E341: Why VC is Changing Forever ($150 Billion LP)

0:00Tell me about consensus risk. I spend a lot of time in the field with investors and kind of the last question I always get asked is, what keeps you up at night related to the things that you're investing in? And as I thought about it, it's consensus risk. For some background here, it builds on an idea by a psychologist named Irving Janus, but people like Buffett, Marks, and Thiel also talk about it. And I specifically reference this thing called the consensus risk trap, which is groupthink, right? It's the illusion of some kind of invulnerability or collective rationalization that occurs when groups converge on a popular theme without really thinking about what could sit around the corners.

0:34So, you know, in venture specifically, which we're going to spend a lot of time on, it's I think about it as those hundred companies that today are valued at, you know,$10 billion or greater. And there's a lot of capital that wants to find their way into those companies. But it's not thousands of companies. It's less than 100. And that kind of gives me some concern. I ran this algorithm when I came up with this idea of if I just picked the top 10 themes that defined private markets in 2025 and fed those into an AI and asked it to stack rank them based on how much media coverage each theme got.

1:03I think as I worry about 2026, it's which themes got the most coverage from the media that was generally promoting. And I think there's some risks that we could face there. And we've actually seen a few of those play out in the last month or so. It's a quantification of a potential bubble of sorts. Yeah, I think that's right. How do you know something's a hot sector versus a bubble? it becomes pretty obvious when things move up into the right pretty fast. And look, with that kind of growth, there's always kind of bubble-like characteristics. So one of the questions I get a lot in these same meetings is, are we in an AI bubble, for example?

1:32And my answer is like, when Sam Altman or Jensen Wong say things feel a little bit bubbly, they're probably a little bit bubbly. And one of those risks I talked about in the consensus risk trap is, is there an AI valuation reckoning? I honestly didn't contemplate it being, could AI disrupt the software business model, but we've seen a bit of that play out right now. This whole question of, are we in a bubble? I think it's actually the wrong question. A bubble is just downstream of human beings investing, meaning everything will eventually bubble with enough returns. And you see this in other asset classes.

2:06You saw this in SPACs. You saw this in Bitcoin treasury. It's not a question of, are we in a bubble? It's how far are we into the bubble? and potentially how far before the bubble pops. In other words, if you know that you're five years away from the AI bubble popping, the right thing to do is to stay invested. There's always a bubble for any asset class that goes up. The question is how far into it are you and how big of a bubble is it? Not are we in a bubble? I think that's right. And maybe the bubble never pops. It just lets a little bit air out of the system and then it reinflates as it kind of makes its journey to kind of the future state.

2:40People have made this analogy. If you think about the internet bubble of 1999, which is when I first joined HarborVest, there was a lot of venture capital flowing into companies that were measuring eyeballs, and then that bubble burst. And when Internet 2.0 came around, there were a lot of VCs that decided they weren't going to invest in the internet. Well, that was exactly the right time to invest in the internet, because that's where the business models kind of got sorted out. And the dot-com boom, it took three, four years of 20 plus percent losses. It's not like a literal bubble that just popped.

3:06It actually just went down over three, four years. If you go back to late 99, early 2000, when the bubble burst, there was this weird thing that happened where I think a lot of entrepreneurs abandoned startup activity. They actually went back to big technology companies and there was a bit of a dearth of innovation that didn't happen from 2000 to 2010. What you need is these kind of moments, like these innovation cycles to play out that allow entrepreneurs to recognize there's an opportunity to build a company on top of the cycle. And I think this has been referenced before probably 2007 and the iPhone was that moment.

3:37But from an institutional investor standpoint, there was a period in like 2010, where if you look at performance data from Cambridge Associates on the venture industry, the 10-year return was negative. And a lot of institutions had concluded that this is not an asset class. The venture model is broken. And the irony is from 2000, if you measure performance in private markets from 2010 to 2020, it is by far the best performing sub-asset class within private markets. So I know it's never one-to-one and it's never like a textbook or like an academic thing, but do you see a direct correlation between investing in venture in the worst possible year?

