AngelList data isn’t the only source that suggests venture returns and the public markets are uncorrelated.
Portfolio theory suggests that making investments in uncorrelated assets could substantially lower the risk that investors must shoulder to achieve their desired investment returns. Unfortunately, one well-known complication with portfolio optimization is that it is very challenging to predict the future correlations between asset classes. For instance, Russell Investments data suggests that over the past 30 years, the correlation between stocks and bonds has shifted from modestly positive to modestly negative in most years but with occasional sharp reversals.
Invesco’s whitepaper The Case for Venture Capital features an astonishing result casually tucked away in a table on the second page: that the correlation between venture capital returns and large-cap equity returns is actually slightly negative, at -0.06. This was a surprising result because we would expect to see a positive correlation. For example, startup exit values such as IPO prices are highly dependent on public market valuations.
Fortunately, AngelList Venture makes so many early-stage investments—we participated in the seed rounds of more than 1,500 startups in 2019—that we can examine the recent correlation between public markets and early-stage venture using our internal data. The below figure shows the gross returns1 of the AngelList seed portfolio on a monthly basis against the performance of the Nasdaq Index from January 2015 through March 2020. Results from the first quarter of 2020 are shown in pink.
The correlation between these two time series is 0.0, totally consistent with Invesco’s original finding.
An obvious rebuttal is that it is unrealistic to expect simultaneous changes between public and private markets. Instead, a more accurate model of the world could be that the public markets do well or poorly, and that performance is then reflected gradually, perhaps over the next twelve months, in the private markets as companies get priced up or down when they go out to raise money. So what we really should be interested in is the lagged correlation between the index and our portfolio, which we should expect to be modestly positive over a near-term window. That turns out to not be the case either:
In this plot, the blue line is the lagged correlation between the monthly percent changes in the Nasdaq index and the gross performance of our seed portfolio. The orange lines represent the critical correlation values for significance (shown at p < 0.01, in an effort to accommodate the multiple hypothesis testing here): values between the orange lines are not statistically significant. Through 20 months none of the lagged correlations are statistically significant, even at the p < 0.05 level, and even fishing through multiple hypotheses.
We can think of several possible explanations for why early-stage venture might be uncorrelated with the public markets.
First, in the immediate aftermath of the recent stock market crash, every liquid asset—stocks, bonds, gold, oil, Bitcoin—saw their asset prices collapse in what appeared to be a flight to dollars. This increases correlation between these asset classes because all of them are moving simultaneously downwards. Early-stage venture could be insulated from some of these effects because of its illiquidity; even if investors wanted to sell off their positions, they would be unable to. This forces them to treat early-stage venture capital as a distinct asset class in the short term.
Additionally, early stage venture returns are generally driven by a few outliers that grow tremendously over a long period - Uber was over a 2,500X return for investors, but it was 10 years between the early stage financing and the end of lockup for those investors. If startup valuations are bets on what will happen many years later in the market that could provide insulation from the fluctuations of short-term market conditions.
The AngelList Venture investment portfolio is only seven years old. To learn more about long term trends, we looked at venture capital benchmarks published by Cambridge Associates. We see only a very weak correlation between annual vintage TVPI performance and public market equivalent indices:
Source: US Venture Capital, Index and Selected Benchmarks, Cambridge Associates September 30, 2019, page 13. NASDAQ Index is a constructed index. Please refer to the full Cambridge Associates report for full methodology.
Similarly, indices with very long time horizons do not appear to be correlated with public market equivalent indices:
Source: US Venture Capital, Index and Selected Benchmarks, Cambridge Associates September 30, 2019, page 6.
These results may align with conventional investing wisdom. As we have mentioned, venture investors typically expect a small number of breakout companies each year to drive the vast majority of venture returns. This smaller sample may have more sources of variance and thus a lower correlation with a large public market index. Moreover, the value of these breakout companies is likely driven by idiosyncratic, company-specific factors. Whether or not a startup can bring an emerging technology to market and dominate their industry is usually a bigger driver of value than the health of the market or economy.
In short, we find no evidence for correlation between early-stage venture and public markets looking at both AngelList and long-term performance data. It’s never the wrong time to build the future.
1 Gross returns do not reflect the fees and carry that would have been charged to investors. We use gross returns here to include the fund investments that make up the majority of recent AngelList seed investments and the impossibility of accurately dividing their portfolio-level fees to the individual investment level. Informally, the effect of looking at net returns would be to shift all of the scatterplot points down a bit, which would have limited effects on correlation.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.
Investing in venture capital funds is inherently risky and illiquid. It involves a high degree of risk and is suitable only for sophisticated and qualified investors.
AngelList returns contained in this presentation are as of April 1, 2020. They may include valuation events that occurred (or were learned about) after that date, which is standard practice. We undertake no obligation to provide updates or revisions to reflect any changes in actual or expected returns.
Although AngelList has no reason to doubt the veracity of Invesco and Cambridge Associates benchmark data, it has not made any effort to independently verify its accuracy
Past performance is not indicative of future returns. This document and the information contained herein is provided for informational and discussion purposes only and is not intended to be a recommendation for any investment or other advice of any kind and shall not constitute or imply any offer to purchase, sell or hold any security or to enter into or engage in any type of transaction.
The simulated portfolio returns shown and discussed above do not represent the actual composition and performance of any current or future AngelList fund. These simulated portfolio returns have inherent limitations. They do not reflect the impact that material economic and market factors had or might have had if actual investments had been made. Returns achievable by actual funds may also differ from simulated portfolios due to differences in the timing and prices of investments and the identity and weightings of securities holdings. Data concerning returns from simulated portfolios also do not consider tax impacts, fee waivers, and other factors that would cause actual returns to investors to differ materially from the simulated portfolio returns.
For purposes of calculating unrealized returns, investment values are prepared in accordance with the methodologies described below. For early-stage companies, valuations are generally marked up or down to a company's latest priced round. Companies that do not have a new priced round since the last mark are held at the last mark or cost. Investments may also be marked down (but never up) at our discretion. This is an industry-standard method. For later-stage companies, investments are sent to a third-party for valuation if the company is valued over $100M, the investment is estimated to be worth over $10M, and 24 months have passed since the last investment. Smaller investments in later-stage companies are valued using the same method as early-stage companies. Estimated values for early-stage companies do not account for liquidation preferences and other non-financial terms that may affect returns. While AngelList’s valuation sources and company activity updates are believed to be reliable, we do not undertake to verify the accuracy of such sources. Valuations presented herein are calculated by AngelList based on data available to it as of the presentation date and have not been audited by a third party. Contact us for full details on our valuation methodologies.