NEW YORK - While the best private equity deals can be hard for institutional investors to get into, foundations and endowments often have an advantage over pension funds, said Mark Yusko, chief investment officer at the University of North Carolina at Chapel Hill. But attracting managers' attention takes work.
One of Mr. Yusko's main goals is for the $900 million endowment he runs to be considered a top private equity investor, he said at the Fifth Annual East Coast Endowment & Foundation Summit on Investment Management in New York earlier in the month.
"I want the general partners to come and talk to us at the same time that they talk to Yale and Harvard," he said.
To gain entree into the top buyout and especially the top venture capital funds, you have to woo their managers, he said.
"Send them flowers, basketball tickets, whatever it takes. Some do make room for you if you're in their face enough," he said. "It used to take months to raise a fund, but these days it can be done with a few phone calls. Some of the best managers are kicking out pension fund money to get endowment and foundation money instead."
Potential investors should refine their due diligence and know who is raising money. They also should explain to their boards that they need to commit $2 for every $1 of exposure they want, said Mr. Yusko.
Longer term investors?
Managers see endowments and foundations as more long-term oriented than pension funds, and believe they are providing a service to the schools, Mr. Yusko said.
UNC had only 1% committed to private equity when he became CIO in January 1998. The endowment's policy target for private equity is now 15%. It has reached 87% of that goal, with investments in nine buyout funds, and 19 venture capital funds. If it were up to him, he said, he would raise the target to 30%.
"The returns have been fabulous. So are the egos involved," he said.
According to Venture Economics, which tracks venture activity, all venture capital investments returned 45.5% for the year ended June 30. And for the nine months through Sept. 30, $41.1 billion has been raised in commitments, up a whopping 240% from the $12.1 billion raised in all of 1998.
`Too much capital'
Buyout activity, meanwhile, has dropped off, as it takes longer for managers to put the money they raise to work, Mr. Yusko said. "There is too much capital sloshing around the U.S. International buyout funds are doing better with a median internal rate of return running from 83% to 85%."
The key to doing well in venture capital is gaining access to top-flight managers, Mr. Yusko stressed.
"Hook up with fund-of-funds managers such as HarbourVest, Commonfund, Horsley Bridge," he advised. "If you get a 35% compounded rate of return, pay the extra 1% fee. We're getting a 100% internal rate of return from Commonfund."
Some funds are still closed to new investors and some boards say no to funds of funds, which is a big mistake, he said. "They can give you an extension of staff," he said. "We get the breadth of their expertise. It's well worth paying an extra incentive and management fee for that."
Competition an issue
One of the biggest issues for private equity investors is competition for entrepreneurial talent, Mr. Yusko said. There isn't enough out there to start new companies. And the investment cycle has been shortened so much that money is being returned to investors in less than a year in some cases, when it used to be three years. Valuations are extraordinary.
Current trends include strong merger and acquisition activity and corporate finance. Executives at technology giants such as Dell Computer Corp., Round Rock, Texas, and Intel Corp., Santa Clara, Calif., have become major corporate investors in venture cap, Mr. Yusko said. They are investing as a form of research and development and also making large personal investments.
The markets for venture cap activity are expanding to include the Washington area; Atlanta, because of spinoffs from America Online Inc.; and Seattle, where some $40 billion will be leaving Microsoft Corp. as employees cash in their options to start new companies.
At another panel, Tom Van Zant, managing director at the Commonfund, Westport, Conn., said alternatives can be a great diversifier for smaller endowments and foundations.
The Commonfund, which invests only for endowments and foundations, has access to the good deals and good managers. The larger the endowment, he pointed out, the greater its appetite for alternatives. "Yale University has 20% of assets committed to alternatives; the MacArthur Foundation, 15%; and the University of Washington, 17%. Because these can be 10-year funds, there is no liquidity, and efficiency is difficult, so good managers are essential. We recommend committing at least 5% of assets, which isn't easy."
Meaningful asset allocation is as critical in private capital as it is in public markets, Mr. Van Zant said. He added that institutions need to overcommit to reach target allocations and to diversify among different types of capital investments.
Can't keep up
At Philips Academy, Andover, Mass., the $460 million endowment has a smaller allocation to alternatives than it would like, because distributions keep coming back so quickly, said Elliot Hacker, comptroller and assistant treasurer.
"The market has done so well, we can't keep up," he said.
The endowment has 9% of assets invested in private equity, including 30 private equity funds and six fund of funds, plus 6% in hedge funds and distressed debt. The goal is to add three percentage points to the allocation.
The endowment can invest from 5% to 25% in alternatives and is aiming for an allocation in the upper teens, Mr. Hacker said.
No one on staff works on the endowment full time, which is typical at small endowments. The Philips endowment provides 37% of the money for the 500-acre campus's operations, including maintenance of 150 buildings. At most schools, it's usually no higher than 20%, Mr. Hacker said.