4:10If you just consistently did that versus investing in the best possible year, you would have outperformed? Or is there more nuance to how you should invest? There's more nuance to it. What I'd tell investors if they're going to allocate the venture is they just need to be committed that they're going to do it over the long term because there are these windows where the outcomes are very big, but the windows are pretty narrow. And you need a ripe portfolio to sell into that type of market to make your return. And the mistake a lot of investors make is they're confident investing when the returns are phenomenal, but there might then be this period of time where those returns dry up, but you're planting the seeds that are going to sell into the next part of the cycle.

4:47There is correlation if you look at vintage year performance in venture and leverage buyout. In the years that the most capital is raised, there tends to be the lowest performance. and in the years the least capital is raised tends to be higher performance. I think that correlation - Shocking. Yeah, I know. But I think it's actually stronger in the buy-off space than it is in the venture space. Taking a step back, give me a sense for how big HarvardVest is today and tell me about your role. HarvardVest is a global private equity firm, but we call ourselves multi-manager. Our motto is built off of building really core LP investor relations with some of the top managers around the world.

5:22So think large investor relationships with 150 to 200 of the top performing venture growth equity funds and leveraged bio funds. But then we have a platform approach where we invest directly into companies alongside these managers, and we're also a very large secondary investor. So we provide liquidity into the market many times around these managers, and that's what we call platform approach. But to answer your question specifically, today we are more than 150 billion of assets under management. We have over 1200 people around the world. We have 15 offices around the world. Our original strategy was a venture fund.

5:56So our founders, Ed and Brooks, when they set out to raise our first fund, it was a multi-manager venture fund of funds, thought to be, if not the first, one of the first of its kind. But today, we give investors access to private markets, venture, growth equity, leverage buyout, private credit, infrastructure. And more importantly, we give them access through three different entry points. You can be an investor in a blind pool fund that might be raised by Excel or Index or somebody like that, you can invest directly into companies alongside those firms or their respected buyout cohort. And then the secondary strategy, we give them access through that access point.

6:32And that type of diversification across all those different areas just results in a very consistent, diversified, high quality performance experience for the investors. In the world we're in today with 150 billion plus of AUM, there's probably, we're not on an island on our own, but there's probably just a couple of other peers that are the same size that we're at. Expert calls have always been one of the most powerful ways to build conviction, but today investors are asked to cover more companies, move faster, and do it with leaner teams. With AlphaSense AI-led expert calls, their TGIS call service team sources experts based on your research criteria and lets the AI interviewer get to work.

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8:27Take advantage of AlphaSense AI-led expert calls now. The first to see wins. The rest follow. Learn more at alpha-sense.com slash how I invest. When we last chatted, you told me about how you use your skill to your advantage. Tell me about how you partner and why is your scale advantage? So we want to be not just an investor with leading firms. We want to be thought of as a strategic partner to leading firms. So in select situations, we have capital relationships across fund investing, direct investing, secondary investing. That might be$2 billion,$3 billion,$4 billion or greater of capital alongside what are some of the larger leading funds in the industry.

9:05And therefore, because of that scale and the capability that we bring to the table, it's not just passive investor. Our partners look at us more strategically than they do perhaps other firms. So I won't name names, but there's company examples. Some that were recent exits, you know, think$20 billion plus exits where through our fund investment, we gained access to the company at the formation stage. It could have been seed or series A. And let's say it was a$20 billion plus outcome. We would have gotten in at$100 million or less through our fund investments. And then as that company grows and de-risks, we might be presented with the opportunity to come in as a direct investor to price around in the company.

9:42And then through our secondary strategy, we could accumulate interest in that company that give us indirect access to the cap table through that process. So there was a recent cybersecurity exit, put it in the$20 billion plus category where we participated in the A through our managers. That was probably a 30 or 40 times return. We did a preemptive direct co-investment where we made three times our money. And then we did a continuation vehicle in the secondary market where we made two times our money. And it was a sizable total return for our LPs. Continuation vehicles just passed$100 billion as an asset class.

