Markets Are Chaos

Last weekend, Jason Zweig wrote about our ability to mentally and emotionally withstand today’s market volatility. He introduced a framework by Daniel Kahneman; the key to investing is having “a well-calibrated sense of your future regret.” In essence, you should ask yourself if you will be more upset if

(A) you buy into the market and your position goes down 50%, or

(B) you sit this one out and the market goes up 50%.

Then, act accordingly.

Full article can be found at wsj, excerpt below:

This framework applies to the private markets in many ways too.

If you were to ask the above question to early-stage investors, they’d often reply (A). Growth investors skew to answer (B). Of course, everyone wants to make knock-out investments, but only early-stage investors are willing to repeatedly take chances on opportunities that have a weighty chance of going to 0… its a much bigger risk to miss out on the opportunity that breaks out. Growth investors think about things with a much tighter aperture. Since they’re investing in more mature startups, their expected return is lower and they need to minimize loss ratios. Simply, this is an increased risk aversion.

Today, COVID-19 has shocked the venture ecosystem, impacting investors’ risk appetite:

These phenomena introduce friction to the VC-Entrepreneur market which has been extremely liquid. This friction will lead to risk aversion in the short term causing some early-stage investors to more frequently choose (A). Some investments may not be made, some at lower prices.