The picture of a venture capitalist is changing. Gen Z angels, digital natives, and purpose-driven investors are leading the charge in venture capital, aiming for higher returns with less risk.
Public market investors are facing high inflation, low yields, and volatile markets.
Even those who diligently followed the “gold standard” portfolio allocation of 60% stocks and 40% bonds suffered one of the worst years in recent history.
In the search for yield, there are now countless options to choose from.
Having begun our second week of coverage into fintech ecosystems with a look at how artificial intelligence (AI) is being applied to wealth management, here in our second instalment of the week, we’re tapping into the subject again, but this time with a much broader scope.
A rollercoaster of financial conditions over the past few years has caught most of us off guard. Small businesses, in particular, have been hit hard and have suffered the worst during the COVID-19 pandemic. Now, inflation and recession fears are looming again, harming individuals and organizations alike.
Amid the soaring volatility in the public markets, investors continue to look for alpha, and many are turning to alternative investments. A recent survey conducted by With Intelligence found that while investors and allocators are bullish on both private equity and hedge funds, (private equity) PE is leading the way in investor intentions.
Many individual investors often look at public markets like they are the only game in town to make money and meet their financial goals.
But with lofty valuations of public companies and depressed bond yields, the traditional 60/40 stock-to-bond portfolio has been thrown to the wayside, so the next generation of investors needs to pivot away from their parents’ investing methods.
While they can still try to squeeze all the juice possible out of the market, the most sophisticated endowments and institutions are looking elsewhere.
Institutions understand that value is often created in the early stages of a company’s growth, before it is publicly traded.
As a result, institutional managers seek out and invest in private markets and alternative assets — like private equity, venture capital, real estate and more — where opportunities exist for better returns with lower volatility and without taking on excess risk.
For example, over the last 30 years, Yale University’s investments in non-traditional assets grew to greater than 70%, from less than 20%, by leveraging venture capital, private equity, hedge funds, etc.
This “endowment model,” created by the late Dr. David Swensen of Yale, started the shift of endowment portfolios into illiquid private investments, and is credited with generating $20 billion in excess returns for the university. (Swensen, a PhD, was an institutional investor, endowment fund manager and philanthropist. He was the chief investment officer at Yale from 1985 until his death in May 2021.)
Right now, institutional investors have more than 55% of their assets allocated to alternatives largely due to their return potential, diversifying power and lower volatility. Meanwhile, retail investor allocation remains in the low single digits, because of historical access constraints.
With this in mind, it’s important for these next-gen investors to think about how they can close that gap by increasing allocations to alternatives. In the past, investors had to network for opportunities and build the team and infrastructure to invest in private markets.
Today, new technology platforms make it simple for individual investors to invest directly in alternative assets.
There are plenty of recent examples of successful on-ramps offering accessibility to new asset classes such as cryptocurrency, art and early- and late-stage private companies. With easily accessible options to gain entry into alternatives, investors can now seek out a holistic allocation strategy to invest in private market assets beyond traditional sources.
To stave off the volatility of inflation, rising interest rates and geopolitical uncertainty, next-gen investors are increasingly allocating to alternatives, which represent a great long-term investment due to their low correlation with and lower volatility compared to public markets. An estimated 81% of investors expect their allocation to alternatives to increase by 2025.
However, investors need to know what to look for when evaluating their investments.
I believe active fund managers are critical. Fund managers are good stewards of capital because they actively manage the portfolio by being on the board, participating in strategy sessions, hiring strong teams and increasing value all the way through an eventual exit. They nurture the companies they invest in to encourage their success and capture “private market alpha,” or the outsized returns that often occur when exposed to breakthrough companies.
There are always risks to consider when investing in the private markets. Those include opaque market information, illiquidity with longer-term hold periods, high investment minimums and the large variance in performance between top and bottom managers in alternative asset classes.
New entrants into the alternative investing space should start with funds or fund-of-funds that are found through reliable sources, making smaller contributions to build up toward their target allocation. Diversifying investments across different funds, asset classes, geographies, sectors, stages and vintage years can also help mitigate risk.
