Improving Alpha: Decoding the Research in Secondaries, Co-investing, and Impact Funds

Speaker A: Improving Alpha Innovation in Investing, ESG and Technology with Michael Oliver Weinberg in partnership with Vidrio Financial. Vidrio Financial is a premier data management provider shouldering the responsibility for your data. From collection to extraction, transformation and enrichment. Vidrio monitors over 2,000 diverse funds, processing millions of data points each month. Discover how Vidrio empowers your institutional portfolio data by combining advanced AI and human expertise to yield comprehensive analytics on performance, cash flow, risk valuation and more, all delivered seamlessly through Vidrio's data management hub. Save your investment team valuable operational time providing actionable insights like never before. Explore more at AH Vision.

Speaker B: This is Michael Oliver Weinberg. Welcome to the Improving Alpha podcast where we explore innovation in investing, ESG and technology. Today, renowned Harvard Business School professor Josh Lerner joins us. We will dive to his background before tackling the core trends shaping the industry. Investors, academics and and business leaders alike will gain immense value from his unique insights. On that note, welcome to the show Josh.

Speaker C: Thanks so much. I'm really glad to be here.

Speaker B: Great to kick things off. Josh, tell us a bit about your background. Briefly share how you got where you are today.

Speaker C: Well I'm afraid at age 10 I was not born saying I want to be a uh, venture capital scholar. I sort of ended up stumbling into it and um, originally had studied in college, mostly physics and then got interested in many of the issues around the commercialization of science and technology and in particular spent a couple years after college at Brookings and on Capitol Hill dealing with many of the issues which were very new at the time but continue to be ones that we think a lot about today. In other words US competitiveness in advanced technologies, how we get more out of academic research and ultimately how to encourage startups and entrepreneurship which of course have only become more important questions ever since. So I've been at Harvard Business School for many years and hovered between the finance and entrepreneurship groups, mostly working on those kinds of questions.

Speaker B: Great. The podcast has three segments, uh, innovation and investing, ESG and technology. Let's start with investing. Um. Your recent research highlights the um trend towards over allocated institutional investors turning to secondary markets. Um as we know a function of um uh the higher cap rates, um maybe deals that were done when times were different in a zero rate environment um uh and the commensurate overallocation diminished uh M and a market um and an inability to transact But I guess for that's my level hacket at what's going on uh for listeners where do you come out on it all and what did your research Find.

Speaker C: Well, I think that certainly there is been few more dramatic trends in private equity than the rise of the secondary market. That while private equity and venture capital have both grown dramatically since the year 2000, the growth in secondary market has really been um, at a pace that outstrips it quite dramatically. And when it comes to understanding why, it's a great question. Certainly many of the factors that you raise are important ones that we've been in a period where getting liquidity out of private equity and venture capital has been very hard. Right. That there were just a lot of uh, you know, when you look, even relative to historical patterns, the amount of time that things are staying in the portfolios of private uh, equity and venture groups has become much longer. And for many limited partners who are under financial pressure, you can think about the endowments as an example. The need for liquidity is really quite important. And that's created an opportunity for both traditional secondary transactions where we essentially had asset owners such as endowments or pensions selling to other institutions or specialist funds, as well as what we call GP led secondaries or essentially transactions arranged by the private equity groups themselves, where they're basically selling um, something out of their fund into a special vehicle that they control. So while I think we can point to the sort of short run ebb and flow, there's also a broader structural thing that's going on in some sense when you think about public markets, you know, almost all the trading is secondary. Right. There's a few shares that people buy at the time companies go public. But by and large what people are doing is trading used shares that a share of um, you know, of meta that's been owned by hundreds or thousands of people beforehand and we don't think twice about it. While in private equity, unusually we've had a situation where typically the shares have only been bought initially at the time that they're offered, never really traded again. And I think one of the things that we're very much seeing is a uh, sort of shift where the trading of used shares of used partnership interest is likely to be something that's going to be increasing whatever the sort of short run fluctuations that take part.

Speaker B: Okay. In your work analyzing co investments versus solo institutional investments, if I'm not mistaken, you found that solo investments often outperform are multi year co investment deals underperforming because illiquid managers are effectively doing what they've done for many years, offering their most scalable, highest capacity, lowest returning investments to institutional investors. Uh, I'll mention protege, where I was chief Investment officer. Uh, and I know you're familiar with, um, as there was an HBS case study that colleagues of yours, I believe, wrote on us. Um, so my question is, is that right? And how should allocators adjust to this and deal with it?

