Venture returns require convexity, pacing and position sizing

Transcript

From the transcript How I Invest publishes with the episode.

1. 29:32

   When people ask me about what venture funds should I invest in, what startups should I invest in, I always first make sure that they have the right framework. And the way that I do my venture investing is you have to really understand the role of venture capital in your portfolio. Venture capital is not treasuries. It is not the S and P 500. It is not real estate. It is not private equity. It has a singular role, and that is to deliver outsized asymmetric returns once in a while.

2. 30:05

   It is the most bipolar asset classes, the most bipolar underlying portfolio companies. So the the way that I look at venture is you have to be both paradoxically bold and have the right portfolio construction. What does that mean? You wanna be bold. Every company should be this 100 or a thousand x or zero. Of course, depending on what stage you're on. But even today, I think the reason Benchmark is raised or is is raising a growth fund is because they believe that's...

3. 30:35

   There's there's their power laws at the growth stage. Yep. I don't think Benchmark woke up and suddenly became greedy. They've been one of the most disciplined investors in the world. But regardless of stage, you wanna take these highly asymmetric bets. A 100 x or zero. Just think about it from from an oversimplified... Companies like Anthropic, companies like Instinct, which was Mhmm. This this personal AI app, which, you know, I don't know.

4. 31:00

   Some probability, it'll go up to $500,000,000,000, and some probability, it'll go to zero. Right. And probably nothing in between. And then... And this is the thing that people get wrong. A lot of people get excited by that. A lot of people have this gambling compulsion. They're like, okay. Great. This is great. I wanna put all my all my money on, you know, the number 31 on the roulette table. The next and most important thing is you need to have the right portfolio constructions.

5. 31:23

   You need to be diversified. You know, in our fund, we have roughly 20 positions. So wanna take these very aggressive bets, and you wanna be diversified across different verticals. If you're an LP, you wanna be across multiple funds. So now you have, let's say, five funds of twenty twenty companies per vintage. So now you have a 100 companies, and then, you know, you you have one Anthropic, and one of your 100 portfolio companies across your five managers, you're doing well.

6. 31:48

   What do you think about that, and how would you improve upon that model? It's very, very similar to the way we we think about the world. So I think that the very difficult part for investors is to understand that venture is a great twenty year asset class. In any given period, in any... With any given fund, you you may have a flat spot. Even the best managers, it is it is not as perfectly predictable as as people might like.

7. 32:25

   What some folks do... You mentioned five. We use 10 in in our strategy. But what some folks do is say, well, great. Well, I'm gonna go and buy an index of the... A venture of some kind. And so what you lose in that, which is the problem, is because of the dispersion, you you end up losing all the convexity. And the only reason to do venture is convexity. It is you want the shot at an anthropic. You want to make sure that the potential is that the weight of that anthropic, ideally, will be great enough that even if it was in one of your funds, that it would still give you a...

8. 33:04

   An an exceptional return. You would still have a much better return than you would have if you'd been invested in Nasdaq or or some other benchmark asset. And I think that's the first key. I think the second key that's really hard for investors, and I'm sure you've seen this in your portfolio, we see it in our own, is that it's always tempting to think there's a right time and a wrong time. Right?

9. 33:34

   I shouldn't invest in the benchmark fund. It's the top of the market. AI's in a bubble, whatever. Yeah. Or or it's a terrible time. Companies are having trouble raising money. This doesn't feel like a very good time to be investing in venture. Or I've just lost a bunch of money. Now's a terrible time. Pacing and sizing. Pacing and sizing is what Matt Cortola, my partner, and I talk about all the time.

10. 34:02

    It's the great advantage the individual investor has because they can set their portfolio. So pacing, develop a program, multiple funds, multiple years. Sizing, ensure that the size is adequate, that you can continue that program over time. And then if you're sizing individual positions, you know, size them on a on a matrix that that allows you to take sufficiently sized bets over time such that no one bet wipes you out.

11. 34:36

    You know? As I say, the dead don't compound. So, you you know, you can't get... You gotta survive. And so I think when people think about that corner of their portfolio, then they can start to make probably what I would consider more appropriately aggressive allocations with the recognition that they... It's gonna have a very different return profile than perhaps what they're they're used to. So so many great points there.