Episode 275: StepStone Insights: Demystifying Venture Capital for Insurance Portfolio Managers

 

Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name is Stewart Foley, I'll be your host.  Hey, welcome back. It's great to you have you. We've got a really interesting podcast for you today on a topic that is not always center of the fairway for the insurance crowd. We're going to be talking about introducing venture capital to insurance general accounts. We're joined by Anthony Giambrone and Stephen West, both managing directors on the venture capital and growth team at StepStone. 

Gentlemen, thanks for being on, thanks for taking the time. Certainly appreciate this and I can't wait. I know that I'm going to learn a lot because it's not my asset class either, and looking forward to it. Welcome. 

Anthony: Thanks, Stewart. It's great to be here. 

Stephen: Thanks, Stewart. We're really looking forward to it. 

Stewart: Good deal. We want to start this one the way we always do, which is try to get to know our guests a little bit more than just on the asset class side. I'll start with you, Anthony. Where did you grow up? And what was your first job, not the fancy one? 

Anthony: Well, Stewart, it's always fun for me. I'm from the great state of West Virginia, and come from very humble beginnings. My first job was actually managing a service station back home in West Virginia. 

Stewart: What town in West Virginia? 

Anthony: I'm from Morgantown, which is a great college town where West Virginia University is located. 

Stewart: Yeah, it's interesting. We had Bob Morgan from another of our clients, and he is from Huntington. It's not that there's a tremendous number of people from West Virginia. I'm from rural Missouri, so I can way relate. My first job was I mowing lawns. Then my first where anybody got a W2 out of me was at McDonald's. I completely understand that one. Welcome to the show. 

Stephen, how about you? Where did you grow up, and what was your first job? 

Stephen: I grew up also in the South, in Charlotte, North Carolina. My first job was when the Carolina Panthers got their franchise in Charlotte, when they first moved into the new stadium downtown, I worked for my cousins who owned a bunch of parking lots as a parking attendant on game days. Some years when they were doing really well, you were super busy running around. And other years, there wasn't really a car to flag in, so you were hustling for every car to come in the lot. 

Stewart: Wow, that's interesting. I can only imagine that environment has to be really interesting to be on. I didn't have anything nearly that cool to do in Imperial, Missouri. But hey, we all ended up in the same place. Here we are on this podcast. 

It would be helpful I think, and we talked a little bit about this before the show started, but most of the CIO seats, folks have a pretty solid fixed income background. There's exceptions to that, but most of the time, my colleagues and the people I used to work with, they are deep in the fixed income side. We didn't come across venture capital all that often. Just to level-set for us, what is venture capital as defined at StepStone? 

Stephen: Yeah. Venture capital at its core is providing equity financing into high growth credit companies. It plays a crucial role in the innovation economy by supporting these companies, the ones that drive technology advancements and economic growth through different traded products and services. If you looked at some of the largest companies in the world, Apple, Google, Microsoft, Amazon received most of their early external financing from venture capital.

It has a large impact on the US economy. There was a study from Stanford that nearly 40% of employees at US public companies founded after 1979 worked at firms who received venture capital investment. I don't think it's controversial to say VC is a significant contributor to US economic growth, even if it's not a common investment. 

Stewart: Yeah. I would just say not a common investment on the insurance side. But certainly, I think one thing's for sure is that insurance company portfolios are significantly more diversified than they were even 5 years ago. The timing of this is outstanding.

Anthony, speaking of 10 or 15 years ago, how is VC different today than it was? I've been at this for a minute. I think sometimes, people get in their head an idea about an asset class or a set or characteristics associated with an asset class that may no longer be the case or may have changed significantly. Give us the rundown on VC. 

Anthony: Yeah, it's a great question. It's one we could probably spend the entirety of the conversation on. You could dissect it from lots of different vantage points. But to come at it from more of a macro lens, number one, I would say we are seeing much wider participation. It's no longer just for endowments and foundations, but sovereign wealth funds, both public and corporate pensions, insurance companies, hospital systems, family offices, and even increasingly through the private wealth channel, the purpose-built solutions. We're just seeing every type of allocator now participating in venture capital. 

The second point is really how its grown as a part of broader PE portfolios. If you look back at the era, say 2008 to 2010, VC was probably 15% to 20% of a total PE allocation. When you look at those portfolios today, VC's probably representing somewhere between 30 and 35 percent of the total PE allocation. 

