Why are VC returns correlated over time but mutual fund manager returns not??

Try on these propositions for size:

1. Intangible-rich businesses are harder to fund with debt, because the lenders cannot take home much in the way of physical assets.

2. Intangible assets, because of their potentially scalable nature, can produce the kind of “home run” successes that VC investors look for.

3. Given that intangible investments are relatively uncertain, the idea of successive funding “rounds,” with successive evaluations at each stage, makes more sense in those cases, and that too matches the VC model.

4. Companies with lots of intangible assets try to take over markets that are “contested,” but note that leading VC firms behind these investments are heavily invested in the entire ecosystem.

5. If a good VC company is plugged into the right social networks, and investing in a highly productive ecosytem, it can reap high returns year after year, and from a relatively “within-sector” diversified position.  The VC companies can outperform the broader market, even if the VC leaders themselves would not be superior “stock pickers” in a mutual fund context.  That said, the VC leaders may not be well diversified across sectors, and so a systemic tech bust can hurt them.

6. Not everyone can build those social networks with equal facility, so VC advantages can endure for considerable periods of time for the leading firms.  It is the ability to “position socially and manage contestedness and spillovers and maintain the flow of good deals” that is so hard to scale up.

That is all from the forthcoming Capitalism Without Capital: The Rise of the Intangible Economy, by Jonathan Haskel and Stian Westlake.  Their discussion of venture capital offers further points of interest, including a discussion of why it is so hard to replicate VC environments in other settings.  Here is my previous post on the book.


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