Hedge Funds That Want to Go VC Need to Beware
(Bloomberg Opinion) -- After the pummeling they suffered at the hands of Robinhood retail traders, hedge funds are speeding over to private markets and the turf of venture capitalists. The eagerness can be breathtaking: Enormous checks written within minutes at the negotiating table, with not even a board seat in recompense, just to get part of the action. The swiftness of the matchmaking puts the likes of Masayoshi Son of Softbank Group Corp. to shame.
In the second quarter, New York-based Tiger Global Management LLC became the world’s most active venture capitalist, doing 1.3 deals a day versus SoftBank’s one, according to CB Insights. Coatue Management LLC, also based in New York, is now among the top 10 investors in U.S.-based startups. In Asia, Zhang Lei’s Hillhouse Capital Group — which began as a hedge fund — is engaged in a bitter rivalry with Sequoia Capital China, the venture capital shop led by Neil Shen.
Wall Street banks love this because they can broker the deals: They have close ties to the hedge funds, sovereign wealth funds and pension funds that want in. Goldman Sachs Group Inc. recently set up a growth equity fund to help clients buy stakes in maturing startups around the world. If smaller funds can’t write Tiger-sized checks, they can invest through Goldman instead.
But there’s a world of difference between public markets and startups. Are hedge funds and their investors truly prepared for the risks? Money alone won’t be enough.
For example, do they know how to survive the death valley curve? It’s VC nomenclature for that delicate and dangerous moment at the beginning of a startup’s operation, before it has started making any money from its business and is completely dependent on investment funds. A hedge fund that also does venture capital investing — a crossover, in industry jargon — may be too much in the habit of valuing a business in terms of sales and profitability, and not familiar with how long it takes to commercialize a company in the first place. That is, take it through the valley of death. It’s all part of the care and feeding of unicorns that venture capitalists are used to.
Crossovers should also be prepared for how intensely public private markets can be. Stock exchanges are more or less democratic: your $1 million in the shares is equal to my $1 million in shares. Unless you’re an activist investor and have to pull your weight in very loud and public ways, you and I can quietly invest our money and — if we’ve done our homework — watch it make even more money. Few people had ever heard of Bill Hwang of Archegos Capital Management until he lost $20 billion in a matter of days.
In the magic forest of unicorns, however, name recognition matters. A startup is much more likely to prefer Masa Son’s $1 million to yours (or mine) because it gets to boast that it’s in the Vision Fund portfolio. Because of such cachet, the best-known venture capital funds get the first picks; their dollar goes a bit further.
So, a crossover must learn to shed its shyness and love the cameras. Hedge fund managers need to speak at tech conferences, give media interviews, and even publish books on investing. Last year, during the pandemic, both Hillhouse’s Zhang and Sequoia’s Shen fought to stay in the limelight, doing separate one-on-one interviews with Blackstone founder Steve Schwarzman, who has become a popular business icon in China, according to The Information. Zhang also wrote The Value, a book about his investment methods.
Lots of other things, however, come with the spotlight: jealousy, additional levels of scrutiny, a loss of privacy. According to the Financial Times, some investors in Tiger Global were concerned that so much success might lead to a lack of business focus in the company, citing the $120 million purchase of a nine-room Palm Beach, Florida, mansion in February by Scott Shleifer, who runs Tiger Global’s private investments funds.
That’s nothing, however, compared to the recent distractions Hillhouse’s usually reticent Zhang has had to deal with. He started his firm in 2005 with $20 million from Yale through his mentor David Swensen, who famously pioneered the Yale model of investing. Hillhouse is now an investment powerhouse with more than $100 billion in assets, with a portfolio that includes U.S. tech names such as Zoom Video Communications Inc., Chinese e-commerce giant JD.com Inc and Indonesian logistics unicorn J&T Express.
Earlier this week, however, Hillhouse had to dispel a social media rumor that Zhang was on Beijing’s no-fly list — an alleged catalog of business tycoons at risk of fleeing China over possible financial woes. Hillhouse was among the big investors in the for-profit education sector, which the government has now forced to become non-profit. It has stakes in New York-listed TAL Education Group as well as unicorn Yuanfudao, which had $15.5 billion valuation as of last October and was seeking even more this February.
For now, the crossovers are mostly doing fine. As of July this year, Tiger Global is in the green even as SoftBank’s shares are in a slump. The bigger problem for crossover funds is that, during the often years-long wait to monetize their private investments, will they be brave enough to continue walking down the dark valleys of public opinion?
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.
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