Individual investors consistently underperform market indices at an average of 1.5% per year. Performance is even worse in volatile times, with individual investors underperforming the S&P500 by 11% in March 2021.
The more active the individual investor, the worse the performance. According to a Berkeley study, “the vast majority of day traders are unprofitable, and many persist despite an extensive experience of losses.”
As Warren Buffett puts it, “I don’t think most people are in a position to pick single stocks,” They underperform because they lack the requisite diversification, research, and objectivity. Investors who conflate their hobby of stock-picking with serious investing often make novice mistakes, and behavioral biases can compound these costly errors.
In reality, they would be better off investing in index funds. Index funds provide diversification and remove the need to pick individual stocks. The same principle applies to private market investing for most investors, but diversification is prohibitively expensive due to high capital requirements and lack of liquidity. Gridline enables low-cost diversification in the private markets.
Return dispersion of VC and PE
The return dispersion for venture capital and private equity is much higher than for public equities. This means that the penalty for picking the wrong investment is even more painful than with public stocks.
One reason for this higher dispersion is that private companies are much less efficient than public companies in allocating capital. Private companies also tend to be more levered, and leverage magnifies both upside and downside risk.
Given the higher risk and higher dispersion of returns in private markets, indexing can help investors achieve more consistent results. By investing in a basket of private companies, investors can smooth out the ups and downs of individual companies and achieve more predictable returns.
Private markets are less efficient than public markets
The efficiency of public markets has been a topic of debate for decades. The efficient market hypothesis (EMH) posits that all investors have access to the same information and that prices reflect all available information.
However, the EMH does not hold for private markets. In private markets, there is a lack of transparency and an asymmetry of information between investors and issuers. As a result, prices in private markets are not as efficient as in public markets.
This lack of efficiency allows active managers to find attractive investments mispriced by the market. By investing in a basket of companies through Gridline, investors can gain exposure to a wide variety of private companies and benefit from the potential inefficiencies in the market.
Proper private market diversification
Investors in private markets should diversify across several factors, including asset class, geography, and investment stage. Research highlights that investors can simply minimize private market return dispersion by diversifying across these factors. Diversification is the only free lunch in investing, and it is especially important in private markets where return dispersion is high.
Participating in private markets presents immense opportunities for alpha generation and wealth creation, with top-quartile VC funds outperforming the S&P by ~2X over the last 5-, 10-, 15-, and 25-year periods. However, adequate fund selection and diversification require rigorous due diligence, a structured methodology, and access to a large universe of managers.
Gridline enables investors to gain exposure to a broad cross-section of the market with a diversified portfolio of private investments.