Technology, Venture Capital, Private Equity

For a long time (in fact even before I joined the PE industry), I used to think about what’s the ideal strategy for making investments (especially PE/VC ones) to earn superior returns, and I had vaguely concluded that deep domain expertise in specific industries was perhaps the only way to beat the market. And a recently released study by BCG reaches the same conclusion. The report concludes that domain expertise and industry networks rather than financial engineering or fund structure is what differentiates top funds from the rest. Frankly, I am quite surprised that almost all funds define their investment criteria by stage and deal size and we haven’t witnessed that many “experiments” with industry specific funds which invest across stages and deal sizes.

In my opinion, immense information related synergies can be leveraged by having a portfolio of companies in a particular industry and this coupled with sound risk management systems can enable one to earn superior returns over time. For example, lets say a fund that’s focused on tech industry. It could take exposures on (say) innovative startups that are working on search and hedge that with an appropriate (long) position on the incumbent (publicly listed) leader - Google. Similar examples can be conjured for other industries such as pharma, biotech etc. In fact, I was talking to a PE investor some time back, who has done a few deals in the auto component sector both in PIPEs and private cos. He was saying that this offers an edge to them in two ways - a)it helps them validate the picture painted by entrepreneurs pitching to them by having their stories vetted by others in the industry (especially senior managers of other large cos) b)it enables them to gain credibility with entrepreneurs as well since they value the industry perspectives that they bring to the table. Given the plethora of PE funds that are operational and the competition for good deals, I’d guess that without such genuine differentiation that would enable a fund to a)earn a shot at good deals (most funds are not even in the reckoning for most deals) b)evaluate the opportunity better (owing to industry knowledge), and c)bid competitively without overpaying (owing to the value the entrepreneur sees in having the investor on board), it will be hard to sustain superior returns over long periods.
So, for any potential investors convinced with my above thesis and willing to part with their monies for trying out, I’d love to hear from you