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Comment by boulos | Hacker News Reader

So, I keep seeing articles comparing S&P 500 return versus the IRR of a VC fund, but none seem to compute "IRR" for the S&P 500. That is, they all seem to assume $1 invested at t=0 in S&P 500 (and I assume total return, so reinvested dividends), and then compare that to venture investing.

Except an $100M fund isn't $100M instantly deployed. The investors are putting probably $20M/yr into it via capital calls. That makes a huge difference in IRR.

This isn't to defend the particular investments or performance of any firm, but it does seem like the reporting is quite poor. Even taking the time to compute a "what if each year you invested 1/5th into the S&P 500" would be a marked improvement. But you definitely don't get to say "The 2010 Andreessen Horowitz fund performed slightly better than investments made in the S&P 500 in the same year" (as the article does).

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I agree that it's not an apples-to-apples comparison, but it's arguably somewhat in A16z's favor. This is because the fund manager has the ability to defer capital calls as long as possible, because that starts the IRR clock ticking.

This is fairly little known, but large fund managers like A16z have access to "capital call lines of credit," provided by specialty lending arms of banks. These are loans secured by the commitments from highly-creditworthy institutional investors that allow the fund manager to fund expenses and investments by drawing down on the LOC instead of making a capital call. This allows the fund manager to push out the IRR clock even longer, and effectively levers their returns.

A more effective comparison might take into account both your comment regarding deployment period, and also the effect of investing on margin with the CCLOC.

Edit: an article on the phenomenon and how it is a bit tilted towards the fund manager: https://www.pionline.com/article/20180402/PRINT/180409992/ri...

If the fund manager leaves your money sitting around in cash for a few years, that impacts your returns, since you could have put that money to work elsewhere. Including the gradual investment as part of IRR is the correct thing to do.

Sorry for not making it clear: they don’t ask for the money, until it’s “needed”. The term of art is “capital call” and while it’s possible to call at any time (perhaps you want to make a huge investment and you don’t have the cash currently), it’s usually somewhat spread out. The “default” behavior is an even-ish set of calls over say a 5-year period for a (nominally) 10-year fund.

Isn't the money in some sense tied up if it has to be ready for a capital call? At minimum it should be in some relatively low risk liquid investment. So there is opportunity cost regardless of whether the investor or the fund holds it until it is deployed?

Yep, but that’s equally true of any IRR calculation (for any IRR, you should compare to the risk-free rate or alternatively some other equal-risk benchmark). As an example, perhaps the real comparison for VC investment should be to having your “capital to be called” in the S&P 500 while waiting for capital calls. Except, as you allude, that’s quite risky for “you are required to deliver” (and IIUC, often within days). That makes the easiest assumption some sort of money-market fund or treasury something something.

In any case, the $X in S&P 500 at t=0 versus the IRR of a venture fund is not an apples-to-apples comparison. There are many ways to meet your capital calls, and I suspect that sophisticated investors aren’t keeping the cash in their checking account waiting for an email.

I agree it isn't apples to apples. I wonder if it is nevertheless the best comparison, though, because they're two fundamentally different beasts.

If I have a lump of cash I need to deploy, I can buy lump sum SPX at t=0. I can't call a VC and say "here's X money, invest it all immediately."

The fairest comparison probably would be lump sum SPX against a blend of VC IRR and money market, converted from one to the other at a typical capital call rate, but as the number of variables increases so do the number of assumptions, and given the low returns on money market funds I don't see how the extra complexity adds much to the story.

Am I missing something?

Kind of, it just needs to be sufficiently liquid that you can meet the capital calls as they come. If you've got 10% of a portfolio committed to a VC fund, you can keep the rest in the S&P and just sell shares as needed. However, you would have series of returns risk of the capital calls came during market crashes.

If you've got 50% committed, then you need to do even more careful cashflow planning.

You cannot compare the S&P returns to a VC return since the risk profile is different. You would need to compare the risk-adjusted return (alpha).

For example, as a hedge fund, I got 5%, and the s&p did 13%. Howver my stddev is 0.1% while the s&p is 20%.

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