While I won't to pretend to understand the details behind the article, but just looking at the many "startups" without a clear business plan, revenue stream not to mention profits which are valued in billions of dollars all of a sudden should make everyone's eyebrows rise if just a little.
10-15 years ago if you made an exit in 100's of millions it would be a worldwide sensation, these days it seems you sneeze and get 100M in funding and the WSJ posts an article about your company being valued higher than the GDP of some developing nations.
I remember when in the mid 90's Checkpoint got like 70M $ in it's NASDAQ IPO which was then a sensation which was talked about for year, these days that's considered a cold round 2 funding run for the next sexting app. Even with "inflation" and all that other nonsense the fact that since 2006-2007 you could probably count at least 40 US techstartups which got valued for over 1bln should hint a that something stinks.
Heck evernote which their current business model seems to be more focused around selling 70$ socks and 200$ messenger bags instead of you know their own actual techonlogy is valued these days at what 4-5bln, really? A company with 18M in yearly revenues after almost 8 years with no real assets to speak off, with a user base smaller than even marginally popular online games with almost no profit that hasn't even returned it's initial investment runs is valued at 300 times their pre-tax income?
Insurance companies and pension funds make up 50% and upwards of an average VC. The rest of the money also comes from sources which directly affect you such as local government, banks, and other "public" institutions. "Rich individuals" on the other hand do make up only a fraction of the VC source funding with less than 2% on average.
And while it's true that it doesn't represent the portion of the money a pension fund has invested in a specific VC. If you look at the breakout of your pension fund you'll find just how ridiculously high that percentage actually is. And BTW an insurance company or a pension fund that gets hit with even 5-10% loss means that tons of people lose coverage, premiums sky rocket and you end up losing more money that you could invest yourself otherwise.
https://www.calpers.ca.gov/eip-docs/investments/policies/inv...
Besides public funds you also have corporate and private funds which also risk a huge portion of their money in risky capital not only VC.
Total VC investments in 2014: $40 billion 300 largest pension funds control: $12.7 trillion
Total annual VC investment is 0.003% of pension fund value. That doesn't even include insurance companies and other smaller pension funds.
It doesn't mean anything when you say half of VC funds come from pension funds. It's still a miniscule amount when looking at the total value of pension funds.
Public pension: 20%
Corporate pension: 7%
Insurance companies: 7%
Union pension funds: 2%
---
"Insurance and pension" total: 36%
1.5. Elsewhere in this thread, dogma1138 suggests that the Bloomberg mention of CALPERS trimming their VC allocation is "to 1 percent, from 7 percent..." What is left off is the crucial kicker: "...of its private equity portfolio." Meaning that even CALPERS is allocating only 0.5% or so to ALL its venture capital managers.
2. The fraction of an institutional portfolio that goes to any one VC fund is usually well under 1%.
How it actually works (foundation / endowment model):
- Estimate asset class returns, volatilities, and covariances. This is done with historical analysis and some forward-looking hand-wave mumbo-jumbo.
- Chart out the "efficient frontier" of expected return per unit "risk" (volatility of return) across several model portfolios (each of which is a set of % allocations to the various asset classes). This makes a nice hyperbola that looks like a "C" and you pick one of the ones in the top left, meaning, more return and less risk.
- That asset allocation will almost certainly look something like:
Public Equity: most
Bonds: second-most
Hedge Funds: small
Private Equity: small
"Alternatives" in vogue at the time (timber, gold, real estate, rice paddies, comic book royalties, whatever): small
- Then, within the "Private Equity" bucket, you divvy that up and do a similar exercise:
Large Buyout: most
Middle-Market: recently more fashionable
Venture Capital: small
- Then, within each of those buckets, you pick a variety of "managers." Probably at least 3-5 in the VC bucket.
- Then, with each VC "manager" (VC firm) you allocate your commitments such that you can have some continuity of investment across the serial funds of that firm. (Note: if you don't have the size or sophistication to manage managers, you might just buy a "fund of funds" to achieve diversification within the VC sub-allocation of your PE allocation).
If an institution has 10% allocated to PE, they might have 2% allocated to VC, and of that, 0.5% might be allocated to a particular manager (firm), and it might well be put no more than 0.25% into a particular fund.
2.5 Insurers and pensions work differently from the above (endowment/foundation model) in some ways, the same in other ways. Crucially they both have to manage the expected liabilities of near term payouts -- but they don't do that with private equity / venture investments, they do it with bonds. See "immunization." They do, however, try to generate a "total return" on the surplus that is not expected to be used near term. Also I'm leaving out minimum 5% spend, etc., I know.
