Primaries vs Secondaries vs FoF: risk and return

Luca Mannucci, Managing Partner at Sella Venture Partners, recently participated in a linkedin discussion regarding secondary vs primary funds investing. Enjoy the reading!

The starting point was this picture:????????????????

Just by considering this graph you could imply that investing in secondaries is much safer than investing in primary funds. What about returns and upside? As one of my MBA teachers used to say, “there is no free lunch”, i.e., in the case of investments, there is no reward without risk.

Let’s then check the risk/return profile of investing in the different strategies available by using some data from Preqin.

I extracted all funds data in the vintage range 1993-2015 for three subsets of funds:

·?????? Secondaries funds

·?????? Venture Capital funds

·?????? Fund of funds

(Please note that Preqin does not allow for a subset of data for secondaries and FoF, which is a mixed vc/pe universe)

The result is the following:

How should we read this?

While it is true that the percentages of secondaries fund that do not return 1x is the lowest among the three strategies, it is also true that rarely a secondaries strategy will return over 2x (the top decile threshold is <2x as per table above).

The direct vc universe is by far the most polarized one: over 30% of funds will not return capital and approximately a quarter will return over 2x. Not surprising, as in the long run 1 every three vc funds has a negative return.

What about fund of funds? Rarely a FoF does not return its capital (only 5% but the vast majority of fund of funds with a TVPI of less that 1x are vintages around 2000-2002, i.e. when the vc industry was still in its early days). At the same time a FoF strategy has the higher probability among the three to return over 2x. Despite the double fee argument that us managers of FoF have to hear all the times.

Few final comments:

·?????? VC is a polarized asset class, and fund picking is difficult if you are not constantly exposed to the market. A non-specialist and unsophisticated stock picking in vc would result is a 30% probability of losing money;

·?????? Secondaries funds are a safe option but also an option capped on returns. It is important to carefully assess the speed in DPI when picking a secondaries GP;

·?????? Fund of funds: it is a balanced investment strategy, with a lower risk of single fund picking but still with a good upside opportunity. When I speak with LPs about FoF, I usually suggest focusing on the underlying quality of investee managers and less on fee structure (though still relevant).

In the end pick your strategy(ies) according to your level of desidered riskability, as this will clearly also drive your implied returns.