Tue, Mar 19, 2024
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
Opalesque Futures Intelligence

The shortfalls of Venture Capital: Why VC has to become a scientific investment discipline

Thursday, November 21, 2013

By John Bhakdi

When we think about Venture Capital (VC), we think about great entrepreneurs, secret deals, and the adrenaline rush of hitting the "next big thing". Silicon Valley is in many respects the financial cousin of Hollywood: full of great successes, grand failures, of divas, heroes and villains. Financially not very pleasing, but a fun sport.

John Bhakdi operates a venture capital fund that utilizes an algorithmic method to make allocations.

But there is a new way of doing business in VC: an approach that uses advanced analytical science and algorithmic investment principles to assist in making funding decisions to remove risk, and give investors much more structured exposure to the world's most promising asset class.
But before I jump into the details, I have to make one important point: The reason we developed a scientific investment approach to VC is not that we have a general bias towards scientific investment in the first place.

"There is a new way of doing business in VC: an approach that uses advanced analytical science and algorithmic investment principles to assist in making funding decisions..."

We developed the i2X quantitative VC framework and the corresponding Innovation Index because we realized that the financing of innovation is a very special challenge.

The factors that determine the success of any individual early stage technology startups often lie far outside the company and even the founders themselves. They can found not by looking at just the company, but only by factoring in a much larger set of factors that we call "ecosystem".
And even after factoring these ecosystems in, it remains impossible to predict an individual startup's success for logical reasons. Therefore, we have to look at a larger set of startups - a "cluster" - and start looking this cluster an investment object. Only then do we get into a territory that offers statistical significance.

This new quantitative approach to VC is personally important to me. It applies the tools of scientific investing to solve probably the biggest problem in global asset management, which I describe as a lack of alpha.

As Ray Dalio once famously said: "In the long run, income can never grow faster than productivity." And productivity is a simple function of technology innovation whose largest growth comes from technology startups.

Since VC is in charge of financing innovation, it is not just a fun sport. It is the financial infrastructure that is responsible to generate growth across all asset classes.

And right now, it's a grandiose failure. At a $26b US volume, dismal returns of 6.9% p.a. - a negative alpha of 2.8% below the Russell 2000 - no liquidity and 30%+ risk, the numbers look not good.

The reason lies in an outdated approach to VC in that Venture firms simply apply the Private Equity playbook to technology startups: they look into their financials, their growth rate, their past. But this is not how innovation works. Truly disruptive startups have no past: they are new. Startups are future potential that unravels far too fast to wait for it to unravel before you invest.

By failing to provide a financial infrastructure that is built around the fundamental traits of innovation, VC fails to build the startup breeding ground our entrepreneurs, financial markets and economy rely on.

This failure and its negative effects have driven us to take action, and develop a financial technology that accounts for the unique nature of startup innovation.

Following this logic, I want to start the description of the i2X Innovation Index and quantitative VC framework by taking a closer look at the system of innovation it empowers. It is a system of four macro-factors which together form a wonderful mechanic of progress that we call the "Innovation Machine".

To read the full article click here.

ABOUT THE AUTHOR

John is CEO of i2X, the Innovation Index and Exchange. i2X offers targeted, highly risk-mitigated exposure to a scientifically designed index of the best US technology startups. John combines personal startup experience with an extensive track record as corporate executive with a focus on unlocking innovation potential across sectors and organizations. During his career, he has worked with C- and VP-level executives at WPP and Omnicom agencies, Deutsche Bank, Credit Suisse, MasterCard,Ebay, McDonald's, Dow Jones, Microsoft as well as top-tier Silicon Valley VC firms. John is a thought leader on innovation ecosystems, lean startup culture and scientific investment methodologies in Venture Capital.



 
This article was published in Opalesque Futures Intelligence.
Opalesque Futures Intelligence
Opalesque Futures Intelligence
Opalesque Futures Intelligence
Today's Exclusives
Today's Other Voices
More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. KKR raises $6.4bn for the largest pan-Asia infrastructure fund[more]

    Laxman Pai, Opalesque Asia: The New York-based global investment firm KKR has raised a record $6.4bn for its second Asia-focused infrastructure fund, underlining investors' continued appetite for private markets. According to a media release from the alternative assets manager, the figure top

  2. Bucking the trend, top hedge fund makes plans for a second SPAC[more]

    From Institutional Investor: SPACs aren't dead. At least not to the folks at Cormorant Asset Management. The life sciences firm, whose hedge fund topped its peers in 2023, is confident it will match the success of its first blank-check company. Last week, the life sciences and biopharma speciali

  3. Benefit Street Partners closes fifth fund on $4.7 billion[more]

    Bailey McCann, Opalesque New York: Benefit Street Partners has closed its fifth flagship direct lending vehicle, BSP Debt Fund V, with $4.7 billion of investable capital across the strategy. Benefit Street invests primarily in privately originated, floating rate, senior secured loans. The fun

  4. 4 hedge fund themes that are working in 2024[more]

    From The Street: A poor earnings report from Tesla (TSLA) has not hurt the indexes on Thursday. The decline in Tesla stock, which is losing its position in the Magnificent Seven pantheon, is more than offset by strong earnings from IBM (IBM) and ServiceNow (NOW) . In addition, the much higher-t

  5. Opalesque Exclusive: A global macro fund eyes opportunities in bonds[more]

    Bailey McCann, Opalesque New York for New Managers: Munich-based ThirdYear Capital rebounded in 2023, following a tough year for global macro. The firm's flagship ART Global Macro strategy finished the year up 1