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For reliable excess returns, VC funds need 500 investments

institutionalinvestor.com

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Re: For reliable excess returns, VC funds need 500 investments

#31

Post by xorfish »

darawk wrote: post #26

> 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…

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.

Re: For reliable excess returns, VC funds need 500 investments

#32

Post by robert_foss »

threeseed wrote: post #19
ry454 wrote: post #3

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 need…

> 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 t…

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.

Re: For reliable excess returns, VC funds need 500 investments

#33

Post by darawk »

xorfish wrote: post #31
darawk wrote: post #26

> 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…

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.

> Is venture capital or private equity really uncorrelated to the general stock market?

Somewhat, yes. It's not that it's completely uncorrelated, but it is less correlated than other public companies tend to be.

> It is also difficult to evaluate the volatility of an asset if the price is evaluated infrequently.

Yep, you're absolutely right. This is sometimes called the 'liquidity premium'. People tend to pay less for illiquid assets than liquid assets, all else equal. Which means that investing in illiquid assets should, all else equal, produce better risk-adjusted returns on average over time, especially if you are selling them after they become liquid.

Re: For reliable excess returns, VC funds need 500 investments

#34

Post by georgeecollins »

lpolovets wrote: post #7

(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…

>> I'm skeptical of simulations Yeah, no kidding. Once you see a monte carlo simulation your eyes should roll. This is like all financial predictions that have a bell curve outcome hidden in them. Dice are easy to predict when you roll them many times. Finance is just like dice, just ask the Nobel Prize winners at Long Term Capital Management.

Re: For reliable excess returns, VC funds need 500 investments

#35

Post by Tomminn »

vkou wrote: post #15
chii wrote: post #13

Earlier quoted context omitted.

> 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

Your math is wrong. 0.5 * 90% + 7 * 10% = 1.15 average.

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.

Re: For reliable excess returns, VC funds need 500 investments

#36

Post by adwn »

robert_foss wrote: post #32
threeseed wrote: post #19

Earlier quoted context omitted.

> 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 t…

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.

> 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.

Re: For reliable excess returns, VC funds need 500 investments

#37

Post by Tomminn »

zzleeper wrote: post #10
lpolovets wrote: post #7

(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…

(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!

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.

Re: For reliable excess returns, VC funds need 500 investments

#38

Post by mikekoscinski »

lpolovets wrote: post #7

(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…

Right. It seems commonly misunderstood that the universe of investable startups represents a zero-sum game for investors. It isn't as simple as "invest in more companies"; one fund's investment represents another fund's forgone investment. (Not many good companies want a five-fund Series A where each fund buys 20%.)

Having the capital and desire to make an investment is the easy part of investing. Actually earning that allocation is difficult.

Yet, most conceptions of investing seem to be shaped by public markets and their ubiquity. That is to say, public market float is taken for granted - when in reality it is missing from every asset class (practically or literally) save for G7 (+China) secondary-market public equities (and now cryptocurrencies).

Re: For reliable excess returns, VC funds need 500 investments

#40

Post by vijayr02 »

Tomminn wrote: post #35
vkou wrote: post #15

Earlier quoted context omitted.

Your math is wrong. 0.5 * 90% + 7 * 10% = 1.15 average.

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.

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)

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