Investor Education Series: What is a Fund’s Vintage Year and Why Does it Matter?
In private market investing, a vintage year is the time stamp attached to the year that a private fund has a first close and starts making investments. For example, if a fund begins raising capital in 2022, but doesn’t make its first investment until 2024, it’s vintage year would be 2024. The reason this is important is for comparison purposes between fund managers who started investing in the same vintage year. Benchmarking companies such as Cambridge Associates, Pitchbook, Preqin, and others, obtain information from fund managers to construct indices that are used by investors to help them understand how a fund compares to others in that vintage. Some argue that benchmarks aren’t entirely reliable because many managers aren’t included and those that are, do not submit their performance data on a consistent basis. Public market indices are different because public companies are required by the SEC to share their information. Private market fund managers do not have to. That being said, private benchmarking companies obtain performance data on thousands of managers each year, so many investors consider them a suitable resource.
A fundamental tenet of investing is to buy low and sell high. This applies no matter the sector or industry. In the private markets industry, “buying low” may be a function of how early in a company’s lifecycle one invests or one’s ability to negotiate terms. But more often than not, it’s a function of what’s happening in the broader market. When investors are flush with cash and actively seeking new investments (like they were between 2012 and 2021), startups can demand higher valuations and friendlier terms. Many funds that began investing toward the end of this bull market period suffered write downs in their top companies as market dynamics changed. See chart below from Carta that illustrates this point.
Per Carta — “In Q1 2023, the median Series D valuation on Carta was 58% lower than a year earlier, in Q1 2022. The median Series B was down 44%. Seed valuations were more resilient than other stages, but they’re still down 14%.” While these valuation declines are large, their occurrence is a natural part of the venture capital cycle. Some investors know this and if they are able, they will maintain or increase their exposure to funds whose vintage aligns with these periods when valuations/pricing is more favorable. On the contrary, there is a tendency by most investors to back away from the asset class during periods of decline because the “returns” aren’t there. However, what many of these investors fail to realize is that because it can take several years for the top companies to materialize, the historical returns that attracted them to the asset class were generated by companies that started when markets were in decline (see companies such as Uber, Airbnb, WhatsApp, Instagram, and Square that all started during the Great Financial Crisis in 2008 and 2009).
In summary, a fund’s vintage year signifies the year it started making investments. There’s absolutely no guarantee that just because a fund’s vintage year happens to begin in a down market that it’s guaranteed to succeed. That would be a bold but preposterous assumption. However, markets are cyclical — fact. Private market valuations are significantly lower than they were a few years ago — fact. Could valuations fall further? Maybe. Could this period of heightened uncertainty continue for another few years? — I don’t know. The overall point for investors is that vintage year diversification is important due to the cyclicality of the market and is one of the reasons why investors will support a fund manager through two or three vintages.
Next week:
In next week’s post we’ll talk about how venture capital firms construct portfolios by time and composition.
-Cheers, KM
