Well, there is clearly lots of money sloshing around in alternative assets like hedge funds, private equity, and venture capital. That being said, I still believe there are plenty of great investment opportunities. In an earlier post titled, "Go Early, Go Late, or Go Home," I shared some of my thoughts on what company stages of development looked attractive for investing. In addition, I highlighted the blurring of hedge funds and private equity. As hedge funds receive more dollars and the markets, therefore, become more efficient, hedge funds need to find new ways to generate returns. Increasingly, hedge funds are moving just from private equity and now more aggressively into venture capital. Barron’s highlights this trend in an article from this past week’s edition.
Investors had better take notice. As hedge funds search for new strategies to produce the holy grail of "alpha," or outsized returns relative to risk, private-equity investments of all stripes are suddenly turning up in the industry’s portfolios.
The holdings — ranging from modest positions in startup companies to multibillion dollar corporate buyouts to a variety of more esoteric instruments, like subordinated debt — already amount to $65 billion, or 7% of hedge-fund investments, according to estimates by Freeman & Co., a New York-based financial boutique. That tally, the firm believes, could swell to $100 billion by next year.
Today’s Wall Street Journal has an article (can’t find online source but in Marketplace B3C) on hedge funds entering the venture capital market. It is no secret that hedge funds took flyers on early stage tech companies during the bubble. However, what’s different this time is that hedge funds are looking to create separate vehicles to make venture capital investments with a longer time frame to withdraw capital. As the article states, the big concern is if hedge funds can be patient enough to generate the needed returns. Instead of worrying about the tick, hedge funds need to understand that VC is a 5 year game plan. The other area of concern for me is the idea of even more money plowing into early stage deals. I can vividly remember during the boom being priced out of a few deals from some hedge funds who were willing to give money at a higher valuation with less oversight to eager entrepreneurs. All this being said, this trend is just starting but one to which we should pay close attention. I just do not want all of this capital to end up badly in the next bubble.