Recent analysis of the venture capital landscape reveals some interesting trends: emerging specialist managers and smaller funds consistently deliver stronger performance, outpacing their larger counterparts. What factors give these emerging players an edge, and why does their approach seem to foster success? In this blog, we take a look at the dynamics and advantages that set emerging specialist managers apart, examining how their focused strategies and perspectives may contribute to sustained outperformance in venture capital and counterintuitively why a smaller fund size tends to be an unfair advantage.

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Emerging Managers Outperform

New venture capital managers are increasingly emerging as top performers, offering fresh perspectives and strategies.

Recent evidence shows that emerging fund managers are outperforming their more established peers in the venture capital space, driven by a combination of ambition, expertise, and targeted investment strategies. According to a recent Pitchbook study, nearly 18% of first-time funds achieve an internal rate of return (IRR) of at least 25%, compared to only 12% for more seasoned funds.

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Similarly Cambridge Associates, highlighted in their report on how VC positively disrupts intergenerational investing, that between 2004 and 2016, top-performing US funds were predominantly first-time or relatively new funds.

Several factors contribute to this outperformance:

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• Specialisation and focus

Specialist first-time venture capital managers have consistently outperformed their generalist counterparts by focusing on targeted sectors. Data from Pitchbook demonstrates that specialist VCs outperform generalists across various performance metrics, including higher IRRs. This focus on niche markets enables new managers to build stronger networks, source superior deals, and provide more targeted support to their portfolio companies.

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By leveraging their expertise and focusing on specialised sectors, emerging managers often bring fresh perspectives and strategies to venture capital, allowing them to deliver outsized returns in an increasingly competitive landscape.

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• Motivation is a key factor

Emerging managers often bring an exceptional drive to succeed, as their personal and professional stakes in the fund's success are notably higher.

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The other thing emerging managers generally have going for them is size.

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Size matter - Small funds outperform

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The above analysis by a VC investor using Pitchbook data demonstrates the strong performance of smaller funds based on Total Value to Paid In Capital (TVPI). Other analysis based on data from Pitchbook and analysis from Sante Ventures also showed that venture funds smaller than $350 million are 50% more likely to generate a 2.5x return than funds larger than $750 million.

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Why? It is easier to have fund-returning exits in smaller funds.

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A $50M fund only needs to grow to $150M to reach a 3x MOIC (Multiple on Invested Capital), while a $1B fund must scale to $3B for the same result. Or to think about this in another way: how important is a 15x return on a $5M investment? The answer depends on fund size. In a $75M fund, this investment would return the entire fund value to investors. But it is less than a quarter in a $500 million fund and therefore must be repeated several more times to produce the same return which is less likely. Sante Ventures summaries well in their 2023 paper Why Venture Capital Does Not Scale “Winning deals must generate significant returns as a fraction of the total fund size rather than as a multiple of capital invested. This is an unintuitive but essential point.”

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The law of large numbers limits larger venture capital funds return

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One of the key reasons smaller venture capital funds (under $250M) often outperform larger ones can be traced back to the law of large numbers. This principle explains that as the number of investments increases, overall returns tend to converge toward the market average. Larger funds, with more capital to deploy, generally have larger portfolios or can only invest in the largest rounds. Where they invest at the same stage as smaller funds, they are forced to spread their capital across a larger pool of deals. This dilutes their ability to benefit from rare outliers that drive outsized returns.

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This pushes larger funds into larger investments which naturally are less numerous, tend to be higher-priced and have a lower probability of high exits, whereas smaller funds can be more selective, giving them a better chance at generating exceptional returns.

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In separate analysis by Energy Transition Ventures based on Prequin data, smaller venture funds have consistently outperformed larger ones, with data highlighting the superior performance of funds under $250 million. Over half of the top decile performers were funds smaller than $250 million, and 30% of these were $100 million or less. Notably, no mega funds exceeding $1 billion made it into the top decile. Mega funds underperformed across various metrics, with net IRR (return rate) results showing these funds lagged all other fund size buckets in three out of four vintages. In contrast, small funds, particularly those $100 million or less, either matched or outperformed other fund sizes in every vintage analysed. The middle-tier funds, between small and mega funds, showed more mixed and volatile performance across these metrics.

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In conclusion, size doesn’t correlate with higher performance in venture capital. Smaller funds, driven by the flexibility to invest selectively and the ability to create significant impact with a small number of high-return exits, consistently outperform their larger peers. In addition, emerging managers tend to have smaller funds which combined with their specialised knowledge and motivated teams, further strengthen the case for targeted funds as engines of both innovation and returns.

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About Climate Tech Partners

Climate Tech Partners, is a new venture firm investing in climate solutions specialised in the energy, transport, industrial, and mining sectors. CTP partners with corporates and industry to help accelerate their transition strategies by scouting and investing in globally scalable climate tech startups.

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CTP's strategy aims to derisk the investment approach by focusing on solutions that address specific industry decarbonisation needs. CTP leverages the commercial and technical expertise of corporate partners to maximise the potential of investments. Currently, CTP has 12 corporate partnerships with ASX100 companies, multinationals, and a few private firms across energy, transport, industrials, and insurance.

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Climate Tech Partners is currently raising a wholesale VC Fund.  If you are interested in learning more, please click here

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References:

• Pitchbook – Establishing a case for emerging manager
• Cambridge Associates - Venture capital positively disrupts intergenerational investing
• James Heath
• Santé Ventures – Why venture capital does not scale
• Energy Transition Venture – Small venture funds outperform large funds

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Disclaimer

This paper, authored by Climate Tech Partners (CTP), has been prepared with care. However, the references cited have not been independently verified by CTP. Readers are advised to exercise their own judgement and conduct further verification. CTP accepts no liability for any errors, omissions, or outcomes resulting from the use of this document.