Investors are constantly being told to diversify risk – that is, to spread their investments across a range of assets, sectors or markets. It appears the sensible rule to follow to avoid financial wipe-out. But sometimes financial risk is less diversified than expected or intended. For example, high-profile financial disasters such as the near-collapse of Lloyd’s of London and the split-cap scandal demonstrated how financial risk was ill-spread, despite appearances to the contrary.

Funds that invest in the venture capital (VC) industry appear to spread their risk by putting their money in a range of VC firms, but in fact there is less diversification than expected: an institutional investor may, for example, be invested in several VC firms which in turn, via syndication, all choose to invest in the same venture. The result is an inadvertent systemic risk for the institutional fund.

This paper demonstrates the development of a random sampling model to explore this network scenario, encompassing both the source and the destination of VCs’ funds. The study uses a data set of 20 VCs and 73 institutional funds. The study finds that VC syndication is less effective than expected in mitigating investment risk for institutional funds. In fact, there appears to be a conflict of interest between VCs and institutional fund managers, with syndication mitigating risk for one party at the expense of exposing the other to greater risk. The paper has implications for managers by demonstrating how interorganisational networks can be both emergent causes of – and constraints on – risk.

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