When making an investment decision, there are numerous factors to consider, but one of the most important is risk aversion. Investors seek to maximize their expected return for a given level of variance (risk) in their portfolio. It is not a fixed characteristic and can change over time depending on an investor’s individual circumstances and goals. It’s also important to note that investors don’t just care about variance — ie, they don’t just care about the ups and downs of their portfolio — they care about when the variance shows up.
Many people will focus on risk aversion through the lens of investment amount. Committing smaller investment amounts, even to riskier assets, feels less risky. When most investors start to explore private markets, they begin making angel investments which are typically smaller investments into early-stage operating businesses. When losses occur (the business fails), they appear less severe, given the timing and the fact that failures happen over an extended period of time.
But the returns of angel investors are highly dependent on their own actions, and those who dedicate more time to due diligence, possess industry experience, and provide mentorship to the invested companies tend to achieve higher returns.
But is that effort worth the investment amount?
Many sharp observers have noted that Venture Capital returns follow a power law distribution with a small number of wildly successful investments responsible for most of the returns. When a notable Venture LP looked into this effect across the managers they allocated to between 1985 and 2014, they found that 6% of venture deals returned more than 10 times the money invested in them. A well-diversified portfolio across a large number of investments is more likely to find a few high-potential companies, and the best way to accomplish that mix is through fund commitments.
In venture investing, it’s a mix of quantity and quality. While investing smaller amounts may seem less risky, a lack of due diligence and diversification can undermine this strategy and ultimately contradict the risk-averse investor’s objectives.
-Logan Henderson, Founder and CEO
Webinar: Meet the Manager
Join us on Thursday, June 29th at 11 am ET for an interactive Meet the Manager session with Lacey Mehran, Managing Director at VSS to discuss structured credit and how firms can capitalize on the current market environment to drive returns for investors.
VSS is a private investment firm that invests in the Healthcare, Business Services and Education industries. Since 1987, VSS has partnered with lower middle-market companies working closely with management teams, providing flexible capital solutions to drive growth.
This webinar is open to Gridline Members. If you would like to join us, please complete the process to sign up for an account and we will send you your personal link to join the webinar.
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