Private Market Basics | AWM Insights #153
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Episode Summary
Private Markets represent a broad range of asset classes and opportunities for investors. Historically, the best-performing segment of Private Markets has been Venture Capital, which has also significantly outperformed public markets.
Investing in highly innovative companies early in their life cycles is a risky proposition, but if this strategy is implemented correctly, aligned with your financial structure, and the proper Due Diligence is done, it puts you in a position to potentially realize outsized returns.
These are the companies that will be household names in 5 to 10 years, and investing in them now not only improves your expected return but also propels our country and economy forward.
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Episode Highlights:
0:00 Intro
0:50 Why do we invest in Private Markets?
3:10 Why do we invest in Venture Capital specifically?
4:25 What do historical Venture Capital returns look like compared to Public Equity market returns?
7:10 Investing in Venture Capital with a multigenerational mindset.
8:14 The Impact of Investing in Venture Capital.
9:55 Expanding your network and growing your Net Worth through Physical, Intellectual, and Social capital.
12:10 Investing in the most innovative companies.
14:01 Text us
+ Read the Transcript
Brandon Averill (00:09): All right, Justin. Well, something was born out of our last conversation. We started talking a little bit more about the private markets and we hit stop on the record and I think came to fruition that what we thought would be really helpful for clients listening to hear is for us to impact this whole private market opportunity and very specifically the venture capital opportunity. And talk a little bit about why do we invest in venture, how do we actually go about it when we're implementing your guys' portfolio and making allocations here, what are we considering and how are we actually implementing? And so we're going to go through a little series here and really tackle a few different questions, but we're going to start with a very basic question.
(00:52): And that is why do we actually invest in venture? Why go through all of this rigamarole to do so? And then we can certainly get into more of the nuances on why doesn't everybody invest in venture capital? Why should you be really comfortable with us, as AWM, investing? And then our systematic approach to how we go about it. So there's a lot to unpack here, so that's why we're going to break it up into several episodes. But high level, I'd love to hear from you, Justin, when you think about our clients that are listening, what is the opportunity and why are we even investing in venture capital in the first place?
Justin Dyer (01:32): So I'd answered that question even taking one step back and say private markets in general, and we can even redefine that. I know we've touched on that throughout the podcast here. But why even think about the private markets in general? There's a number of reasons, which we'll definitely get into. But even stating that the private markets produce or represent a vast opportunity set, and just by the nature of how we think about investing, diversification, and getting access to as much of the power of markets as possible generally leads to more predictable and really healthy outcomes to meet your priority. Let's go back to those basics. That's what's important to us. So the private markets represent an incredible opportunity set. It's something like 98% of all companies in the world, I believe are private. So the public marketplace, which gets the vast majority of the coverage, you watch the news or you go to CNBC or Bloomberg or whatever, your website of choice, you're going to see numbers quoted from the public market indices.
(02:37): Certainly there will be chatter and headlines around private markets, but the bulk of the attention goes to the public markets and for good reason. They're large, the biggest companies are there for the most part, et cetera. It doesn't mean that private markets are not large and big companies don't exist there. But if we take a step back, we say, "Okay, well, wait a second. The public markets are not the only place, the only game in town, and we want access to the private side of things." And then we can look at the various types of private markets. So you have traditional private equity of which venture capital is a subset. And then you have venture capital, which the easiest way to think about the difference between those two is private equity is typically more mature companies. Maybe they were public at one point in time, or they're the size that they could be public. And venture capital is a new company. You're taking a guess or adventure, if you want to put those two words together, with starting or making an investment in venture capital.
(03:37): And the difference between those two, they're both attractive asset classes, but there's a big difference, and getting to your question, finally, the answer of it is why invest in venture? The short answer is it's the best returning asset class there is within the various asset classes that are commonly tracked. There's probably some out there that we're not going to hit on that maybe returns more than venture, but guess what? You probably can't allocate efficiently to it or it's a very small market. So really the short answer, long story, long response to your question is why venture? It's really the best asset class overall from a return standpoint. There's some caveats to that, which we're going to get into, but it's a phenomenal asset class from a pure return standpoint.
