What’s Really Holding You Back? Small Endowments Can
Finally Invest in Early Stage Venture Capital
Previously an overlooked asset class for small endowments, lower capital minimums, and easier-than-ever fund manager diligence now enable small endowments to invest like Ivy League institutions — and finally earn the same returns.
Written by Spring and Summer Venture Fellow Michael Tellini
I make the case that small endowments have been overlooking venture capital as an asset class, as the supposed barriers to entry no longer pose the same challenges they once did. The rules of the game have changed, but portfolio allocation has not.
First, it’s important to establish the fact that venture has higher returns than other asset classes. Mutual fund and hedge fund underperformance has been well-documented, but less attention has been paid to the higher returns in private equity/VC. An anonymous Ivy League endowment professional I spoke with said, “Theoretically, venture exhibits the highest returns among the conventional asset classes.” Another Ivy endowment manager — arguably the most successful over the past few decades — David Swensen from Yale, pioneered the approach of taking advantage of the illiquidity premium, allocating a higher portfolio share to venture and private equity. As a consequence, it’s no surprise that Yale has beaten out its peer institutions and the market average.
Seen in this graph, Yale has outperformed all sizes of endowments in average nine-year rolling performance. 60–40 refers to a market basket portfolio of 60% stocks and 40% bonds.
The exact breakdown of Yale’s portfolio compared to endowments of differing sizes provides some insight into Yale’s holdings (far left).
If you run a small endowment, you’re probably looking at these graphs and thinking that Yale’s approach differs from yours for three reasons:
1) Yale can better diligence fund managers
2) Fund capital minimums prevent you from investing in the asset class
3) Yale can get access to A-list fund managers
Let’s approach these concerns one at a time.
Fund diligence is easier than ever now given the order of magnitude increase in information sharing. Gathering references and information on a fund manager’s pedigree has been buoyed by tools such as LinkedIn, Burgiss, Pitchbook, and Preqin. Additionally, gathering information on portfolio performance is easier than ever thanks to new platforms like Carta. An uptick in funding, leading to more rounds and more frequent valuation updates, has also resulted in more information sharing between portfolio companies and VCs, making the historical returns VCs share with prospective LPs more meaningful.
Capital minimums are no longer the obstacle they once were for small endowments for two main reasons. First, smaller funds have been on the rise, which often don’t have capital minimums at all. No capital minimums means small endowments can diversify across an array of small venture funds. Second, smaller funds also enable small endowments to gain an allocation in what one-day could become a large, successful, and difficult to enter fund. On the note of smaller funds, they exhibit better returns too:
Given small endowments have viewed capital minimums as obstacles to diversification in venture, the argument that the asset class is too risky for small endowments no longer holds. Said one anonymous small endowment manager, “Don’t underestimate the risk aversion of the small guys. Only part of my job is to make money; the main part is to not lose money.” Yet, small endowments have been allocating approximately 25% of their portfolio to hedge funds for the past decade (Preqin), suggesting that at least part of that amount could alternatively be invested in other illiquid assets.
Access is also a frequently cited barrier to entry for small institutions. Without decades-long ties to A-list venture firms, how else is your small endowment supposed to achieve the same returns? Interestingly, first-time private capital fund managers continually beat the industry benchmark, and the S&P 500. Naturally, the rise in new venture funds has coincided with a rise in first-time fund managers. Given first-time fund managers also tend to charge lower management fees, they pose a unique opportunity for small endowments. Large institutions can’t invest in first-time managers because the institution would take up too large a percentage of the fund — and the check sizes aren’t worth their time — but small institutions can benefit from the outsized returns, while still able to diversify because of the already discussed changes in capital minimums.
In sum, small endowments are already investing a quarter of their portfolio in illiquid assets, so why not invest where the returns are higher? We’ve seen that diligence, capital minimums, access, and diversification are no longer obstacles for small institutions. Said an anonymous endowment office professional, “If I were running a small endowment, would there be a place for early stage venture in my portfolio? Of course. So long as I could diversify across managers.”
As a bonus — and in the spirit of full disclosure — here’s a look at the early stage venture firm I represent, DigitalDx Ventures.
Located in the heart of Silicon Valley on Sand-Hill road, DigitalDx invests in healthcare-AI startups that save lives through diagnostics. We are doctors, lawyers, CEO’s, venture capitalists and investors knowledgeable about all aspects of finding, nurturing, scaling and exiting our companies. Top-tier venture funds in the valley have relied on DigitalDx’s partners for years and the team is deeply connected to Stanford and UCSF, among other preeminent medical institutions. Collectively, our Fund Partners have invested in over a dozen companies which today have a combined value of >$4 Billion. We have had five exits at 5x to 40x multiples and collectively have over 60 issued patents to our credit.
