BEATING THE Syndicate Room looks at how advisers can use radical diversification to outperform venture capitalists.
C
ontrary to conventional wisdom, Syndicate Room’s latest study reveals that investing at random in at least 30 start-ups could help you beat the returns of not only the infamous TV Dragons, but also most professional venture capitalists. The study tracked every UK start-up that raised seed or venture equity finance in 2011, for which reliable data was available: that’s 506 in total. This includes now-household names like TransferWise, The Culture Trip, and Nutmeg. Using the same dataset, we looked at the venture capitalists and Dragons that invested in this cohort to determine their 2011 start-up portfolios. Comparing the performance of these portfolios with that of the cohort as a whole, we discovered that radical diversification can help you outperform venture capitalists for one very important reason: by picking and choosing just a few businesses to back, these big investors are very likely to exclude the companies that go on to perform best. So, if a large and broad cohort of start-ups out performs the Dragons and most venture capitalists, this begs the question… IS IT TIME FOR A START-UP INDEX FUND? Overall, the cohort of 506 start-ups grew in value at an average rate of 28% per year between 2011 and 2018 (compound annual growth rate, or CAGR). Over the seven years, it saw: • 83 exits • 93 deaths • 86 companies enter venture stage • 74 companies enter growth stage • 170 companies become zombies
24
GB Investment Magazine · June 2019
Had you invested £10,000 in the full cohort back in 2011, by the start of this year your portfolio would have been worth £72,800. Given that the majority of the 2011 raises will have been eligible for EIS tax relief, the gain for qualifying investors would have been even greater. By comparison, publicly reported investments made by the Dragons in 2011 and 2012 grew at an average rate of 16% up to 2019. Our data also followed the 2011 portfolios of 479 venture capitalists, which together grew at 19% CAGR. Indeed, based on investments made in 2011, only 38% of UK venture capitalists were able to outperform the start-up cohort as a whole. This means that most venture capitalists would be better off picking their investments at random, rather than trying to pick the ones they think will succeed. RADICAL DIVERSIFICATION After carrying out repeat simulations of various investment strategies (100,000 simulations per strategy), we found that one of the most successful was to spread your risk among as many companies as possible. We dubbed the strategy ‘radical diversification’. We simulated investing into companies that raised between £500,000 and £5 million in 2011 to create portfolios of varying sizes. The simulations assumed that a fixed amount was invested into a single round of each company, with no follow-on investments being made. On average, a portfolio of 30 investments returned 3.7x of the initial investment in total over a seven-year period; when diversifying even more dramatically into 80 companies, this figure returned 4.7x. Radical diversification continues to hold true when applied to smaller start-up rounds (£150,000–£2