3. It is totally rational to put a small but meaningful sliver of your large portfolio into venture capital, especially and crucially at a time when entire industries (e.g. taxicab, booksellers, maybe internal combustion cars??) can get decimated by technology disruption within a decade. If nothing else, it's like buying a cheap put against the old-line stocks in your portfolio.
4. Yes, VC has its issues but dogma1138 is not pointing out any of them.
So, I'm sorry, but you're completely out to lunch if you think a VC fund or private equity fund is going to cause an insurer or pension "even 5-10% loss [such that] tons of people lose coverage, premiums sky rocket," etc.
The other problem is that today's so called "tech companies" have very little with tech. And, sadly, many companies including Evernote found out that hype pays more that actual working product. So they sell socks: why not? It gives them more revenue then Evernote subscription.
So there will be no new Oracle, new Cisco, new Sun in this bubble... Just bubble...
3rd in my life.... I hope will make money in next one.
Most venture capital funds return between almost nothing and nothing. Most venture capital companies are horrendous stewards of institutional money. You can look up the available data, it's ugly for everything outside the best of the best.
I fail to see how it's worse to take a 97% loss on the bottom 3/4+ of VC firms, as opposed to taking the same total loss on a spread of crowd equity funding investments.
1. Very large investors actually don't do anything different. The best game in town is the efficient frontier (modern portfolio theory; essentially, spread the bets around so some zig while others zag). Once you have more than $10 M or so, it becomes worthwhile to start optimizing at the margins; there are things that can be done with tax efficiency that have tiny but real gains, and there are things like exploiting the short rebate and negotiating for special concessions. But as a passive, financially-oriented investor, you're basically playing the diversification game.
2. That said, very large investors almost all get to be that way not by the diversification game, but by the concentration game. Think about the wealth generation period of any industrial fortune: it comes from highly concentrated equity holdings in a corporation undergoing a massive change in valuation (archetypally, profitable growth, although many an investor has done well by changing the valuation through other means, see ESL and K-Mart).
So. The way a person gets super rich is by doing something very different than what you are (should be) doing. And so while they are in that period, their portfolio looks very different. But once they are super rich, if they go to the world's best advisors, they are likely going to get something that looks like a well-diversified asset allocation according to modern portfolio theory.
For most people above $200K income, biggest expense is usually taxes. So it makes a lot of sense for wealthy people to dominantly invest in instruments which has lowest taxes. They take advantage of 15% tax rule for capital gains and also they take massive advantage of real estate sales which are taxed at zero or rates as low as 20%. In addition they can invest in real estate in countries with lax tx policies or where things are very cheap right now such as Italy, Greece and Iceland. Many wealthy also invest in new business projects happening in their social circle. For example, investing another friend's new beach hotel chain or in infrastructure project contract for some government. In these they have advantage that their friends have lot of inside information on how things will go and what are their key strengths, weaknesses and risks. If regular people are allowed to invest in these, they have lot less leverage and no opportunity for timely cash out when things are going to go south. Finally, regular Joe with $100K have far limited avenues for diversification (essentially just stocks and bonds) and even more limited resources for research and re-allocation of assets. Wealthy can literally exercise 100s of options including currency trading, commodities, foreign equities, futures and so on combined with sophisticated call/put options. While a regular Joe probably meets an accountant twice a year, super rich usually have staff of dozen or more in a dedicated office space to continuously analyze and re-allocate assets in realtime. It is not an accident that Bill Gates total networth has more than doubled despite of his massive giving drive and almost a decade long retirement.
Like when ordinary people invest into the stock market, and buy a company like Adept Technologies (ADEP) that goes from $21 to $6 in ten months (ADEP has been publicly traded for 20 years).
Or buy into a company like Dendreon (DNDN) which goes from $40 / share and a ~$10 billion market cap, to literally worthless in 36 months.
A person with $1,000 can easily lose all of it in the public markets. There's nothing stopping them from drowning in their own ignorance.
Investors often ride investments down, telling themselves in a delusional fashion that their investment will turn around if they just hold out. This occurred rampantly during the collapse of the Nasdaq in 2000/01.
Or companies like Bear Stearns or Lehman, that vaporized in a matter of weeks (Bear went from like $60 to $2 in two trading days), essentially completely wiping out public shareholders. Worldcom and Enron are other similar examples.
It's also quite easy for investors to play with options in the public market and rapidly lose everything. All it takes is filling out one form.
The only part of the economy that contracts in the Cuban scenario is the market for Yachts and Teslas (exaggerating, but you get the point).
The only way it spreads is if there are other macro factors that we haven't been told about by Cuban (because he doesn't know or understand them).
They will definitely lose their bets but it would be excessively simplistic to assume that if a bunch of VC's bust, their bust will not affect the market (stock market, etc) in any way.