E398: Hamilton Lane ($1T AUA) on Venture Capital, AI, and Private Markets

0:0031 % of all private markets today is venture and growth. Yeah. What does that mean for investors? It's a portion of the market that you just can't ignore. It's a portion of the market that historically these institutional investors had access to through their public market investments. Amazon went public in the late 90s. It had$19 million of revenue and had a$350 million market cap. Had you invested in the Series A of Amazon, by the time it went to an IPO, you generated 10 times your money. If you had invested in the IPO, you're generating something like 2 ,000 times your money. The better place to invest in Amazon was as a public company.

0:41My guest today is Miguel Luenia, co-head of Global Venture Capital at Hamilton Lane, a firm with more than$1 trillion in assets under management and supervision. In today's conversation, Miguel shares the lessons Hamilton Lane has learned from evaluating investing to venture firms across multiple market cycles, what separates great venture investors from average ones, and where Hamilton Lane believes the next generation of outsized returns will come from. Without further ado, here's my conversation with Miguel. Before we started recording, we were talking about the three largest IPOs going on.

1:14We've had SpaceX, then Anthropic seems to be going next, and then OpenAI probably by the end of the year. What are the second order effects of these liquidity events for venture LPs? First off, it's going to create a lot more cash and a lot more liquidity to reinvest into the market. We've seen this kind of dynamic within venture where the longest term investors in venture have been over allocated to the asset class because venture has been one of the best performing strategies, at least within the private markets over a longer period of time. It's also been the strategy that's returned the least capital back in terms of DPI.

1:54And so you have this effect of compounding returns with less capital coming back. And what we saw was that a lot of the longer-term investors within venture continue to be bullish in venture, but they're just capped out in terms of asset allocation and portfolio construction. Getting capital back is going to be able to reinvigorate that and restart that flywheel and have more cash coming in to make more commitments to the new funds. The other dynamic that I think is really interesting is that it's also going to create a little bit of a challenge for LPs to really be able to peel back and see who's been driving consistent, repeatable performance and who, let's call it, got lucky because they happen to have one of three companies in their portfolio.

2:43And when you're investing in venture, you're investing for outliers. It's the power law dynamic. It's the outliers that drive return for the overall industry. So you're constantly seeking that. But then when you have it and you have just a couple companies that have driven that, the question is, how repeatable is it? Can they continue to do that? I think that's going to raise a lot of questions for LPs around some track workers are going to look fantastic and they're going to look completely unrepeatable at the same time. You've been an LP now for several decades. Probably the most difficult thing is to differentiate luck from skill when it comes to GPs.

3:16How do you do that? That's the secret sauce, right? I mean, that's constantly what we're evaluating. There's this element in venture that is based on chance. You can invest in a number of companies you don't know which one is going to perform well. And in fact, talk to some of my best relationships, most trusted VCs. And what they tell me is within the first two or three years, a lot of times they get it wrong. Three years into a fund, they tried to call which were their best performing companies. And five years later, it was a different set of companies that actually drove the returns. And so there is some randomness to it, but there are clear ways to tilt the table in your favor.

4:02And that's what we're looking for is people who can tilt that table in their favor. And they're not going to get every call, right? Venture by nature is a high risk asset. You get a lot of these things wrong, but it's being able to have a better chance of getting those things right that end up driving the better returns over a longer period of time. And so what does that look like? That's people who have just kind of outstanding networks, outstanding connectivity. When I think about the venture investment value chain, it's sourcing opportunities. Do you see the best opportunities? Are you with the best networks?

4:38Are you with the best founders that are going to create that next generational business? Two, are you good at selecting? Can you evaluate who actually has the best chance of succeeding based on largely the quality of that team and the quality of that founder? And then to a lesser extent, especially at the early stages, the quality of the idea itself. And then three, can you access that opportunity? So once you see it, once you evaluate it, do you have a right to win? Why are they going to let you into the cap table? This is a really competitive market. Great founders are not unknown for the most part.