Brandon Averill (04:18): I think that's a fantastic [inaudible 00:04:20] cut straight to the chase. They have the higher expected returns. And you hit on this, I think when we talk about highest expected returns, sure, you're going to be able to find an example, you're going to find an example where somebody hit it rich somewhere. What we're-
Justin Dyer (04:35): Crypto 2020 [inaudible 00:04:36].
Brandon Averill (04:36): Yeah. What we're talking about is when you look for persistence, when you look for evidence that things have patterns, for instance, venture capital, and we will get into the nuances even within venture capital, but venture capital is a broad set, has had the highest expected returns of most available investments. And to put some real numbers to this, Cambridge and Associates, which is a really well known research body, has a benchmark and at the 3/31/2019, a kind of ending period, they created a benchmark and they measured from 2010 to 2016 the return, so the actual return back to the investors, was 21.9%. And over that same period of time, the public available stock market returned 12.2%. So there's a magnitude here. We're not talking about a couple of extra percentage points. There is a pretty significant magnitude, and I'd be remiss if I don't go into this because Eric, if he's listening, would jump all over me because people don't live in percentages.
(05:46): But putting real dollar numbers to that is in the public markets, say you put $100,000 into the S&P 500, five years later if it returned that 12, it's very simple illustration for everybody, but it returns that 12.2% return, in five years, it's $177,000, in 20 years, it's almost a million bucks. So pretty significant. It's why we allocate to the public markets. It's why we want to have have our money grow there. But if you're having the opportunity to participate on the venture side, here's the magnitude. 21.9%, that same $100,000, rather than growing to 177,000 in five years grows to 270,000. And when we get out to the 20-year market, instead of growing to a million dollars, it grows to $5.2 million. So those numbers-
Justin Dyer (06:42): Substantially, yeah.
Brandon Averill (06:43): ... are substantially different. And that's why we do this. And so I think the other big part of it, people will realize listening, is when we start to allocate to these asset classes, there are reasons why. We'll get into the reasons why people don't participate here. But I think a good trigger and a good mindset to have is because you need this time for these investments to grow and compound like that, you are making these investments probably not for your lifetime. You're making them for the generations ahead. And that's where a lot of people get in trouble is I think they think like, "Hey, we're going to get rich quick here," but really a consistent-
Justin Dyer (07:20): Not that game. Yeah.
Brandon Averill (07:21): ... yeah, mature approach to investing is to be consistent here and think about it for that multi-generational aspect.
Justin Dyer (07:28): Totally, totally. So I think that's a great foundation and it's pretty straightforward, cut to the chase. It's a phenomenally well performing or strong performing asset class. We're going to get into the trade-offs and the nuance to that in future episodes, but I want to definitely hit on more of a qualitative aspect to it, which is the impact. So venture capital is also often labeled the innovation economy. You probably potentially heard that around the SVB banking collapse, but it really is. It is where innovation is happening at the highest speed in the most, let's call it, critical and impactful areas. So you can't necessarily tie that directly to returns. You maybe could, you could try, but let's not get too cute and just say, "Hey, impact and the innovation economy continues to support the United States, the world from a productivity standpoint, taking on some of the toughest challenges." And you're doing so and you're getting a good return, or you should be getting a good return too. Again, there's some nuance to that. But I think that overall idea of impact is a great reason to invest as well.
Brandon Averill (08:41): Yeah, I think it's huge. And I think when you're investing in venture capital, you're fundamentally making a vote. We talk about voting with your dollar. You're actually voting on a very optimistic future. You're investing in the people that are trying to change things. I think a great example to bring tangible to it is we've invested in a fund that took those dollars invested in a company that's rethinking the entire in vitro fertilization process. As somebody that personally has gone through that, Luke, your buddy, your number three round of in vitro, it's a painful process, it's an expensive process, and there's a company out there that's trying to make that approachable for everybody.
