Fri, Dec 19, 2014
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. Investing - Big hedge funds win again on PetSmart, Riverbed, RBS sells real estate loans to hedge fund Cerberus, Talisman energy speculation: Which hedge funds could benefit?[more]

    Big hedge funds win again on PetSmart, Riverbed From CNBC.com: Another week, another set of wins for activist investors. On Sunday, pet supply retailer PetSmart agreed to the largest leveraged buyout of the year at $8.7 billion. Hedge fund firm JANA Partners had been pushing for a sale a

  2. Outlook - Hedge fund manager who remembers 1998 rout says prepare for pain, Bond guru Bill Gross predicts U.S. economic growth to dip to 2%[more]

    Hedge fund manager who remembers 1998 rout says prepare for pain From Bloomberg.com: Stephen Jen landed in Hong Kong in early January 1997 as Morgan Stanley’s newly minted exchange-rate strategist for Asia. He was soon working around the clock when investors began targeting the region’s

  3. Opalesque Exclusive: U.S. legal receivables fund launched in August[more]

    Benedicte Gravrand, Opalesque Geneva for New Managers: Investing in asset-backed receivables is a strategy that has been an integral part of the alternative investment space within the overall fixed income asset c

  4. Comment - High fees and low performance hit hedge funds[more]

    From FT.com: Disenchantment over high fees and lackluster performance may finally be turning the tide against hedge funds, fresh data suggest. Despite generally weak returns since the global financial crisis, hedge funds have enjoyed positive net inflows every year since 2010. This helped assets und

  5. Performance - Lansdowne, Man Group, other hedge funds profit from shorts in oil, Turmoil boosts hedge funds that bet against Russia, oil, CTAs post strongest returns since December 2010[more]

    Lansdowne, Man Group, other hedge funds profit from shorts in oil From Valuewalk.com: The rising short interest in oil companies implies that the worst for oil is yet to come. Data from Markit shows that short exposure in energy sector of S&P 500 is still looming close to the highest mar