5:13And so they have their pick on which venture manager they want to work with. And so you need to have a right to win. The great managers can do all of those things. And then over time, we also need to see them be able to generate liquidity. And I think that that's a dynamic that is changing a bit within this market as well, where there are more off-ramps. We're talking about the big IPOs today, and that's historically been the largest source of liquidity for the market. But increasingly, there are more secondary opportunities. Even with new primary rounds, there's opportunities for early investors to sell some shares, to be able to manage that liquidity, be able to de-risk those positions, but at the same time, maintain their exposure to those compounding winners and drive overall returns for the fund.

5:59It's a balance, but we think that the best managers are doing that more effectively. In Q1, 75 % of capital in the entire venture capital ecosystem went to a handful of companies, less than five companies. It feels like VC is becoming a consensus asset class. One is, do you believe that to be true? And two, if that is true, how important is the selection part of the GP job? It does feel like it's becoming a lot more consensus. I think one of the differences within this cycle is that we're seeing revenue a lot earlier. So if you go back a couple of decades, you had multiple startups, they were pre-revenue for a number of years, really difficult to tell who was going to be the winner.

6:43You had multiple people funded. Today with AI businesses, we're seeing revenue ramp earlier than ever before and at scales that we haven't seen before. So it's not uncommon to see companies go from two, three million to over $100 million of recurring revenue in 18 months. We were in Lagora, the fastest growing enterprise company to$100 million in, I think, 18 months. It's unbelievable. And the thing is, five years ago, that would have been completely unique and absolutely unheard of. But there's a whole group of peers for companies like that today. And there's a number of other businesses that fit that category.

7:22And so you have investors really rallying behind these early winners early on. but i think what's interesting is is we're not entirely sure that revenue momentum it certainly helps predict a winner but at this stage of the companies they're still really young they're still only 18 months old two years old there's opportunities for other companies to come and outgrow them and philosophically are you trying to index these hyper competitive spaces like OpenAI, Ananthropic, Harvey, and Legora? Or are you trying to pick winners? Indexing venture has historically been a really poor strategy. On average, venture has not really been worth the...

8:07The median return would be one of the worst asset classes in the world, if not the worst. The liquidity lockup for that median return is longer than any other portion of the market. So buying an index of venture, we think, is not a great idea. So what's our strategy? Our strategy is to generate top tier venture returns, and you can quantify that in whatever way that you want. But our focus is really on investing in the best possible opportunities and compounding them over time. we talk about these consensus winners. There is definitely room to invest in those businesses and there's the need to invest in those businesses.

8:46So a lot of our clients are large institutional investors. One of the dynamics that we've seen is that the entire tech opportunity set has moved from the public markets into the private markets. Companies are staying private for longer. By the time they go public, generally their valuations are very high. Their growth rates have slowed. The return on capital that you can get as a private market investor is significantly higher than you can as a public market investor. These companies are also highly disruptive businesses. And so we saw the whole SaaSpocalypse phenomenon at the start of the year.

9:22People are looking at their portfolios and they're saying, hey, look, we have a hole here. AI technology is clearly the engine of economic growth. The majority of those companies, aside from seven publicly traded ones that are more kind of infrastructure related at this point because of the amount of capital that they're investing into, into basically like the base layer of AI, the majority of these businesses are in the private markets. And if we don't have a good venture and growth strategy, we're missing out on this entire market. And so some of these market leaders is, I think, are really important in order for these investors to be able to drive their longer term returns in order for them to even be able to track the indexes and the benchmarks that they're looking to achieve.

10:09Is that the best way and the only way to drive returns within venture? Absolutely not. So when you're investing in the early stage, that's where the opportunity is to drive the biggest returns because you can get into these companies at the lowest valuations and ride them all the way up. That's also a different approach to investing. And so if you're putting really big dollars to work, you want to make sure that you have a mix of some of these later stage businesses. If you're looking to just drive pure returns and you're a really long-term investor, you also want to be investing in the next generation of these companies you want to invest in at the early stage.