Speaker C: It's a great question because certainly if we think that the rise of a secondary market has been one megatrend, the rise of CO investments and other kinds of what I term outside the box transactions, in other words, investments being done by limited partners or asset owners outside of a traditional fund structure has also risen very dramatically. And a lot of the motivation for that has been this desire to essentially avoid the 2 in 20 tax that characterizes many alternative investments. Right, the management fees and the carried interest. Because certainly, while the evidence around the performance of private equity relative to the public markets is a little bit mixed, maybe it's slightly better, maybe it's a little below. Once you adjust for everything. If you could invest in private equity and not pay the 2 in 20, it would be a, uh, terrific investment because that fee drag of the every year's management fees and the carried interest ends up being very substantial. The problem is that when you look at CO investments, um, where you essentially have a fund manager who offers, um, um, an asset owner like a pension or an endowment, an opportunity to co invest, one would think one would see outperformance. Because in most of these cases it's either on a no fee, no carry basis or else there's just some sort of upfront commitment fee. But it's certainly the cost of these investments in terms of what the private equity group is taking is, um, certainly much lower. And if the investments were apples to apples, the same as the ones that went into the funds, you'd almost for sure have outperformance. When we looked at the, um, information from State street and State Street's custodian for many of the largest institutional investors in the world, and as such has, you know, essentially unfettered access to their investments in private markets, whether they're investing through funds or else through co investments. We found at the end of the day that the CO investments did essentially the same as the fund investment. In other words, even though the fees and the haircut associated with fees was much less, at the end of the day, the net returns were actually just at par with that of the very high fee, uh, fund investments. And that really suggested that the quality of the underlying investments that were being offered the asset owners, the CO investments that they were doing, uh, was in some sense lower. That basically the Gross returns were lower so that after this sort of small haircut rather than a large haircut, they ended up in the same place.

Speaker B: Yeah, go on. Sorry.

Speaker C: No, I think your question really gets at what really is the bottom line question, which is why is it, why is it that this seemingly sure thing investment ends up uh, not doing better? And you know there seem to be several things going on, one of which is perhaps not surprisingly, these were very concentrated in time and you saw a ton of investments in essentially in buyouts right before the financial crisis in 07 you saw a lot of venture investments in 2020 and 2021 right at the market peaks, which of course with the benefit of hindsight in general, uh, is the worst time to invest. But what you also saw is that you saw the very largest deals out of the private equity group or the venture group's funds being the ones which were being offered in terms of co investments. And in general one thing that we know is that very large deals being done at market peaks is really not the way to go. Um, that for many of the groups that we were looking at, the largest co investment they'd done on the buyout side was TXU. The largest co investment on the venture side was WeWork. Right. So there were these sort of super large high profile deals that certainly at the end of the day didn't uh, pan out. I guess in some sense you can say is this adverse selection? Um, you know, and certainly the private equity groups, that's probably where they're going to need a lot of help is in the periods when they're investing a lot of money and particularly in the bigger deals. But it certainly seems that the kinds of opportunities that were offered the asset owners, limited partners ended up being uh, inferior on, on average.

Speaker B: Well, okay, so that, that, that raises a lot of uh, questions and topics and thoughts. Um, does, does that indicate that is there, can one extrapolate that there is a sort of generally a correlation between inverse correlation between size and returns and would that bode for lower middle market private equity investing being superior to upper middle market or is that too much of a stretch?

Speaker C: No, actually those are. I mean I think that that's very much related and in particular Greg Brown and his co authors using the Burgess data, uh, have shown that there is a sort of negative relationship between return and deal size that basically bigger deals on average do worse than smaller transactions. And my colleague Sabrina uh, Howell along with some of her co authors have shown that the process of getting big or scaling up it ends up being associated with Lower performance as well. So not only is it that big is not beautiful, but getting big in particular seems to be associated with a deterioration of performance.

Speaker B: And again, yeah, and that's exactly. That was our protege model that, you know, you want to invest in the small and the small, uh, uh, you know, lowest capacity, highest returning, less scalable, let's say investments, as opposed to the largest, most competitive, highest, you know, lowest, highest, most scalable, uh, low risk returning. Anyway, uh, so to m me that makes a lot of sense.

