I decided to invest in two private funds: 1) Kleiner Perkins 20 (KP20), and 2) Kleiner Perkins Select2. Kleiner Perkins is a top venture capital shop which has made more recent home run investments in Figma and Ripple. This article will explain why I invest in private funds even though they charge higher fees.
KP20 is an $800 million venture fund focused on early-stage investments in enterprise, consumer, hard tech, or fintech, and healthcare companies. Select2 is a $1 billion fund that extends its core investment strategy to focus on high inflection investments across those same five areas.
Investing in these private funds does not come cheap. The management fee is 1.5% – 2.5% (fades over time) and the funds charge 20% – 30% of profits (increases after a return hurdle has been met). If you want to make a lot of money, I highly recommend being a venture capitalist!
These fees are much higher than your favorite Vanguard ETF or index fund. The average Vanguard mutual fund expense ratio is only 0.10%. Meanwhile, the industry average mutual fund expense ratio is about 0.6%.
So why invest in these private funds even though they charge much higher fees? Let me share some of my reasons. Some are obvious, while some are not so apparent.
Why Invest In Private Funds With Higher Fees
For those of you interested in investing in venture capital, check out the Fundrise Innovation Fund. It invests in private growth companies and charges a much lower fee. In addition, it is an open-ended fund accessible to all with only a $10 minimum, unlike traditional venture capital funds that are invite-only and have $250,000+ minimums.
I've been investing in private funds for over 10 years. Here are my thoughts on why I do and why you might.
1) Diversification and potential outperformance.
The majority of investors should invest 80% – 100% of their public investment capital in low-cost index ETFs or funds. At the end of the day, it's very hard to outperform any index. When you tack on higher fees, roughly 80% of active fund managers underperform their respective indices over a 10-year period.
If you're an investing enthusiast, you are free to allocate some of your capital towards individual stocks, active funds, and private funds for potential outperformance or diversification reasons. After all, you can never outperform an index if you just buy the index. Then again, you will never underperform an index if you just buy the index either.
Personally, roughly 30% of my investments excluding real estate are not in index funds. If I'm honest, I'm mostly looking to outperform with this capital because I've had some big hits before that have helped change my life.
2) More gains are accruing to private investors.
Private funds, like venture capital funds, are investing in earlier stages of a company's life. If the fund is able to identify a promising company early, the returns could be massive. Investing in public equity is at a much later stage, even though many publicly-traded companies continue to grow.
Here's a slide from Fundrise that highlights investing in private non-traded real estate and tech stocks. Fundrise offers private real estate funds that invest mostly in new developments, multifamily housing, and single-family housing projects. The platform charges a 1% total fee, which is low compared the vast majority of other private real estate funds.
Imagine developing a residential project in a location that becomes vibrant three years later due to an influx of companies. Each house costs $200,000 to build and rents out for $16,000 a year (8% gross rental yield). In three years, rents rise to $24,000 a year for a 12% gross rental yield.
Over time, the investors' gross rental yield just gets higher based on the static building cost. An amazing return for private real estate fund investors that tends to increase over time.
Finding The Early Stage Private Company
Ideally, you want to invest in a successful company in the early stage that becomes a multi-bagger. Many private companies are staying private for much longer and going public at much larger market capitalizations. Private company management doesn't particularly enjoy public scrutiny and volatility either.
For example, Microsoft went public for $777 million in 1986 (~$1.9 billion in today's dollars). Meanwhile, Uber went public in May 2019 with a market capitalization of $82 billion! Therefore, more of the gains are accruing to earlier investors. With changing times comes a change in the stage of investing.
I own Amazon stock. But at a ~$1 trillion market capitalization, it's unlikely to be a big outperformer going forward. Eventually, the law of large numbers catches up. I'd rather spread more capital out to promising earlier stage companies.
3) Dampen portfolio volatility.
The more capital you have, the more you worry about loss. As a result, you seek to dampen your portfolio's volatility with private investments. Since private funds do not have daily market value updates, unlike publicly-traded stocks, you may go under the illusion that your private fund investments are more stable.
Private funds in the venture capital and venture debt space tend to update their Net Asset Values (NAVs) quarterly. Some do so semi-annually or annually. As a result, private fund investors don't get distracted by daily moves. They can go about their business without much stress.
