[Areading314]

If the fund manager leaves your money sitting around in cash for a few years, that impacts your returns, since you could have put that money to work elsewhere. Including the gradual investment as part of IRR is the correct thing to do.

[boulos]

Sorry for not making it clear: they don’t ask for the money, until it’s “needed”. The term of art is “capital call” and while it’s possible to call at any time (perhaps you want to make a huge investment and you don’t have the cash currently), it’s usually somewhat spread out. The “default” behavior is an even-ish set of calls over say a 5-year period for a (nominally) 10-year fund.

[609venezia]

Isn't the money in some sense tied up if it has to be ready for a capital call? At minimum it should be in some relatively low risk liquid investment. So there is opportunity cost regardless of whether the investor or the fund holds it until it is deployed?

[boulos]

Yep, but that’s equally true of any IRR calculation (for any IRR, you should compare to the risk-free rate or alternatively some other equal-risk benchmark). As an example, perhaps the real comparison for VC investment should be to having your “capital to be called” in the S&P 500 while waiting for capital calls. Except, as you allude, that’s quite risky for “you are required to deliver” (and IIUC, often within days). That makes the easiest assumption some sort of money-market fund or treasury something something.

In any case, the $X in S&P 500 at t=0 versus the IRR of a venture fund is not an apples-to-apples comparison. There are many ways to meet your capital calls, and I suspect that sophisticated investors aren’t keeping the cash in their checking account waiting for an email.

[609venezia]

I agree it isn't apples to apples. I wonder if it is nevertheless the best comparison, though, because they're two fundamentally different beasts.

If I have a lump of cash I need to deploy, I can buy lump sum SPX at t=0. I can't call a VC and say "here's X money, invest it all immediately."

The fairest comparison probably would be lump sum SPX against a blend of VC IRR and money market, converted from one to the other at a typical capital call rate, but as the number of variables increases so do the number of assumptions, and given the low returns on money market funds I don't see how the extra complexity adds much to the story.

Am I missing something?

[cjlars]

Kind of, it just needs to be sufficiently liquid that you can meet the capital calls as they come. If you've got 10% of a portfolio committed to a VC fund, you can keep the rest in the S&P and just sell shares as needed. However, you would have series of returns risk of the capital calls came during market crashes.

If you've got 50% committed, then you need to do even more careful cashflow planning.