INVESTING IN BLOCKCHAIN VENTURE FUND OF FUNDS
Blockchain Coinvestors Letter from London
Vol. 2, No. 3, April 2023
The Rationale Revisited
Fund VII Now in Formation
Blockchain Coinvestors funds provide investors with global, diversified exposure to early stage investing into the blockchain space. Our fifth Fund of Funds, Fund VII, is now in formation and is available to qualified investors. We are happy to find a way to connect with you and answer your questions.
Venture Fund of Funds: The Rationale Revisited
In 2014 when we first realized the potential of Blockchain technology we began to build a strategy to capture value from this new innovation. We expected then that we would see a value creation event akin to the 1990’s Internet which has driven much of the return investors have earned since the 1990’s.
To summarize, we believed that similar dynamics would emerge:
High Expected Returns. During the dotcom boom and bust, most startups would ultimately fail, but immense value accrued to sector leaders - if you owned Amazon in 1997, you by now have earned a better than 300x (300,000%) return
Concentration of Return to Best Investors. The best investors in the new sector accessed the best opportunities and earned the highest returns. In addition, they were persistently top quartile so that securing access early was rewarded with subsequent superior returns
Diversification Advantages. Given the distribution of early-stage venture investing, diversification was advantageous, and because innovation was becoming increasingly globally distributed, so too, global coverage beneficial
Selectively Follow-On. Follow on investing into the mid stage did make sense, but only when the signals from existing and new investors were clear in the view that the company was an emerging category leader
Fast forward 20 years, and today 19 of the top 45 largest companies in the world are Internet technology companies. The best early-stage venture investors in these companies have generated some of the world’s best returns for their LPs.
The venture capital industry has grown significantly from a cottage industry in the early 1990’s into a globally significant asset class, due to the potential for outsized returns from investing in innovative, high-growth companies at the early-stage. However, venture investing also carries significant risks, with a high likelihood of failure for many early-stage companies.
Leveraging Prior Experience to Create our Blockchain Investing Strategy
Understanding these dynamics, we decided that the optimal strategy would be to strictly apply the best practices of Internet investing, to the new world of Blockchain investing.
More specifically, we decided to construct a global, diversified portfolio of leading early stage Blockchain venture investments by partnering with, and investing in, the leading Blockchain-native venture funds around the world.
Below, we revisit the theoretical and practical rationale for a venture fund of funds:
Venture Returns Follow the Power Law
The Optimal Strategy is Diversification
Invest with the Best Managers for Persistent Returns
As we enter the next phase of adoption and growth in the Blockchain industry, we believe the strategy of venture fund of funds investing remains optimal on a risk-adjusted return basis for this high growth, nascent asset class.
A. Venture Returns Follow the Power Law
A normal distribution is where a range of outcomes are a symmetric, bell-shaped curve with most data points near the mean. Most people are familiar with a normal distribution – also called a random or Gaussian distribution – as many outcomes are indeed normally distributed, such as heights or IQ scores. E.g., most people are average height with a small minority being exceptionally tall or exceptionally short.
However, in practice, we also see that the power law often holds as well. Power law distributions are asymmetric. Whereas in a normal distribution, extreme values are rare; in a power law distribution, extreme values are much more common. Phenomena such as earthquakes and income distribution follow the power law. E.g., most earthquakes are of a very low magnitude with a small minority being exceptionally large.
Importantly, in venture, we see that the standard deviation of returns is much larger than most people realize. Said differently, a few winners in the portfolio generate most of the returns, while most companies fail to generate meaningful returns, or even return capital. Another way to think about it is that a middle outcome of return is rare. This means that the distribution of venture returns follows the power law and that a small number of companies will generate a large portion of the good outcomes.
This holds true even for individual fund managers. As you can see on the chart below, the dispersion in venture manager performance is also not normally distributed and in fact there is significant variation between managers. The top quartile of venture fund managers will generate significantly outsized returns – far above other asset classes. On the other hand, the average returns are somewhat in line with other asset classes and the worst returns underachieve.
B. The Optimal Strategy: Diversification
As you can see from the above data, venture capital investing can be a high-risk, high-reward asset class, with the potential for significant returns but also a high likelihood of failure. This is true at the individual portfolio company level, but also at the manager level. As a result, some investors struggle to make sense of this difficult risk-return tradeoff.