Hedge funds, on the other hand, tend to send out monthly performance updates. If a hedge fund is doing its job by actually hedging, then it should also help dampen portfolio volatility. However, plenty of hedge funds leverage up and take outsized risks to their detriment. We can all hedge ourselves, which is why paying a higher fee for hedge funds is harder to justify.
Below is a chart showing the average daily percentage move in the S&P 500 is usually between -1% and +1%. The public equities markets have only become more and more volatile.
4) Gain access to investments you don't have.
Anybody can invest in any public stock for no trading fees nowadays. Google, splitting 20-for-1, will also now make it even easier for retail investors to buy one share.
However, not everybody can invest in a promising private company without connections and a glowing reputation. There is a ton of liquidity out there chasing the best companies. By investing in a private fund with experienced operators, you gain access to their deal flow.
Investing in private funds is like buying access. And if you or your business have synergies with the investments, even better.
5) The opportunity to co-invest.
Sometimes, when a private fund invests in a company, the company may offer up the opportunity for the limited partners (investors in the private fund) to co-invest. Co-invest is when the limited partner directly invests additional capital in the company.
For example, hypothetically let's say the KP20 fund leads an $40 million Series A round in a hot fintech startup in San Francisco. The fintech CEO asks KP20's managing partner whether his fund has any limited partners who are in the media or who operate personal finance sites.
The managing partner reaches out to me and sends me the deck on why they invested in the fintech startup. He then tells me the company has opened up the capitalization table for me to invest an additional $50,000 – $250,000 in the company directly.
The opportunity to concentrate more of my capital in a company Kleiner already believes is attractive could end up being very profitable. Imagine if that company was Stripe? A $50,000 investment would be worth tens of millions.
Meanwhile, as a direct investor in fintech, my interests are aligned in helping their company grow with my platform.
6) More opportunities to network.
Once you invest in a private fund, you join a family of limited partners with similar goals. If you need some advice, want a warm intro, or need to get some deal done, you might have an easier time getting some help from another limited partner. Heck, there might even be a holiday party held by the venture capital firm for its limited partners.
Being a fellow limited partner acts as a screening mechanism. It's kind of like being more responsive to alumni of your school if they seek your help. Your fellow limited partners come from all sorts of backgrounds. If you want to tap into the network, you can.
Further, once you invest in one private fund, you'll have an opportunity to invest in the next one if so desired. The reason why the fund I invested in is called KP20 is because it is their 20th fund after 50 years. I'm a limited partner in the KP18 fund.
The Private Fund Market Is Small
As a stay at home dad who isn't trying to build an empire, I don't have much interest in networking to create more wealth. However, I'm always interested in promising fintech companies that could help the Financial Samurai community.
So in a way, investing in a venture fund that invests in early-stage fintech companies gives me some added insights. Further, living in San Francisco since 2001 has provided me numerous front-seat opportunities to meet and work with promising new companies.
One of my private investment funds actually rented a SF Giants box this season for the limited partners to meet, eat, drink, and be merry. Then Kleiner hosted an incredible holiday party at Menlo Circus Club where the top venture capitalists in the Bay Area all came out.
With my platform, perhaps I'll be a venture scout or source deals myself as part of investing $1 million in capital.
Venture Capital Investment Amounts By Region
Below is U.S. venture capital investment amounts by region in Q1 2023. As you can see, the San Francisco Bay Area leads the way by far. Therefore, it's easier for those who live in the San Francisco Bay Area to network and participate in more venture capital funds.
7) Forces you to keep on investing over several years.
After committing a certain amount of capital to a private fund, not all of it is called at once. Instead, your commitment may be called over a one to three-year period.
For example, let's say you commit $100,000 to a fund. 20% or $20,000 might be called once the fund closes followed by 10% a quarter for the next eight quarters.
A capital call schedule keeps you investing through good times and bad times. It keeps you disciplined. Whereas investing in public investments is largely up to you. After automatically contributing the maximum to your tax-advantaged accounts, you've got to then proactively decide how much to invest in your taxable investments.
Life often gets in the way. As a result, it's easy to accumulate excess cash over time. Investing in private funds forces you to invest regularly. Further, investing in private funds forces you to stay on top of your cash. If you know there's a likely capital call coming, you've got budget accordingly.
