Diversification, risk, and returns in venture capital

Abstract

We explore an alternative, finance theory-based explanation for the documented positive relationship between fund diversification (or lack of fund specialization) and performance in venture capital (VC). Our proposed "Risk Hypothesis" posits that the expected negative impact of diversification on fund risk induces fund managers to endogenously select riskier investments, which in turn leads to higher performance of more diversified funds. While other channels may also be at play, we provide results that support this hypothesis for an international sample of VC funds. However, this effect is weakened when expertise is limited. The study offers implications of how VC fund managers investment decisions are influenced by strategic portfolio considerations, which in turn affect which innovative ventures receive funding.

Herd behaviour in buyout investments

“…This unique feature of the data enabled us to construct the herding measures developed previously, which was essential to explore the determinants of herding behaviour of the PE funds and estimating the relationship between the fund-level herding and performance. Other studies have also used the CEPRES database (e.g., Buchner, Mohamed, and Schwienbacher, 2017;Cumming, Schmidt, and Walz, 2010;Franzoni, Nowak, and Phalippou, 2012;Krohmer, Lauterbach, and Calanog, 2009).…”

“…A lack of anonymity can encourage PE firms to only provide information on better performance and suppress poor performance. Buchner, Mohamed, and Schwienbacher (2017) provide detailed discussions of the CEPRES data collection process, the information available on PE firms, and how the database compares with other databases on PE funds.…”

“…Through our study, we provide evidence that the PE fund managers also take the investment behaviour of their peers into account in their own portfolio composition. On a related note, previous studies have examined the impact of specialisation versus diversification on the PE and hedge funds as well as performance persistence, although their findings on which strategy is the best are contradictory (Buchner, Mohamed, and Schwienbacher, 2017;Cressy, Munari, and Malipiero, 2007;Cumming, Dai, Haß, and Schweizer, 2012;Humphery-Jenner, 2012;Knill, 2009;Shawky, Dai, and Cumming, 2012). This suggests that the results are likely to be context-specific, depending on whether it is venture capital or buyout.…”

The application of venture capital strategies tomusharakahfinancing

“…Petty and Martin (1983) and Buchner et al (2017) revealed that VC is a high-risk and high-return investment. Therefore, investments should be diversified into different portfolios to ensure that investment risks can be minimised.…”

The Role of Venture Capital on Start-up Business Development in Indonesia

“…However, venture capital companies remain cautious in determining investment. In accordance to Buchner, Abdulkadir and Armin (2017), the investment decisions made by the managers in the venture capital companies are reflected in serious investment analysis, especially to assess the expertise in fund management by the start-up companies as potential investees. Lee (2017) in his research on the peer-network identification and measurement of the venture capital role towards start-up companies found that many start-up companies have partnered with venture capital companies based on the provided capital assistance and the success of creating innovative products made by the start-ups.…”