One way to mitigate the risks of venture investing is to diversify your portfolio. By investing in many companies, you can spread your risk and increase your chances of capturing the upside potential of the rare company that generates significant value creation.
Authors at the Institutional Investor journal decided to test this theory through statistical simulation. They ran a Monte Carlo simulation of returns in two venture funds, using randomly selected outcomes based on the real observed probability of venture deal performance. They compared a portfolio of 15 early-stage investments versus another portfolio of 500 investments.
As you can see above, the 15-deal fund results behaved very similarly to the real-life venture manager’s performance we showed earlier: in short, there was a large dispersion between the top managers, who performed exceptionally well, and the worst managers, who performed in-line or underachieved.
On the other hand, the 500-deal fund significantly tightened the range of outcomes, capping upside but also capping downside. Importantly, the predicted average IRR was still higher than the 15-deal portfolio.
The results of this statistical analysis are clear: with significant diversification, venture investing presents an attractive risk-adjusted return profile as you maintain or improve your average outcome while reducing your downside risk.
C. Invest with the Best Managers for Persistent Returns
Of course, building a diversified portfolio of venture investments is not easy and requires a deep understanding of the industry, access to top-tier investment firms, and the ability to effectively manage many investments.
Each year, ~5 million new businesses are established in the US and around 1,000 venture capital firms raise capital globally. As you saw from the analysis above, identifying the best managers is paramount to outperforming markets and capturing top-quartile returns.
What’s more, top quartile venture fund managers have strong persistence in generating top returns. The correlation between funds within the same manager is 0.7 within venture capital, as compared to 0.5 within private equity and a non-existent correlation within public markets.
Said differently, top-quartile funds are expected to continue outperforming the market for subsequent funds, with a 45% probability to remain in the first quartile and a 72% probability to perform above the median.
The rationale is simple: deal flow access matters because it operates as a virtuous cycle; entrepreneurs accept lower valuations from more prestigious firms and early success leads others to view firms as more prestigious. Strength leads to strength as Marc Andreessen has said.
Source: University of Chicago Becker Institute for Economics; Has Persistence Persisted in Private Equity?, The Persistent Effect of Initial Successes (2019)
The View from London
Taken as a whole, we believe the above analysis validates venture fund of funds as an optimal strategy for investing in a high growth, new asset class like Blockchain. Through investing with the top managers in the space, a venture fund of funds can efficiently gain exposure to a large and diversified portfolio, which suggests an attractive risk-return profile in an industry where the distribution of returns follows the power law. Moreover, if you can identify, access, and invest with the best managers in the space, those managers will be persistent in generating above average returns.
Does the Strategy Work?
As always, the proof of the pudding is in the eating (an old English proverb that implies that the demonstration of something valuable comes from the experience of it in practice).
We are very pleased to report that our first fund of funds remains one of the world’s top performing in its category. Similarly, through our network, access, and unique position in the ecosystem, Blockchain Coinvestors has invested with some of the best managers in the space. As you can see in the following exhibit, the managers we have partnered with are performing exceptionally well compared to the venture industry benchmarks.
(1) Net TVPI performance as of Q3 2022; includes latest reported data, Cambridge Associates Benchmark
No strategy can offer a guarantee of results. However, we believe that the rationale for a fund of funds approach to the early stage of Blockchain investing remains compelling.
Our fifth Fund of Funds, Fund VII, is now in formation and is available to qualified investors.
Contact our capital formation team directly at ir@blockchaincoinvestors.com if you are ready to start investing.
Thank you for reading,
Mitch Mechigian
Partner, London
ABOUT BLOCKCHAIN COINVESTORS
Launched in 2014, our vision is that digital monies, commodities and assets are inevitable and all of the world’s financial infrastructure must be upgraded. Our mission is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and projects. Our investment strategy is now in its 9th year and has to date invested in more than 40 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of more than 750 blockchain companies and projects including approximately 55% of all blockchain unicorns. Our funds rank in the top decile amongst all funds in their respective categories on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in Grand Cayman, London, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.
FUND PERFORMANCE
The Blockchain Coinvestors Fund of Funds strategy was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark. Fund I Net TVPI is 4.55x with an IRR of 59.8% and is one of the highest performing fund of funds in the world according to Pitchbook and Preqin. Fund II shows equally impressive early results with Net TVPI of 1.39x and an IRR of 30.9%. Fund III closed at the end of 2022 and will begin reporting this year. Our newest fund of funds - Fund VII - is now in formation. Email us at ir@blockchaincoinvestors.com to learn more.
