Harvard’s enormous endowment of $50.9 billion is managed by Harvard Management Company, an in-house nonprofit, to support the University’s mission. Needing to balance short-term and long-term needs, the endowment owns traditional stocks and bonds. However, it also owns something many might not expect: a disproportionate investment in venture capital. While traditionally viewed as a risky arena, there are good reasons why Harvard has chosen to allocate heavily to this asset class and why high-net-worth investors should consider following Harvard’s approach, among other endowments.
Why Venture Capital? Exploring the Benefits of Investing in Early-Stage Businesses
Venture capital provides unique opportunities to invest in early-stage businesses. Because these companies are still growing — and often needing cash infusions — there are opportunities to acquire significant equity at lower costs. These startups provide chances to buy equity with tremendous upside on the road to profitability.
These relatively low-cash inputs and longer-term horizons tend to align with investing strategies for the high-net-worth investor. Additionally, this venture capital investment strategycan offer the investor more ability to serve as a resource and advisor and monitor their investments than they would have in the public domain. These abilities to have more control over and insight into an investment are key reasons why endowments and HNWIs keep re-upping their allocations to venture capital.
The Advantages of Venture Capital Investments
Consider these other four benefits of VC investments:
1. The ability to influence. High-net-worth individuals can more effectively influence their investments because of the potential to obtain a large equity stake. By acquiring a larger equity share, HNWIs can steer the investment in ways they could not if it was a publicly traded investment.
2. High returns. The average returns on venture capital investments tend to be higher because of the barriers to entry, the patience required, and the inherent risk.
3. Personal connection. In general funds that buy broad swaths of the market, there are no chances for managers to connect with the invested companies’ leadership teams. They can listen to earnings calls and pore over prospectuses and 10-Ks, but there are few opportunities to connect with the companies and either influence managers or mentor them. Investing in the private sphere provides those unique abilities.
4. Diversification by promoting diversity. Traditionally, minority groups have been underrepresented in the business world. VC firms can seek to provide opportunities to people historically not able to access equity and debt markets — not only potentially living their own values, but also finding talented innovators and business leaders in places where others are overlooking.
How Endowments and VC Firms Mitigate Investment Risks
Endowments, like VC firms, are looking for strong returns on investment. However, neither can risk their capital carelessly. Endowments and VCs alike need to manage both short-term and long-term needs, often managing restrictions and investment protocols while also meeting annual return goals. Venture capitalists answer to their investors, and they have to show that the capital is not only growing, but also safe. Both endowments and VCs manage these needs and risks in similar ways.
In disciplined thematic investing, managers form hypotheses about specific areas and companies and carefully deploy capital into them rather than injecting it all at once. By diversifying their investment pools over several managers, continuing to monitor their investments, and tweaking their capital deployments, they mitigate the risk of poor investment results. In this way, even though they may not seek broader investment exposure, they are diversifying their positions and mitigating downside risks. Endowments look to do the same.
HNWIs looking for outsized returns may find them in venture capital. The tales of companies like Twilio and Warby Parker serve as examples of what can happen when venture investing goes right. However, it’s also important to realize that part of the value lies in the uniqueness itself — by stepping outside of traditional markets, there is an element of going off the beaten path. But when analyzed closely, that risk can be mitigated. Moreover, as discussed above, not exploring this field might be risky in itself by having a portfolio with too many redundancies and not enough alternative investments.
Image by Markus Leo