Early-stage investing is hard. We all know the odds are against us. In fact, 62% of all VC financings lose money, per Kauffman Fellows Research Center. But investors hope to make money back on a small subset of their deals, and maybe, maybe, we happen to invest in a small company that ends up becoming the next generation-defining company. This, of course, is the lure of venture capital. As Fred Wilson puts it, “you lose more than you win”. So, for investors attracted to early-stage investing, how does one approach the asset class with greater sophistication and stability? The answer isn’t that unheard of — it’s all about diversification.
Abe Othman is the Head of Data Science at Angellist and their team recently analyzed the portfolios of more than ten thousand Limited Partner (LP) investors on AngelList to determinethe effects of portfolio size on performance. They found that having investments in more companies (i.e., by investing in individual syndicate deals or through microfunds on the platform) tends to generate higher investment returns. Below are a few takeaways:
View venture capital like an asset class and invest systematically
In the first section of the paper, Abe’s team examined thousands of LP portfolios on the platform to show that both median and mean portfolio performance increased with the number of investments made. In the second section, they looked at the performance of investors in the AngelList Access Fund, an investment vehicle that broadly indexes into early-stage venture capital. They show that, across a range of year-cohorts, the typical Access Fund investor outperforms the typical investor who does not invest in an Access Fund.”
Performance increases by investing in a greater number of deals
Performance generally increases in the number of investments made; the coefficient of the linear regression line here is 9 basis points per investment (one basis point is one one-hundredth of a percent), suggesting that the typical investor with a 100-investment portfolio outperforms the typical investor with a single investment by almost 9% a year.
Early-stage investing is not for the faint-hearted
Venture capital returns continue to look appealing. Data from Cambridge Associates data suggests that venture capital has outperformed the public markets over the past decade. But the secret to producing consistent returns in venture is the same – invest systematically, and increase the number of early-stage investments you make – one of the easiest ways is through a fund of funds, investing in a fund directly, or investing in indexes directly like through Angellist. For more, read the official whitepaper, “How Portfolio Size Affects Early-Stage Venture Returns”