undefined | Better HN

0 pointswhack5y ago0 comments

In an efficient market, investments that are more risky will produce higher returns. If they didn't, no rational investor would invest in them. Why invest in a venture that is more risky, unless you're compensated via higher returns.

You can already see this playing out in the public markets. Stocks produce far higher returns than corporate bonds, which produce higher returns than treasury bills.

There's further nuance here around systematic risk vs unsystematic risk, but I don't think it's as relevant to VCs since their number of investments is too small to diversify away all unsystematic risk.

0 comments

smogcutter5y ago

The point is that risk = higher return is an oversimplification. What that risk means is a significant chance of a much lower return. So if a basket of risky assets predictably overperforms... it isn’t actually that risky. Prices should rise in that case (and returns fall).

Having a higher potential return and actually being +EV aren’t the same thing. Just ask any bookie.

whackOP5y ago

> The point is that risk = higher return is an oversimplification. What that risk means is a significant chance of a much lower return.

Well yes. This is exactly why higher risk generates higher EV in an efficient market. Because of the significant chance of lower returns.

> So if a basket of risky assets predictably overperforms... it isn’t actually that risky

Depends on your time horizon. The S&P 500 predictably generates higher returns than T-Bills, over a 100-year time horizon. But it is still very risky to a 70 year old retired pensioner. This risk is why the S&P 500 generates higher average returns than T-Bills

j / k navigate · click thread line to collapse