Risk-Adjusting the Returns to Venture Capital

Performance evaluation of venture-capital (VC) payoffs is challenging because payoffs are infrequent, skewed, realized over endogenously varying time horizons, and cross- sectionally dependent. The authors of this study show that standard stochastic discount factor (SDF) methods can be adapted to handle these issues. The authors’ approach generalizes the Public Market Equivalent (PME) measure commonly used in the private-equity literature.

The authors find that the abnormal returns from both VC funds and VC start-up investments are robust to relaxing the strong distributional assumptions and implicit SDF restrictions from the prior literature: VC start-up investments earn substantial positive abnormal returns, and VC fund abnormal returns are close to zero.

The authors further show that the systematic component of start-up company and VC fund payoffs resembles the negatively skewed payoffs from selling index put options, which contrasts with the call option-like positive skewness of the idiosyncratic payoffs. Motivated by this finding, The authors explore an SDF that includes index put option returns.

This results in negative abnormal returns to VC funds, while the abnormal returns to start-up investments remain large and positive.

A solid start for Australian private equity in 2013

The first quarter of 2013 saw the Cambridge Associates LLC Australia Private Equity and Venture Capital Index (C|A Australia Index) post gains of 2.36%, according to the latest quarterly report released by The Australian Private Equity and Venture Capital Association Ltd (AVCAL) today. Over the same period, the S&P/ASX 300 Index continued to rise on the back of growing confidence in the US economy and domestic interest rate cuts, increasing by 8.04%.

The C|A Australia Index over the medium to long term outperformed listed equities, posting annualised net-of-fees returns of 7.18%, 3.71% and 8.99% over the three, five and fifteen-year horizons respectively. However, ten-year returns showed listed market returns of 10.21% outpacing an 8.37% return by private equity.

One-year returns for the C|A Australia Index were steady at 6.72% on an AUD basis and 7.42% in USD terms. For ten of the last eleven years, annual rolling returns for the Index have been positive.

Australian Private Equity & Venture Capital Association (AVCAL) CEO Dr Katherine Woodthorpe said, “It is interesting to note that the first quarter of 2013 saw the highest level of distributions to limited partners in the last five quarters, and the second highest level since records began. Despite the challenging environment for exits, it is encouraging to note that private equity is generally delivering good returns to investors, particularly with realisations being top of mind for many limited partners at the moment."