Speaker C: And of course it's fair to point out that for many of the largest institutional investors who represent a big chunk of the private equity market, whether you think about sovereign funds or some of the very largest pension funds, in some sense going small is really not an option. Right. Simply because they have so much capital to deploy and often a pretty lean staff. And as a result they put a big emphasis on limiting the number of relationships that they have. But certainly for those who can go small and delve into lower middle market or smaller venture funds and the like, it seems that that's been certainly historically really the way to go.

Speaker B: Yeah, yeah. But one more question on this. It could it be though a um, selection bias? Because generally, right, institutional um, investors have an opt in, opt out of co investments. So could it be a selection bias issue that, that do, you know, have you researched that? You follow me?

Speaker C: Obviously, yeah. So we've not done that. You know, when we did our, one of our projects on co investments, we, we got essentially 10 of the largest investors in the world who had each done somewhere on the order of a billion dollars of co investments for a decade or more to all throw their data into a pot. And then we mixed it all together and de identified it. So, you know, no one knew whose data was what or even whom we got the data from. But you know, we asked them during that process to get us the list of the deals that they had looked at and not invested in, in addition to the deals that they had done. And unfortunately they were not able to um, you know, the quality of their records was such they weren't able to come up with a comprehensive list of deals not done. But that question ended up inspiring a few of the institutions that we had worked with subsequently to do exactly that exercise, to really look at the ultimate performance of deals done as well as deals that they passed on. And you know, this is anecdote, but a couple of the groups ended up saying that when they uh, ultimately did the analysis, looking at this, that they found the performance of the ones that they had passed on was essentially indistinguishable from the ones that they had said yes to. And which really suggests that, you know, in a way, the way that co investments are set up, right, where you basically as a asset owner typically have a very short period of time, a week or 10 days to review the transaction and make a decision is just such that it's very hard for most institutional investors, even if they can access a data room and so forth, to really make a careful uh, decision as to whether this is uh, uh, an attractive deal or not.

Speaker B: Yeah. And plus, my view is what you're. And again, I mean this is similar to what we teach at our course at Columbia Business School. You know, you're also making a statement that you're effectively as good as, or possibly better than. Right. The manager in manager selection, because the manager is putting together a portfolio and you're then in turn saying you have the. As an institutional allocator who to your point, may be limited in resources, uh, you have the research capability to be as good or comparable to or possibly better than the manager.

Speaker C: Right, exactly. We would think by and large that the people who are the best deals guys will not be working for large pension funds or endowments, but instead will be mostly working for the ultimate fund manager simply because it's pretty much impossible in most cases, um, for the um, pension fund or even a sovereign wealth fund to really offer sort of market level compensation.

Speaker B: Yeah. Okay. And then last part of the investment section. Uh, I'll start with a strawman, so bear with me. And then there will be a question. Um, my view is, uh, currently it's a lot like the first tech bubble when I was a portfolio manager at Soros for George Soros, Stan Druckenmiller and Scott Besant. Um, we've got a bit of overinvestment happening in the short term, uh, long term it'll probably all be fine. But uh. And um, we're seeing it particularly in venture capital, but specifically in AI Venture and possibly some other subsectors like Defense. But anyway, particularly AI. Um, and the question for you is, are we in a structural over investment? Well, is the over investment cyclical? Structural. Um, do you have a view on whether there is an overvaluation in AI vc, for example? Um. Thoughts on that?

Speaker C: Well, it's a great question and obviously if I really knew the answer to that, I'd be relaxing on my yacht in the Caribbean with, uh, Leonardo DiCaprio and not, um, running around Boston thinking about grading finals. Um, but I think we can make a couple observations, one of which is that it's clear that almost every revolutionary technology that's come along has been associated with some sort of boom, um, and also with a correction. Right? And you can not just simply think about, you know, dot com, but you can go back in time and think about the PC revolution or go way back and think about electricity or railroads and canals and you'd see the same period of, you know, excitement translating into frenzy and then some sort of period of adjustment and correction followed by of course, in the case of electricity and railroads and so forth. These were real innovations that had profound consequences, but where it wasn't a sort of clear up and to the right kind of motion, but there was, you know, these, these proverbial bumps in the road.

