The Power Law in Venture Capital

Maybe you have heard that returns from venture capital are governed by a "power law". But what exactly is that? When I first read about this I was confused. I have now figured out the technical steps need to convert the general idea of the power law you may see in popular articles into something actually useable. I'll skip those steps and show you what I think is a useable version of this idea. First we need to distinguish between investments that lose money and those that deliver a multiple of one or more times the capital invested. My version of the power law is just for profitable investments with a multiple of one or greater. The equation is:

This says that the probability P that the multiple M is greater or equal to m is equal to the formula on the right, where alpha is the power of the power law. To take an example, if alpha = 1.75 and m is 10, the probability is 0.178 or a 17.8% chance that you get more than a 10x multiple. Conversely, the probability that the multiple is between 1 and 10 is 1-0.178 or 0.822. Remember, that isn't the probability that your investment makes this much money, rather, that if it makes money how likely will it make more than m.

The interesting thing is that for 1 < alpha < 2, the probability of getting a given payoff decreases slower than the payoff is increasing. This means that more and more of the expected value of your portfolio is derived from higher and higher multiples (again for alpha = 1.75):

Expected value is just the product of average payoff and probability. This is why people say that you need to make a lot of investments in venture capital to get good results. If half your investments go to zero, you need to get an average multiple of more than two on the other half to make any money. If you only make ten investments, a 128-256x outcome, which has only a 1.1% probability of happening among your successful investments, probably won't be in your portfolio. 

 

 

20 Years of Moomin Valley

Reading Sam's post on 17 years of Financial Samurai, I realized I missed the 20th Anniversary of Moomin Valley! These were the first two posts. In the early years, I posted a lot. Since the GFC and even more since 2012, I have posted less. The nadir was in 2017 (25 posts)–the year after our first child was born. But I still managed a few posts beyond the monthly and annual reports. 2018 was a bumper year for posting and since then, I've stabilized at around 60 posts a year on average. In total there have been 2,270 posts or about 110 per year.

At first, I wasn't sure what I would use the blog for. Mostly, it has been for accountability for myself. I know I need to post about the ups and downs each month. Writing about investments means that you need to think about them. I hoped my wife would read it to learn about our finances, but that didn't really happen. 

More Gold Exposure

I brought my gold exposure back up to 10% of gross assets. But instead of investing in the PMGOLD ETF I invested in the L1 Gold Fund. This is a hedge fund invested mostly in gold mining stocks. I am lumping this in with gold metal as the price of gold is the main driver of gold mining stocks. If the government's capital gains tax changes are implemented, it will be better to have a franked dividend paying fund instead of a gold metal ETF in my personal name.

I also sold some Regal Investment Fund (RF1.AX) and bought some more Pengana Private Equity (PE1.AX). Despite the success of the SpaceX IPO, which is its largest holding, it dropped sharply today! One possible reason is that Pengana is launching a new AI fund, Maybe some people are selling this to buy that?

4% Rule Failure Rate

I have been discussing retirement planning with my brother who is two years younger than me. As a result of these discussions, I have added stochastic investment returns to my projection model as well as the Australian Age Pension (which is means tested) and I increased the planning horizon to 2060 from 2050. Moominmama would be 85 in 2060. Previously, I stress tested the projection by using very low constant rates of return.

Running my baseline spending scenario–linear growth in real spending with stepdowns of 1/6 after each child finishes university–it is very rare to run out of money by 2060. This is defined as negative net worth beside our house. In 100 runs there are no failures.

But if we spend according to the 4% rule, we run out of money by 2060 about 10% of the time, though rarely by 2050. This is using the monthly returns distribution over the last 30 years of the benchmark target portfolio as investment returns. In many more cases, real (2026 dollars) net worth is below AUD 1 million by 2060 and falling fast. If I use our own historical returns–which were very bad before 2012–the failure rate is around 40%. With our returns and linear spending the failure rate is around 25%.  

This graph compares the target portfolio, our track record, Australian shares, the MSCI World Index, and gold:

Spending according to a 3% rule and the target portfolio returns has no failures in 100 runs, though a few near misses. 

So, we need to keep our spending well below 4% or increase returns if we don't want to run out of money.

Things I Don't Invest In

For every investment I do make, there are a lot that I look at and decide against. A recent example that I blogged about is the Pabrai Funds. 

