Who Picks Winners in Venture Investing?

Nobelist Gene Fama, the seventh most cited economist, is known for his doubt that fund managers can pick winners in public markets. He backs up his belief with exhaustive analyses of historical data. I have heard him sum up this work to the effect that only 3 percent of managers beat the market and that you could not tell in advance who they were. Fama is the greatest proponent of the Efficient Market Theory that, in broad terms, proposes that all pertinent information is incorporated in market prices. This implies that it is not possible for stock pickers to pick winners consistently in deeply-traded public markets. Fama does accept however that there are anomalies in this theory which could be caused by how widely disseminated market data is.  One of these anomalies came up in my interview of early-stage VC Wan Li Zhu's Page.

As Wan Li Zhu said to me in his interview:

“If you look at founders that have had repeat success … In fact there was a study done by HBS professor, Josh Lerner, who studied founder performance persistence and looked at repeat founders. He found that repeat founders tend to have a very consistent skill in being able to time the market. The way he did it is he looked at the relative success rates of the entire cohorts of companies that started at a certain period of time within certain markets and then looked at how these successful founders picked these markets. They tend to pick a market time where more companies are successful in that particular domain than in other periods of time. It’s really interesting to me that market timing is actually a skill. It’s actually a skill of successful founders”.

I guess it should not surprise us that it is possible for expertise to exist in markets that are highly influenced by technology. Certain founders, given their deep experience with particular technologies and markets, have a better understanding of when a product is feasible. Given the number of these niche markets and the difficulty of understanding them it makes sense that expertise should count in a way that does not show up in public markets.

I invite you to listen to this highly informative and accessible podcast at: Angel Invest Boston Podcast on iTunes