LPs’ take on the changing world of venture

PitchBook senior analyst Joshua Chao discusses key trends from the H1 2021 Greater China Venture Report before Hamilton Lane managing partner Miguel Luiña joins to share his perspectives on the challenges facing emerging fund managers, the democratization of venture capital and the lack of liquidity for venture investors. 

Listen to all of Season 4 and subscribe to get future episodes of “In Visible Capital” on Apple Podcasts, Spotify, Google Podcasts or wherever you listen. For inquiries, please contact us at podcast@pitchbook.com. Transcript Marina: Hi, Miguel. Thanks for taking the time to come on the “In Visible Capital” podcast. I always enjoy talking to you, and I have a long list of questions for you to discuss today. Why don’t we just jump right in? My first question to you is, if you can please tell me a little bit about Hamilton Lane and what role you play in the venture capital ecosystem.

Miguel: Yes, absolutely. Great to talk to you. It’s always entertaining. A little overview of Hamilton Lane, we are one of, if not the world’s largest LPs, so we help institutions invest into private markets. We cover everything from real assets through venture and buyout and credit, and within the venture and growth equity space, we do the same thing. We are one of the largest, if not the largest investor, within the venture space. We have about $110 billion of assets under management and supervision in venture managers, and about 300 or more relationships with general partners as well.

Marina: Right. I understand there is more of a fund-of-funds component and an advisory service that you offer. On that fund-of-fund question, I understand that many LPs have written off funds-of-funds. It’s too expensive and basically [not] delivering market returns. What are you doing that should cause them to take another look?

Miguel: I think that the fund-of-fund model has a lot of different nuances to it. One of the challenges of fund-of-fund investing is that it’s basically a plain vanilla strategy for all LPs who come into it, and people want different exposures. We do offer a small fund-of-fund product for smaller investors who are looking to access the space and want top-performing managers, but really, the core of what we offer are separate accounts. Those are tailored programs specifically to our clients’ needs. It doesn’t just have broad venture exposure, but it has very targeted venture exposure to get the results that our clients are looking for.

As far as the fund-of-fund model goes and the reason for working with a group that looks like us, either through a separate account or through a fund-of-funds, is the complexity of the venture market, which has really changed a lot over the last decade or so. Whereas it used to be a simple strategy within venture or you either had access to the top five names within the venture space, or you were essentially chasing returns within the market. Today, where it’s very much fragmented, there are a lot of emerging, interesting opportunities. There’s a lot more that you need to navigate. There’s a lot of industry and vertical specialization and niche managers that are delivering really strong returns.

Then, what’s stayed the same over that time period is that within the venture space, there is the largest distribution of returns across managers. If you’re in a top quartile venture portfolio, you are going to vastly outperform a portfolio where you’re in bottom quartile. As you think about the fee that you’re paying to a group to help you get access, if you think that by selecting better and getting top performance, you’re going to help perform by 5% to 10% annually over the next 10 to 15 years, which is essentially the duration that a lot of these portfolios have, the returns that you’re going to get in excess of those fees that you’re paying another group are going to dwarf anything that you’re paying them.

Marina: That’s an important point. How do you go about evaluating managers and figuring out who are going to be the ones that are going to be in the top quartile? What are you looking for now in terms of geography, sector, themes and more?

Miguel: That’s the challenge is that we’re in a very dynamic space. Established managers have quite a bit of rotation within their partners, and because of the nature of the venture market, there’s always going to be different sectors that are going to emerge as the winners and using the same playbook that you used in the past is not going to be effective going forward. What do we look for within groups and how do we build portfolios? One is we start with a macro view. We take a look at geographies, sectors, where do we think the next big winners are going to come from?

I think what we’ve seen is over the last decade or so, there’s been a real democratization of venture and technology and entrepreneurship globally. We think that the next great founder is not necessarily going to come from Silicon Valley. They can come from really anywhere in the world. Our portfolio reflects that. We have exposure within Asia. We have exposure in Europe, in North America and other key geographies.

The second piece that we look for is repeatability. There’s a lot of serendipity within the venture space, but there is some order to all the madness. It’s a known market and top founders oftentimes have their pick of which VCs they want to work with. We’re looking to partner with the groups that we think are going to get that first look, and they’re going to have essentially their pick of the litter of which founders that they want to work with, and that’s naturally going to lead to better outcomes over the long run and more repeatability within a strategy that looks relatively chaotic at the surface.

