Blurring lines: public and private markets (Part I)
Prior to joining OMERS Ventures in Europe, I lived a life dictated by the opening and closing hours of various public markets. With some gardening leave under my belt, I’ve had some time to reflect on my transition into the world of venture capital and the lessons I learnt from my time on the trading floor.
I want to share some initial thoughts about what I learnt from my time in public markets and how, despite the drastically different timelines between day trading and VC investing, there are commonalities which exist. Moreover, it’s becoming even more evident that the significant wave of start-ups democratising access to private markets (more on this to follow) mean there is much which private and public investors can learn from one another.
What are the differences? What can be learnt?
An obvious place to start, is the sizeable difference in the risk and return being pursued by VC firms. Despite my background in Emerging Markets, which led me to previously think I had some concept of ‘illiquidity’, I’ve quickly seen that’s not the case. Indeed, early stage VC bets make Kazakhstani bonds look like blue chip stocks. Not only is there an illiquidity premium to factor, but as funds chase outliers, investments are being made in entirely uncharted waters — be that in frontier technology, companies which are pre-revenue, or who are yet to achieve product market fit.
This is also the case with the ‘reward’ being chased by VC investors. The concept of a home run in public markets is essentially little league to the major league baseball of VC. Even with the record returns seen in some global equity markets (e.g. the KOSPI returned 30% in 2020), the fact remains that a home run is remarkably different between the two asset classes. Single digit returns are aspirational in public markets. In the world of venture, we are chasing 20–30% IRR, which typically means you need a 3x return of your fund. Moreover, to be a real outlier fund, of late that has meant even higher multiples to return.
The importance of past returns:
Any trader will tell you, you’re only as good as this year’s performance. It’s irrelevant if you were the star performer in 2016 when you called both Brexit and Trump’s election correctly — that won’t keep you in your seat if you’ve underperformed since. Indeed, I think most people are familiar with the investment disclosure that ‘past performance is no indication of future returns’. The financial press of late is littered with stories of former rock star funds — who have underperformed and, in some cases, collapsed (e.g. the ill-fated Melvin Capital).
In the world of venture, things are viewed a little differently. A fund’s reputation can still very much be governed by the one unicorn in their portfolio from 2010, the halo effect in most instances doesn’t seem to dim. While you can argue that a lot of this is due to the far longer feedback cycles in venture, in my view there is another factor at play. I believe a large part of this is due to the asymmetric availability of information in private markets, which impacts in multiple ways.
This is particularly the case, when it becomes apparent that the validity of the halo itself in some cases should be questioned. In other words, funds can enjoy the prestige and PR which comes with a successful hypergrowth investment, even if this hasn’t generated hypergrowth returns for the fund. Because the average outsider doesn’t typically know whether a fund has a 2% or a 20% stake, it means that it can be as much about the PR of associating with a great investment, as the investment itself.
In a business which is built on connections, there is no equality in information access, and top tier funds do (for now) have a cutting edge. This is changing somewhat, given a) the number of emerging players in VC and b) the lower cost of capital for anyone looking to start a business — meaning founders are emerging from previously overlooked avenues.
On a personal level, I’ve also noticed one primary difference. VCs are supremely optimistic people — anyone can point out why the thousands of companies which OMERS Ventures meets a year might fail, but it takes optimism and talent to spot the reasons which will lay the foundation for a company to not only succeed, but become world leading. This optimism is not shared by the majority of people on a trading floor — and especially not those who have a number of crises under their belt. What can be learnt? Life is better as an optimist.
What are the similarities? What can be learnt?
Diversification still matters regardless of which side of the fence you have a vantage from. One thing which is often overlooked, if we leave aside seed stage funds, is that traditionally later stage VCs do not invest in conflicting portfolio companies. This is changing somewhat as outlined here, but for the large part there is an understanding that we are looking to back only one team who we truly think can lead the market in their segment. This leads to a natural diversification in terms of sector and target markets being pursued within a portfolio. VCs also think about the portfolio composition in terms of geographical coverage, vertical coverage and the ‘moon shots’.
Despite the isolated bubble of the VC world, it is ultimately governed by the same exposure to economic cycles. Valuations are tied to public and private market comps, which leaves little protection from periodic global stock market wobbles. While the path to public is growing longer (more on this to follow) for most companies, public markets still anchor daily conversations around fundraising and marks. I’m no longer in the day job of predicting market moves — but inflation expectations might put pause to the recent runaway market levels and valuations. This is definitely something that people are growing increasingly aware of, and I would expect the macro climate to be a more frequent topic in VC spheres.
Finally, there is one unifying trait amongst this all — public and private investing are both businesses which are based on instinct and conviction. Ultimately you need to have the conviction that your position is the winning position. Be that whether you think the US 10 year looks cheap or whether you think you’ve found a category defining Series A start up (we happily have a few of these 😊). I’m hopeful that the years of being asked ‘what’s your view?’ on various currencies will stand me in good stead for the years ahead.
After years of being told ‘it’s better to be lucky than good’ by various colleagues across the trading floor, I do indeed feel exceptionally lucky to have joined the OMERS Ventures team in Europe. If you’re a founder in Europe who is curious about how we work, feel free to reach out and I can be found @lilymshaw. Keep an eye out for part II of this where I’ll be exploring the implications of companies staying private for longer alongside the blurring of lines between public and private markets.