Lagging Indicators

Thomson Financial and the NVCAon Mondayreleased their latest private equity performance numbers, and Im trying to analyze them in the context of Sevin Rosens VC model is severely damaged argument.I see some validation for Steve Dow & Co., and also some contradiction (between Dow and the numbers, not between Dow and this company). Dow believes that VCs are blindly adhering to the following article of faith: Short-term ROI isnt very good, but long-term investment in the VC asset class will outperform most major public indices. After all, some variation of that line has been in every Thomson/NVCA performance press release that I can remember (including todays). So stick with us, the VCs tell their LPs, because “well make you money in the end.”

The blind part is that such statements do not seem to acknowledge that the 10-year VC performance figures are around one year away from a harrowing fall. In fact, it may have already begun. 10-year horizon VC performance through Q2 2005 was 27.4%, then dropped to 22.7% at the end of Q1 2006 and currently stands at 20.8% (performance data lags by one quarter). Now imagine what will happen once the data begins to include all of the bubble-era Internet and telecom deals. Well be looking at brutal ten-year returns at least through 2009, and probably a bit longer. Dows basic point here is that the VC model isnt nearly-damaged its been damaged for quite some time, but the long-term numbers just have not yet reflected it.

But it also is noteworthy that the three-year and five-year VC performance data has begun to tick up a bit (discussing one-year returns is like discussing how a wine tastes one day after its been barreled). Dow would certainly counter that neither the latest three-year (9%) and five-year (-3.5%) VC returns are outperforming much of anything and hed be right but the trend-lines upward swing should be enough to at least instill some optimism that investors have learned from past mistakes. Perhaps its simply that the too much money chasing too few deals paradigm has become a bit less severe. Certainly possible. But its also worth considering that the real lagging indicator here is the recent upward swing, not the older downward one. (Note: Thomson Financial signs my paychecks, but Im not involved in the data collection).