I'm Going On An (Ad)Venture

To contextualize the asset class where I spend most of my time, I often dive into a simple yet comprehensive quarterly report published by JP Morgan called the Guide to Alternatives. Perhaps very few readers of this report see the twelve other asset classes (Europe Core Real Estate, anyone?) with the same wide-eyed interest as the world of venture capital offers. Behind the manager dispersion and portfolio correlation statistics lie the fascinating aspects of power law, non-consensus bets, and the rocket emoji.

As a venture fund takes around 15 years to deliver, it was only logical to take a step back and contextualize the environment we’re in. What’s been clear is that overall venture fundraising is back to levels where it was in 2015. However, relatively stickier behaviors have stayed on. I wanted to reflect on three observations – the first more structural, the second that may seem controversial, and the third which is what keeps me excited.

The first observation is that for an industry that is more concentrated, returns will continue to remain dispersed, with top returns no longer restricted to a few.ed, with top returns no longer restricted to a few.

The concentration of funding into mega-funds has been an ongoing trend – a Cornell paper in 2000 extrapolated that by 2005, 50% of new money would be raised by fewer than 5% of venture firms. Fast forward more than two decades later: 9 funds alone in 2024 raised more than half of the total VC LP funding, and 30 raised two-thirds. The rest was spread amongst the remaining 10,000 (presumably smaller) firms.

How much of this is rational market behavior is a broader topic, as smaller funds have been shown to produce higher returns than larger ones. One argument is that larger funds are offering lower volatility as they are predominantly focused on funding (relatively) lower-risk Series B/C rounds. Sometimes the greater fool theory starts to operate, and the company has a higher chance of getting (over)funded by others. The deal sizes now start to look a lot more appetizing for other asset aggregators like secondary funds. This segment is starting to look like a different stratum within venture than the mantra followed by smaller funds. Surely returns are not going to be venture-like? I would personally like to see more analysis on this stratification of venture going forward.

The other argument is perhaps not as sophisticated but based on human behavior, i.e., raising a large venture fund sure appears rational to i) a fund manager for whom fees alone in managing $1 billion exceed fees and carry to someone managing $200 million even if the latter delivers top-decile returns, and to ii) large LPs (higher deployment, less career risk).

Below the mega-fund cohort lies the classical venture capital zone. This is where one sees the venture model operate in being this uncorrelated, non-consensus, funding-the-hard-stuff type of investor set. Specialized managers who can source well and leverage insights and networks have a better chance of backing breakout companies than generalists, as for what it’s worth, specialists outperform generalists by 4% IRR. Success would then depend on how a manager can navigate building a portfolio of potential outliers in a heavily funded market.

The second observation is around the lack of a ‘substantive’ effect of this funding.

Cyclically, like any other risk capital, venture funding is not always efficient, nor is it funding the truly hard stuff. Billions will be spent on white elephants with little to no real-world or tangential value created. Hype funding has been a bane of this asset class, backing things no one asked for. We were told that crypto would replace fiat currency and followed the narrative that we needed decentralization in our lives. How much for this? More than $100 billion.

The industry then caught on to Generative AI – funding an extremely unprofitable segment that is running out of training models. Is it all wasteful? Certainly not, as some truly remarkable technological advancements have emerged. Is it hyperbolic? Yes, as it’s not as transformative to productivity even in the medium term as the forecasters suggest.

Once invested, this pressure to make a return on it will be felt by venture investors, who will have to generate returns on these overvalued assets and by global tech firms spending hundreds of billions in AI capex with little sight of profitability.

Given this concentration, two questions emerge: are there no other high-growth sectors left? And the second one, which is more sobering – when we live in a world where a third of the population is still not ‘connected,’ where two-fifths remain poor, and living on a planet that is getting worse off – doesn’t this seem a bit disconnected?

This is what gets me to my third observation and why I remain excited about emerging markets.

My day job involves working for BII to invest across some of the most vibrant and fast-growing entrepreneurial ecosystems. Some of these markets really challenge the status quo and put the whole non-consensus investing philosophy to the test.

The emerging market venture ecosystem paradigm is fascinating – high growth, strong talent base, low cost, etc. It takes an entrepreneur and investor who truly live the markets to relate to some of the biggest problem statements of emerging markets. The best thing is the capital efficiency of it all – the cost per dollar of funding required to truly make lives better for the people and the planet is great – making it a great place to deliver top-tier returns if done well.

Will we see more breakout innovation and high-growth sectors? Yes – but investors have to moderate their sense of scale and therefore how much capital to put behind them. Perhaps this is why a segment of the venture industry still continues to be seen as true backers of innovation, where the benefits are to many and not just to a few.

Here’s to true innovation, backing the hard stuff, and going back to the roots of venture capital.