Maybe you shouldn’t — it depends on your goals.
If you look at the Cambridge Associates or Horsely Bridge data, or other third parties, there is one consistent theme … so-called “emerging managers” produce from 20–30% of all venture returns. Or something like that, rough-and-tough.
And at a more anecdotal and qualitative level, it feels like even more than that when you are seeking the highest absolute returns on smaller investments. E.g., Lowercase Capital, First Round, Founders Fund, Emergence II, etc. all produced Best of All Times-level performances from new managers and new funds. Others like Union Square took off not too long after being new. But the funds aren’t that big.
So at first blush, it would seem you almost have to continually invest in the best new funds, not just the “top 4–7” funds.
But it’s not that simple. Several factors make investing in new funds really hard:
- The bite size is too small. Big LPs often like to write checks of at least $25m and don’t want to own more than 10% of the fund. That means a fund smaller than $250m really isn’t even an option for many LPs.
- Without past returns, can’t get it approved. Many conservative LPs require an established track record. Yes, a new fund with proven GPs from an established fund can meet that hurdle, sort of. But sometimes literally they want a “Roman V” investment — a fund that has been established already over 4 prior funds, with decent results.
- Lack of social proof. Social proof is important to many LPs just as it is to VCs.
- Lot, lot, lot, lot more work to invest in new funds. It’s a lot more work to write a check into a new fund, with a limited track record … than to just mail another check to Sequoia. This is a big deal.
- No one ever got fired for investing in Sequoia.
Ok so maybe you know you need to mix it up, add the next Chris Sacca to your portfolio … but for the 5 reasons above … you can’t.
Then should you just invest in the Top 4–7 funds?
Maybe. Maybe even if past results don’t guarantee future performance (an important issue in LP returns).
But … there isn’t enough room.
The Top funds are 90%+ full and usually way oversubscribed from their existing LP base. And even if you can get into them, you may only get a small allocation at first.
So if you can’t get enough capital deployed in the Top 4–7 funds AND you don’t want to take high alpha + high beta risk in Emerging Managers … you’re left with figuring out which other established funds you believe will outperform their peers.