LPs like to think that selecting top fund managers means a greater likelihood of blockbuster returns. And that conventional wisdom is especially prevalent in venture capital, where a few well-timed bets can yield truly incredible returns.
But new research from PitchBook suggests that in most cases, the ability to pick superior GPs may not generate any more alpha in venture capital than in buyouts, an asset class where the gap between the best and worst managers is narrower.
“That was the biggest surprise,” said Andrew Akers, PitchBook’s lead quantitative research analyst who led the analysis spanning 2004 to 2024. “The standard thinking is that there is more upside to manager selection in VC, due to the long right tail of outperformers.”
An LP that’s highly skilled at picking the best VCs added around 61 basis points in returns yearly over 25 years—or about 15% cumulatively.
Meanwhile, for buyout funds, an LP that is very adept at backing top fund managers may expect to see a cumulative advantage of around 16% over 25 years. PitchBook’s analysis assumed a 20% allocation to alternative assets, and a highly skilled LP had more than a 40% chance of picking funds in the top quartile.
This raises questions about the cottage industry of consultants and data providers that has been built to help LPs identify top venture fund managers.
The underlying thinking has been that since venture capital exhibits the highest dispersion among alternative asset classes, it must be particularly beneficial to select the best funds. IRR for the top quartile of VC funds ranges from 10% to 30%, and in the lowest quartile it dips all the way to -25%, according to PitchBook data.
There are a few reasons why top venture fund managers don’t yield as much alpha as an LP might expect.
One is that there’s more luck involved. PitchBook found that the probability that an LP’s venture portfolio with top VC fund managers will outperform a random venture portfolio 98.1% of the time. For buyouts, that figure is 99.9% of the time.
Venture may have a bigger luck factor when it comes to an LP’s returns, but luck doesn’t make for a compelling pitch to LPs. “While luck influences outcomes, you can’t build a repeatable strategy around it,” said Shamin Walsh, managing director at BAM Ventures.
Another issue has been the lackluster returns in venture since the tech market downturn began in late 2021. The top-performing funds, which rode the wave of the late 2010s, suddenly lost ground on their ultimate fund performance, and their outperformance has been subdued over the last few years. It impacted the ultimate fund performance of even the best VCs that were riding high in the late 2010s.
With that said, many of those VCs are now hoping that their AI investments will make up for that.
There’s also an important caveat. PitchBook’s analysis assumes that all LPs have equal access to top venture funds, which is far from the case. Investing in the Sequoias and Founders Funds of the world, historically premier funds, is an exclusive club. And these VCs, with the strongest reputations and networks, can reap outsized rewards. “It gets you into the right rooms sooner,” Walsh said.
And many of the elite VC funds’ returns are unknown and not captured in PitchBook’s data, due to the lack of a requirement for funds to disclose them. In fact, it leaves the possibility that the value of investing in these elite VC funds well exceeds a few basis points.
Featured image by Josie Doan/PitchBook News
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