When you wrap that all together, it just means that there's just much greater scale. VC has really grown from a cottage industry to now a fully institutional asset class. Just looking at VC AUM, it's 10X in 15 years, now greater than $3.3 trillion. It is a really eye-opening number. But at the same time, what we're seeing with respect to magnitudes of outcomes in the asset class, they're much higher. We think that's one of the reasons that it continues to be a really compelling place to allocate. 

Stewart: That's super helpful. The question reads why would an insurance investment portfolio want exposure to venture capital? My editorializing on that is that mutual carriers in particular don't have access to outside capital, and it's hard for them to grow their surplus outside of retained earnings. This asset class, in my mind, is a potential fit for that. 

Stephen, what in your mind is why insurance company investors want VC exposure? 

Stephen: Well, certainly the most relevant reason is returns. According to industry research, venture capital is the highest performing asset class over the last several decades. This is one of the reasons that other longterm investors like endowments have increased their allocation to venture in particular, as Anthony mentioned. Furthermore, certain insurers typically have a very, very strong understanding of the likely timeline for their capital needs. Therefore, an insurance portfolio can use these long time horizons to invest in illiquid venture capital. 

Then lastly, the universe of public companies has shrunk, and companies are continuing to stay private longer. When HubSpot when public in 2014, for example, it's revenue the prior year, 2013, was $77 million. Klaviyo, it went public in 2023. Its revenue the prior year was $472 million. There just seems to be a much higher bar for companies to go public today, meaning that growth and those investment gains stay in the private markets. If you're not investing in the private markets and you're not investing into VC, you're potentially missing out on those significant gains. 

Stewart: That is a really interesting point about the bar being raised to go public. I hadn't thought about it. That makes great sense.  In addition to why, the other relevant question is how. When you consider an insurance company, as is always the case, every insurance company's different, their mix of business is different, their duration targets and everything else are different. But how would you recommend someone ... Maybe a two-part question. If you have a venture allocation now, where would you add? And if you had no venture allocation today, where would you start? 

Anthony: Yeah, it's a fun question for us, Stewart. I think we at StepStone, we invest out of a platform with solutions that span really the entire lifecycle for VC companies, so from the earliest to the latest stages. I think the answer is it really depends. We would say it depends because every investor really has to define the objectives that they have, and then really align those against what is the risk-return framework that they would want to participate in.

For example, some investors might say, "Hey, we want exposure to the innovation economy at the earliest stages." This is obviously high risk, potentially high rewards. In a scenario like this, we might recommend a more diversified approach as a way to manage risk. Something like a fund of funds where you can build a broader basket of exposure to elite and emerging elite funds. It might be a little bit longer in duration, but it does greatly increase the odds that you can capture some of the outlier outcomes that Stephen was even describing. 

At the end of the day, capturing these outcomes and these outliers is paramount to achieving upper core tile performance. VC has always been and always will be a power-law driven asset class. It's really a small number of companies, at the end of the day, that drive most of the returns for the entire asset class. That's one of the most important things I think to remember. 

Looking at it from another lens, you may work with an investor that's, say allergic to the J-curve, very sensitive to duration. In cases like this, we might say, "Hey, a secondaries-oriented strategy would really make a lot of sense." You're going to be investing, at the end of the day, into more operationally-mature assets, much closer to an exit. In theory, you could be giving up a little bit of the upside, but the path to seeing distributions can ultimately be much shorter. 

The biggest thing that we would leave people with, and that we coach our clients and people that we have conversations with about building venture portfolios, is that you really have to be consistent. In venture, it's impossible to time the market, as many asset classes. We would say venture may be one of the hardest, if not the hardest. But the penalty for missing vintages in venture over a long time horizon is really significant. 

To quantify this, we've leveraged our own internal data at StepStone, looking at across more than two decades. What the data showed us was that about 80% of VC performance was attributable to just five to seven vintage years over more than two decades. If you missed any of those 5 to 7 vintages, your returns and your end-of-day performance really suffered. That's why the consistency component is something that we think is really important as a leave behind for people thinking about building venture into their portfolios. 

Stewart: That's super helpful. When you think about partnering, why do you think it makes sense for an investor to partner when investing in venture capital? The rationale here makes sense to me. Talk to me about the partnering aspect. 

Stephen: Well, venture capital is really hard. Institutional investors into venture often face either an access issue or an identification challenge. The best venture capital firms often stay quite small, and therefore are typically impossible to gain an allocation into for new investors. As longtime investors into venture capital, a fund of funds partner like StepStone may be able to provide hard to access allocations.

