This article by Allan Sloan of Fortune contains a very interesting chart, based on data from Cambridge Associates. The chart shows, for eight asset classes, the differences between the top 5th percentile of asset managers, the top 25th percentile, the median, etc for the past ten years. Here is the chart by itself:
(note: David Swensen presents similar data in his book.)
With the customary caveat that it's very difficult to compile accurate return information on alternative money managers, I draw the following implications:
1) The chart reinforces the observation I've heard before from Michael Moritz of Sequoia among others, that venture capital is a sucker's game unless you can invest in one of the few top firms--the top 24 out of 483 in Cambridge's data. If you could only manage to invest in a top 25th percentile VC fund, you would have been better off paying way lower fees and taking less risk in any of the four classes of publicly traded securities.
The top firms are the firms that everyone's heard of, whose partners are in the magazines and on Charlie Rose. They are the rich and get richer, because VC is not just about money, it's also about validation and access to a network. If you're a startup company, you'd much rather tell the world that you got $10mm from Kleiner Perkins than the same $10mm from your rich uncle. You'd also much rather have access to Kleiner Perkin's network of other investees and executives. Startups know this and therefore seek funding from the top VC firms. VC firms know this and therefore are able to extract very favorable terms on their investments. I hope to expand on all this in a future post. For now, check out these articles about top New York venture capitalist Alan Patricof. The myth that you can start a Fortune 500 company in your garage may be true, but it's much more difficult to start a VC firm there.
This dynamic is true to a lesser extent in PE.
2) The eye-popping returns earned in the past ten years by the best PE and real estate funds are almost certainly largely the result of leveraged bets that worked out well. I doubt the next ten years will be as favorable.
3) In any asset class, the ability to identify and invest in a top performing money manager rather than an average or poorly-performing one is a valuable skill. Encouraging news for me I guess.
4) If all this data is updated through 12/31/08, it will look a lot different.