Opening Day
Results dispersion and America's Pastime
A comment that pops up periodically got some traction on LinkedIn the other day, and we need more than a comment thumbed away on our phones to provide our thoughts on it: "look at that, the median VC fund struggles to beat the S&P 500.”
I find this comment to be silly, and if I am tired, borderline dumb, since the S&P 500 is a hand selected, very frequently adjusted INDEX of leading companies in the US public markets, while a venture capital firm invests in 10-20 early stage companies in a much more concentrated way — not as an INDEX, but as a bet on future potential.
Since Spring has sprung and baseball season is upon us, let’s use this great game as an extended analogy. If every player is like a single company, the S&P 500 is like taking the top 500 players (those that play in the Major Leagues, excluding those sent down to the minors) and then comparing their results in a single year to a long-term bet on 12 year olds playing in the Little League World Series this summer in Williamsport.
The results dispersion of each of those 12 year olds is SUPER wide — some may end up playing in the Majors, but others will get hurt, or burn out in high school or college or even the minor leagues, or just decide that they are tired of baseball and want to be an accountant. BUT, although their results dispersion is super wide, you might also invest in them early with a risk-reward setup that may be compelling given how inexpensive they are compared to $70 million for Shohei Ohtani.
Buying into the S&P 500 is expensive, and the risk is relatively low, and the reward is relatively narrow — buying the index is better than trying to pick a single company (remember the glory days of GE or Yahoo or Dell or Whole Foods on the S&P 500?), but also very unlikely to go to zero or 100x, since the Index Committee meets roughly monthly to add and remove companies from the S&P 500 (with 4-5% turnover each year, or 20-25 companies) and the S&P has historically represented ~70% of total US public company market cap, and the earnings stability of these companies is solid.
The problem? There is a lot of POTENTIAL in the private markets, and a lot of VALUE accumulates there. Just like on the Yankees or Dodgers or Mets or Phillies rosters, roughly ~50% of the S&P 500 will change in any given decade. And meanwhile, south of the $30M/year price point of Ohtani or Juan Soto or Zack Wheeler or Aaron Judge (aka the MAG 7), there is a college southpaw or a high school shortstop who is creating a ton of value for their team, showing potential for the future, and can be invested in for a fraction of that cost. Not every one of those investments will go to the Majors (IPO), so you want to have more than a few of them on the roster (portfolio), but if a few do (Power Law), then you’ve made an incredible return.
All that said, back to our question at hand: If the MEDIAN venture fund, selecting players at the LLWS, or maybe a high school AAU roster, or maybe the NIL contract of Power 5 conference player, stays within tax-adjusted range of the hand selected, 3-5 day lead time for turnover, highly liquid index of the the Yankees (S&P 500)… then maybe it’s actually… not bad? And what about TOP DECILE venture firms?
But given fund selection is hard, and nobody chases the median, and the worst of these firms can lose most of your money… what about a hand-selected group of the best scouts (funds) of baseball (startup) talent across a bunch of different categories and strategies, plus double downs on the players (companies) that show the earliest promise, helping them continue on their long journey to the Majors (S&P 500)?
(Sorry, I’ve extended this waaayyyy too far…)
PLAY BALL!