Building the S&P 25,000
Index investing in the public markets has yielded superior returns for most investors than active stock-picking. The data shows that fewer than 20% of active money managers outperform an index (such as SPY) over 10 years. Stretch it out to 15 years, and fewer than 5% of active money managers will outperform a broad index.
This is true of the private startup markets as well, as this data from Angel list shows. It takes a top-quartile fund to outperform the entire early-stage investing market. It’s rare. 8 out of 10 managers who try to beat the market, fail to do so. And of the few that do manage to do it for Fund I, rarely do it again for Fund II and Fund III.
Even in crypto, many folks have concluded that just HODL-ing BTC/ETH provides index-like exposure to the crypto space, and often equal or superior risk-adjusted returns.
Pareto principle — index investing wins 80% of the time (or 95%, if you look longer), compared to active deal- or stock-picking.
Building a better Index
Given the above, instead of asking which stock/startup I should invest in, we should instead ask — what makes a better index? What are the structural advantages? Why do indexes win, and how can we win more?
There is significant data to show that the size of the index correlates with higher total returns, by capturing outliers:
We see this in the public markets as well, where the Total Stock Market outperforms the S&P500 and the Dow.
On the whole, apples-to-apples, there is a performance reward for going earlier in the lifecycle with younger, smaller companies.
We see this when early-stage investing (Venture Capital) to late-stage investing (public markets) as well:
We also see seed-stage funds outperforming mid/growth-stage funds. I saw conclusive data on this last year, but can’t track it down to link source at the moment.
👉 There are structural, ongoing rewards for:
- Going early vs late, to capture more growth and upside.
- A large sample pool vs small, to capture the outliers that drive most of the returns.
Magic Wand: S&P 25,000 🪄
Index construction likely requires its own series of posts, but if we could waive a magic wand and create an index of 25,000 credible, early-stage startups, then that would be a larger pool to capture outliers than any index that exists today.
To some extent, YCombinator is following this strategy with ever-larger pools of ~800 startups per year now.
Why startups? Capture as much of the growth & upside as possible.
Why 25,000? 🤷 Could be 10K, or 50K plausibly as well. I think 25K is both achievable, and large enough, to capture outliers being missed by existing indexes (both public and private). Also mitigates risk by going so early.
Inclusion criteria? Subject for another post, but some combination of objective criteria around revenues, diligence, valuations and co-investors. This is a solved problem, by studying other indexes.
Based on everything we know, an index like that should outperform:
- 80% of VC funds and active money managers
- Broad indexes like the Dow, SPY
- Technology-specific indexes like QQQ
This would be a Vanguard for private, early-stage investing. And there are ways to open this up to all investors (retail yay!), anywhere (double yay!). Subject for yet another post.
Why hasn’t anyone done this already? 🤔
