A very interesting post from Dan McCrum on the FT Alphaville blog, attractively titled “Abandon all hope, ye who venture here” unearths some truths, (is misled by and) fosters some consolidated misperceptions while opening up for some comments – a couple of which I made at the bottom of the post.
The first truth proposed, among a few observations drawn from a Kaufman Foundation paper is that “venture capitalists, like hedge fund managers and private equity barons, are doing their best and responding to clear incentives“.
I consider this as a piece of information that investors should simply but always keep in mind when considering incentives. I’ll come back to this.
The second truth is that LP have developed “an acceptance of inconsistent and not fully informative VC performance reporting”.
And the related third truth is that “databases offer conflicting and incomplete snapshots, and investment consultants are themselves self-interested parties who would make little money advising on portfolios of index funds“.
In spite of the apparent awareness (and the abundant academic evidences) about quartiles ineffectiveness and IRR weakness, LPs and the Kaufman Foundation seem to keep judging their VC investments through the IRR lens.
The fact that the effectiveness of private capital investments is judged confronting IRR and public indices adds to the misperception.
Even the mPME, defined an apple versus apple methodology, does not make any realistic sense. Would anyone trade the public markets based on the dates of the capital calls and distributions of an underlying private fund and then compare the performance of this illogical strategy with the performance of the fund?
I believe that the solution is simple – it is agreed that the IRR does not work but, at the same time, the IRR is the key incentive and the control variable: LPs should just abandon the IRR….
The evidence that VC and PE can be part of an efficient allocation of savings will automatically follow.