Speaker B: Right.

Speaker C: And in some sense that's not surprising that markets find it hard to assess many of these new technologies and in particular figuring out how they are going to really take shape is very, very challenging. Right. So you know, when you think about, you know, the um, craze.com period, right. There were certainly a number of companies that ended up getting funded during those period which ended up being, you know, tremendous investments. And we can sort of point to um, um, you know, certainly, uh, Amazon, Google as examples, uh, along those lines. But clearly there was also a huge amount of stuff, uh, that was basically wasted on speculative, speculative companies that really didn't have much potential and so forth. But at the time, whether because of excess enthusiasm or just because of the inherent ambiguities associated with the situation,

Speaker A: uh,

Speaker C: there was a lot of money that flowed to them. So I think that given everything we know, to say there is going to be a correction is I think a pretty safe proposition. The real challenge is to figure out when. Right. And certainly if you think back to the.com boom, there were certainly venture groups who concluded that, you know, the dot com companies were overvalued and they should stop investing. Unfortunately for a number of those groups, they made that decision in a year like 1996 and they missed out on four more years of frenzy, um, and a lot of potentially profitable investments before the correction arrived. And then the second question is, you know, is there a way to sort of really pick out who are the, you know, the Amazons and Google's as opposed to the pets.com and the other loser companies who are, uh, no doubt they're in their AI equivalents out there. And this is really fun to think about and it's also really hard, right. One big question is, you know, if you look at how the market seems to be thinking today in the us it seems that the assumption is that all the values really captured by the foundational models and the companies which are essentially facilitating the people developing those foundational models, the anthropics and OpenAI's and Google's of the world and so forth, as well as of course the chip companies who are providing them with the tools that they need. And that's an interesting argument, but it's not necessarily the case. Right. That certainly, um, for those uh, listeners who've spent time in China, there one senses that it's really much more of a free for all in terms of lots of different alternative lms circulating uh, around and where a lot of the action and innovation and a lot of the value creation has really been at the application level layer of figuring out how to, how to use these AI tools, whether in robots for manufacturing or um, systems to facilitate health care delivery or the, or the like. So I think that just like these earlier booms, not only is there, you know, this sort of process of excitement which is no doubt going to um, eventually have some sort of correction to it, but also where there's some real ambiguity as to who's ultimately going to capture the value from these uh, from these innovations.

Speaker B: Yeah, I largely agree with. Yeah. Uh, I mean my m. View is that there's a correction. It goes down a lot and a lot more than people expect and then it goes up to new highs. And to your point, Yeah, I mean foundational model is a great example where, you know, look, I think some of them could be a zero. I think it could be just like during the first tech bubble where they actually don't have viable revenue models or it's highly competitive, there are some losers. Um, they possibly fall behind technologically, they're mismanaged, um, and on and on it goes. So, uh, it'll be interesting to watch it all shake out. But moving to the next topic on the UM podcast. So your research shows that impact funds target high risk frontier sectors that traditional VCs avoid. Uh, yet dual objective funds historically earn lower IRRs for allocators focused on generating alpha. Is this lower return a permanent structural trade off required to achieve the true social additionality? Does that make sense?