Here is a snapshot of four capital calls I've received from three private funds. Investing in private investments is a nice way to regularly invest in good times and bad times.
8) Forces you to hold for the long term.
Private funds generally have five to ten-year lifecycles before your capital is returned. Therefore, you're forced to invest for this period of time. The longer the investment time horizon, the greater your chance of making more money.
If you're investing in public securities with zero cost to liquidate, it's much easier to panic sell. Public investments can be a tantalizing source of capital every time there is a downturn or some type of emergency. As a result, some people can't help but tap their investments to their long-term detriment.
Once you commit capital to a private fund, you're committed for years. When there is no other alternative, your mind often feels more at peace. It's having too many choices that often stresses people out.
Below is a snapshot of unrealized appreciation on $109,200 in capital deployed between end of 2019 through 3Q2021 for my KP18 fund. Whether the $207,921 in unrealized appreciation is real or not is hard to say, especially with a downturn in stocks in 2022.
But I like how my $140,000 capital commitment forced me to invest $109,200 during the pandemic. I may have just sat on the cash otherwise. Investing for the long term with private funds is much easier. And investing for long term is more than half the battle to building wealth. Time in the market more important than timing the market!
9) Increases your chances of finding a home run investment
When you invest with smart and connected people, the chances of you discovering a home run increases.
For example, on September 15, 2022, Adobe announced it would be acquiring Figma, a design company, for $20 billion. The Kleiner Perkins 17 fund led Figma's Series B round at around a $400 million valuation. In other words, after dilution, the return is between 35-40X!
I remember when my softball buddy joined Figma back in 2019 after Uber. It was such an odd move to join this random design company. But here we are, just three short years later selling for mega bucks.
Alas, the deal was blocked in December 2023. That said, Figma received a $1 billion breakup fee from Adobe and it probably still worth over $10 billion.
The Downsides Of Investing In Private Funds
Besides paying much higher fees, there's no guarantee investing in a private fund will provide positive returns, let alone outperformance. Competition is extremely competitive for private funds to invest in the best deals.
The top funds tend to get the first look at the best deals. Therefore, if you're not investing with a top-tier fund or with a well-connected fund manager, your returns might not be that great.
If I could invest in Sequoia or Benchmark funds, I would. However, I'm not a friend or family member of any of the managing partners. But you know what? I should proactively reach out to them given I have a platform that can help promote their investments.
The other downside to investing in private funds is keeping track and filing all the K-1s that go with each fund. So long as you are organized, you should be fine. But it's just one more thing to stay on top of each year. Each firm will have its own online system as well.
Finally, investing in private funds require locking up capital for often 5-10 years before seeing any type of returns. In general, investing for the long term is good for returns. However, if you don't properly manage your capital calls, you might find yourself in a liquidity crunch.
There has been an increase in unplanned capital calls during higher interest rate and slower private market environments. As a result, private fund investors need to more carefully manage their cash flow.
Private Fund Returns 2007 – 2021
Below is a great chart from Pitchbook about private fund returns since 2007. You'll have to zoom in to see the font. It includes returns from Venture Capital, Buyout, Growth-Expansion, Private Capital, Secondaries, Real Assets, Funds of Funds, Other PE, Private Debt, and Real Estate.
A 15-year horizon IRR above ~10% outperforms the S&P 500 historical return average. And of course, not all private funds are equal.
As an individual investor, the key is to somehow gain access to the best private funds. If you can identify a talented manager and invest early in their tenure, you should be able to continue gaining access to their funds if they one day become a rockstar.
They will “take care of you” by letting you into their heavily oversubscribed fund because you believed in them from the beginning.
How To Gain Access And Invest In Private Funds (Venture Capital, Venture Debt, Private Equity)
Unfortunately, there's no easy way to invest in certain private funds. The ability to invest in private funds often has to do with who you know.
You either have to work at the fund, know someone who works at the fund, get introduced, proactively reach out and see if there are any synergies you can provide, or come from one of the companies the fund has invested in.
A lot of private funds have “anchor investors” from institutional funds, endowments, and ultra-high net worth individuals. Once the anchor investors are in, the fund managers and anchor investors invite smaller investors. It just goes down from there until the fund size targets are achieved.
The “friends and family round” is where we have opportunity if we know someone. All limited partners have the ability to invite their friends and acquaintances to invest.
