Venture capital shares : an investment analysis

Abstract

An investors' objective is to earn a return from savings due to their deferred consumption, compensating the investor for the time, the expected rate of inflation and the uncertainty of the return. Arguably, the equity markets in general offered relative moderate returns over the past number of years. Venture capital investments on the contrary are perceived to offer super returns but also bear very high risk. Given the restricted ability of the equity market to produce super returns, the likelihood to include venture capital in an investment portfolio must be considered. Therefore, when considering supplementing a well diversified portfolio with venture capital equity, one should investigate whether this action potentially increases the portfolio's rate of return significantly, whereas the associated portfolio risk augments insignificantly. At first this paper examines Portfolio theory under the Markowitz and Sharpe Models. It then moves on to Capital Market theory that extends Portfolio theory and develops a model for pricing all risky assets. Subsequently, scrutinizing investment risk, investment's rates of return and the risk return ratio associated with investments are done. Upon completion of the literature study, an empirical study was done on the JSE Venture Capital securities to assess the validity of including venture capital in well diversified portfolios. This study has found venture capital securities to be characterised with low or no rates of return. Since there is no correlation between the rate of return of the security and the market return, the beta coefficient as a measure of market related risk for venture capital can not be used. Furthermore, the venture capital low or no rate of return phenomena causes high variability in the coefficient of variation. Consequently, using the coefficient of variation as criteria for comparing venture capital security risk/return relationships with other securities isn't suitable. The results also indicate that venture capital and small capitalisation securities yield similar results. Therefore, when portfolio compilation is done, small capitalisation securities can be exchanged for venture capital securities without increasing the risk or altering the risk/return relationship of the portfolio.