Marina: That leads to an important question of emerging managers. How do emerging managers attract LPs, especially since founders probably want to work with established managers the ones that have a brand name, but at the same time, there have been a lot of discussions about emerging managers generally outperforming established ones, at least over the last decade or so?

Miguel: There’s a really powerful flywheel effect within venture. Once you’re an established manager, you have a number of winners that you’ve invested in, founders want to work with you, you have a built-out reputation, it’s easier for you to access those companies. For LPs, it’s also easier for them to evaluate those managers because there’s an established track record. There’s something to take a look at it from past performance that should be somewhat indicative of the manager’s quality and ability to generate returns going forward, but that legacy flywheel of having great investments is not the only way to do it, and we’ve seen some really innovative strategies from emerging managers.

Some emerging managers just have a phenomenal reputation within their vertical, may have founded one of the leading businesses, or had been a critical player within there. Founders are going to want to work with them even though they don’t have that established brand. Some of them bring something different to the table. Like we saw this with Andreessen Horowitz about a decade ago, where services became a bigger part of the overall venture ecosystem, and they really paved the way with a different way of thinking, how do you serve the founder in a different way of thinking what it means to be founder-friendly. There’s other groups that are tackling that issue through different ways.

Then finally, there are the groups that could be great that venture investors are taking a more traditional approach, but from an LP perspective, it’s a little bit more difficult to evaluate and to decide which ones of those are going to succeed. From our perspective, we have seen a lot of managers that are in funds, one, two and three, performing really well. There also is survivor bias to some of that data where we don’t think that we see all of the data from the groups that started the strategy and weren’t as successful and rolled off. Within that more emerging manager space, there’s a lot of potential, but there’s also a lot more risk, and so that’s important for LPs, and as we evaluate it, it’s important for us to make sure that the risk-return dynamics are there and really think that it’s something highly differentiated that makes it worth taking that additional risk.

Marina: Another question I have about emerging managers is that here at PitchBook, we track new funds and fund formation, and we noticed that a number of new funds has fallen significantly over the last couple of years, but at the same time, venture has added more capital than ever. Can you explain that paradox? Why is it harder for emerging or new managers to get started now?

Miguel: I think that there’s a couple of components to that. I think one is the more established players are looking at their platform from a business perspective, and there, they realize that they have the ability to take much more wallet share from their LPs than they have historically. If you think about the top players historically, they’ve kept their funds relatively small, and they were massively oversubscribed.

Today, a lot of those managers are raising growth funds or international targeted funds for different geographies or additional strategies alongside those, and so they’re capturing way more of those LP dollars than they were before. When managers are coming back to market faster with more products and they’re taking more of those LP commitments, there’s just less capital available for others. Even in a growing market, there’s less room for new entrants.

I think the second piece of that is probably specific to the environment that we’re in, where everything we’re doing is over Zoom, and this is a relationship-based business. If you are an established manager, you have a long-term relationship with your LPs, there’s a lot of data points and a lot of references that LPs can have. It’s easier for that LP to make that commitment to an established manager. For a new group that’s still trying to build those relationships, more difficult to do it over Zoom. I know a number of LPs who won’t commit to a manager without having met them in person, and so just much more friction from that standpoint.

Then, related to that, one of the things that I’ve really noticed in this environment is LPs are willing to take a lot more meetings because it’s easy. You don’t have to travel anywhere. You can schedule them back-to-back on Zoom. I think the result of that is each meeting is just a little less meaningful, and there’s lots of follow-up after that because they are jumping onto that next Zoom, and there’s less time to think through and add them. That’s another challenge that needs to be overcome more so by the emerging managers than the established ones.

Marina: Speaking of a lot more capital coming into this market, where do you notice a lot of the capital coming in from, and what kind of institutions trying to get a bigger allocation to the venture market?

Miguel: I think from most areas. If you think about the historical backers of venture, probably the majority of capital came from foundations and endowments. I think foundations and endowments, they’ve seen their portfolios grow. They’ve also faced some headwinds over the last year and a half, and some of them can be overweight, the venture and growth space. I think we’ve seen continued focus on venture growth from those types of LPs but less overall growth because they were already at a point that was a little bit more saturated than other LPs. We’ve seen a big influx, probably five-plus years ago, from sovereign wealth funds. They’ve come into the space in a big way. They continue to grow, and so that is one big source of new capital.

The other source of capital that is finally behind them are public pension plans where many of them wrote off venture 10, 15 years ago because the asset class wasn’t performing for their portfolios and also because it was difficult to scale. You look at where the market is today, the asset classes outperforming pretty much every other private market strategy. These funds have grown to a size where they start to make sense for a public pension plan who’s looking to deploy capital in relatively big-ticket sizes. A lot of those groups have gone back to the drawing board and are thinking through ways of getting more access to the space.

