv interviews on just about anything.
- senko 6y ago
  > And between them and their diverse network of other 40 year old, white males they have a rich, deep understand of the customer's wants and needs As a 40yo white male, I resent this generalization. You should have qualified that further with "...living in the Bay Area".
- robert_foss 6y ago
  ಠ_ಠ Not sure if this is sarcasm or not. I'm leaning towards sarcasm, but if there ever was a place where someone would say this with a straight face it would be HN.
  - adwn 6y ago
    > Not sure if this is sarcasm or not. It almost certainly is. > if there ever was a place where someone would say this with a straight face it would be HN. This is not my impression of HN at all. It might have been true, what, a decade ago? but contemporary HN is pretty sceptical of VCs and VC culture.
  - deleted 6y ago
    [deleted]
cryptica 6y ago
I disagree. VCs are great; they are the backbone of our economy and are responsible for creating millions of jobs. A good VC is a huge value-add to any startup and provides valuable advice to aid the value-creation process and streamline the value chain.
- yowlingcat 6y ago
  > A good VC is a huge value-add to any startup What does a good VC add that would be hard to get otherwise? The obvious counterpoint to your argument is that good VCs play primarily passive roles in comparison to the good operators they invest in, by a very wide order of magnitude.
1e-9 6y ago
> VC is a casino for the rich and just like gamblers in casinos they have no idea what they are doing Except that the VC expected return is positive. They just need a sufficient number and diversity of bets to lower their variance to a small value relative to their expected return, which most of them don’t do.
silexia 6y ago
VC's are predators. Avoid them like the plague. Get your funds from friends, family, and fools unless you are building a nuclear power plant. Even successful businesses will be destroyed by VC's demanding leverage and higher returns and quick exits.

greesil 6y ago

Takes a lot of samples to converge to the mean of a fat tailed distribution.

zeroer 6y ago
If ever. The Central Limit Theorem requires the distribution to have finite standard deviation.
arthurcolle 6y ago
you should read Taleb's new book "Statistical Consequences of Fat Tails"
- spekcular 6y ago
  I realize this is a bit off topic, but no, the parent poster should not. It's a mish-mash of poorly explained introductory probability material. There are numerous other textbooks on statistical aspects of heavy-tailed random variables that would be far more insightful.
  - dannyw 6y ago
    Taleb is a great writer, but not a great teacher.
  - arthurcolle 6y ago
    I enjoyed it, but I can see why someone might get that impression. Care to share other reads?
    - spekcular 6y ago
      Didier Sornette, Critical Phenomena in Natural Sciences: Chaos, Fractals, Selforganization and Disorder. Springer, 2nd edition. This covers the mathematics of heavy-tailed distributions and a lot of fun applications, and also touches on some other interesting, Taleb-esque topics (fractals, renormalization group). For financial stuff in this vein (heavy tails), Bouchaud has some books with various coauthors (e.g. Theory of Financial Risk and Derivative Pricing: From Statistical Physics to Risk Management). Admittedly I have only browsed them, but what little I've read has been good. Also, on a tangent which may interest you, Charles Martin and Mike Mahoney (of UC Berkeley) have some recent work which uncovers heavy-tailed laws in neural networks. You can get started here and follow the citations: https://arxiv.org/abs/1901.08278 https://arxiv.org/abs/1901.08278.

maxekman 6y ago

On the upside, that means a lot more founders are given the chance to test out their ideas. That should hopefully lead to more experimentation and faster iteration of ideas in general.

ackbar03 6y ago

I think this is pretty much what PG and YC have discovered from reading their essays. They're not really concerned about the idea of a startup, if anything they would like there to be more startups to invest. The exponential nature of growth means averaging over large numbers seem to still provide decent returns and all they have to filter for are teams that are really serious about getting something done.

