FIGURE 3 : Daily Closing Price of the Nasdaq Composite Index ( January 1 , 1998 – October 31 , 2002 )
Overcrowding in Silicon Valley
“ What has been true of railroads has been true of other forms of permanent investment . First , high charges and high profits . Then speculative investments in the same line . Next , an overstocked market , and no profit at all . Finally , cutthroat competition and widespread insolvency .”
— Arthur Twining Hadley , former president of Yale University
In 2000 , David Swensen , the CIO of the Yale University Endowment , published his classic book , Pioneering Portfolio Management . The book shared many details of Yale ’ s investment strategy , which enabled its endowment to substantially outperform other peers . But many institutional investors misinterpreted Swensen ’ s advice and concluded that blunt allocations to alternative assets , such as venture capital , were the secret to producing Yale-like returns .
Source : Yahoo ! Finance
Few realized that it was the rare strength of the people making the decisions at Yale that accounted for their success .
Over the next two decades , institutional investors substantially increased allocations to alternative asset classes , and venture capital was a common destination . In 1995 , assets under management ( AuM ) in US venture funds was $ 38.9 billion . By 2021 , total AuM hit $ 995 billion . The problem , however , is that much like the New Bedford whaling industry , the supply of high-tech home runs is limited , and a small number of top-tier firms are far more likely to snag them . This is why Swensen cautioned investors that , “ In no other area of the capital markets does the identity of the source fund matter in the way that it does in the venture capital world .” To this day , few institutional investors heed his warning .
The Shifting Tradewinds of Venture Capital
The drilling of the first oil wells in Titusville , Pennsylvania ended the reign of the great whaling financiers of New Bedford , but profits were already suffering from increased competition and shrinking whale populations . For the 20 years ending in 1836 , an average of 77 ships departed New Bedford each year . For the 20 years ending in 1856 , this increased to an average of 242 ships . Unsurprisingly , the profitability of voyages declined from 21.3 % to 13.4 %.
The US venture capital industry now faces a similar challenge . From 1981 to
1999 , an average of 196 venture funds made new investments in any given year . For the 15-year period ending in 2014 , an average of 604 funds made new investments . Net IRRs followed a predictable trajectory . For the 20-year period ending in 1999 , the average , equal-weighted pooled IRR was 28 %. For the 15-year period ending in 2014 , the average , equal-weighted pooled IRR had declined to 11 %.
Severe overcrowding in the US venture capital industry is a conundrum . While the magnetism of venture investing may shield premier venture firms from severe consequences , second- and thirdtier firms seem unlikely to thrive . Like the 19th century whaling investors , modern venture capital investors are hunting in a crowded sea . It is up to trustees to decide if they should search for undiscovered treasures in uncharted waters — or avoid the perilous seas altogether .
Mark Higgins , CFA , CFP ® is a financial historian , experienced institutional investment advisor and frequent contributor to Financial History magazine . His book , Investing in US Financial History , recounts the full financial history of the United States from 1790 to 2023 . The book will be published in February 2024 by Greenleaf Book Group .
Sources 2015 National Venture Capital Association
Yearbook . Thomson Reuters . 2015 .
Ante , Spencer . Creative Capital : Georges Doriot and the Birth of Venture Capital . Boston : Harvard University Press . 2008 .
Clark , Jim . Netscape Time : The Making of the Billion-Dollar Start-Up That Took on Microsoft . New York : St . Martin ’ s Press . 1999 .
Davis , Lance E . In Pursuit of Leviathan : Technology , Institutions , Productivity , and Profits in American Whaling , 1816 – 1906 . Chicago : University of Chicago Press . 1997 .
Nicholas , Tom . VC : An American History . Cambridge : Harvard University Press . 2019 .
O ’ Mara , Margaret . The Code . New York : Penguin Books . 2019 .
Swensen , David . Pioneering Portfolio Management : An Unconventional Approach to Institutional Investment . New York : Free Press . 2000 .
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