Speaker C: Absolutely. And certainly when you generally talk to impact groups, there's often a sense of saying you can have your cake and eat it too. Right? That we're essentially doing great investments which are beneficial to society and at the same time are going to generate the kinds of returns that are Comparable with those of traditional UH funds that don't have this kind of dual objective. And I think if you look over the academic literature, it sort of sadly says the good news is it says impact funds can make some real contributions. And you know, one of the areas that I've highlighted with the work that I've done with my colleagues, uh, um, Sean Cole and Leslie Jiang and Ben Roth and Natalia, uh, Rigaud has been this pioneering aspect of going into areas that ah, traditional investors have not done. Certainly um, many of your early investments, for instance in clean uh technologies, green technologies and the like were really pioneered by these um, uh, venture funds. That he had these sort of dual, dual mission. And that's great. And in many cases what we've seen is that the impact funds go in first, they validate the idea and then eventually the more traditional funds will follow. One's also seen a little bit of the same dynamic in terms of geographies that if you look at the less traditional markets for venture investments, often it's the funds which have some sort of community development focus, again a double bottom line kind of perspective that go in first and only later do, if they have some success, do the traditional venture groups follow. So certainly viewed from a social perspective, one can say these impact funds are doing great stuff. Particularly if we worry that the traditional venture sector has tended to focus on some pretty narrow areas and that there's probably a lot of stuff out there that could be socially beneficial that's not attracting funds from traditional venture groups. The problem is not with that side of the proposition, it's really with the other side that by putting money with these impact groups that one's going to have performance that equals or in some cases may even do better than uh, that of traditional funds. And here not only our work, but that of a number of colleagues at other uh schools have highlighted that the track record is much, much that that claim is not really borne out that there seems to be a consistent underperformance on the part of impact funds. Now again that's not to say that there aren't some people who should, may want to invest in them anyway. So if you think about a uh foundation for instance, who normally might be giving out donations where there's zero return, if they can do a program related investment in impact fund and get some money back, but not um, a market rate, it still may be attractive investment. Similarly for a family, families often are very philanthropic wealthy families. And this provides a way to say, you know, we want to invest in this. We're sort of excited about these funds. But and even if we don't get market returns, you know, that's not a major tragedy for us. But for the asset owners who have fiduciary responsibilities, and you can think about a pension fund as an example where they are really obligated to invest in funds that give the highest returns. It's a much more problematic kind of dynamic because it certainly seems again we as researchers can only look in the rearview mirror and see what was the performance of funds from five, 10 years ago or before. But certainly the historical track record has suggested that on average impact funds have not done as well as traditional single bottom line, financially uh, oriented funds.

Speaker B: Yeah, and that's what I've observed as well anecdotally, um, or having been at uh, apg, the Dutch pension investing, in my experience practically, it's very challenging to say the least to find something that to your point has both the benefit of impact and returns that are comparable, certainly not better. Anyway, um, moving on to the next topic within ESG and impact investing, um, you've done some research using US Census microdata, um, that regarding impact firms and social outcomes, um, like minority hiring and equitable wage distribution. Um, but if I don't misunderstand, you've noted that um, overall employment and payroll growth may lag, um, behind traditional uh, VC backed peers. And my question is, is that net optimal for society?

Speaker C: Well, it's a great question. So what we did just to give a sense of the project is took essentially um, all the impact funds we could identify who would invest in the United States, figured out which companies they'd put their money with and then match that to the data that had been assembled by the U.S. census and the Internal Revenue Service that not only has information about the companies themselves but also the individual workers at those companies. So we're able to look at great detail at those people who worked at companies where impact investors had invested. And then we did a companion set where we tried to match it from time and location and industry and the like to say let's look at you know, traditional uh, venture and growth equity funds because that's sort of, you don't see a lot of impact funds doing sort of classic LBOs. So they're mostly in the venture and growth equity space. Let's look at a similar set of funds that were the just pure financially oriented and similarly look at all the workers that are there. And as you say, it's a bit of a two sided story certainly if you look at the pure job creation associated with the, and the sales growth associated with the businesses, you see that the impact backed firms were lagging their single financially oriented peers. Now again, how we interpret that is uh, a little bit nuanced, right? Because that could be really for two reasons. One reason could be that they were less effective, the impact groups were less effective at adding value after the deals were done. But it could be also that many more of these deals were in disadvantaged neighborhoods in industries that were, you know, in some sense, uh, not in favor. And as a result, you know, we're sort of starting um, you know, maybe a little bit staggered behind the uh, you know, 10, 10ft beyond the um, start, uh, line in the 100 yard dash. So as a result, you know, whether the compare, the pure comparison of employment or sales growth is a fair one is something that we can debate. What is clear is that when you look at the workers at these firms, that the ones who are at the impact backed firms seem to benefit in a variety of ways, both in terms of compensation levels, in terms of the longer run career prospects, and particularly if you look at subsets like minority workers, ones who did not have a college, uh, education, um, and the like, you see that they in particular seem to benefit at the um, impact backed firms.

Speaker B: Interesting. Okay, um, in the name of time, let's move on to the last section. Uh, technology and innovation. Um, let's see, where should we go? Um, you've talked about the dance between government policy and private finance, um, with global decoupling accelerating and cross border venture capital shifting. What does it mean for the future of domestic deep tech innovation? Do you have a view on that?

