Frontiers of Modern Asset Allocation by Paul D. Kaplan

Author:Paul D. Kaplan
Language: eng
Format: epub
ISBN: 9781118172995
Publisher: Wiley
Published: 2011-11-14T16:00:00+00:00

DATA

With venture capital investments, there are only two times a market-determined investment value is known: when the initial investment is made, and when the investment is liquidated. Over the entire life of the investment, the rate of return can be measured by the internal rate of return (IRR). During the life of the investment, there are a series of cash flows, but with no intermediate values, venture-capital investments have no time series of historical returns.

For venture capital investments that are yet to be liquidated, IRRs are typically calculated using reported values as if they were liquidation values. Venture capital partnerships report values on the basis of historical values and appraisals. The investments are infrequently revalued. Hence, the time series of IRRs based on reported values is likely to be far less volatile than what would be observed if the investments traded in a liquid public market.

Venture Economics collects data on initial investments, cash flows, reported values, and liquidation values for more than 900 venture-capital funds. It forms benchmarks for funds on a quarterly basis. If a fund terminates during the quarter, Venture Economics uses the liquidation value; otherwise, it uses reported values. Venture Economics calculates the IRR on each fund and combines the results to form benchmarks (“1999 Investment Benchmarks” 1999). The pooled IRR for all venture capital funds is estimated to be 14.9 percent from 1969 through 1998.

Of all the funds that Venture Economics follows, 148 had liquidated as of June 30, 1999. Venture Economics provided us the date of first investment, liquidation date, and terminal IRR of these funds. The average tenure of these funds is about 14 years. The oldest fund is about 39 years old and the youngest about seven years old. The earliest date of first investment is Jan. 1, 1960. The realized median annual IRR among the 148 funds is 8.5 percent, and the average is 9.99 percent. The highest annual IRR is 74 percent, and the lowest is negative 72 percent.

Cochrane (2001) points out that selection bias could be a problem in analysis of the venture-capital investments that are liquidated, because venture-capital investments are more likely to go public or be acquired when investments are successful. Cochrane applies a method to correct the potential selection bias in his study.

We agree that selection bias is a serious problem in analysis of a short-term history of the performance of individual venture-capital investments, but we believe the selection bias is reduced sufficiently in our sample for two reasons. First, our sample includes funds that invest in multiple venture-capital projects rather than the individual projects themselves. Therefore, the return data realized by venture-capital funds include both successful and unsuccessful projects.

Second, as our data cover 40 years, the funds that have not been acquired, gone public, or gone out of business become a relatively smaller portion of the total sample, assuming stable entry and exit characteristics. Furthermore, as our results are not very different from those of Cochrane (2001), the bias that is present in our work does not appear to be significant.

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