Hence, your goal should be to get to know an individual who is a limited partner in various funds. Due to sensitivities, it's hard for the fund to reject warm introductions unless the fund is way oversubscribed.
Alternatively, there are private funds accessible to unaccredited and accredited investors online. The JOBS Act that was passed in 2012 has helped democratize access to private funds.
As a result, you've seen the emergence of real estate crowdfunding platforms, art investing platforms, wine investing platforms, farmland investing platforms, and more.
New Venture Capital Fund Open To All
I just wrote about how gaining access to venture capital funds like Kleiner, Sequoia, Bessemer, and so forth is hard without knowing someone. And even if you know someone, the minimum investment amount can easily be $250,000 or more.
This is why I'm pleased to introduce the Fundrise Innovation Fund. It is an open-ended venture capital fund investing in high growth private companies. The minimum investment amount is only $10 and is accessible to all.
The Innovation fund invests in the following five areas:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
Creating A Fund Of Funds
As someone who really doesn't like the stress of losing lots of money, I enjoy investing in funds. Then I like to invest in a diverse number of funds across categories such as real estate, venture capital, venture debt, bond funds, and equity index funds.
This way, it's a little harder for me to lose all my money in the next bear market. At the same time, these funds have the ability to perform as well.
I've only got about 25% of my net worth invested in public equities because I simply dislike volatility. Waking up to see my Netflix stock down 25% in one day is no fun. Nor is seeing the S&P 500 crash by 32% in a month.
The March 2020 implosion forced me to write a meaty article about how to predict a stock market bottom. Then I had to follow what I preached by uncomfortably deploying a lot of my cash. Although things have worked out, they easily could not have.
With public securities, I can't help but look at how the stock market is doing every day because it's so easy to do so on my phone or laptop. Therefore, I've decided to limit my public securities exposure to a level I'm comfortable with. So should you.
I'm at a stage where I'd much rather pay someone to think and deploy my cash for me, so I can spend more time with my family.
My Favorite Reason To Invest In Private Funds
My favorite reason to invest in private funds is that I get to forget about my capital once it is invested. It's nice knowing that savvy investors who want to make themselves a lot of money are doing their best to take care of my capital. It's like I'm offloading my stress of managing money to someone else.
Only in five to ten years will I get to truly see how well my investments have done. In the meantime, I will have spent my time doing the things that provide me the most joy. And making money from money is not one of them. It's one of the reasons why I got out of the finance world in the first place.
Investing in private funds is not for everyone. In fact, various private funds may not be available to everyone due to the need to be an accredited investor. However, if you are one, you might come to appreciate some of the benefits private funds have to offer.
Here is the investment statement of a venture capital fund I invested in in 2018. I committed $140,000 in capital and so far have funded $119,000. The ending balance as of 12/31/2022 is $364,241 for a four-year IRR of 27%. Not bad.
Real Estate Private Fund
One of the easiest private funds to invest in is with Fundrise. Fundrise manages over $3.3 billion invested in single-family and multifamily properties across the country. You can invest in one of their private funds for as little as $10. In an inflationary environment, investing in real estate to capture rising rents and property prices is the logical move.
I've personally invested $954,000 in private real estate funds since 2016. The stability, passive income, and diversification has been wonderful. When stocks are selling off, private real estate funds are an oasis. People want to own tangible assets that have utility during uncertain times.
Below is my latest real estate private fund dashboard showing I've received $624,000 in distributions since 2019. I got a $122,000 “surprise” distribution in July 2022. The distributions will continue for the next several years.
Again, check out the Fundrise Innovation Fund. It is an open-ended venture capital fund investing in high growth private companies. The minimum investment amount is only $10 and is accessible to all.
What's interesting is that you can click the link and check out its portfolio of 20+ private growth companies. Then you can decide whether to invest and how much. With traditional venture capital funds, you have to first commit money and then hope the general partners invest in great companies.
Readers, do you invest in private funds even though the fees are higher? If so, why? Kleiner Perkins is one of the oldest venture capital firms that invested early in Google, Amazon, Netscape, and Genentech.
For more investing content, you can join 60,000+ others and subscribe to my free weekly newsletter. I worked in equities for 13 years and have been helping people achieve financial freedom sooner since 2009, when Financial Samurai began. Everything is written based off firsthand experience because money is too important to be left up to pontification.