Speaker C: Yeah, this is a big question that in some sense if we look at the last 30 years, up until, let's say 2022, you saw a very profound trend in venture capital moving away from uh, many of what we might call the tough technologies, whether it's advanced materials or computer hardware and semiconductors, um, and to instead essentially software and software through the Internet, software through AI and the like, but essentially still stuff that's fundamentally software driven. And in a lot of ways you can very much understand why that was right, that in a way when we think about how the venture game is played, a lot of it is about, you know, essentially putting small initial amounts of money in and getting a signal. And the stuff which gives you a good signal, you put more money in. And if you continue to get a good signal, you put a lot of money in. And that seems to be very well suited for software in the sense you can do Some code you can prototype in one city if you're doing a ride share or you know, with one market segment and then you can very much scale it up, subsequently spending the money on marketing or logistics or whatever one needs to do to scale up the business. When it comes to the real world or tough text, it's a lot harder, right, because you essentially have a bioreactor. For instance, it might work in the prototype with 30 gallons, but then you go up to 30,000 gallons and suddenly you got all these weird chemical reactions that didn't take place in the minimal size prototype. And you essentially don't have the sort of phenomenon code. If code runs once, it's going to run a million times. So that the real world introduces a lot of problems. It's also just many cases non divisible investments. If you're building a fab line, it's going to be for a new semiconductor, it's going to take you many billions of dollars until you get really the first semiconductor. And only then can you really go out and figure out if you really have product market fit or not. So all those things sort of pushed the private equity industry in some sense to much more or the venture industry much more into this sort of software oriented mode. What we've seen in the last few years has been a, ah, shift and part of this has been driven by geopolitics that certainly today there's been a huge amount of public funding for instance, going into areas like trying to ensure America's competitiveness uh, in semiconductor, um, manufacturing and rare earths and magnets and the like. And that has sort of created real opportunities in a way that's not been seen for many years for venture capitalists to jump back into these tough tech areas. You know, I guess one thing we can say is that even with the public funds tough tech is tough. And I think the jury is still out as to how these investments are going to fare. But certainly there are reasons for thinking that for instance if you think about the area of defense procurement as an example, many of the aspects of the venture industry, its nimbleness, its ability to try things and uh, quickly prototype, um, and fail easily and so forth, certainly you can imagine could be very complementary um, relative to the traditional way that defense R and D has been pursued, you know, certainly in the United States and Western Europe.

Speaker A: Yeah.

Speaker B: And then all that and your prior point that ties into um, some of the work like, like good examples I think are like quantum computing infusion where it's like um, you know, how does, how does venture underwrite those technologies where in my view there's such a long and highly uncertain horizon for commercial viability?

Speaker C: Right, yeah, it's a big question, right, because you can think about both those areas as examples. Right. And again they have the flavor that these are things that really take, you know, billions until you reach the point where you've got the kind of preliminary indications that you might be able to do in a more uh, social media startup with just a few thousand dollars and some vibe coding tools. So it's a really hard game to play in and it clearly is one where um, the venture sector I think can play an important role. But clearly the role for public funds and other kinds of investments are also really critical if it's going to come to fruition.

Speaker B: Yeah, totally. Uh, and then last point on technology, um, you've touched on the architecture of innovation and corporate creative structures. And it's funny because I wrote a non academic paper on this when I was, when I was at Protege some years ago. And um, and um, and my point then was that M, uh, a lot of the, we used to have, we used to have innovation from companies like AT&T's Bell Labs and like we had a lot of innovative, we had, we had research labs at corporations that were doing sort of out of the box thinking. And though they may, you know, that research may have orthogonal or unrelated to the core business or sort of tangential, you know, literally the semiconductor and things like it, transistors and all sorts of the world's most changing innovations came out of some or many or most of those like Bell Labs particularly. And, and so anyway, after that rant, the question is why do large corporations consistently fail to internalized disruptive technological breakthroughs, um, forcing them to rely on effectively buying venture backed startups instead.

