The Fiduciary Responsibility Of Limited Partners

"Only in the fullness of time will we know whether we chose wisely…" is the wisdom by which limited partners are satisfied investing in venture. Smh.

A thought-provoking article by Chris Douvos, a Limited Partner (LP) and co-head of the private equity division at The Investment Fund for Foundations (TIFF) that appeared in PEHub and ended with the sentence:

“Only in the fullness of time will we know whether we chose wisely…”

prompted me to quickly drop another blog before my vacation and remove part of the lingering bundle of insecurity that continues to hover around investing in Venture by LPs.

I refuse to believe our future is that fragile. You will, too if you know what I have learned about Venture.

Nevergreen Horizons

Chris’ stance and his role as an LP for many government agencies reminded me of a CalPERS video in which the Chief Actuary of the $229 billion pension fund describes his attempts to align his 70-year investment horizon interests with those of the 10-year horizons of its Chief Investment Officer. Chris’ proclamation of “the fullness of time” differs depending on what investment hat you wear. Moreover, many government pension funds allocate tiny portions, usually in the range of 1-2%, to Venture (so does Chris’), and thus in fairness, his remarks should be reduced pro rata his dedicated commitment to Venture. He, after all, does not depend on Venture to produce viable returns.

I responded to Chris’ article with a closing sentence “Hope is nice, but it has to be hope we can believe in.” Referring to the dangerous continuation of doing nothing to a laissez-faire financial system in Venture that is now responsible for negative 4.6% 10-year average VC returns.

The problem is that a non-scalable subprime financial system by economic principle is simply incompatible with the scalable opportunity for innovation and thus can never improve the outlook for Venture no matter the length of the investment horizon.

Venture Escapism

A further reduction in VC firms will do nothing to improve the absolute performance of Venture. It will only reduce the damage incurred by LPs. It will certainly not maintain or propel our leadership position in innovation globally unless other countries are so stupid as to copy our current Venture Capital practices.

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Only about 35 out of 790 (original) U.S. VC firms make any consistent money in Venture. And many of the few past performers are now in grave danger, too, given the continued deflation of risk deployed to a specialized sector that relies on it. The subprime Venture maelstrom is taking no prisoners.

With dilutive investment networks, alternative investments vehicles (including PIPEs), and alternative investment sub-sectors (green tech, biotech, health tech, agtech deploy fundamentally different vintage returns), the remaining Venture Capital funds have over time deployed many options for widespread Venture Capital escapism, hang on to high-flying secondaries they did not see coming, and in some cases produce returns unjustly or selectively attributed to their Venture acumen.

Prima Donnas

Clueless about how to systemically improve their performance so it lines up with the massive opportunity for innovation, the remaining Venture Capital firms raise new funds from LPs based on their brand name and a past track record built by strong winds that make turkeys fly, while making up snazzy new investment theses (iFund, sFund, secondaries without primaries – anyone?) that as an LP you have no experience, nor reasonable arguments of how to say no to.

How dare you challenge the best of the worst when your only other option is to get out of Venture? Until now.

The recriminating argument is that as an LP, you may just have picked poorly in the supply of wannabe VC funds that were available ten-twelve years ago. VC was amid a bubble in which any innovation was touted and presented to the public as life-changing.

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You may have followed that enthusiasm with hasty commitments to ensure you got a piece of the then-lucrative lies sold to the public. And then reality set in.

Of Mice And Men

With many complicated diversification strategies unique to each asset class or sector, we cannot blame you as an LP for not being able to figure out who are the mice and men in Venture Capital. Still, there is one aspect you are not getting a pass on from me. And that is your fiduciary responsibility to invest Institutional money wisely and not to deploy unnecessary new, self-induced, or embedded risk. Right?

Regardless of asset class or sector focus, here is where many of you have failed in the deployment of sound monetary instruments:

  • No investment category with 10-levels of embedded diversification can accurately trace the merit of its underlying asset
  • No (impromptu) investment cartel scales consistently and deliver outlier returns
  • No financial system that violates free-market principles can consistently outperform other asset classes
  • No financial system that violates free-market principles can support the hyper-growth its global market has an appetite for
  • No risk management theory can reliably calculate the risk and opportunity across your asset classes if you do not know the risk in each asset class

The reality is that no one can predict with 100% accuracy which innovation is going to succeed (albeit undeterred experienced entrepreneurs achieve close to that). Still, we can predict with certainty that a laissez-faire financial system, backed by weak Private Placement Memorandums (I have seen them), that violates free-market principles our country was founded upon, chuck-full of collusion that puts our anti-trust laws to shame, can never outgrow its self-limiting infancy.

For those reasons, Venture has failed to grow up, and unchanged will never produce returns in line with the still massive appetite and opportunity for innovation.

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New Diligence

Whether as an LP, you decide to invest in Venture is yours to make. Please get out of Venture quickly if you need to. But don’t think for a moment that you can escape the identical fiduciary responsibility that will soon test your investment acumen in other asset classes.

Frankly, the ignorance many of you have demonstrated (by action or inaction) will treat any asset class as your first dating experience: a lot of excitement with no real sustainable life partner in view. Hopping around to other asset classes will not improve your long-term outlook.

Our financial systems (across the board) are a mess and the cause of our economic instability. With eleven times the size of production, our financial systems can, in their current incarnation, never accurately trace the market opportunity for production. The only LPs that will be successful are those who take the economic principles in the deployment of the financial system seriously.

Intent is the new hope

Chris’ story was quite a bit more innocent than I took it, and our line of communication is open. His message may have been to ask for help if you need to. But the times of sitting back and doing nothing are over. We are, after all playing with the people’s money and trust here. With trust as the only sustainable currency of success.

The opportunities in Venture are better than ever because when the majority of LPs, by a laissez-faire financial system, invest subprime, a brand new counter-cyclical opportunity for prime Venture investing opens up that is as modern and flexible as the opportunity that lies in waiting.

And no sector can act like a better and more omnipresent bonding agent for a more prosperous future than technology.

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