Michael Mauboussin has rendered yeoman service to thousands of investors with this note on the migration of American money from public markets to private markets. While the note focuses on the United States, there are lots of interesting takeaways for Indian investors. We have listed below our three main takeaways but would strongly recommend that serious investors read this note for themselves.
Takeaway #1: The need for higher returns has been a big driver which has pushed American institutional money from public equity to private equity (PE) & VC funds. Over the last 30 years, US pension funds and US endowments have been under the pump to generate more returns. Since, as described below, PE & VC funds (especially PE funds) have consistently generated better returns than US public markets, pension funds & endowments have swung their allocation decisively in favour of these superior return generating asset classes: “CalPERS had about $350 billion in assets as of late 2019. The assumed return in 1962, at 4 percent, was about equal to the yield on the Treasury note. Through the early 1980s, the plan’s assumed rate of return was consistently below the yield on Treasury securities. By 1992, the assumed return had drifted up to 8.75 percent and the yield on the 30-year Treasury bond was about 7.75 percent, which meant the fund only had to earn a risk premium of about 1 percentage point to satisfy its return objective. At the beginning of the 2021 fiscal year, the assumed return is a more modest 7 percent but the yield on the 30-year Treasury bond is 1.4 percent, implying a risk premium of 5.6 percentage points. The chief investment officers of pensions and endowments, and the boards that serve the beneficiaries, have little choice but to seek risk in order to generate higher returns. For example, in June 2020, CalPERS announced that it would add leverage of up to 20 percent of fund value, or $80 billion, in order to increase the portfolio’s expected risk and reward. Historically, buyout and venture capital funds have helped meet the demand for returns.”
Takeaway #2: VC returns in America have been similar for the most part to public market returns except in the decade of the 1990s. In contrast, PE funds have consistently generated returns which are 10-20% better than American public market funds.
Takeaway #3: Whilst returns from all types of funds – public market, PE & VC funds – are dispersed, the dispersion is the most dramatic in VC funds (i.e. the best VC funds generally exponentially higher returns than middling VC funds). Even PE funds have higher dispersion in returns than public market funds. A corollary of this is the bulk of the returns in the PE & VC asset class are taken home by a handful of superstar funds and PE & VC funds which screw-up do so bigtime. In contrast, public market returns are more evenly spread out over funds: “Venture capital has the most investments that lose money but also has more big winners. Buyout funds have more losers than public equity but also have more winners. Only about one-quarter of public stocks lose money during this period, but the skew to the right is more modest than for either venture capital or buyouts.”
Takeaway #4: Unlike in public markets, where past performance does not seem to have a significant bearing on future returns, there is persistence in the returns generated by PE & VC funds (and especially so for VC funds): “Persistence is strong when the next result has a high and positive correlation with the last result. Funds that have done well continue to do well, and funds that have performed poorly continue to underperform. Research shows that both buyout and venture capital fund returns were persistent prior to 2000. Since 2000, however, venture capital fund returns have remained persistent while there is less evidence that buyout fund returns have. Some scholars attribute the persistence of VC returns to “preferential access” to subsequent attractive investments as the result of better-than-average results with initial investments.”
Our big takeaway for the Indian investment landscape: The RBI says that 95% of Indian households’ wealth is in physical assets (real estate & gold). Over the past 30 years, these assets classes have struggled to generate a rate of return above inflation. Now, as Indian families plan for retirement or for their children’s university education, it seems likely that they will allocate increasingly large sums of money to financial assets.
In common with America, high quality Indian companies are focused on building intangible assets and IP. Such investments can be funded more easily by PE & VC funds than by the public markets in India (which find it harder to take a well-informed view of investments where the main asset is IP). Hence, as in America, the number of IPOs in India will continue to shrink and the number of high quality listed companies in India will continue to dwindle (unless of course the regulators wake up and do something about it).
Finally, those Indian investors who are currently smitten by the notion that they can make more money from their angel & VC investments will learn in due course that returns from unlisted investments are unlikely to be consistently higher than returns from public market investments.

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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