10:13LPs are ambivalent to say the least. They both love it and hate it. and oftentimes it's within the same LP. They both love it and hate it. Talk to me about the best practices for investing in continuation vehicles in venture specifically. First, the evolution of this continuation vehicle really just started, you know, it was nascent if you go back to six or seven years ago and it started in the buyout space and maybe the growth equity space. And now, as you noted, within the secondary market where there was 200 billion of volume in secondaries last year, CVs, either single asset or multi-asset accounted for about 50 % of that total volume.

10:45So it's very sizable. And I believe it's a part of the market that's here to stay. The buyout market was the innovator. Venture has kind of been a bit of a slower follower, I would say. Venture really hasn't embraced this concept until maybe two or three years ago. But now with companies staying private longer and the duration of the hold period for these companies just being elongated as they stay private longer, the secondary market has stepped in and provided a solution for an investor that wants liquidity that's not going to happen through the normal course of action. Now, to get you a question, as the GP and the original LP or the buying LP, you've got to create alignment.

11:21You've got to remove as much of the potential conflict that could exist in that type of trade. And the conflict really kind of centers on the GP who owns the asset because they're selling on one side and they're buying on the other side with, in many cases, two different constituents, right? And you want to just make it a fair trade. Where the market's evolved is there's intermediaries now that facilitate these transactions. They run a broad process just like any investment bank would, and they go out and get a market price. And then what's fortunate is the original LP, if you have the ability to work within the constraints, which are usually time constraints, you have the decision to either take the deal or not take the deal.

11:58So if you think the secondary buyer is getting a good deal, you can roll into that same deal, but maybe you're prioritizing liquidity and you're going to take some money off the table because of where your plan might be or things that are unique to your institution situation. My personal view is that it's very difficult. It's been very difficult for LPs to block this activity because they essentially have the option to roll. So it's a hard psychological position to have that I'm against it, but I could be part of the deal. So those that are against it, in many cases, just aren't built to operate under the timelines and constraints that are required to actually make some kind of decision, right?

12:33So there's many institutions that might be quarterly with their investment committees, or they have governance that makes it just hard for them to be nimble. So almost by default, they're forced to take the default provision. And given how young this is, I think those original LPs are going to kind of evolve over time and they're probably going to pre-negotiate what their deal should be when they sign up to the fund originally, right? So it's understood. And I think we'll see some evolution there. I also, I've seen certain GPs, you know, are you a price taker or a price maker, right? Or setter?

13:04And I've seen some recent CVs where the GP kind of sets the price and the secondary market has to decide whether to take or not take the price that's on the table instead of having the secondary market come forward and offer a price. So I think we're going to see continued innovation and evolution with respect to the CV that frankly will probably further cleanse any concerns around conflicts. I had Michael Woolhouse from TPG Capital who created a$1.9 billion fund to go after these CV opportunities, and they're all in direct buyouts. And there's so much demand for this, that he's literally bringing in his competitors to go invest with him.

13:40That's how much demand there is for this product. One of the interesting things about direct investing in general, I talked about this with Roger Vincent, who was at the Cornell Endowment. And there's this misnomer of diversification when it comes to investors, where they feel the need oftentimes to diversify on two different levels. What does that mean? That means if I have a$20 million position in a company, yes, that could go to zero. But if I have 30 of those positions, then that could be diversified. And then you can also get diversification if you're in multiple managers, but people become so focused on, oh, I can't make this single investment that's in one company.

14:14I'm not diversified. There's almost like this disconnect between diversifying on the company level and on the portfolio level. As incredibly simple as it sounds, it seems like something that people have trouble with. At HarborVest, we have what's called our quantitative investment sciences team. It's over 50 people that are literally rocket scientists who have now come to kind of synthesize all this proprietary data that we sit on related to private markets, whether it's at the fund level or at the portfolio company level. And that really informs us on portfolio construction and specifically on how we should be thinking about diversification.

