The current market downturn is presenting a crossroads for LPs. Early-stage venture remains an attractive investment area, particularly now given the more rational pricing and abundance of later-stage dry powder waiting for the right opportunities.
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But rather than continue to invest with the diverse and emerging managers that received so much traction when capital markets were booming, the risks in the current environment are redirecting some LPs to deploy their capital in the (perceived) “safer bet” funds, the household name-brands.
LPs need to step up
It’s time for LPs to make an important decision. How these institutions choose to deploy capital over the coming year will give the world a clear perspective on where these investment organizations, and the people who manage them, actually stand on diversity.
Do they actually believe that investing in more diverse partnerships helps drive potential returns in venture? Or were their previous investments in this area just lip service in order to get social credibility by investing in more diverse firms?
The thesis on early-stage venture and the unique (and valuable) perspectives underrepresented emerging managers bring to investing has not changed. People with diverse backgrounds have a unique edge in the investing market because they look at the world differently and consequently identify investment opportunities that may otherwise be overlooked. When interest rates were low and the market was booming, this edge drew tons of investor attention and has substantial data points to back it up. Now that risk is back on the table, the LP calculus seems to be shifting despite this thesis remaining not just intact, but more lucrative than ever before.
The pace of innovation continues to accelerate. There are many great startups with solid fundamentals that are hungry for investment. In fact, some companies forged during times like these have historically outperformed. Valuations have turned friendly to investors and the long-term thesis of early-stage investing remains the same as it always has been. If you believe, like we do, the data that shows that diverse emerging managers have a unique edge in venture investing, then these are precisely the managers you’d want to allocate to now in order to generate outsized returns over the coming decades.
The ‘safe’ bet
Unfortunately, the market seems to be signaling that institutional LPs are more interested in capping their (perceived) risk by investing in the long-established household names in VC (even despite many of those firms’ consistent lack of diversity), rather than doing the work to properly select diverse-led emerging managers. But that’s just it, isn’t it — it’s a perceived risk that they are attempting to cap. The data shows us that emerging and diverse managers can outperform; it’s the picking that matters.
LPs need a serious gut check. Does their willingness to “invest in diversity” stop when risk goes up? Or their willingness to put in the work to properly access and select them? I’d argue that they’ve never had a better opportunity to showcase their belief in diversity and generate best-in-class returns.
Illustration: Dom Guzman
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