Sovereign Wealth Funds
Governments Kick Start EU Venture Capital
But don't forget good governance and design.
October 18, 2010
Jennifer Bollen has a nice article in Financial News on the (dire) state of venture capital investing in Europe and the role governments are playing in attempts to revitalize this innovation engine. Indeed, governments are, according to her article, increasingly “plugging the equity gap starving small enterprises” through the creation of new, publicly funded, venture capital vehicles. Typically, this takes the form of a ‘fund of funds’ that puts the new capital in the hands of pre-existing European VCs:
“Last month, the Irish government launched a €500m venture capital fund of funds, Innovation Fund Ireland, aimed at boosting the country’s economy…Ireland’s move mirrors the launch last year of Britain’s flagship UK Innovation Investment Fund, following a government report recommending intervention to help companies seeking between £2m and £10m of growth capital. The government agreed to commit £150m to the scheme, and picked two venture firms to manage the cash – Hermes GPE, a joint venture between Hermes Fund Managers and Gartmore Investment Management, and European Investment Fund, which invests on behalf of the European Union. The pair have started raising money from third parties, aiming for a total of £1bn.”
It’s interesting to see governments moving into this space, as VC is an extremely risky asset class. However, the existing VCs are still gun-shy after the .com bust nearly a decade ago, which is why governments are trying to get things moving again.
But, as you might anticipate, the returns for government backed funds haven’t been very good. In particular, the UK’s Department for Business, Innovation and Skills has struggled:
“…BIS’s nine regional venture capital funds posted an average IRR of -15.7%. Comparable funds generated an average IRR of –0.4%.”
Um, losing 15% to your peer group / benchmark is…how can I put this kindly…not good. So, what gives?
Nick Ashmore, head of private equity at Ireland’s National Pensions Reserve Fund, has an interesting theory:
“Many have been created by government organizations that felt they had to be prescriptive to manage the risks to government – the risk of embarrassment and money not going to the specifically targeted destination. But the schemes end up driving the design of the underlying funds, and funds designed by civil servants are not a strong source of venture capital returns.”
Oh, and you thought you were going to make it through an entire post without being subjected to a lecture on the benefits of good governance and institutional design? Ha! Actually, you know what, I’m feeling generous, so I’ll spare you my long-winded explanation for why good governance is the foundation for success and instead just tell you why we should all be more interested in governance and design: returns. Yes, it’s all about returns.
As the case above shows, there is a link between the poor governance/design and underperformance. And, significantly, this holds up in the academic literature: Keith Ambachsheer showed that the difference between superior and poor governance practices can translate into as much as 100 to 200 basis points per year, while Clark and Urwin found that best-practice funds have a performance roughly 200 basis points per annum higher than “average funds”. Now, that may not be the 15% highlighted above, but it’s still big. OK I’m done sounding like a broken record…
This post originally appeared on the Oxford SWF Project website.