14:47On the diversification front, I think it has to do with what is the range of potential outcomes? What is the dispersion in the part of the market that you're investing into? And if there's limited dispersion, then you probably don't need as much diversification, but if there's greater dispersion than you do, and then it's also the skill piece. You're not blindly selecting these assets, right? You're underwriting them and you're making a decision on what you want to buy and what you don't want to buy. I kind of go back to what is the original law of diversification? Like you're adequately diversified when you, I don't, I think the number is like 22.5 investments that you've made.

15:17The other thing, like where we sit on the fund side, where we build portfolios of funds, Should our number be 25 funds in a portfolio? If those funds are each putting us into 30 underlying portfolio companies, what is the right diversification at that level? So I don't know if this addresses kind of where you're going with your question, but that's kind of how we think about diversification inside HarborVest. There's also these questions that seem very simple or dumb, but are actually good questions, which one question is, are you diversified? And the follow-up question to that is, what does that even mean?

15:46I define diversification as in what percentage of the time will your portfolio have a certain type of drawdown. In other words, some investors might be comfortable with a 10 % drawdown. Some might be with 20. Some might completely not be comfortable with any drawdown. So they should be in like bonds and cash and things like that. But I think there's actually a scale to diversification as well. Is that structural alpha? What is that exactly? Or is it access? Is it all the above? So I think it is a bit of all of the above. So it's an inform on how we build out portfolios, but then it's both access and identification.

16:19So there is academic research. It shows there's persistence in performance across managers and private markets. So a new entrant, especially in venture capital. So a new entrant might quickly figure out these are the top firms I want to invest in, but they may not be able to get into them. Dell PCs with Intel inside are built for the moments that matter, for the moments you plan and the ones you don't. Built for the busy days that turn into all night study sessions. The moment you're working from a cafe and realize every outlet's taken. The times are deep in your flow and the absolute last thing you need is an auto update throwing off your momentum.

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20:04If it was completely random, it would be 25%. Some would though say, yes, venture has been persistence, but now you have these mega funds, these 15, 10,$20 billion funds. How do these funds continue to return venture returns? Or is it just a new asset class? Call it somewhere between traditional venture and public. When you say I invest in venture, I think the next question is how do you invest in venture? And I think the asset class is bifurcating, right? And the profile of an early stage portfolio is going to look very different than the profile of some of these mid or late stage portfolios.

20:38And I go back to this consensus piece. I was having this discussion with what I call the lifecycle investor, the mega fund just the other day. If there's a fund that's targeting those 100 companies that are 10 billion to SpaceX is at the upper end at the$800 billion valuation, what is the mortality rate of those companies? It's much less probably than the mortality rate of the seed fund. So it's a different risk return profile we have investors taking on. I think the thing you identify here is all these large firms used to define the early stage, and then they became lifecycle investors. So the asset class has changed considerably.

21:14Is investing in open AI that's doing tens of billions of dollars in revenue at an$800 billion valuation, is that a venture deal? The industry says, yes, but we can debate that. But it's clear to me, there's a ton of investor interests, whether it's coming from the traditional venture firms or other financial services firms to gain access to those types of companies. It reminds me, David Sachs, when he started Kraft Ventures, he went to Bill Gurley and he asked him about this heuristic, every single portfolio company having to return the fund. Bill Gurley told him it's a rule of thumb. Obviously, if you're investing in the Series D, you don't need it to return the fund, but it's been kind of repeated as if it's gospel at every single round, every single situation.

21:51It's a really useful razor. And it basically teaches you never underwrite a company to a three or five X or you're going to have a bad portfolio, but it's more meant to be taken figuratively, not literally. I think that's right. Everybody, I mean, Bill Gurley is kind of the voice in the room here, right? There's a lot of wisdom there. One of the more recent discussions I've been having with firms, and it's with these scale deals, is it harder? If you're a seed fund and you say, I can return the fund with a$500 million exit versus one of these scale funds. Let's say you have$5 billion fund size and you need a$50 billion or$100 billion exit to return the fund.