10:47Last time we chatted, you said that 31 % of all of private markets today is venture and growth. What does that mean for investors? That means that it's a portion of the market that you can't ignore anymore. I started at Hamilton Lane in 2009. largely what we had been telling our large institutional investors for the last decade was that venture was not an institutional strategy it's just too small of a market

11:21there's only a handful of managers who are really generating strong returns those fund sizes are limited it's hard for you to invest the dollars into the space it's long duration it's high risk It's high volatility in such a small portion of the market that it's really difficult to be able to generate returns from it at a large scale. And at that point, it was single digit percentages of the private market, probably lower single digits. Exactly. And so so then you look at it today and it's a portion of the market that you just can't ignore. Right. It's a portion of the market that historically these institutional investors had access to through their public market investments.

11:59One of the best examples was Amazon. So Amazon went public in the late 90s. It had$19 million of revenue and had a$350 million market cap. Had you invested in the Series A of Amazon, by the time it went to an IPO, you generated 10 times your money. If you had invested in the IPO, you're generating something like 2 ,000 times your money on it. So definitely the better place to invest in Amazon was as a public company. Today, you look at the companies that are going public, and most of those returns have now happened within the private market. If you're not putting an allocation into these venture-backed businesses, you're not capturing that whole portion of the market that is creating value for the overall economy.

12:44And so what you're doing is you're risking falling behind your benchmarks. you're inadvertently taking a position against disruptive technology, which, you know, in our view is probably the wrong position to take at the very wrong moment. 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. The magic is in the AI interviewer, purpose-built and knowledgeable-based information to conduct high-quality context-rich conversations on your behalf, acting as a trusted extension of your team.

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15:33Is it manager selection? Is it deal selection? Is it just asset allocation? Their benchmark was 40 % venture and growth. They had zero allocation to venture and growth. When venture and growth is the strongest performing asset class for the last decade, and you're comparing it on a 10-year time period, it's clear why they're underperforming. And so that's not something that they realized. And this particular client, and we see this across a lot of institutions is very fee sensitive. And I think that that's particularly the type of client that struggles the most with this, which is venture and growth is a very expensive asset class.

16:13There's no way around it. And by the way, it's an asset class where you get what you pay for. So the more expensive managers, the more expensive fund structures actually on average return significantly better on a net basis than the cheaper ones. I think most of the top 10 firms are 2.5 and 30 at this point. Pretty much. And I've been told by GPs that if they don't go out with 2.5 and 30, they're signaling that they're a non-premium brand. I think, unfortunately, that is right. You mentioned this client that you did a review for, and their benchmark was 40 % venture and growth, and they had zero in venture growth.

16:51It's one thing to understand that you're off in terms of your allocation. But venture capital is also an access class. If you're not in the top funds, the Sequoia, the Benchmarks, the Founders Fund, etc., how do you go about building a portfolio today? It's really important to be with the top performing managers. It's really important to be in the top performing companies. But it's not a handful of managers anymore. And you can be a lot more strategic about the way that you find access into these businesses. And so if we look back just at the last five years across our platform, on average, we've seen somewhere between 350 to 400 venture and growth funds per year.

17:33And so if you're investing in the top decile of them, that's 35 to 40 different funds that you can select from if you're going just for the top 5%. It's very subjective what is the top 5%. But that's still 15 to 20 different funds a year. Based on a lot of work that we've done in terms of historical cycles, portfolio construction, we think that ideally a venture portfolio, particularly one that's focused more on the earlier stages of venture, you should probably be selecting eight to 10 managers a year in order to get the diversification that you need to capture those outliers. and it's interesting because there's always this push and pull right two things are true at the same time venture has a lot of volatility within the returns it's driven by outliers at the same time there is persistence the top managers consistently perform better not on every single fund but consistently over time perform better and so you want this concentration of top managers but you want enough diversification in order to be able to consistently capture the outliers and you don't know exactly where they're going to come from within the venture market.