Speaker C: It's a great question and it's a tough question, right, that in a way when we think about, you know, the AT&TS and IBM's of the world, it's clear that they had created labs which did amazing stuff, right, that you know, certainly when you measure it by Nobel prizes or just simply economic impact on the world we live in, you know, these were, you know, exceedingly influential organizations. But certainly in general the ability of corporations to translate, you know, research and particularly research coming out of these central R and D facilities like Bill Labs into commercialization, commercialized products has been pretty poor. And I remember 25 years ago, maybe even longer, Mike Jensen did an analysis where he looked at the net present value of uh, R and D spending by large US Corporations and compared it to their market capitalization. And for many of the companies, if you looked at that capitalized R and D stock, it was actually greater than their market cap, which suggested that, you know, essentially they were spending all this money on R and D and building all this knowledge. But it wasn't really getting translated into stuff that investors were valuing. And we can think about a lot of reasons why that might be. Certainly one of the big ones is, um, you know, the process of killing things off. You say one thing that venture guys are great at is killing, um, companies, right? That, you know, even the really smart guys, like the Sequoias of the world, you see estimates that something on the order of 70% or so of the businesses end up being. That they invest in, end up being disappointments. Um, and that's okay. And people are comfortable with that. For corporations, it's often much harder. I was talking to one of my former colleagues from medical school who's now at a large pharma company, and he was saying, um, at their company that he works at, killing a drug development project is harder than it was firing a tenured professor at Harvard. Right. In other words, it just doesn't happen. These things just have enormous momentum, and the train just keeps on rolling down the tracks. And you also see this with many times when I've visited corporate skunk works, where they say, we've invested in 12 projects and all 12 of them are really doing well. And you say, wait a second. How can it be that venture capitalists are failing in three out of four of the things they're doing, and you're batting, you know, 1,000. And you realize often that in many of these instances, they're just keeping stuff alive because they don't want to admit that things failed, which is a recipe for wasting a lot of. Wasting a lot of money. I think the other thing is really the translational process, right? That when we think about, you know, the kind of, you know, what is it that makes entrepreneurs successful? A lot of it is their ability to pivot, to try 20 different things until they achieve project market fit. To be able to just go one route and get some signals and very intuitively pivot to another route. That's often very hard to do in a corporate setting where every. I mean, remember one, uh, corporate venture group, we did a study on, when they launched something, they had to have the documentation ready and 40 separate languages, including Swahili, because that was the way they did product market launches. In other words, that kind of nimbleness that we sort of associate with the entrepreneurial business of just let's get it out there and see whether the dogs eat the dog food is just very hard to replicate in a corporate setting.

Speaker B: Right, right, right, right, totally. Um, okay. And then. And we've covered the bulk of the uh, um, of the uh, topics um, quickly, aside from uh, any books or favorite books that you've read. It could be related to uh, what we've discussed or just totally orthogonal as well.

Speaker C: Well, I've been reading a book most recently uh, by fellow who's a professor at the Toulouse uh, School of Economics, Cesar Hidalgo, which is actually called the Infinite Alphabet. He's actually not an economist but a uh, physicist. And he's really asking the question of where ideas come from, how do they spread and the like, really drawing from a ton of super fascinating stories and then a little bit of sociology and economics and physics and whatnot. And I think it's just sort of um, maybe because it's such a cross disciplinary look at this question of where do ideas appear and how do they get traction that I found it super fascinating.

Speaker B: Great, I'll get that today. Um, excellent. Um, and then any advice you have. Again it has to be just quickly since we're running out of time, um, for allocators, um, or regarding what we discussed earlier or not.

Speaker C: Well, I think that certainly I feel like us academics can give many of the broad brush of some of the sort of central patterns that we see in the data. We talked for instance about some of the challenges with for instance co investments as an area and certainly raising some uh, flags and cautions. But in a way, for instance, when you look at let's stay on co investments for a second, what when you look across the groups who do co investments you see that some do a lot better than others. Not surprisingly, the ones who are great fund investors often tend to be the great co investors as well. While we as academics can sort of show that and sort of at least suggest some correlations of what's associated with these groups. To really put that in a bottle and figure out how to do that effectively is probably beyond our scope of what we can do in a uh, paper with 95% confidence levels. So I have to be a little humble in terms of really telling the guys who are doing this on a daily basis exactly how to uh, how to do it.

Speaker B: But I think just this just is taking again just based on our discussion alone and I mean one of your research is the big conclusion, right, Is on a net basis co Investments have performed in line with funds. So if, if investors think they're lowering, if, if, if, if, if the net returns are the same. Right. If I didn't misunderstand you in the study.

