What a difference a year makes. At this time in December 2021, we wrote that venture capital portfolios had given institutional investors “a lot to cheer about,” and we noted that the “US IPO market is crushing it and valuations are on an upward climb, with no ceiling in sight.”
Alas, institutional investors are feeling rather gloomy about venture capital these days, as the IPO window has shut and the once-hot tech sector has cooled. Responses to questions in our LP Perspectives 2023 Study were more negative than last year for nearly every question we asked about venture capital.
Institutional investors say they have seen a deterioration in the performance of their venture portfolios and don’t expect to see an improvement in the next 12 months. That being the case, fewer LPs plan to invest more in VC funds in the coming year. They are particularly averse to funds focused on late-stage and growth investments.
Not very hungry
LPs’ interest in venture has dropped sharply. Just 23 percent of those surveyed said they planned to invest more capital in VC funds in the next 12 months, down from 40 percent last year. Likewise, 20 percent said they plan to invest less capital in VC funds, nearly double the prior year. Finally, 58 percent said they would invest the same amount, up from 49 percent one year earlier.
Waning interest in venture isn’t surprising, given that LPs have seen a deterioration in performance. Last year, 68 percent of those surveyed said their VC portfolios had exceeded their benchmarks, but just 46 percent said that was the case this year. On a similar note, 23 percent said their VC portfolio performance fell short of their benchmarks, up from just 5 percent a year ago. Less than a third (31 percent) of LPs said their VC holdings performed in line with their benchmarks, an improvement from 27 percent a year earlier.
Looking ahead at the next 12 months, most LPs (50 percent) said they expect their VC holdings to meet their benchmarks, about the same percentage as last year. However, just 18 percent said they expect outperformance, down sharply from 40 percent last year, and 33 percent said they expect underperformance, three times more than a year ago.
No to blind dates
Fewer LPs expecting outperformance from their VCs means that first-time venture managers will have a tougher time securing a commitment. Of the LPs who invest in VC, 28 percent said they are less likely to commit to first-time funds in the next 12 months, up from 17 percent who said the same thing last year. On a positive note, only 28 percent said they don’t invest in first-time managers, under half the portion who answered in the negative a year earlier.
The majority of LPs are right where they want to be with their allocations. Most (54 percent) said they are at their target allocation (up from 43 percent last year). Just 15 percent said they are overallocated and 31 percent said they are underallocated.
Despite some LPs souring on venture, just 3 percent said they planned to decrease the number of managers in their portfolio, an improvement from 6 percent a year earlier. The proportion of LPs looking to maintain their current stable of managers increased from just 28 percent last year to 41 percent this year, while the percentage of investors looking to increase declined from 66 percent to 56 percent.
Funds focused on late-stage/growth investing will feel the biggest impact from decreased LP interest. About a quarter of those surveyed said they planned to invest less in that strategy in the next 12 months, in contrast to just 5 percent who said they would invest less in early-stage funds and 3 percent who said they would invest a smaller amount in seed-stage vehicles.
Asked to name their main challenge when investing in venture capital, most LPs (26 percent) said they were unable to access the best funds, followed by 20 percent who said they couldn’t invest as much capital as they would like. The third most cited reason (at 17 percent) was lack of transparency by managers.
Methodology and demographics
For the 2023 study, we surveyed 107 institutional investors. Fieldwork was carried out from September to October. Participation is always anonymous. Pension funds account for the largest share (23 percent), followed by funds of funds (15 percent), insurance companies (14 percent), and family offices and high-new-worth individuals (13 percent). Banks, endowments/foundations, sovereign wealth funds, corporations and others each account for less than 10 percent. The respondents are primarily located in North America (35 percent), Asia-Pacific (30 percent) and Western Europe (30 percent). As for particular asset classes, the respondents had the largest allocation for private equity (68 percent), followed by infrastructure (54 percent), private real estate (49 percent), private debt (43 percent) and venture capital (38 percent).