Yale and the Wolf, a Venture Capital Performance Tale

Every year, the press coverage about the release of the annual financial reports of one of the most prestigious investment offices in the world, often referred as the benchmark for long term investing, reminds me of a classical tale. And it’s not the first time I write about it, but reiteration deserves an encore.

Now I can see your puzzled face.

For those who can’t figure out what I am referring to, or don’t know the story, The Boy Who Cried Wolf is one of Aesop’s Fables.

Ok. Where’s the Wolf?


From an investment performance perspective, in Yale’s last Endowment Update and its previous issues there is a reiterated “wolf claim” that makes me think about the tale.

Spotting the “wolf” requires an unusual mix of fixed income and venture capital/private equity notions and specialist knowledge of what tells time-weighted and money-weighted performance measures apart.

It’s a distinction that makes all the difference.

The last sentence of the Venture Capital performance commentary at page 16 of Yale’s 2015 Endowment Update states that “over the past twenty years, the venture capital program has earned an outstanding 92.7% per annum.”

The Wolf is the “per annum”.

The “per annum” suffix should apply only to time-weighted performance measures to imply that the return (in this case the 92.7%) is the compound average growth rate of the initial capital over 20 years.

The proper version of the sentence should have been “over the past twenty years, the venture capital program has earned an outstanding 92.7% IRR.” But not per annum….

The IRR is a money-weighted measure of performance that does not represent the growth of the capital over one full reference period (i.e. the year) by default (as it is instead the case for time-weighted measures).

As a consequence, the 92.7% growth of Yale’s venture capital portfolios was actually realized during shorter sub-periods of time in every one of the 20 years referenced in Yale’s financial reports. I have written about why this happens in my previous post.

Can this be proven?

Of course it can. If the return of Yale’s VC portfolio had truly been at 92.7% per annum for 20 years, today Yale’s endowment would have reached a significantly bigger size than its current one (USD 25.6 billion).

In numbers, if only 1% of the estimated USD 5 billion NAV of the Yale endowment in 1995 (i.e. USD 50 million 20 years ago) had been allocated to Venture Capital and delivered the 92.7% return per annum stated above, the overall value created by the Venture Capital portfolio would have been:

USD 50 million x [(1 + 92.7%)^20] = USD 24.9 trillion

In other words, if the per annum condition held, 1% of Yale’s endowment of 20 years ago would be worth over 970 times its today’s actual total value.

Why does this matter?

As in the tale, crying wolf carries a risk. The point has a relevance at an industry-wide level, well beyond the specificity of Yale’s case. But Yale’s investment office has a visibility that hits the headlines and its messages set industry’s tone and investors’ expectations.

The risk is that investors can become disappointed (for the wrong reason) with the venture capital industry because it will not deliver the kind of “doubling the money every year” that a 92.7% per annum implies – and that Yale “advertises”.

Investors won’t see this kind of performance because even the best and most sophisticated investors like Yale don’t see this kind of performance on average and over prolonged periods of times (as the per annum and 20-year reference imply). And this has nothing to do with their distinguished ability to pick good managers and possibly achieve better than average performance levels.

The issue is in the obsolete and misleading methodology of performance measurement that they keep using without the associated well-known warnings – in absence, as shown above, the IRR produces results that are disconnected from actual time and money evidences. The PME methodologies introduced to improve the comparability of IRR with the listed markets don’t help much.

It doesn’t matter if it has always been done this way. Standards can always and should be improved, if proven inaccurate.

Accurate performance representation is at the core of the notion of trust in the financial services industry.

Beyond the hype that risks diluting its effects, the FinTech revolution is delivering a message to the financial services industry and it’s about transparency, accountability, simplicity. It’s about restoring trust.

When reporting performance, the whole investment industry (whose people-business nature won’t be changed even by robotization) has to be accurate and realistic in delivering comprehensive information that allow the definition of the true growth of the wealth over time.

Not to be fooled by returns, investors can anyway use a “duration watchdog”.
It always tells whether there’s a wolf.


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