18:40So our view is eight to 10 managers. And so there's plenty of selection out there, but you have to go maybe a layer deeper and not pick the most obvious one because those are very much access constrained. They're built up relationships over time. You can work with other groups who have access to them to be able to get access into these managers, which will help drive the portfolio. But if you have a team that is focused on uncovering those next generation managers, seeing those groups that maybe don't have yet the brand, but have generated the returns, have the access, have all of the ingredients in order to continue to drive better returns.

19:18That is a great way to find more opportunities. And then the other dynamic here too is the venture market has expanded way beyond what it was before. There's a lot more tools to invest into venture today than there were before. There's$3.4 trillion of NAV within venture. And so to think that we can only invest into a handful of managers in order to drive our returns, I think is not necessarily realistic. And so there are more managers, but there's also more entry points. So there's the other dynamic where you want to pile in and put more capital behind your winners. That is something that most of the top investors will tell you.

19:58So the best way to invest is when you find those companies early. And then when you find a company that is really outperforming, that is really going to drive returns, you want to double down into them. Support for today's episode comes from Square. It's all in one way for business owners to take payments, book appointments, man's staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground. I was actually thinking about this the other day when I stopped by a local cafe here.

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23:09And the further removed that you get from the managers, the more you have to invest into your own thought and your own opinion of these businesses. And then the other way to do it too is through secondaries. Because there are outliers, the concentration of these funds into these outlying businesses becomes greater over time. And so you can get access into these outliers through a secondary approach where a lot of times you can invest into these businesses at a discount. You know what assets are in there. the manager and the blind pool risk comes down with that. And you can find some really interesting points of arbitrage, honestly, within the market to be able to access this.

23:49And just to double click on that, funds become victims of their own success. We were talking Justin Fishner-Wilson from 137 Ventures. It was reported they had a$20 billion stake in SpaceX at IPO price. And of course, that's a positive thing, but I'm sure he had some pressure from LPs to sell some of that along the way. Now, it sounds like he didn't sell, which is pretty heroic, but for most GPs, it's practical to take some of that off the table. So it's not that they're short SpaceX or that they don't think it's a great company. It's that now 90 % of their fund might be in one company and now it might be extremely logical for them to sell off a portion.

24:28Absolutely. And this is where in the private markets, you have to align incentives and getting the structures right can be really challenging within this. But one of the tools that we're seeing emerge, and it's been around for a few years, but we're seeing really kind of pick up steam, are continuation vehicles. And so you have early LPs who have benefited from really great returns within these businesses. each LP is totally different. You talk to one LP, you've talked to one LP. Each LP will tell you something different about what they want in terms of liquidity, what they want in terms of your continued management of the portfolio.

25:09And so you have a number of LPs who want liquidity. You have a GP who still believes in a business, continues to want to invest in that business and generate compounding returns. And then you have a whole market of secondary investors who want to get access to those businesses. And so it's about finding a market where you can bring new capital in, buy out the early investors that want liquidity, roll that into a new vehicle going forward where the new investors are happy because they're getting access. They're getting access to a significantly higher price. The early investors are happy because they're getting out at what is a really good return for them.

25:48And the GP is happy because they continue to participate in the upside. And importantly, it's DPI. A continuation vehicle is officially a secondary, which means you actually sold it from the fund. So now you have DPI. You could show not only your current LPs, to your point, but also future LPs. You could show that you actually have returned capital to invest. Yeah, for sure. And it's really funny. if you're investing in the private markets, what you realize is that this is completely a relationship game. And you could drive a truck through an LPA and you can negotiate every term within an LPA.

26:26And so when you look at the term for most funds, at the end of the term, you either can get an extension from your LPs or you can go into liquidation. And liquidation sounds like this scary term that's like, everything's going to be sold. But the reality is that the way that most LPAs are drafted is that in liquidation, managers can maximize returns and they have a lot of discretion to do that. And how do you maximize return within venture? You wait for an IPO. And so the difference between having an existing term and being in liquidation, it's really not much, right? And so the legal bounds, I think that the legal triggers for GPs to start creating liquidity for their LPs is not very strong.