Diversifying a portfolio across various asset classes is the first principle for enhancing returns without significantly increasing risk from an investment standpoint. Traditionally, the go-to formula has been a 60/40 split—60% in stocks and 40% in bonds, a practice primarily due to the limited accessibility of alternative asset classes. However, recent years have seen a democratization of access to a wider array of asset classes, including private equity, venture capital and numerous alternatives, opening doors for more investors to explore areas once reserved for the privileged few. This broadening of opportunities is undoubtedly beneficial to many.

Yet, it introduces a new challenge: How do we assess fund managers across different asset classes? This task can be daunting even for seasoned investment professionals, as investing encompasses a vast range of specialties. A common mistake is posing the wrong questions, as assessment criteria are not interchangeable across asset classes. It is akin to comparing athletes from different sports—evaluating NBA players is not the same as evaluating MLB players since each asset class is akin to a distinct sport. For instance, inquiring about the batting average of an Olympic gold medalist swimmer is as illogical as expecting an NBA MVP to be proficient with a baseball bat. 

It’s also unwise to question a fish on its ability to skate!

This blog post is the first in a series designed to demystify this process. I do not claim expertise in all asset classes—no one can. However, I hope to share my experiences to help you sidestep common mistakes and empower you with the basics to evaluate investment opportunities in unfamiliar territories, especially early-stage venture capital, which is my swim lane and relatively few people have the experience to assess. Please note, this blog post does not constitute investment advice or a comprehensive guide across all asset classes as we only cover a handful for illustration purposes. 

Here is a chart that highlights the key differences:

How should you interpret this chart? Let me use early-stage venture capital, or simply referred to as VC, as an example.

Assessing VC is more art than science and more qualitative than quantitative. It offers far higher return potential than almost any other asset class. On the other hand, the risk of losing money is also higher than in other asset classes, with the predictability of the potential target return being low and its variance high.

Individual investments within a fund portfolio have a very high failure rate, even for the best funds. This is by design because VC is a home run derby. Strikeouts, singles, or doubles don’t impact the return at all, as only the home runs count. This is unique to VC and counterintuitive to managers from other asset classes.

The dispersion among fund managers is also much higher, as the top decile funds generate significantly better returns than the rest. Vintages also make a far more significant influence, as market downturns have an outsized impact on fund returns, even for the best funds. However, the best funds still generate very good returns during bad years. These funds simply generate enormous returns during the good years!

VC takes a decade or more to generate returns. The first few years usually have nothing to show for because it takes a few years to find the startups to invest in, and they take time to grow and realize the gain. Because of this, VC funds are usually illiquid.

On the other extreme, fixed income is more science than art. It is number-driven, much more predictable, and has lower returns, but any default is a cardinal sin!

Each row on the chart deserves a separate blog post. Stay tuned for subsequent posts in this series, where we’ll dive deeper into these topics.

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