A report claims that the long-term benefits of investing in venture capital are so great that families, for example, should consider dramatic increases in the share of their wealth placed into the asset class.

There has been a big influx into venture capital as an asset class over the past 10 years, with some top-performing institutional investors parking as much as 15 per cent or more of assets into VC, a study of the sector that trumpets its virtues says.

A study of VC by Cambridge Associates finds that institutions in the top decile for returns had an average of 15 per cent allocation in venture – and some higher than that, and a greater share may be appropriate for private investors. In fact, families should consider bumping VC up to 40 per cent of their assets if their time horizons can accommodate it, it said.

The report comes at a time when organisations such as family offices, foundations and endowments have been encouraged to consider VC and other relatively illiquid asset classes. This is because investors win a superior return compared with more mainstream areas such as listed equities, particularly in an environment of very low interest rates. 

The asset class has matured from the highly volatile pattern of returns seen in the dotcom frenzy of the 1990s, and changes in the structure of how companies are financed and owned means that potential for VC is much greater today, the report, entitled Venture Capital Positively Disrupts Intergenerational Investing, said.

One concern has been that there is now more than $2.0 trillion of “dry powder” in private capital markets (private equity, private debt, venture capital and forms of infrastructure) – a term applying to money that is available to be deployed. Without sufficiently profitable opportunities, the concern is that such a large lump of money will squeeze returns. Preqin (25 September 2019) found that venture capital assets under management doubled over five years to 2018, reaching $856 billion as of December 2018. VC comprises 14 per cent of the $6.06 trillion global private capital industry.

Cambridge Associates’ report argues that there is plenty of headroom in VC because a higher proportion of businesses today are privately held than was the case two decades ago. Over the past 20 years, the number of publicly traded US stocks has shrunk by almost half, to 4,336. That compares with 8,353 unrealised and partially unrealised VC-backed companies in 2019.

Source: Cambridge Associates

“While not all these companies will survive, or prosper, many will generate significant returns for investors,” the report said.  

“Fears of too much money being raised in the VC space are consistently based on historical levels, rather than future potential. When put into context, the amount of money raised in VC represents a fraction of the market value of the industries being disrupted by many venture-backed companies, and a fraction of the total addressable markets of emerging business categories being created by VC,” it said.

VC, in fact, is tiny compared with the overall investment universe, the report said: VC at $340 billion net asset value is less than 0.5 per cent of the $85 trillion in global equity valuation. 

The report cautioned about the media noise around “unicorns” (firms valued at more than $1.0 billion) and some of their associated IPO disappointments (Uber, and others). “Once aptly named, unicorns are no longer rare and elusive,” the report continued.

The benefits to investing in VC over the long-term when set against listed equities are clear, Cambridge Associates said. “Given muted return expectations for public equities over the next 10 years, increasing allocations to VC may prove to be beneficial. Consider the following maths: A properly constructed VC portfolio will target a 300 per cent return over the life of the fund (typically 10 years). By comparison, to earn a 200 per cent return on a public stock over 10 years, the stock would need to have an annualised return of about 7 per cent,” it said.