Speaker C: Absolutely, yeah.

Speaker B: Then, then, then really there is no benefit to co investments and in fact you could argue, you know, it's more effort, more resources. It's actually probably dilutive because there it's more costly. More effort, more resources.

Speaker C: Yeah. Unless you really know what you're doing and have developed a real routine and a uh, methodology to approaching it, it certainly seems like it's not uh, uh, a strategy for the faint of heart.

Speaker B: Okay, great. And lastly again, since we are tight on time because quickly, and I know your research is voluminous, but anything we didn't discuss today that I should have asked you or. That's top of mind.

Speaker C: Well, I think it's always a dangerous question asking a professor about his research because I always can wax enthusiastic about this. But certainly I think one of the things we only barely touched on, which I think is really one of the most fascinating issues out there, which is how is the kind of geopolitical tensions that have sort of swept the world in the last um, particularly in the last uh, decade really going to translate into areas like venture capital and transform it. That's an area that I've been spending a lot of time thinking about and hopefully over the course of the next uh, year or two we'll have some new insights to share.

Speaker B: Any teaser.

Speaker C: Uh, let's just say that the venture industry is showing a lot of evidence of the same kind of bifurcation that we see in everything else from academia to uh, the Internet. And while that may be problematic in some respects, it's there. And it poses both challenges for investors as well as for entrepreneurs who are trying to think through some of their strategies.

Speaker B: I'm going to sneak one more last question and before we wrap up, um, and you can be brief on the answer, I have this sort of left tail view, um, or view that I have a. I wonder if, um, because the barrier to entry to creating a company is becoming so low with agentic AI vibe coding, um, lovable. On and on it goes quite anthropic. The barrier to entry to creating startups is and companies doing just about anything is beyond is or will be lower than it's ever been. And my question is if, if, if, if, if, if it's actually going to be, get ah, to a point where it's very difficult um, to create companies that have an expected value Great. Greater than the wacc, the weighted average cost of capital. I'm just curious if you have any thoughts on that.

Speaker C: Yeah, it's a really interesting question. I mean certainly, you know I, I've been teaching for the last few years, um, a series of entrepreneurship classes in Harvard College. And you know, obviously you see a lot of very young people going out and using some of these tools very adeptly to create things. It's fascinating that there's a ton of money out there in the size of um, a $250,000 check for entrepreneurs to these young entrepreneurs to go out and develop their ideas and do something with it. Where it seems to crunch really comes as a next stage, that sort of series A where you start getting real money, that you really start seeing this funneling and um, the challenges out there. So I think that it is an interesting question as to whether we are going to see just a ton of early stage nascent kind of stuff and the weeding out being at a slightly later stage or whether this is going to just simply translate into a ah, situation where we really do have this enormous flowering of entrepreneurship and perhaps as um, jobs and traditional employers like consultants and banking get impacted by AI, people will be ending up moving instead to these sort of entrepreneurial routes. It's going to be really fascinating to see how that plays out.

Speaker B: Josh, thanks so much for your fascinating discussion and for sharing your most valuable asset with us. Your time. We hope listeners now have a deeper appreciation for your perspective and how we can all apply these insights as investors and allocators. This is your host, Michael Oliver Weinberg inviting you to join us next time when we speak with another thought leader on improving Alpha through innovation. Thank you for listening and thank you for your time. Josh.

Speaker C: Thank you Michael.

Speaker A: Thank you for joining us on the Improving Alpha, uh, Innovation in Investing, ESG and Technology podcast. Presented in partnership with with Vidrio Financial and sponsored by Alternatives Watch and um, PEVC Tech, Vidrio Financial offers a cutting edge data management solution that not only collects and cleans your data, but also empowers investment teams to cut through the noise and extract valuable insights for better decision making in areas such as valuation, risk assessment and portfolio management. If you're an endowment, foundation, pension, sovereign wealth fund, asset manager, OCIO or family UM office facing challenges with your data pipelines, we invite you to connect with us today and explore how Vidrio can seamlessly integrate with your investment team to enhance your data management capabilities. The information covered and posted represents the views and opinions of the guests and does not necessarily represent the views or opinions of Vidrio Financial or our host, Michael Oliver Weinberg. The content has been made available for informational and educational purposes only. The content is not intended to be a substitute for professional investing advice. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding investment planning.