On the other side of the coin, there is this long tail of emerging managers which anyone could potentially access. However, it's very difficult to pick the best ones out of the over 1500 emerging venture capital firms out there, unless you have the team with the size and skill to speak to diligence and identify these great opportunities.  It's really a challenge that a partnering in venture capital can help you solve by working through both that access and identification issue. 

Stewart: Two questions, one for each of you. First, Anthony, you mentioned secondaries. I didn't really think of or realize that there's a secondaries market in venture. Is there a secondaries market in venture? 

Anthony: Yes. I would say it's probably one of the fastest growing components of our platform, and really becoming more of a common theme in the asset class. I think we've done some math on the unrealized nav in venture, and it's somewhere around $1.4 trillion for vintages that are 2020 and older. 

If you think about that, you're talking about the GDP of some sizeable countries. You have a lot more investors that are getting on the bus at different points in time. At the same time, you have investors that may need to get off the bus at certain points in time. While secondaries 20 years ago were far less common, I think we are seeing secondaries become a much bigger component to what we're doing. That's obviously driven by capital market conditions. Over the past several years, it's very well known there's not been as much M&A. We haven't seen as many IPOs. LPs everywhere are really seeking those opportunities for liquidity. 

At StepStone, we've done as much as we can to educate a lot of venture GPs on how to think about some of these things. Where, say in an asset class like a buy-out, secondaries have been very common for a very long time, it's a very well-developed market. But in VC, maybe less so. Helping GPs think through some of these liquidity solutions that they can help sponsor for their LPs is a big part of what we've been doing as the market has really been through a reset in the past few years. 

Stewart: Then, Stephen, you've talked about data at StepStone. I think it's worth nothing, and we've talked about this in the past, that StepStone has the SPI database, which is an extremely robust private assets database that is core to the investment process at StepStone. It's an extraordinary tool. Can you just unpack that a little bit, and talk a little bit about SPI and the kind of dataset that you're working with there? 

Stephen: Yeah, absolutely. SPI, as you mentioned, is one of the real weapons for us at StepStone. Just in terms of people, we have over 100 team members on our portfolio analytics and reporting team, over 35 on our data science and engineering team. Our SPI platform, which is the proprietary database, tracks over 120,000 companies, 18,000 GPs, and 43,000 funds. Just a significant amount of data that we're able to bring to bear across all asset classes to help us make decisions, spot opportunities, and identify risks. And leverage that information for clients as well. 

Stewart: That's super helpful. We're recording this on January 16th, which is four days ahead of the inauguration. We've got a new administration. I saw a news flash hit that said mortgage rates are above 7% for the first time in a long while. Talk to me about the time is now a good time to invest. I'm mindful of what Anthony just mentioned, about you need to be consistent, you need to be in this market year, after year, after year, because it's very vintage dependent. But talk about the timing a little bit. 

Anthony: Yeah. To your point, Stewart, it is a very hard asset class to time, but I would make a few points. One is that there was a lot of irrational exuberance in the market, a lot of frothiness in the venture asset class from, call it the end of 2020 through the first quarter of 2022. Since then, we've really seen what is a healthy reset in the asset class. We often say tourist investors, these are people that tend to show up when the market is reaching the top, a lot of those investors have since left. Valuations are much more rational and very much in line with historical averages. At the same time, funds sizes have really normalized. Net-net, this is all very good for venture return math. 

Additionally, and I'm sure you've had other people talk about this or people have heard this out in the market, but the opportunity in AI is something that we really can't ignore. We would say probably still very much in the early stages of the AI era. There's really no shortage of opinions on the opportunity in AI. Some might say it's over-hyped, but I think a lot of investors, and in particular investors we think that are very smart, would say it's probably under-hyped. 

Stewart: I would agree with that, by the way. I think it's under-hyped. It's a daily part of my life. It makes me way smarter, way more productive. It makes me a much better writer. We use it frequently, or I do. I have no background in it. I can't imagine what you can do if you really were skilled with it. I think it's going to be revolutionary in the same way that the industrial revolution was a century so ago. 

Anthony: Yeah, that's right. One of my favorite quotes I saw from an annual meeting last fall from one of our close investors was that, "The tracks always come before the trains." I think what you've seen in the public make with Nvidia from an infrastructure perspective, you've seen with some of the large language and foundational models, that's really setting up what is coming. I think what we do know is that with every platform shift and innovation wave, so say the internet, mobile, cloud, they've all benefited from and have been larger than those that preceded it. I think we really lean in the case of optimism on the AI topic.  
To your point, we think AI will have really profound impacts on all of our lives, both personally and professionally. 

