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Jacob Miller discusses the factors that can potentially drive sustained outperformance
Key Takeaways
- Unique information and access are possible in private markets - unlike in public markets where such practices would be considered insider trading - and are vital to consistent fund outperformance.
- Venture capital managers with historical success in a specific space often have better data and connections, which can drive consistent outperformance if they focus on asset management, rather than asset gathering.
- The difference in performance between top- and bottom-quartile venture capital managers is significant, elevating the importance of identifying managers with persistent access and information advantages.
When you think about what drives outperformance, I have a very simple framework. First, you can have unique information. You know something others don't. Second, you can have unique access. You can buy or sell things others can't. Third, you can have unique insight. You're just smarter than everyone else. We can all hope for this, but it's a hard game. And fourth, you can get lucky. We can all, you know, rub our rabbit's feet, but probably not where we want to bet the farm.
Putting those things together, now, in traditional public markets, those first two are illegal. That's insider trading. But that's the lifeblood of private markets. And this isn't in some nefarious backdoor dealing sort of way. This is very simple stuff. Imagine if you're out there founding the next great engineering toolset, you found some product market fit. You have your first few customers. Who do you want to lead your next round? Well, if there's a VC who led the last great round into the company that came before you three or four years ago, it'll be a great stamp of approval if they invested and led your round as well.
And so you get this thing where that company, a leader in its space, will reach out to the VC who led the last thing, who now actually has better data because they back other companies in the space. This gives them both information and access that others don't have, which can lead to serial outperformance through time. Now, of course, this doesn't always last forever. And past performance is not indicative of future results. What we found in going over the data is as long as managers don't grow too quickly and focus on asset management versus asset gathering, that outperformance can persist, and those networks can lead to outperformance through time. But if you're growing too fast, 100% fund over fund, more trying to deploy billions of dollars in a year, it can be really hard to keep that limited access information piece as a consistent diversifier and driver of outperformance.
And you see this in the data. The difference between top and bottom quartile for a long-short public equity manager, depending on the year, is somewhere in the 4 to 6% range. The difference for venture capital is more 25 to 30%. And so those access and information differentiators, if you know who to partner with and have the right alignment, can lead to significant outperformance over time in a way that is really hard to drive in public markets. But the other side of that sword is you really need to have trust in your private markets partners and have a diligence process that helps you get to the point where you think that their access and information are likely to persist as they invest your capital.
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