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ACADEMY: What is the "Portfolio Effect?"

Posted by Erica Duignan Minnihan on Jun 7, 2016 11:37:00 AM


The “portfolio effect” is the decrease in overall risk in a portfolio of high-risk, but relatively uncorrelated assets. In venture investing, it typically refers to the strategy taken by experienced investors of investing smaller amounts of capital into a fairly large number of startups, rather than putting all of their capital into one or two companies. It is often very hard to predict exactly which of a group of high growth potential startups will end up as the “winner-that-takes-all”, so better risk-adjusted returns can be achieved by investing in a portfolio of 30 high quality companies over time. Many startups fail, and the returns to investors are often binary, meaning you tend to either get a high multiple return at an exit, or you don’t get much of anything back at all. The portfolio effect gives you a better chance of mitigating the losses generated by the relatively high percentage of failures, with the outsized gains generated by your successful investments, which can reasonably produce 10-100x returns on investment over time.

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Topics: Venture Investing Academy