Pension funds and endowments that are experienced investors in alternative asset classes are turning their attention to distressed debt investing and other niche strategies.
One reason: so much money is pouring into the generic buy-out and venture capital partnerships.
Officials with the Virginia Retirement System and the endowments for the University of Texas and Stanford University all said they have increased or are considering increased commitments to distressed debt.
Meanwhile, Chicago-based Ark Capital Management's Ark Direct Capital Fund, which seeks to invest in middle-market companies owned by women and minorities, reached its first closing. Among the pension fund investors are the $3 billion Cook County Annuity & Benefit Funds, Chicago.
Ark Principal Michael Granger said other pension funds have made verbal commitments to Ark's second round of capital raising, if the first closing was successful.
Ark has raised $20 million for the first closing - of which $6 million was from pension funds -and will add $30 million in the next six months, according to Mr. Granger.
The definition of a niche strategy within alternative investments is pretty amorphous, said Kevin Albert, managing director of the private equity group at Merrill Lynch & Co., New York.
"It's everything other than vanilla venture capital and vanilla LBOs, where the bulk of the money has gone," said Mr. Albert. Other strategies considered niche alternative investments are: hard assets including energy, timber and agricultural land; international private equity; and private equity investment in public companies.
"There is a natural reluctance to do it (niche strategies), but people are doing it because of concerns about money flowing into mainstream strategies," Mr. Albert said.
Large public pension funds can't make an impact (on returns) with commitments between $100 million and $200 million, said Mr. Albert. And smaller funds have a hurdle because "they have to start from scratch figuring out what makes it (niche strategies) tick."
"My view is, if I am a small guy, I would use it (size) to my advantage by focusing on the niches the big guys can't participate in," he said. "Those (investors) that can uncover these opportunities, will get a pickup in returns."
Distressed debt, while not as popular as buy-outs and venture capital, has received enough attention to become an investment sector in its own right, according to Mr. Albert.
And, New York University Finance Professor Edward Altman forecasted in January that the market for distressed and defaulted securities would increase considerably. "The overall economy is beginning to show signs of weakness," stated Mr. Altman. "The huge new issue supply of non-investment-grade debt in the last four years of over $150 billion should result in an increase of default amounts in the coming years."
Mr. Altman's view of the market was part of the due diligence the $3.2 billion Stanford Management Co., Menlo Park, Calif., performed prior to increasing its commitment to its distressed debt program, according to Harry Turner, managing director-equity..
"His work is credible with us, and it's one of the many factors that we would consider," said Mr. Turner. "We made our (increased) commitment last year in anticipation of what you may be hearing."
Mr. Turner declined to say how much Stanford increased its commitment to distressed debt.
Likewise, the University of Texas Investment Management Co., Austin, is looking at the strategy.
"In September, as we enter our new fiscal year, we will put a lot of thought (toward) if distressed securities will be a new asset class," said Austin Long III, vice president of private investments of the $5 billion endowment.
The Virginia Retirement Systems, Richmond, has about $120 million already committed to distressed debt, and Managing Director Larry Kicher said he wouldn't be surprised if an additional $25 million to $50 million is committed in the next six months. The fund, said Mr. Kicher, would be a limited partner in a partnership.
"I view the distressed area as one of the more favorable," said Mr. Kicher. Virginia's approach would be to invest on a non-controlled basis, which seeks to buy bonds at a discount and, following a restructuring, end up with bonds at or near par.
An investor that invests on a controlled basis seeks to gain the lead debt position in a bankrupt company, turn around the operations and receive equity in the post-bankruptcy company.
"This (non-controlled) is the most attractive niche right now," said Mr. Kicher.
In contrast to distressed debt, little attention has been paid to investing in companies owned by women and minorities. The market, said Mr. Granger, is pretty robust.
Revenues of companies owned by minority group members increased from $860 million in 1972 to $23.2 billion in 1993, according to U.S. Commerce Department figures supplied by Mr. Granger.
Corporate procurement is driving much of the revenue growth of minority-owned firms, he said.
"I believe that large corporations are doing minority purchasing for business reasons," said Mr. Granger. "They have a business imperative that they treat minority groups fairly and that they (the corporations) are perceived as fair."
As large corporations streamline and consolidate their purchasing, minority firms that are suppliers will need access to capital in order to compete, said Mr. Granger. "That would favor what we are doing."
The instinct has been to describe Ark's strategy as social investing, but Xcylur Stoakley, a principal, said that is not the partnership's focus.
"Our return objective and target is in the 20% to 25% range," said Mr. Stoakley. "Our returns (projections) are competitive with the institutional experience within the private equity area.
"Institutions have not traditionally participated in the growth of this marketplace," said Mr. Stoakley. "We understand that some investments might generate other benefits, but that is not our driver for seeking them out and pursuing them."
Ark's strategy is to invest equity capital in established minority-owned companies - with annual revenue between $10 million and $100 million - for expansion and to back minority entrepreneurs in acquisitions, said Mr. Granger.
"Disadvantaged businesses are not our focus or orientation," said Mr. Stoakley.