The old economy.
I started in the venture capital business ten years ago, on June 8, 2001. That day the NASDAQ closed at 2,215.
A lot has happened in the interim: Google went public. Netflix went public. Apple invented the iPod, iPhone, and iPad. Microsoft launched the first XBOX. LinkedIn, Facebook, Skype, YouTube, and Zynga were founded. Blu-ray was invented. And there were equally important advances in pharma and clean tech. You would assume that the NASDAQ was on a tear for the last 10 years, right?
Fast forward to yesterday; the NASDAQ closed at 2,357.
The NASDAQ gained 142 points in 10 years. If you bought an index fund in 2001 you would have had 60 basis points per year in compound growth. That is lower than inflation and worse than the interest rate at your local bank.
And that is the good news. If you lived outside the United States the returns on the stock market were even worse. I charted two lines below – the blue line is the NASDAQ as we see it and the red line is the NASDAQ translated into Euros using the daily exchange rate.
As you can see, the “growth” between 2002 and 2011 is an illusion. This is the economic miracle of the last decade - outsourcing, subsidies, and productivity gains have somehow masked inflation. Meanwhile growth has stalled. The only investors making money in this market are hedge funds trading at 200 times a second.
This may be the steady state of the old economy: “safe” investments, high on compliance and low on growth, eeking out average gains of 60 basis points a year.
The new economy.
I learned in graduate school that the “venture capital asset class” is highly correlated to the NASDAQ. Throughout the 1990s you could recreate the returns of venture capital just by buying the NASDAQ with leverage. Here is a short explanation:
In the 1990s, venture-backed companies went public at an early stage. Cisco’s valuation at IPO was $225MM, Amazon’s valuation at IPO was $440MM, Yahoo’s valuation at IPO was $550MM, eBay’s valuation at IPO was $715MM. In absolute dollars, over 95% of the valuation growth happened after these companies went public. By investing in the NASDAQ you participated in this upside.
This has changed in the last five years. Witness Facebook, which has continued to raise money at valuations north of $50BN with no IPO in sight. Companies don’t need to go public anymore. As a result, a new private economy is emerging with returns diverging from the public market.
You may wonder why companies aren’t going public. For starters, it is easier and cheaper to fund growth from private investors. I have seen $100MM transactions close in two weeks, with minimal fees and hassle. There are many other advantages to staying private: expert networks don’t call your employees for inside information, hedge funds don’t trade your stock 200 times a second, and you don’t have to share every iota of your operating activities with competitors.
And if the secondary markets are not adequate liquidity, there is a lot of money on the sidelines for M&A. In the last few years Microsoft, Cisco, Apple, and Google have quietly stockpiled over $200BN in cash. And that is just four companies.
This is the new economy. I don’t know what the returns look like in the long run, but at the moment they are much better than the public market.