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Concentration risk does not reduce as the fund size gets larger: Waterfield study
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Some of the largest funds have the highest dependency on a single investment for high returns, said a report by multi-family office firm Waterfield Advisors titled ‘The India PE/VC Funds Report’.

The expectation is that concentration risk would reduce as the fund size gets larger. However, the data sets in fact contradict this, said the report that studied 40 domestic funds to analyse trends in the country’s alternatives space.

At the other end of the spectrum, smaller funds do run the risk of depending on a single investment, as is expected of them. Most funds below $50 million (Rs 357 crore at current exchange rate) seem to have a higher concentration risk, said the report. Only five out of 18 such small funds from the dataset had a lower concentration.

The report also says that since most investments made by these funds are illiquid in nature, the internal rate of return (IRR) and multiple on invested capital (MOIC) are determined based on the valuation of each portfolio company in their latest rounds.

All VC fund managers target a 20-25% IRR with a four times multiple on the capital raised. IRRs tend to show an upward curve in the first few years of the lifecycle as there are fewer drawdowns from limited partners (LPs), according to the report’s findings. On the other end, as capital called by a fund reaches the committed amount, IRRs tend to taper into a more rationalised area.

And the data analysed also goes on to indicate that a fund manager’s decision to undertake fundraising for a new vehicle appears to coincide with the IRR climb of their active fund.

“When you are investing into a venture capital fund you need to understand as an LP that we see funds are taking a lot more risk – and they should – which means a bulk of the companies will actually not do so well, but those very few that will do well is what will drive the performance of the fund,” said Rohan Paranjpey, the head of alternative investments at Waterfield and a co-author of the report.

And there is also a specific period that delivers the greatest returns for a fund. “The three-to-five-year window seems to be the most effective in terms of generating IRR,” said Paranjpey.

What does the future of the Indian alternatives space hold? For one, a greater advantage to homegrown firms as existing and potential LPs take notice of the successes of entities like DSG Consumer Partners and Blume Ventures.

Another trend that funds have started to pursue, according to the report, is a focus by startups on local and hyperlocal challenges and the use of technology to address them. “The government is also furthering this cause by establishing incubators and other essential systems to help fledgling companies find the right guidance, funds and infrastructure.”

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