Is venture capital better than the S&P 500?
US Venture Capital has beaten the S&P 500's IRR by 19% over the last 25 years. Yet returns among VC investors vary wildly, because of the wrong approach. Here's how to build a startup portfolio that gives you consistent and stable returns: 1.
From 1995-2020, the returns differential is even more pronounced, with the CA US VC Index generating an AAR of 32.4%, compared to the S&P's AAR of 9.1% and the Nasdaq Composite's AAR of 11.3%. The data is clear: Venture Capital is by far the best performing asset class of the past generation.
Half of all venture funds outperform the stock market, which is the benchmark most institutions measure VC funds against. Several articles and research papers have been published on the PME and the comparison of VC versus public stock performance.
As of June 2020 the VC funds raised from 2007 to 2016 in the Burgiss Manager Universe had outperformed the Russell 2000 (a small-cap index) by 7% a year, on average, and the S&P 500 by nearly 5% a year. Almost 75% of those funds had beaten the Russell 2000, and roughly 60% had beaten the S&P 500.
2 Furthermore, the S&P 500 slightly edged out private equity, with performance of 13.99% per year compared to 13.77% for private equity in the 10 years ending on June 30, 2020. 1 On the other hand, that was still better than the 10.50% average annual return of the Russell 2000 during that time.
Based on detailed research from Cambridge Associates, the top quartile of VC funds have an average annual return ranging from 15% to 27% over the past 10 years, compared to an average of 9.9% S&P 500 return per year for each of those ten years (See the table on Page 13 of the report).
Berkshire Hathaway stock generally lagged the S&P 500 index since late 2017, but managed to handily outperform the benchmark index in 2022. It lagged again in 2023 after giving up some spring and summer gains.
In total, $394 billion flowed into VC deals across the globe in 2022; a 36% decline from 2021.
Venture capitalists say they are avoiding funding businesses that lack clear signs of revenue growth or a path to profitability. The higher bar has led to a stark decrease in funding: Investment in U.S. tech startups declined 49% in the year ended June 30, according to data from PitchBook.
Venture capital provides funding to new businesses that do not have access to stock markets and do not have enough cash flow to take on debts. This arrangement can be mutually beneficial because businesses get the capital they need to bootstrap their operations, and investors gain equity in promising companies.
What happens to VC money if startup fails?
When a venture capital-backed startup fails, the impact on the investors is significant. The venture capitalists who invested in the startup have put their money at risk, and if the startup fails, they could lose all of their investment.
25-30% of VC-backed startups still fail.
So if you're happy with a portfolio that performs comparably to the stock market as a whole, then sticking to S&P 500 ETFs alone isn't a bad idea. However, if you assemble a portfolio of individual stocks that perform better, you might enjoy a 12% or 15% return over time -- or more.
Key Points. Less than 10% of active large-cap fund managers have outperformed the S&P 500 over the last 15 years. The biggest drag on investment returns is unavoidable, but you can minimize it if you're smart.
Financial experts generally say investing in an S&P 500 index fund is a sound strategy — though it does leave room for diversification. “It could prove an effective strategy if you hang on,” said Douglas Boneparth, a certified financial planner and president of Bone Fide Wealth in New York.
Venture capitalists, or VCs, take a huge risk in the human side of the equation because they can't always predict how human beings will behave. They can't guarantee that the talented management team they are supporting will stay on board or that they really will produce as promised.
A typical VC firm manages about $207 million in venture capital per year for its investors. On average, a single fund contains $135 million. This capital is usually spread between 30-80 startups, though some funds are entirely invested into a single company, and others are spread between hundreds of startups.
VCs that invest in initial stages companies are likely to pay their employees much lower than other VCs. Analysts at a pre-seed and seed-stage VC earn a base comp between $60,000 and $120,000 and a bonus ranging from a daily cup of coffee to $15,000.
Considered the premier mutual fund manager in America, Bill Miller has set one of the highest mutual fund performance records with Legg Mason's Value Trust. He outdistanced the S&P 500 eleven years and running with his innovative value approach to investing.
Ranked: S&P 500 Sectors by 2023 Return
Information Technology, Communication Services, and Consumer Discretionary were the three biggest winners in 2023, all of them up more than 40% for the year.
Is it better to buy Berkshire A or B?
Berkshire CEO Warren Buffett has suggested that investors favor the B shares when the A-share premium is above 1% and opt for the Class A stock if the two classes are at parity, as was the case at the start of 2023. Berkshire Hathaway, like many other companies, has two classes of stock outstanding.
The VC firm could dictate where and how you spend the money, pressure you to take your business in a direction you don't want to go, or even disagree with you to the point of killing your business.
Due to high interest rates, among other things, VC investment in new companies and IPO exits are way down from previous years.
Health technologies and biomedicine, renewable energy, digital economy and fintech, and logistics and Artificial Intelligence are areas that offer lucrative opportunities for visionary investors looking to be part of the transformation and growth in the near future.
Some of them are even AI-driven. Venture firms like Correlation Ventures, Deep Knowledge Ventures, and Lighter Capital have been using this approach for several years, and many more will follow suit in the near future. As soon as it happens, the industry will become fairer and more objective.