The number of alternative investment strategies available is growing rapidly, with new offerings introduced all the time. There are now hundreds of strategies globally and this number will only increase as new products emerge due to advances in financial technology.
Investing in alternatives offers investors options beyond what’s available in public markets, which can be useful for tailoring risk/return profiles or meeting specific goals such as preserving capital during times of market volatility.
— By Logan Henderson, CEO and founder of Gridline
This article was originally published on CNBC.com on April 8, 2022.
You’ve heard the rumblings. You’ve read the warnings. And you’ve seen the data hinting at an impending slowdown.
As Social Capital founder Chamath Palihapitiya recently put it in his annual investor letter: “After a decade of free money, quantitative easing, zero interest-rate policy, and an unprecedented bull market, the best party in town (‘long’ equities) has come to an end.”
Is this the end of venture capital as we know it, or a short-lived dip in the markets? I asked Term Sheet readers to weigh in.
Here’s what you all have to say about the private markets:
“We’re seeing a sort of stalling of some VC energy among a lot of startups in our personal network. Seems like all VCs are slowing down their investment pace right now, which is a huge departure from what it’s been until just recently. Many startups we spoke to decided not to raise in the current environment. Some people we’ve talked to say that if you have to fundraise right now, you have to basically take what you’d planned to raise in January, and cut it in half.” —Torben Friehe, Wingback
“We are starting to see the effects of higher interest rates and the resulting pullback in public technology stocks, most notably in SaaS, in the private markets. This is leading to a rotation from growth at all costs to efficient growth, a general flight to quality, and making software businesses adopting product-led growth (PLG) strategies even more attractive to investors. I expect there to be much less tolerance for high burn without exceptional performance, and an increasing emphasis on unit economics and return on capital.” —Mackey Craven, OpenView
“We closed out our Series A in early February after three months of intense negotiations, not to mention all the due diligence required. This was just as the stock market was cratering, China’s Zero Covid policy was crushing the global supply chains, inflation was at historic highs, and the war in Ukraine was looking inevitable. It’s safe to say that if we had started our raise 30 days later, the deal would probably not have happened.” —Dimitri Falk, Piñata
“Growth optimized businesses, like Amazon aggregators, have relied on VC debt financing and these VCs have pushed a ‘growth at any cost’ business model making it extremely difficult to be profitable. In 2022 we saw a serious slowing of retail demand, increased supply chain issues/delays, and rising interest rates. This confluence of events means these VC-backed companies aren’t able to meet the aggressive growth metrics required by VCs and are being hit especially hard with sell-offs, layoffs, and serious devaluation.” —Alexej Pikovsky, Alphagreen Group
“Experienced founders, entrepreneurs and investors know market conditions shouldn’t dictate their fundraising strategy. When interest rates rise, many founders are inclined to overlook venture debt––but this is often to their own detriment. Even when interest rates are high, and debt therefore seems scary—it can be the better option to ensure you retain ownership of your company, and your cost of capital doesn’t rise as you become more profitable—as it does with equity. Whether you’re looking to raise debt or equity, it is essential that founders use data to tell their company’s story. And when markets are increasingly volatile or conditions seem to be turning against founders, relying on performance data is more important than ever.” —Blair Silverberg, Hum Capital
“Atlassian, Procore—those were companies that were formed just [after] the big Dot-Com Bubble burst almost 23 years ago. And companies like Airbnb or GitHub were formed in ‘08. There are great companies out there, and in many ways, the companies that are going to rise to the top right now…are those that are really seeing the opportunities around them and going for it. So we’re just out there looking for those breakthrough generational businesses—and we think they can be made in any environment.”—Aidan Madigan-Curtis, Eclipse Venturers
“Two things are true: 1) VC funding is pulling back and we are transitioning from a frothy environment to a cautious one. Companies will need to be increasingly careful with cash, reconsidering burn for the 12-18m. 2) This is the best time to fund the best innovators. Some of the best companies came out of the trough in the cycle and, indeed, the most resilient founders thrive when there is less money to be raised. Women founders will have an advantage in such an environment; the data shows they return more on less capital raised. My bet is VCs who want to back founders who can get to product market fit with less capital will find alpha.” —Nisha Dua, BBG Ventures