I'm sent more and more invitations to invest in start-ups. One I saw today was Venice AI. Some complicated story about a privacy oriented LLM (but uses resources from other LLMs maybe?) plus two different crypto tokens. I couldn't understand the pitch and deleted it. In general, I like to see some attention to the "economics" - what is the route to profitability. If it is not discussed at all, I tend to pass on the opportunity.

And then there are more mature opportunities including two upcoming IPOs. One is the IPO of SpaceX. CommSec has provided an Australian version of the prospectus. I already have exposure via Pengana Private Equity (PE1.AX) and if I wanted more I could buy more shares in that fund, which are trading at a discount to what the NAV would be with the SpaceX IPO price. SpaceX is their largest holding by far. S&P have decided not to change their index rules to allow unprofitable and new companies to join their indices. NASDAQ on the other hand will be including it in the NASDAQ 100 index very quickly. I am sceptical of the idea that there will be a pop in price at the IPO beyond the already crazy price–the price is near 100 times 2025 sales. With USD 75 billion of shares being issued in the IPO, most people who want them will probably get them? Most IPOs do not perform well in the short term if you buy at the IPO price.

The other IPO I looked at was a new fund from Pengana focusing on 20 private AI related companies–AIX. Bytedance and Handshake are the two seed assets. They will also be investing in "picks and shovels" and applications companies not just LLM providers. But most closed end funds definitely don't trade well following their IPO. My preference is to be invested in related resources (e.g. via Tribeca Global Resources, TGF.AX) and in earlier stage firms that have routes to profitability (see above).

Treasury Wines Investor Day

Two days after I bought into Treasury Wine Estates (TWE.AX), the company had an investor day where they announced that they would focus on luxury and trendy wines and greatly reduce the number of brands and product lines. They also said that they were reviewing their US operations and were getting good sales growth in China–better than other wine producers. Investors were very happy with this presentation and the stock is currently up 13%. I bought another 7,500 shares to get to 17,500.

 

 

May 2026 Report

International stock markets gained, but the Australian market lagged, presumably in response to the tax changes. The Australian Dollar was little changed moving from USD 0.7179 to USD 0.7185. Gold fell in USD terms. Here is the performance of our benchmarks (total returns including dividends):

US Dollar Indices

MSCI World Index (gross): 5.21%

S&P 500: 5.26%

HFRI Hedge Fund Index (forecast): 1.50%

Australian Dollar Benchmarks

ASX 200: 1.34%

Target Portfolio (forecast, depends on HFRI): 2.56%

Australian 60/40 benchmark: 2.92%

We underperformed all our benchmarks by a lot. In Australian Dollar terms we gained 0.44% and in US Dollar terms we gained 0.53%. This barely covers inflation. The SMSF also underperformed gaining 0.43% while Unisuper gained 2.26% and PSS(AP) 2.31%.

Here is a report on the performance of investments by asset class:

The asset class returns are in currency neutral terms as the rate of return on gross assets and do not include investment expenses such as margin interest, and so the total differs from the Australian Dollar returns on net assets mentioned above. Gold, futures, and private equity lost money but all other asset classes gained. Hedge funds were the best performer and greatest contributor. 

Why did we underperform the target portfolio? The most important reason is that we had a -0.15% contribution from private equity while the target benchmark had a 1.84% contribution. If the target portfolio had lost 0.15% on private equity instead, it would have returned only 0.57% overall. As we will see below, 3i was a major detractor, and we just don't have consistent wins on our venture portfolio yet. This is the J-curve curse. If and when we do have consistent returns–returns are actually positive already– they'll report with a long time lag too.  

Things that worked well this month:

• Six investments gained AUD 10k or more: Tribeca Global Resources (TGF.AX, 44k), Unisuper (18k), PSS(AP) (14k), Pengana Private Equity (PE1.AX, 13k), Acadian Global Equity Long-Short (13k), and Regal Partners (RPL.AX, 10k). Our industry/public sector super funds were nice diversifiers this month.

What really didn't work:

• Three investments lost AUD 10k or more: L1 Global Long-Short (GLS.AX, 27k), 3i (III.L, 22k), gold (14k).

Our distance from our target allocation very slightly narrowed. Our actual allocation currently looks like this:

Almost 70% of our portfolio is in what are often considered to be alternative assets: real estate, art, hedge funds, private equity and credit, gold, and futures. A lot of these are listed investments or investments with daily liquidity, so our portfolio is not as illiquid as you might think.