The third piece of where a lot of growth is coming from is also from the retail channel. I think that that’s a broader theme within the private markets, which is retail investors having more access to this part of the market. Many high-net-worth platforms are increasing their focus on venture and growth and creating products for their client base as part of the market.

Marina: It’s interesting what you’re saying about public pension plans getting into venture. They obviously want to target larger funds because it’s easier for them to allocate through a large fund versus dealing with lots of small ones. What we’ve seen recently is this push towards larger funds. They are making up a larger and larger part of the market. With public pension plans coming to the market, do you think that trend is just going to continue?

Miguel: Yes, I see that trend’s continuing. It doesn’t seem like there’s an end to the demand for capital coming to this part of the market. Although I do think that some of the growth of the fund sizes is starting to slow down. I think that’s a healthy piece, but I think that the real critical piece that will determine it all are returns. Many venture funds raised growth funds, if they didn’t have a growth fund already raised, started raising it probably six, seven years ago.

Many of those funds are performing really well because there’s been a big valuation increase in the public markets that late-stage investments that those funds tend to target are a little bit closer to that ultimate exit and were some of the biggest beneficiaries of the growth and valuations. The returns look really good within those funds, which means there’s going to be more demand from the LP side to get more access to that part of the market. As long as those returns can continue to look really attractive, I think that there’s going to be a ton of demand for them.

Marina: Additionally, we seem to have a lot of new entrants into the venture capital markets, such as non-traditional investors, hedge funds, mutual funds, private equity. What are your thoughts on this?

Miguel: We have seen a huge influx of investors coming into this part of the market. I think it starts with the macro perspective of what’s driving a lot of that. What we’re seeing is a massive secular shift from the old brick-and-mortar online economy to a digital economy. With where technology stands today, we’ve seen companies with faster growth rates than ever before and much larger total addressable markets. That’s created this huge opportunity set of companies that didn’t exist historically for these players to go after.

We’ve also seen those companies delay going public. That’s shifted dollars and exposure from the public markets into the private markets. With that, we’ve seen a number of other groups come into it. Hedge funds who have traditionally focused on high-growth technology companies within the public markets, they’ve looked at this trend and they’ve said, “Well, we know how to evaluate companies in this stage of the life cycle, and the only difference between private companies today and public companies from a few years ago is the capital structure. We can work to figure that out.” Many of those groups have raised private funds targeting this space.

Buyout investors have looked at their business and they’ve seen tons of growth within this part of the market. They said to themselves, “How do we take our platform, what we’ve built, and expand it here because this was one of the fastest-growing segments within the private markets. We want to capture this for our clients and grow wallet share with our clients as well.”

Then, corporates are raising venture funds to go after this part of the market. Other groups like sovereign wealth funds want to get direct access to the deals, and then venture funds, which historically only seeded or did the early-stage investments, and let growth funds do the follow-on rounds. I’ve noticed that they have a competitive advantage as well and that they sit in the boards and have insider information on these companies and can select the winners and double down into those through growth funds and capture a bigger part of that value creation curve as well.

The way that we look at it is every strategy is different. I think that as a category some groups are better positioned than others. As long-time private market investors, we want to see more value add. We typically don’t favor stock-picking strategies. We typically favor strategies that provide something unique and differentiated, whether that is differentiated access to companies because of the unique angle that a platform has or differentiated value add to those businesses to help them continue to accelerate their growth.

Then, finally, there’s also a cultural component to this in that some of these groups, based on their heritage, have a culture that’s better set up to take advantage of the opportunity set. Within growth equity, the growth of the business is the most important component to returns, much less so than what your entry price is and some of the other components that you traditionally see. That can be a little bit of a hurdle for more value-oriented buyout investors to get their arms around and what we see out of more of our venture portfolio.

Marina: What do LPs think about this change? Are they happy to get additional allocation to venture through non-traditional investors such as hedge funds because they obviously allocate the hedge funds under a separate category?

Miguel: Well, I think that the dollars that they’re putting into work show how they’re thinking the market, and hedge fund investors who have come into this market are raising very large funds. They’re deploying them quickly, and then they’re continuing to step up in fund size. There appears to be a lot of demand from the LP side of things for those strategies. I think across the board, there is quite a bit of demand because it seems like all of these strategies are having no problems raising capital for this market.

Marina: What you’re saying is that hedge funds who are raising very large funds are not detracting from the interest in traditional venture capital funds.

