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Machines Smarter than Expert Investors?

August 2, 2022 • Posted in Animal Spirits, Investing Expertise

Do presumably expert early-stage startup investors, whether individuals (Angels) or institutions (Venture Capitalists) invest efficiently? In his June 2022 paper entitled “Predictably Bad Investments: Evidence from Venture Capitalists”, Diag Davenport applies machine learning methods based on information known at the time of investment to evaluate decisions of early-stage investors. He defines early-stage investments as equity deals within two years of incubator completion categorized in Pitchbook as deal types Series A, Series B, Seed Round or Angel (Individual). He define late-stage exit as initial public offering, merger/acquisition or funding categorized in Pitchbook as Series C or later. He uses his first five years of quantitative data and numerical transformations of the qualitative data (text) in training a model with XGBoost to predict future venture success. He then applies the model to the next three years of data to build a portfolio that substitutes conventional investments (such as the S&P 500 Index) for predictably bad ventures. Using venture financials and qualitative information about the CEO from Pitchbook for 16,054 startups accepted into top accelerator programs during 2009 through 2016 (2009-2013 for model training and 2014-2016 for testing), he finds that:

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