BLOCKCHAIN COINVESTORS CURRENT OPPORTUNITIES
Our funds provide investors with global, diversified exposure to early stage investing into the blockchain space. Our Fund of Funds allows an investor to make a single investment to access global, diversified exposure to leading early stage blockchain venture investments on an institutional platform, while our direct funds provide concentrated early stage exposure. We also provide regular coinvestment opportunities to our investors.
Funds are available to accredited investors, with minimums of $250,000 or more at the discretion of our managers.
Explore our funds below or contact our Capital Formation team directly at IR@blockchaincoinvestors.com if you are ready to start investing.
Blockchain Coinvestors Fund VII (Fund of Funds). Our fund of funds strategy provides diversified coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark. Our newest fund of funds - Fund VII - is now in formation and currently taking indications of interest.
Blockchain Coinvestors Fund IV (Early Stage Token) accesses early stage tokenized projects in their formation and seed stages through our relationships with other leading blockchain investors. We leverage asymmetrical information from our 40+ VC Funds to pick the most attractive opportunities.
Blockchain Coinvestors Fund VI (Mid Stage Growth) provides direct exposure to the emerging category leaders in the blockchain and crypto ecosystem. The Fund assesses the more than 400 blockchain and crypto projects in which we are already investors and employs a robust investment framework to select investment opportunities in their mid stage rounds - typically Series A, B, C.
Coinvestments. Our coinvestment program offers our investor community the opportunity to increase their exposure to emerging category leaders in the blockchain space. Please let us know if you want to learn which coinvestments are currently open for funding.
Contact ir@blockchaincoinvestors.com to learn more about any of these opportunities.
INTERESTED IN MORE? REGISTER NOW FOR UPCOMING WEBINARS AND CALLS
Our investment team hosts regular webinars and calls to help educate our community about our investment thesis focused on the inevitability of digital monies, commodities, and assets and the role that blockchain technology plays in enabling them. We discuss what we have learned and how we are using our knowledge to inform our own investment thesis and actions. Below is a list of our upcoming webinars for which you can register.
Blockchain Coinvestors Performance Update
The Blockchain Coinvestors team presents Q4 2023 performance metrics for each of our funds and you can learn about the superior returns captured to date.
Digital Monies and Assets Adoption
As the digitalization of monies, commodities, and assets accelerates, a variety of industries and sectors are adopting these innovations. Learn why this is important for you and your own industry and investing activities.
Recordings of past webinars and calls can be found at www.blockchaincoinvestors.com/webinars.
UPCOMING APPEARANCES
Our team speaks regularly at conferences and seminars around the world. Please join us at any of our upcoming appearances to take deep dives into the most innovative technologies of our time.
Grand Cayman
Matthew Le Merle discusses thefuture of FinTech after the crash of FTX.
Digital Asset Week brings together some of the brightest minds in the space. Join our team as we provide our experienced insights of what is happening now and in the years to come.
RECENT PRESS
CNBC Crypto World: Matthew Le Merle discusses this year’s performance in the space and provides an outlook for 2023
Business Insider: A profile of the firm's investment strategy and why now is the right time to invest in blockchain technology
The Holy Grail of Finance: A podcast with Altvia regarding the inevitability of blockchain technology in conducting digital commerce
Boardroom Governance: Alison Davis gives her unique view on 20+ years of experience in management, investing, and board membership
CoinDesk TV: Interview on unicorns and predictions for 2022
Nasdaq Trade Talks: Discussion on the blockchain unicorn universe research and how to gain exposure
Ashurst: On the ESG Podcast, a discussion of the internet, fintech, blockchain, and individual revolution
Business Insider: Discussing how right now in blockchain is similar to the internet boom of the '90s in terms of growth and innovation
NBC San Francisco: An interview on what are NFTs
Crypto Unstacked: Podcast on the Fifth Era and the evolution of digital assets
BLOCKCHAIN COINVESTORS SWISS
We are excited to announce that Blockchain Coinvestors Funds are now available through Swiss certificates for those of our non-US investors who prefer this approach. The underlying fund is the same, however, our Zurich based team at Blockchain Coinvestors Swiss, who will introduce in future weeks, can provide detailed information regarding this investment option. Email us at mlemerle@blockchaincoinvestors.com to learn more.