Publicly traded venture capital funds: implications for institutional “fund of funds” investors

Abstract

EXECUTIVE SUMMARY Institutional investors supply the bulk of thefunds which are used by venture capital investment firms in financing emerging growth companies. These investors typically place their funds in a number of venture capital firms, thus achieving diverstfication across a range of investment philosophy, geography, management, industry, investment life cycle stage, and type of security. Essentially, each institutional investor manages a 'find of funds, " attempting through the principles of portfolio theory to reduce the risk of participating in the venture capital business while retaining the up-side potential which was the original source of attraction to the business. Because most venture capital investment firms are privately held limited partnerships, it is very difficult to measure risk adjusted rates of return on these funds on a continuous basis. In this paper, we use the set of twelve publicly traded venture capital firms as a proxy to develop insight regarding the risk reduction effect of investment in a portfolio of venture capital funds, i.e., a fund of funds. Measurements of weekly total returns for the shares of these funds are compared with similar returns on a set of comparably sized "maximum capital gain" mutual funds and the daily return of the S&P 500 Index. A comparison of returns on an individual fund basis, as well as a correlation of daily returns of these individual funds, were made. In order to adjust for any systematic bias resulting from the "thin market" characteristic of the securities of the firms being observed, the Scholes-Williams beta estimation technique was used to reduce the effects of nonsynchronous trading.The results indicate that superior returns are realized on such portfolios when compared with portfolios of growth-oriented mutual funds and with the S&P 500 Index. This is the case whether the port&olios are equally weighted (i.e., "naive") or constructed to be mean-variant efJicient, ex ante, according to the capital asset pricing model. When compared individually, more of the venture funds dominated the S&P Market Index than did the mutual funds, and by much larger margins. When combined in portfolios, the venture capital funds demonstrated very low beta coeficients and very low covariance of returns among portfolio components when compared with portfolios of mutual funds. To aid in interpreting these results, we analyzed the discounts and premia from net asset value on the funds involved and compared them to Thompson's findings regarding the contribution of such dtfferences to abnormal returns. We found that observed excess returns greatly exceed the level which would be explained by these differences. Address reprint requests to DavidThe implications of these results for the practitioner are sign$cant. They essentially tell us that, while investment in individual venture capital deals is considered to have high risk relative to potential return, combinations of deals (i.e., venture capitalportjolios) were shown to produce superior risk adjusted returns in th...

Risk and Expected Returns of Private Equity Investments: Evidence Based on Market Prices

“…In related work, Martin and Petty (1983) and Brophy and Guthner (1988) use a samples of 11 and 12 listed venture capital funds, respectively, to examine their risk and ex-post returns over about a five-year period. Bilo, Christophers, Degosciu, and Zimmermann (2005) examine the risk and return characteristics of a larger sample of listed private equity.…”

Risk and Expected Returns of Private Equity Investments: Evidence Based on Market Prices

“…In related work, Martin and Petty (1983) and Brophy and Guthner (1988) use a samples of 11 and 12 listed venture capital funds, respectively, to examine their risk and ex-post returns over about a five-year period. Bilo et al (2005) examine the risk and return characteristics of a larger sample of listed private equity.…”

Risk and Expected Returns of Private Equity Investments: Evidence Based on Market Prices

“…In related work, Martin and Petty (1983) and Brophy and Guthner (1988) investors, which is defined as investors with ownership of more than 3% of the shares outstanding, is about 47% on average. Therefore, even large investors invest through these vehicles.…”