In this white paper, we investigate the effect of adding venture capital to equity/bond portfolios for retail investors. We show that it makes a compelling addition, significantly improving investors’ risk/return profiles.
We adopt the widely used mean/variance optimisation developed in the 1950s by Markowitz. We introduce assumptions using a mixture of market data and established research for equities, bonds and two categories of venture capital: scale-up and seed.
By introducing either of these, we can push up the efficient frontier, suggesting that venture capital can improve returns by 0.5% to 1.0% p.a. without changing portfolio risk for investors with normal risk appetites
We also show that a holistic approach to asset allocation is required. If venture capital is introduced, then we need to adjust the weights of the other assets to keep the overall risk constant. This means reducing equity weights and increasing bond exposure.
We also discuss product areas, list the few exceptions and discuss the fallacy of filling up pension allocation before looking at venture capital.
The UK is lucky to have venture capital schemes that offer significant tax reliefs to investors: Venture Capital Trusts (VCTs), the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). We show that that these tax reliefs hugely improve expected IRRs: almost doubling them in the case of SEIS. Unsurprisingly, these make venture capital even more attractive in our analysis. While there are nuances to applying these adjusted figures in practice, it shows that the original analysis is somewhat conservative.
The net result is that clients with an average risk profile should have venture capital exposure of mid-teen percentages or more, depending on which area of venture they have exposure to.”