How VCs can beat currency depreciation

This story was republished with permission from The Realistic Optimist, a paid newsletter covering the global startup scene. It was moderately edited to reflect Tech in Asia’s editorial guidelines.

Emerging markets have long struggled to gain investors’ sustained trust. Even for the shrewd operators that can navigate political risk, inadequate infrastructure, and low buying power, the stubborn issue of currency depreciation remains.

Many emerging markets, including the most promising ones, suffer from a common ailment: Their currencies tend to lose value over time – and do so generally faster than in developed markets:

• In 2014, US$1 was worth 8.5 Argentinian pesos. In 2023, it was worth over 800 pesos.
• In 2014, US$1 was equivalent to 101 Pakistani rupees. In 2023, it was worth over 200 rupees.
• In 2014, US$1 equaled 168 Nigerian nairas. In 2023, it was worth over 800 nairas.

Investors in these markets need to make sure that their return on investment beats the depreciation rate. If it doesn’t, these investors will have lost money. If it does but only by a little, they might wonder if the trouble was worth it.

Yet, these markets keep galvanizing investors as the macro tailwinds are promising with vigorous economic growth, young populations, and a hunger for technology. So far, however, the investment vehicle that can ride those tailwinds while delivering compelling returns has remained elusive.

Most investment options in these markets remain institutional. Over the past 10 years, the MSCI Emerging Markets Index (which captures the performance of large-cap and mid-cap companies across 24 emerging markets) achieved net annualized returns of 3.01%. The S&P 500, which measures the performance of 500 large US companies, returned 12.39% annually over roughly the same period.

The savvy investor might ask: Why take a risk on emerging markets in the first place, as the available investment options seem to deliver mediocre returns once adjusted for currency depreciation?

Enter venture capital.

Venture capital as a way to beat depreciation

Venture capital takes its roots in the whaling industry, a risky but potentially lucrative business. Investing in whaling meant betting on 10 whaling expeditions with the understanding that nine would come back empty-handed (or not come back), while one would bring back enough riches to net a return.

That same mentality applied to tech companies gave birth to venture capital. This entails betting only on companies with the potential and ambition to become industry leaders while accepting that most will fail entirely.

Venture capitalists don’t invest in stable, steadily growing businesses. They “go big or go home” by design.

Studies have shown that venture capital returns outperform that of public markets over five-, 15-, and 25-year periods. This suggests that investing in top-quartile VCs is a great hedge against most macroeconomic headwinds. The key skill is picking the right VC managers.

Primed markets

Operationally speaking, for startups

Operationally speaking, for VCs

The adequate founders

Who is buying this thesis?

Risk versus reward