Stewart: Absolutely true. I agree with that. 

Anthony: When you really combine what is this macro-level reset that has brought down valuations, brought down fund sizes, made venture math better, and you combine that at this point in time with a really significant technology platform shift, we think you have an unusual potential right now to supercharge the types of returns you could make in the asset class. Obviously, it takes a very long time for this to prove out. But when we look back at periods coming out of the reset, following the Dot Com bubble, really looking at what happened post-2008, venture performed really well coming out of each of those cycles. I think we're primed to hopefully do the same again. We don't have the crystal ball, but a lot of the elements, a lot of the parts of the recipe are really in place for these to be exciting vintages. 

Stewart: I really appreciate that, and I really appreciate a phenomenal education on venture capital. I know a lot more than I did, and I know our audience did, too. I've got a couple of fun ones for you on the way out the door, if you'll engage me. 

This one's going to be a little bit ... The first one's going to be you, Anthony, because you grew up in West Virginia, and I grew up in rural Missouri. It's a lot farther from Missouri to your seat at StepStone than the miles, right? There's a lot, a lot, a lot to know and learn from a rural background as you get in there. What advice would you give a kid from West Virginia who was graduating from your alma mater or similar, who wanted to become a managing director in venture capital and growth at StepStone? 

Anthony: Well, yeah, the biggest thing I would say is probably patience is something you're going to have to master. I think any career in the private markets, but in particular in venture is very longterm-oriented. I was very fortunate to make my way into investment banking, which helped build a great foundation for my career, but have now been participating in the venture asset class for over a decade. It's hard to imagine that it's already been a decade because it feels like now, it's gone by really fast.

But for me, I would say, just putting your head down, being a student, wanting to learn as much as possible. That was really transformational for me early in my career, just trying to read articles, trying to read white papers, trying to just be a real student of the asset class. That has really helped set me up for some of the stages that have been later in my career. I would say I'm still learning, even as an MD. There's really a never-ending amount of things that you can learn. In venture, we're solving new problems in new categories every day, which is one of the things that makes working in venture so exciting. There's just always a new set of challenges that need solved. We're lucky to partner with great entrepreneurs, and have been lucky to partner with really exceptional venture capital firms to help solve some of those problems for society.

Stewart: That's very cool. I appreciate that.  Then the last one is a fun one. Let's say that we're going to go to lunch, you guys are going to go to lunch, a table of four. You each get to invite one guest to join you, alive or dead. Who would you most like to have at that lunch? We'll go to Anthony.

Anthony: Yeah. I would say for me, I've always been a personal fan of Revolutionary history, and would probably say a Founding Father type person. I always enjoyed reading about Thomas Jefferson, so someone like a Thomas Jefferson would probably be one of my invites. I think going back a couple hundred years, thinking about the way that those guys thought about things is really fascinating in the construct of the doctrine and the principles that they put in place for our great country. That would most likely be one of my invites. 

Stewart: That's super cool. We're actually having an ABF real estate infrastructure event in Philadelphia in May, on the 7th and 8th. We're working with docents who come, because there's so much history in Philadelphia, they come in and actually portray the historical figure. I was never a big history buff and I can't wait to figure out what I learn. I can completely understand and align with the direction you're going down there. 

We'll go to Stephen. Who, in addition to the Father, Anthony, and yourself, is joining you for lunch? 

Stephen: I'll stick with the president theme, but go a little bit later than Anthony. That's with Teddy Roosevelt. Not only as a president, which is always incredibly interesting, but he also served in the military, and separately was just an explorer, one of the last explorers of that era. After losing one of his presidential elections, went down to Brazil with one of his sons and was charting one of the last great rivers in Brazil as well. Just a really interesting life that I think you don't see that in today's world anymore. 

Stewart: That's super cool. All right, listen, thanks so much. I really appreciate it. We've had a great podcast with you both. We've been joined today by Stephen West, managing director, and Anthony Giambrone, managing director of the venture capital and growth team at StepStone. Gentlemen, thanks for being on. We certainly appreciate the time. 

Stephen: Thanks, Stewart. 

Anthony: Thanks, Stewart. 

Stewart: You bet. Thanks for listening. If you have ideas for a podcast, please shoot me a note at stewart@insuranceaum.com. Please rate us, like us, and review us on Apple Podcast, Amazon, Google Play, or wherever you listen to your favorite shows. My name is Stewart Foley. We'll see you next time on the InsuranceAUM.com Podcast.