After ERISA, pension funds began to realize that they weren't forbidden from investing in alternative asset classes.
Despite the passage of ERISA, representatives of the venture capital and real estate communities still were having trouble getting pension executives to invest because of concerns over the new law's prudence standards. Lawyers had apparently warned them that venture capital and some real estate was too risky for pension funds under the law.
The 1979 DOL interpretive regulation on the definition of prudence under ERISA eased most pension executives' and money managers' fears.
Ironically, the prudence regulation did not immediately help venture capital significantly as managers and pension executives quickly found another section of ERISA -- the definition of what constituted pension plan assets -- to be a source of concern.
Two more years elapsed before a regulation on plan assets was developed and refined to everyone's satisfaction -- meaning it covered the protective purposes of ERISA while allowing venture capital and the private partnership form of real estate investing to be used by pension funds.
A few pension funds made small commitments to venture capital before the complication of ERISA and were very happy with the results.
General Mills, pioneering once again, had committed $3 million to a venture capital partnership sponsored by Donaldson, Lufkin & Jenrette in 1970 and, despite the uncertainty of ERISA, rolled the commitment into another DLJ partnership as the original one matured. Robert Hoffman, director of benefit finance at General Mills, said the original investment had been "very successful" and that a number of the companies the partnership had bought had gone public or had been sold.
Similarly, Stauffer Chemical Co. invested less than $1 million in a venture capital partnership in 1972 and saw returns outpace the S&P 500 index. Both General Mills and Stauffer Chemical planned to maintain their commitments and took comfort in Ian Lanoff's definition of prudence. Most other pension funds were content to wait until the plan assets question was settled.
By the mid-'80s, pension funds were secure in their venture capital investments. Interest grew steadily through the period, although the asset class remained of interest to a minority of funds.
* Two months after inheriting $2.3 billion from AT&T in February 1984, U S WEST, one of the regional Bell operating companies split off from the telephone giant, hired Citibank as a venture capital adviser and gave it $15 million.
* The Washington State Investment Board hired four venture capital advisers and split $41 million among them.
* Pacific Lighting Corp. hired three venture capital managers and planned to invest up to 3% of its $400 million pension assets in the asset class.
* New Enterprise Associates, a venture capital partnership, picked up commitments of $125 million from 16 institutions, including the General Electric, Oregon Public Employes and IBM pension funds.
But the result of pension funds' pursuit of private investing was often too much money chasing too few deals. This affected the venture capital sector in the late '80s and early '90s so that returns dropped to barely better than the broad stock market, and were far too low for the level of risk accepted. As a result, pension fund commitments to venture capital dried up for a time, and the weaker venture capital firms dropped out of the market.
The picture had begun to brighten by 1993 when the demand for funds began to pick up as a result of a surge in high tech, Internet and biotech startups. Venture capital returns began to improve and pension funds began to invest in venture capital pools again.
At the same time, investing in private equity funds to finance management buyouts or leveraged buyouts also surged. In 1993, 105 private equity funds closed after raising $12.7 billion, up from 82 funds raising 10.7 billion in 1992.
But 1993 began with trouble as J.P. Morgan's $1 billion Corsair Partnership, which invested in private equity deals in the banking industry outside of the United States, ran into trouble. The fund had committed $162 million to Spain's fourth largest bank, which then ran into trouble and was taken over by the Bank of Spain.
But still, pension funds had become so comfortable with private investments that some had begun to invest directly, shunning the funds offered by KKR, Forstmann Little and Castle Harlan and others. Among those choosing the direct route were the California Public Employees' Retirement System, the Pennsylvania Public School Retirement System and the Wisconsin Investment Board.
One investment avenue that attracted pension fund attention for its apparent ability to protect from the ravages of inflation was oil and gas.
OIL AND GAS
These deals came in three key varieties: oil well development; oil well completion; and royalty participation. They were too exotic to attract the attention of many, but a few larger funds began to invest.
One of the first deals involved providing capital to Standard Oil of Indiana (now Amoco) to explore its leases in the Williston Basin in North Dakota, South Dakota, Montana, Manitoba and Saskatchewan.
The General Electric Co. and Hughes Aircraft Co. pension funds -- together with a consortium of insurance companies and other institutions -- agreed to put up $150 million to finance the exploration.
Gary Helms, director of investments at Hughes Aircraft, said oil well investment "uniquely has the ability to keep up with inflation."
Soon after, the pension funds of DuPont, GE and Firestone Tire & Rubber agreed to help finance a deep gas drilling project in the Anadarko Basin in Oklahoma. The assets were to be used for well completion and could not be drawn on until the project was proven.
For their capital, the funds received a 10% net profit royalty interest.
However, as oil prices began to slide from their 1979-'80 peak, pension fund interest in such ventures waned.
GOLD IN ALASKA
The State of Alaska Retirement System took an unusual approach to combating inflation. It bought gold.
Peter Bushre, deputy treasurer, waged a 16-month campaign in the late '70s to win legislative approval for the $700 million fund to invest in gold, foreign securities, real estate and the use of financial futures for hedging purposes.
The legislation gave the fund permission to invest up to 10% of its assets in gold bullion, and within a few months Mr. Bushre had bought a ton of gold at $651 per ounce. By the end of 1980, the fund had bought a second ton of gold for $575 per ounce.
"The record for gold is enviable in preserving real dollar value in times of inflation," Mr. Bushre said. No other pension fund made a significant commitment to gold.
A year later the gold move appeared ill-timed as the price dropped to $470 an ounce. The Alaska fund sold its gold in March 1983 at $414.25 an ounce, or $16.6 million, representing a loss of almost $9 million.
During the '80s, a few funds diversified into commodity futures through managed futures programs. In these, a money management firm selected a diversified group of commodity futures specialists and allocated money to them for investment in commodity futures.
The Eastman Kodak Co. fund became one of the first funds to invest in this asset class when it began its program in 1987 with Mount Lucas Management. About the same time, the Virginia Retirement System also began its program, which eventually grew to an investment of more than $500 million.
Both ended their programs in the mid-1990s as a result of management changes -- changes in corporate management at Kodak and changes in the board of trustees at Virginia.
About the time the Virginia fund dropped its managed futures program, Consolidated Rail Corp. began a $50 million program. After four years, Conrail reported it found the program was riskier and produced lower returns than the Standard & Poor's 500 index. But Conrail officials still regarded the program as a success because the correlation between the managed futures program and the S&P 500 was extremely low -- only 0.25.