Most Venture Capital Firms Suck

It’s well known that if you invest in actively managed stock funds, then the fund manager is going to make out a lot better than you will. Less well known is that the same applies to hedge funds and private equity funds too. Now out comes a new study from the Kaufmann Foundation that asks if venture capital offers a way out. The answer is no.

The report is important because Kaufmann is uniquely well-positioned to examine the issue. As a well-endowed non-profit with a long-term investing horizon and a specific charitable mandate to support entrepreneurship, they’ve naturally been interested in venture capital as an asset class. And since they’ve been investing in venture capital, they have access to a data set about a large VC portfolio that would never be released to a journalist or an academic. You can read the whole report (PDF) in all its complicated glory, but I think this summary chart is the most interesting part:

This is showing you VC fund performance by “vintage.” The basic shape is not surprising. Things are humming along, then there’s an increase associated with the irrational exuberance of the era and then there’s a crash. What’s amazing is that there’s no recovery from the crash. Instead the aggregate performance more or less settles on the zero mark, even though we’re years past the crash per se and obviously there have been a number of successful tech startups in recent years.

The report offers a detailed operational critique of the industry, but I think the structural pattern you see time and again in these studies is that asset classes age like milk. Financial markets aren’t perfectly efficient, so clever people think up ways to make real investment returns. But that happens in the early days when the asset class is considered risky and weird. Eventually a time comes when the class becomes recognized and respected. But by the time that’s happened, there’s too much money in the class and too much of it is dumb money that’s just filling buckets.