“On the downturn, I am actually excited for it. Finally the time will come where companies need to start behaving more responsibly, be more focused on their customers and the ways in which they can feasibly and viably solve their problems vs. just burning cash and breaking business models. Bring it on. May the strong survive and the well oiled machines thrive.” —Danny Le Gros
“I’m one of those founders who found no love from VCs when the markets were hot. It’s time for the spoilt founders to learn a bit of my lived experience—operating lean. The fast learners will be fine.” —Kayode Odeleye, Caena
“I’ve found that founders’ value expectations haven’t really changed yet at basically every stage, and this is somewhat driven by the occasional round still getting done at a crazy price where people are just anchoring to it. Additionally, in almost every high quality project there has been a rogue termsheet which is 40% above market by a non-traditional investor still just trying to win the ‘best’ deals.” —anonymousgeneral partner at a multi-stage fund
“We are not pressing pause. We’re pleased that valuations are coming back down to earth, but I don’t think we’re done just yet. In the next two quarters we are very likely to see that re-opening their last round didn’t work, so they’re going to slash their burn-rates to extend their runway. If they can grow their way out of it, their valuations may stay intact. Most will not be able to, so a down round will likely come next.” —Brian McLoughlin, MTech Capital
“I don’t think employees should come out of pocket to exercise options. I did that when I left Airtime 10 years ago and I am still waiting for an exit. They should negotiate an extension to the option exercise window if possible. Employers still want to get a separation and release and avoid bad press with regard to layoffs, and that potentially gives ex-employees, especially if they coordinate, some leverage.” —Alda Leu Dennis, Initialized Capital
“Growth company leadership teams used to come together somewhat organically; hires were made in phases prioritized by specific gaps within the founding team – more and more we’re speaking with clients who want to understand how to bring on an entire team (or board) at once (with particular focus on team effectiveness and culture).” —Tuck Rickards, Russell Reynolds Associates
“On the LP side – many are tied up capital-wise, but also realize the big opportunity to ‘buy when there’s blood on the streets.’ I hear these are the times ‘forever-companies’ are formed and set up a trajectory to excel long term, at least in our sector (biotech/ healthcare). Hopefully this is the case this time around as well, for patients’ and health’s sake.” —Themasap Khan, Civilization Ventures
“Funds will have a harder time raising capital—LPs across the board are feeling the pinch and if the stock market continues to decline, they will pull back on investing in this asset class. In 2008, I saw major LPs pulling out of ventures entirely, not just scaling back their commitments. This time around, I am optimistic it will just be more scaling back because VC has become such a long term strong performing sector for asset managers and they saw distributions recently. Less LP dollars means GPs need to manage pace better and be more selective. It also means that portfolio companies may be impacted because their customers are pulling back their spend.” —Alda Leu Dennis, Initialized Capital
“The fear is that retail investors will invest more heavily in SPVs run by managers with no skin in the game, [who are] not deploying any of their own money into the deal.” —Logan Henderson, Gridline
“If there is a sustained downturn, it will also be important to watch how CVCs are impacted. Those CVCs that are intimately linked to the corporation’s long-term growth strategy—both structurally and from a governance perspective—will be around but there might be others that cannot weather the storm.” —Brian Walsh, WIND Ventures
See you tomorrow,
Jessica Mathews
Twitter: @jessicakmathews
Email:jessica.mathews@fortune.com
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Jackson Fordyce curated the deals section of today’s newsletter.
“The stock market downturn will rationalize private markets, and now is the best time to invest in a V.C. or a P.E. fund,” says Logan Henderson. How can investors decipher between good and bad investments amid market volatility? “It all comes down to fundamental analysis. For example, the outlook for technology stocks like Snowflake (SNOW) and Microsoft (MSFT) is quite strong,” Henderson adds.
Gen Z and millennials are more purpose-driven than ever before. From ESG investing to supporting social entrepreneurs, there are several ways that venture capitalists can help young people make an impact.
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