Warburg Pincus Counsellors Inc. is about to launch a mutual fund modeled after an unusual institutional product.
The only problem: how to explain it to retail investors.
The model for the fund is a portfolio of post-venture capital distributions that has attracted $800 million since 1989 from large pension funds. These clients - which include The endowments of Duke University and Rensselaer Polytechnic Institute; The Common Fund; as well as the pension funds of IBM Corp.; General Electric Co.; AT&T Corp.; Dow Chemical Co. and the Pension Benefit Guaranty Corp. - have hired the firm to actively manage a portfolio of non-cash distributions from their venture capital partnerships. Rather than liquidating these securities, the idea is to make the most of them. No pension fund sponsor wants to inadvertently sell the next Intel Corp.
The product has performed so well that the firm will use the collective universe of holdings (which are all based on the clients' own venture capital partnerships) as the investible universe for the mutual fund.
The new mutual fund will be called the Warburg Pincus Post Venture Capital Fund.
The co-managers of institutional strategy will run the retail fund, which is still in registration with the SEC. The duo, Elizabeth Dater, senior managing director, and Lynn Steppacher Martin, senior vice president, also run other small-cap funds for Warburg Pincus as part of a five-person team.
The post venture product is distinct from the $7 billion in venture capital managed by E.M. Warburg Pincus, of which Counsellors is a subsidiary.
Counsellors runs $11 billion, including the post-venture product and a $5 billion mutual fund family.
The post-venture product includes start-ups as well as buyouts and financial restructurings.
Some clients want the distributions liquidated within a certain time to be reinvested in the asset class; others allow the managers to add to deals they like, thus turning the portfolio into a specialized emerging growth fund. In fact, that's how they came up with the mutual fund idea.
Only six or seven firms offer a post-venture product, including Brinson Partners Inc., Chicago; and Chancellor Capital Management Inc., New York. Many of these firms offer the service as part of their small-cap effort; some also act as gatekeepers for private equity investing on behalf of pension fund clients.
At Warburg Pincus, by contrast, "we take a fresh public market view of these companies on behalf of our clients," said Ms. Dater. The team oversees distributions from 344 partnerships. Few are sponsored by E.M. Warburg Pincus.
Ms. Martin said: "Clients want someone who hasn't lived through the venture phase and could look at this objectively."
Among the holdings that have "grown up" in their post venture portfolio are Cisco Systems Inc., Xilinx Inc., Altera Corp., Paging Network Inc., Office Depot Inc., First Data Corp. and Associated Natural Gas Inc.
The firm's benchmark is what it calls a "locked box," an index portfolio that assumes none of the distributions was sold. Typically the portfolio has about 40% in technology stocks, 40% in health care and 20% in other sectors.
"We're willing to underperform the locked box in the short term to achieve the clients' goals in the long term," Ms. Martin said. Lockboxes differ for each client. Those who chose their venture partnerships wisely are the most difficult to beat.
So the locked box is not only a benchmark of Warburg Pincus' performance but also of the plan sponsor's choice of venture capital funds.
The firm's goal is to add 100 basis points net of fees over a client's locked box.
The post-venture strategy has outperformed the locked box composite in down years but not always in up years. In 1990, it fell 7.7% vs. the locked box's 7.9% decline and the Russell 2000 Growth index's 17.4% decline.
In 1992, it was flat while the locked box was down 0.6% and the Russell 2000 Growth was up 7.8%.
In 1991, the strategy rose 101.2%, far surpassing the locked box's 90.3% and the Russell 2000's 51.2%. But in 1993, it underperformed the locked box, earning 19.9%, vs. 22.3%. Still, it surpassed the Russell index's 13.4%. In 1994, it again outperformed the locked box, rising 4.1% vs. 2.8%, while the Russell 2000 Growth fell 2.4%.
In the first six months of 1995, it earned 21.6% vs. the locked box's 20.8% and the Russell's 15.9%.
Returns are not net of fees. The management fee is 1% for the first $10 million under management, 80 basis points for the next $20 million and 60 basis points for accounts over $30 million. The new mutual fund is expected to have an expense ratio of 165 basis points in the first year. (The average mutual fund's expense ratio is 1% to 1.5% of assets, according to the Investment Co. Institute, Washington.)
The venture capital cycle is still going strong, according to the managers. "The drought from 1983 to 1990 set the stage for high returns in 1991. We're between 35% and 45% through the small-cap cycle," said Ms. Martin.