Illustration: Shoshana Gordon/Axios
A common refrain to venture capitalists contemplating raising new funds over the last year has been the so-called "denominator effect," which impacts limited partners' portfolio compositions.
Yes, but: Some VCs just aren't buying it. "The denominator effect is largely a mythical beast that was manufactured largely to kindly say, 'no, I don't want to invest in you,'" John Ruffolo, managing partner at Maverix Private Equity, said during a panel on Wednesday at this year's Upfront Summit.
- And he wasn't alone — fellow panelists echoed his comments on stage, as did others privately to me at the conference.
The big picture: For the uninitiated, the so-called effect refers to the imbalance that a public market downturn creates when an asset allocator's overall portfolio shrinks, because of its equities holdings decreasing in value.
- Suddenly, its private capital and venture holdings are much larger in proportion to the rest than they were previously.
- "In the private markets … valuations are subjective and at managers’ discretion … and for many reasons people don’t necessarily want to mark things down," said Greycroft managing partner Dana Settle, speaking about the more opaque valuations of private portfolios.
Between the lines: The VCs' argument is that because private holdings remain artificially inflated in value (at least for a while), they create the appearance of a lopsided portfolio.
- "When I see public markets going down on average 30% yet private equity is going up 15% it’s like, come on," Ruffolo said.
- Cleo Capital managing director Sarah Kunst added that the allocation limits themselves are in a way "fake," though no investor is going to risk their job to prove that.
The other side: Naturally, LPs are insisting that the denominator effect is, in fact, very much real.
- "Most people are slaves to their models," one fund-of-funds managing partner tells Axios, speaking about the pressure institutions face when allocations exceed their targets.
- And some of this attitude from GPs is biased, he suggests. "If I lived in a 'heads-I-win, tails-you-lose' paradigm for 90% of my existence, I'd call bullshit on any prick of reality that might pierce my bubble of self-righteous comfort, too."
Still: Ruffolo did note that liquidity tightness is indeed a real challenge for institutions, especially those that have to balance payout pensions every month, for example.
The bottom line: "It's kind of like when you wake up really hungover and you're like, 'I'm never drinking again,'" the LP says. "That's where I feel like we've been for the last few quarters, but I might see people starting to loosen their tight grip and saying, 'maybe one beer won't kill me.'"
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