2022 was a turbulent year for financial markets, with stocks and bonds shedding more than $30 trillion in value after accounting for inflation as tighter monetary policy and geopolitical tensions spooked investors. As a result, investors are seeking alternative types of investment to generate returns and diversify their portfolios beyond traditional stocks and bonds.
An asset class that is increasingly popular is venture capital. Norway’s sovereign wealth fund asked for a rule change at the start of 2023 to allow it to invest in unlisted equities to boost long-term returns. This follows on the heels of Icelandic authorities which agreed in May 2020 to allow pension funds to own up to 1% of their assets in venture capital funds. And since January 2022, Swiss pensions funds have also been able to invest up to 5% of their assets in venture capital. What are venture assets and how do they compare to traditional asset classes?
Despite the changing regulatory landscape, venture capital remains a mystery for a number of investors. Venture capital (VC) is a type of private equity financing that is typically provided to early-stage, high-potential, and high-risk companies with the potential for significant growth. Investing in venture capital funds is a common way to invest in venture assets as it provides exposure to a portfolio of startups, thereby reducing risk compared to investing in a single startup. However, this typically comes at a higher cost in terms of fees.
Overcoming the challenges
Historically, venture capital investments have generated returns that outperform traditional asset classes such as bonds and stocks. A paper published in 2005 found a mean return of 59% between 1987 and 2000. In the same period, the S&P 500 had a 15.9% return and Treasury bill a 6.8% return.
However, the returns from venture investments are more volatile and less predictable than those from more established markets, while investments also tend to be less liquid giving investors less flexibility to frequently update their strategies.