lpolovets 6y ago

(I'm a VC.) I'm skeptical of simulations like this one because they typically assume that every startup has the same statistical distribution of returns, and whether you pick 15 or 500 startups, each startup will have the same expected value and variance. But in practice it doesn't work like that. A full time VC might see 2000 pitch decks per year, meet with a few hundred of those companies, and end up investing in 5. So they are picking what they perceive to be the top .25% of all pitches they see. If they invested in 20 companies, it would be the top 1%. If they invested in 200 companies, it would be the top 10%. But because these companies are ranked, the expected outcome distribution of the VC's #1 company should be a little better than the #10 company, and a lot better than the #200 company. The further down the list you go, the worse the expected value -- even though some of the lower ranked companies may turn out to be amazing. So you can't just 40x the number of investments you make and say "expected value is the same but variance is now much lower!!1!" because you would be lowering your bar a lot by expanding the # of investments. And your variance would go down considerably, but so would your expected value.

zzleeper 6y ago
(PhD Finance here) Even classical 70s-era finance is against this article: Rich investors don't need their VC to be super diversified. They can just invest into multiple VC funds and get diversification that way. Also, it doesn't matter how much risk is in a given VC fund, what matters is how investing part of my porfolio in that VC fund affects the risk of my portfolio!
- Tomminn 6y ago
  This was the first thing that occurred to me. Why do they need the VC firms to change from an investment perspective? Just buy the asset class as a whole. The lesson is VC funds are more like individual stocks than index funds from an investment perspective. Which is fine. In fact VC funds as a class are like a great class of individual stocks, from an investment perspective. The problem isn't from an investment perspective at all. It's from the VC perspective. VC's which invest in small numbers of companies are trusting the future of their fund on the role of a dice. That is risk they might want to eliminate for their own good.

darawk 6y ago

> How big is diversified enough? Classical portfolio theory says that in public equities, reasonable diversification effects can be expected when one combines 20 to 30 stocks, while more detailed recent studies set this number at 40 to 70. Lol, what. No. Diversification is about correlation, not stock count. If you buy 40 different tech companies, you are not diversified. If you buy 3 etfs, you may be extremely well diversified. > Analysis shows that this handful of successful deals is responsible for around one-fifth of the total cash returned by the industry. To reliably access the excess returns generated by one in 250 deals, a fund size of more than 500 investments is needed. Anything less risks having a portfolio without any mega-winners. This only matters from the perspective of the fund manager, not an investor. From the perspective of the investor, investing in 1 big fund with 500 companies is equivalent to investing in 2 small funds with 250 companies. > This counterintuitive result is further validated by a recent Kauffman Fellows study, which says that at the seed stage, “indexing beats 90 to 95 percent of investors picking deals.” In VC as a whole, it seems from Figure 2 that indexing beats 50 to 75 percent of investors picking deals, since indexing gives second-quartile result When will people stop saying this trash? Indexing beats lots of things. Indexing beats cash, it beats bonds, it beats CDS. But all those things still exist. And they exist because they are uncorrelated asset classes, just like venture capital. Diversifying your portfolio across uncorrelated asset classes elevates your long term CAGR assuming each returns stream has positive expectancy. This is why people invest in things that have lower expected returns than stocks - those things have less risk, and more importantly, uncorrelated risk. All of this is finance 101, and yet, publications calling themselves 'institutional investor' still don't seem to understand portfolio theory. I guess then they can't write clickbait articles about the great mystery of venture capital. There is no mystery in VC. Investors diversify across VC funds. If you are thinking about investing in a VC firm, what you care about is uniqueness of the return stream. You want to be able to pick and choose manages who will themselves make diversified bets, so that your overall portfolio is diversified both across companies, and across perspectives. The system as constructed makes complete sense.

xorfish 6y ago
Is venture capital or private equity really uncorrelated to the general stock market? It is also difficult to evaluate the volatility of an asset if the price is evaluated infrequently. Imagine how good the stock market would look, if you only get the price every 5 years.

siruva07 6y ago

This validates what VC Dave McClure has said since 2010. He literally named his firm “500 Startups.” https://www.slideshare.net/dmc500hats/investment-thesis-fundamentals-april-2016 https://www.slideshare.net/dmc500hats/investment-thesis-fund...

mensetmanusman 6y ago

Sounds like a Ponzi scheme :D But in all seriousness, we all know lots of companies would not exist without VC.

deegles 6y ago

You can rephrase the headline: For reliable excess returns, startup employees need to correctly choose one out of 500 companies.