The concentration-as-magnifier finding has a clean betting analogue: concentration is position sizing, and sizing above your actual predictive edge lowers long-run outcomes even when the edge is real. The Stebbings quote is the empirical version of that. If the best-informed insider cannot rank his own portfolio three years in, the honest estimate of picking edge at seed is close to zero, and the sizing that matches it is broad. What gets priced instead is the story about edge, which is how the widest return spread in asset management ends up paired with one of the lower medians.
And yet I wonder if we face the structural problems of perverse incentives and the frailties of human nature that are also contributing to this situation?
I think that the two and 20 structure provides a lot of incentive for people to pursue strategies that they think will return the most possible wealth to themselves, especially at the early stage where the fund sizes are too small that you won’t become wealthy from fees. If a man truly believed that he had a strategy to create a 10x MOIC return on his fund, he has a great incentive to do so, given that he’s gonna take 20% of the carry.
And then there’s just good old-fashioned human nature lol. In the sense that I think people don’t want to face their limitations or acknowledge that they might not be the next Khosla/Andreessen/etc and might not build the next major venture franchise. It’s a bitter pill to swallow as an investor that you should actually aim for a “mediocre” or “average” return. It is comparatively easier to believe in hubris and arrogance and delude yourself into thinking that you can do it.
Ironically, maybe the sweet spot is to be able to hope for the right tail outcome when building a venture firm well being able to construct funds and portfolio strategies that are willing to deal with the reality not all of us are gonna end up on the Midas list.
Keep in mind that the modelled outcomes are based on an average distribution of outcomes. It's entirely possible for a manager with a more diversified fund to outperform, it's just that the statistical gravity of that approach is a narrower band around 2-4x rather than the much more volatile nature of concentration.
The concentration-as-magnifier finding has a clean betting analogue: concentration is position sizing, and sizing above your actual predictive edge lowers long-run outcomes even when the edge is real. The Stebbings quote is the empirical version of that. If the best-informed insider cannot rank his own portfolio three years in, the honest estimate of picking edge at seed is close to zero, and the sizing that matches it is broad. What gets priced instead is the story about edge, which is how the widest return spread in asset management ends up paired with one of the lower medians.
You are the Yoda of Venture Knowledge!
Dan great post as always.
And yet I wonder if we face the structural problems of perverse incentives and the frailties of human nature that are also contributing to this situation?
I think that the two and 20 structure provides a lot of incentive for people to pursue strategies that they think will return the most possible wealth to themselves, especially at the early stage where the fund sizes are too small that you won’t become wealthy from fees. If a man truly believed that he had a strategy to create a 10x MOIC return on his fund, he has a great incentive to do so, given that he’s gonna take 20% of the carry.
And then there’s just good old-fashioned human nature lol. In the sense that I think people don’t want to face their limitations or acknowledge that they might not be the next Khosla/Andreessen/etc and might not build the next major venture franchise. It’s a bitter pill to swallow as an investor that you should actually aim for a “mediocre” or “average” return. It is comparatively easier to believe in hubris and arrogance and delude yourself into thinking that you can do it.
Ironically, maybe the sweet spot is to be able to hope for the right tail outcome when building a venture firm well being able to construct funds and portfolio strategies that are willing to deal with the reality not all of us are gonna end up on the Midas list.
Keep in mind that the modelled outcomes are based on an average distribution of outcomes. It's entirely possible for a manager with a more diversified fund to outperform, it's just that the statistical gravity of that approach is a narrower band around 2-4x rather than the much more volatile nature of concentration.