Judging VC Skill: The Hardest Open Problem in Finance?

One life skill working in finance teaches people is how to act disappointed, even insulted, at being offered an absurd amount of money for one year’s work. Every bonus season, analysts throughout the industry psych themselves up to be performatively bummed that The Number wasn’t even higher. This is not just about greed; it’s also a cultural performance that gives you camaraderie and job security. “If you’re not fighting me over thousands of dollars,” you boss might wonder, “are you really going to fight for me over millions?”

A negotiation like that doesn’t just happen because two people are fighting over a finite bonus pool. It also happens because nobody really knows what they’re worth. And this is in an industry where your only job is to make as much money you can without violating certain constraints (those constraints vary from hard rules like “Don’t break the law” or “Don’t violate your risk limits” to softer constraints like “If our firm’s founder gave a talk at Davos about the importance of beating climate change, don’t make us file a 13-F with a bunch of oil stocks.”)

In theory, it should be easy to figure out what to pay a portfolio manager: give them some capital, give them limits on how they can trade it, and pay them a percentage of what they make compared to some benchmark. Very simple. The benchmark represents beta, and everything not explained by the benchmark is alpha. But “give them capital and pay them a percentage” is an interesting construction. To the PM, it means their…