Justin Dyer (09:20): It's awesome.
Brandon Averill (09:21): It's just phenomenal and so you're starting to see these are the dreamers that find these processes and you're participating in that impact. So it's a pretty phenomenal statement. And then the last piece of this, we talk about this a lot when we're with you guys in meetings, et cetera, is I would say the third pillar of why do we invest here is it ultimately leads to a more fulfilled life, exposes you to a whole nother breed of people. And this is playing off of the last point and companies and resources that we talk to you all about your physical capital, obviously if you're an athlete specifically, you're achieving or you're maximizing that physical capital right now based on your abilities.
(10:07): Then there's the intellectual capital for our founders that are listening, you're taking your intelligence and you're building up companies and value, et cetera. And at some point, athletes, you're going to have to go to this side as well. Unfortunately, we don't play forever. And then the last piece is social capital. So these are just networks that are accessible to you. You go through San Francisco for instance, or Oakland, it's an opportunity for us to make introductions. There is venture and interesting people all over the country. So it really does expand your world and helps you to fulfill those priorities that you're trying to achieve.
Justin Dyer (10:44): Yeah. And I think maybe this is a good transition or teeing up next episode that it's an incredible ecosystem, it's relationship based, some of the smartest people I know exist there, but you also can't get too caught up in that, in the bright shiny objects that are always in existence. You hear these people that are starting these incredible companies or have these incredibly powerful ideas that may not translate to the market at this point in time. And so that's just teeing up a little bit, the risk profile and the things we need to be aware of when we're getting into venture specifically, but private markets in general, it's captivating, it's compelling. You could put so many words out there that really get you excited, but you do have to take a step back and say, "Well, wait a second, I can't get too ahead of myself." This is still a very rigorous process that can't just be decided based on emotion and a feel, if you will.
Brandon Averill (11:39): Oh, I think it's the most difficult part, is saying no to some of these opportunities. And I've talked about it previously, but it's such a story that illustrates this I think is good to remember. It's walking the floor at the Consumer Electronics Show in Vegas, CES, with David Crane of Google Ventures, one of the early employees at Google. Phenomenal investor, had a tremendous success, walking the floor with him and just watching his excitement. Wow, look at that product, unbelievable. Engaging with the founder, da-da-da. And we get about 15 steps away, it'll never work. It's like, "Holy cow." I was ready to write a check. But I think at the end of the day, that's what the best in venture investors in the world do, they get exposure to a lot of different things. They're wrong a lot.
(12:26): Bessemer, Bessemer Ventures is one of the most... I think they're the oldest venture capital firm in the country. And they've got an entire wall and a page on their website, if you go to their website, of all the deals they didn't do. And the names are just unbelievable. And so this is an extremely difficult game to play. It's why when we talk to you guys that are in the clubhouse, you get these deals that come through, people are talking about them, deal-by-deal is just not a very successful way to go about this business because it is that hard. You're seeing maybe, I don't know, at best, 10, 15 deals a year. These guys and gals are sifting through thousands of deals per year and taking those pitch meetings. So we'll wrap up today.
(13:11): Really just want to summarize why are we investing in venture? First and foremost, highest expected returns. We wouldn't be doing any of this if we didn't believe we would get compensated for it. Secondarily, it is a vote to change the world. You are participating in the innovation economy and you're really participating in the move forward. And then the last piece is it opens up a whole nother world to you, a whole world of network, if you want to tap in and access that. So there's three really good reasons that we invest in venture. We'll certainly get into probably in the next episode, "Hey, this sounds great, Justin, why the heck doesn't everybody do it?" And there's some really, really good reasons. And maybe you're listening to this and you're a client of ours and we haven't advised for you to do this yet. So we'll go through why that might be the case, but it's probably in your future. So without anything else, we appreciate your time and as always, own your wealth, make an impact, and always be a pro.