Moominmama receives employer superannuation contributions every two weeks. We also make monthly concessional contributions to Moominmama's superannuation to reach the annual cap on contributions. There will still be capital calls from Aura Venture Fund II and III. I am receiving monthly pension payments from both Unisuper and our SMSF totalling AUD 5,150 per month. I got a bit more active in the market, making the following investment and trade moves this month:

• We received a large value of distributions this month. AUD 20k from URF.AX, AUD 24k from Aura VF2, 3k from Aura VF1, and more than AUD 10k including the franking credit from WAM Capital. The first of these largely went to paying our SMSF's tax bill of AUD 16k after the annual accounts were finalized. The Aura payments were a welcome boost to our offset account, which is currently at just below AUD 300k:

• I made three investments (USD 2k each) in startups on Angellist. These were my first investments that were not with the Unpopular Ventures syndicate. Two of them are in the medical/health field.
• I sold 20k shares of Tribeca Global Resources (TGF.AX) around the recent price peak. This reduced our margin loan back towards the level I fixed at a constant interest rate.
• I sold 2k shares of the ASX 200 ETF, IOZ.AX. I think I was just getting bored of this! I used the money to:
• Buy 1,000 shares of ZIM again and 10k shares of Regal Partners (RPL.AX). ZIM has fallen since I sold and continued to fall since I rebought... There seems to be a lot of resistance in the government to approve the takeover by Hapag-Lloyd. On the other hand, businessman Haim Sakal has made a higher bid for the firm, though it doesn't seem to being taken very seriously. Regal just seems very cheap given the growth the firm is achieving. These helped us rebalancing as well.
• I also sold 10k shares of Pengana Private Equity (PE1.AX) as the price now seems to reflect the NAV including the expected value of SpaceX at its upcoming IPO. I bought 5k shares of Regal Investment Fund (RF1.AX) instead as it is trading below NAV.

Here are the income and spending accounts * for this month:

I just realised that I have been treating tax on employer superannuation contributions and tax on SMSF contributions asymmetrically and tax on superannuation earnings asymmetrically with tax on non-superannuation investment returns. I have been deducting contributions tax from contributions for employer super inside the "other income" category but all the tax paid on the SMSF, which includes contributions tax, has been relegated to "tax credit". Similarly, all tax paid on non-super investment returns has been in "Other income" but all tax paid on superannuation earnings is in "tax credit".

I think the solution is to deduct all the tax actually paid by the SMSF from other income, while leaving the tax credits received by the SMSF in "tax credit" obviously, but also all the imputed tax on employer super investment earnings will stay in tax credit because we never actually receive that money. The accounts above employ this new approach. This will give us a better picture of how we are performing relative to the 4% rule.

Other income includes Moominmama's salary and employer superannuation contributions but also the tax paid by the SMSF, which was AUD 16k this month.. It was a low spending month at AUD 6k, which is about the same as we spent in March. This number does not include our mortgage payments, which are regarded here as saving and investment costs. Dissaving amounted to AUD 18k, mainly because of the SMSF tax. This is still within the 4% rule limit of AUD 23k. We gained AUD 30k investing, all of which was in retirement accounts. We received a dividend from WAM Capital in the SMSF with associated franking credits this month. We also paid a lot of tax to the ATO from the SMSF. As a result of all this, net worth rose by AUD 6k to AUD 8.231 million. This is net worth is lower than that reported last month due to a fall in the estimated value of our house, where I use the same value for all months of the year.

* Results are shown separately for retirement and non-retirement accounts as well as housing, which nowadays doesn't have much activity. The grey shaded rows are additional notes. Total investment income is split into investment income before exchange rate moves and the contribution of exchange rates. Other income is non-investment income including salaries, employer superannuation contributions, net tax returns minus superannuation contribution tax and all SMSF tax payments to the ATO. Investment income is shown pre-tax. Tax credits include franking credits on Australian Dividends etc. and imputed tax on industry superannuation returns. These are taken away from investment income to get changes in actual net worth. Inheritances include gifts from relatives. Saving is from non-investment income, transfers, and inheritances. 

Having Another Run at Treasury Wine Estates

I did well on my trade last time. Stock is beaten down but rebounding a little. I sold 50 shares of Berkshire Hathaway to fund this.

 Daou Vineyard, California