Because every silver lining has a cloud. Why are institutional investors continuing to pour money into venture capital despite that industry’s recent history of abysmal returns?

Marc Andreessen, the founder of Netscape and other startups (including Ning, which creates platforms for online social networks), thinks he knows the answer.

He notes on his new blog that money is flowing “into venture firms and out to startups at a higher rate in 2007 than in 1997 and 1998,” though still well short of the eye-popping amounts of 1999 and 2000.

He writes:

Somehow we’ve ended up in a paradox: venture capital returns, on average, have been terrible, but contrary to historical precedent, the money keeps flooding in, venture firms keep going, and you have more money chasing deals than you did in the middle of the dot-com boom.

What gives?

Some years back, he says, big investors like pension funds and university endowments changed their asset-allocation models, having discovered that putting some of their money into “alternative investments” (essentially, anything other than conventional stocks and bonds) yielded better returns. Since the amount allocated to venture capital isn’t all that much to them (relative to the size of their overall portfolios), they are willing to sit out weak periods rather than move money into other types of investments.

In one sense, this strategy sounds quite sensible — a sort of buy-and-hold attitude, rather than an attempt to time the venture market.

But this disconnect between returns and investment levels may have a downside, Mr. Andreesen suggests, namely this: “More venture dollars chasing few good deals, and long-run terrible returns for everyone.”

(Continue reading this story on New York Times)

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