Miguel: It doesn’t appear so. We’re at least not at the point of saturation with the early-stage managers. They continue to raise larger funds. I think that there’s also some differences in the client base of both of those groups. Traditional hedge fund investors that are familiar with those hedge funds in the platforms, and they feel comfortable with the strategy and the team and the approach, the bigger backers of their private market strategy as well. I think the same goes for the venture managers that are essentially leveraging their existing LP base who knows and trust them to go after the same part of the market as well. There is some overlap within those LP bases, but they are pretty different.

Marina: That’s interesting. Let’s touch on something that you addressed earlier, that’s the democratization of private markets. Are you thinking of adding products to serve the wealthy, but not the super wealthy?

Miguel: We have a lot of different clients across the organization. One of the fastest-growing client bases is our high-net-worth platforms. We partner with high-net-worth platforms to invest into the private markets, and we’ve seen tremendous growth and interest from that side of the business.

Marina: Great. Thank you, Miguel. Anything else that you are tracking or you find very interesting in the current environment right now?

Miguel: Yes, I think that one of the biggest challenges facing the venture market right now is the lack of liquidity relative to value creation. We’ve had a great IPO year. There is more exit activity today than there’s ever been within the market, but there’s also much more value creation than there’s ever been as well. When we look at our statistics, the distributions are essentially very low compared to their overall net asset value for the industry.

We’re also getting to the point where this big cycle within venture started around 2009, 2010, 2011, and that’s where we’ve seen the biggest value creation, but that’s also where we started to see companies really extending the time it takes to go public. Today, there is well over $85 billion of net asset value within venture portfolios that are over 10 years old, and the typical term for a private market fund is 10 years. We’re starting to see some cracks in the traditional structures that were set up to go after this part of the market.

We’re also seeing more and more need for liquidity, whether that’s LPs needing liquidity in order to be able to reinvest into the next funds and keep pace and continue to back these new products, or whether it’s general partners who may have been investing in fund one, fund two, fund three, great returns on paper but have not had a chance to crystallize any of their carry and stow from a cash perspective, still very much strapped and looking for a little bit of liquidity. Or corporates that have gone into venture and taking a direct approach into the market, but for whatever reason, their strategy has changed, and so looking to sell some of the portfolios.

Even at the company level, the way that RSUs are issued to employees, they contemplate an IPO typically within 10 years or some sort of liquidity of that within 10 years. Without that, employees need to exercise their options, and there’s significant tax implications, and it’s a very difficult situation for somebody that has high gains on paper but relatively little cash. What we expect is that the secondary market is going to be one of the most interesting places to invest into within the venture space over the next five to 10 years. It’s probably one to have some of the highest growth out of the overall industry, as well as a lot of those issues, need to work themselves out.

Marina: I wouldn’t be surprised if it’s going to be big because it just has to be, right. There’s all this money locked up.

Miguel: Yes, absolutely.

Marina: It makes perfect sense that that’s the next wave of things.

Miguel: It’s funny. It’s like it all catches up. It’s like it was public market, like everything happened in the public market, then it shifted over to the private market, and now liquidity is going to come to the private markets, and the private market’s going to look more like the public market, and we’re going to be at that similar place. We’re just going to be in a different category outside of the stock exchange but similar dynamics.

Marina: I guess the big question there is, is this going to be only institutions who are going to play in the secondary market, or can ordinary people participate as well?

Miguel: You’re going to have to do it through a fund structure. It’s too opaque. It’s too over-the-counter, essentially. Although some groups like SharesPost and things like that have tried to crack that, but not very effectively so far.

Marina: Carta is trying to do an exchange, and there are so many attempts.

Miguel: A lot of attempts, that’s right.

Marina: I don’t know if they’re working. Well, thanks to Miguel for taking the time to talk to us today. I always appreciate our conversations.

In this episode

Story continues

Miguel Luiña
Managing Director, Fund Investments

Miguel is a Managing Director on Hamilton Lane’s Fund Investment Team, based in the firm’s San Francisco office, where he is responsible for due diligence of primary fund investment opportunities. He leads the firm’s efforts in venture, growth and technology investments. 

Prior to joining Hamilton Lane in 2009, Miguel was an Associate at GE Antares, GE Capital’s sponsored middle-market leveraged finance group, where he underwrote, syndicated and managed a portfolio of first lien, second lien and unsecured credits. Previously, he was an Analyst in the sponsorship, underwriting and portfolio management group at MCG Capital.

Miguel received a B.S. in Commerce from the University of Virginia.