Institutional investors are remaining loyal to venture capital, despite the painful correction Internet stocks are undergoing.
With many early stage venture funds investing in technology firms, investors are feeling the pinch o the Nasdaq's slide.
"Last year was Star Wars, the force is with you. But this year, it's The Empire Strikes Back," quipped Christopher Ailman, chief investment officer at Washington State Board of Investment, Olympia. Still, his view hasn't changed: "The important thing in venture cap is to invest with bright partners who have good track records -- and to be diversified throughout technology, because certain sectors have fallen out of favor."
The business-to-consumer, or "e-tailing" businesses, have been suffering, with many hitting new lows, leading investors to veer from those and toward business-to-business and information technology or Internet infrastructure companies instead, he said.
Washington State, with $45 billion in assets, and about $1.05 billion committed to venture cap, doesn't have much money invested in e-tailing, Mr. Ailman added.
While the Nasdaq's recent plunges have not influenced Mr. Ailman to change his strategy, he has been asking the system's general partners to quote returns that are realistic.
The internal rates of return "of 100% achieved in January and February are asset levels we're not going to see again," Mr. Ailman said. "So we're using returns as of Sept. 30 and Dec. 31, which are 40% and good enough. I'm trying to manage our board's expectations."
Good time to buy
Other fund executives also said they were staying the course.
Michael Gutnick is chief financial officer at Memorial Sloan-Kettering Cancer Center, New York, which has a $200 million allocation to early stage venture cap, with half invested. "Hopefully early stage venture cap people will find this a good time to buy into new deals at cheaper prices, and returns could be even better . . .," he said.
Mr. Gutnick was among those emphasizing that decisions about venture cap were made on a long-term basis, not on day-to-day trading activities. He said the recent volatility wouldn't affect the endowment fund's strategy.
Jay Yoder, director of investments at Vassar College, Poughkeepsie, N.Y., concurred. "We're long-term investors," said Mr. Yoder, who oversees $650 million in endowment assets, with $39 million invested in venture cap, all through funds of funds. "One week's happenings and short-term volatility don't affect our strategy. There would have to be some significant changes over several years for us to make a change."
However, he doubts venture capital investors will continue to reap the stunning triple-digit returns of the past few years.
The recent downturn in hot Nasdaq stocks happened too quickly for people to make big changes yet, observed Mario Giannini, president and chief operating officer at Hamilton Lane Advisors, a Philadelphia-based consulting firm that also runs private equity funds of funds.
Hamilton Lane, which is investing $250 million raised from European investors, is not having any problem finding investments. "Deal flow is still strong and the IPO window remains open for selected industries," Mr. Giannini said.
But Danny Bowers, chief investment officer at the $1.7 billion Houston Firefighters Relief & Retirement Fund, had a poor outlook on venture cap well before the tech stocks began to correct.
That fund has only about $16.5 million in venture capital investments, "and we haven't been adding to it," Mr. Bowers said.
"When you see that flood of money pouring into all those (venture cap funds), a lot are going to be investing at very high asset value levels, which means the resulting returns are going to be very poor."
He said Houston Firefighters takes an opportunistic approach and buys out-of-favor assets. It owns some venture cap through secondaries, which he believes might benefit from softness in the market. It also has a strategic relationship with Centennial Funds, Denver, for various stages of technology.
From his vantage point, too many systems have rushed to add funds of funds, "grabbing for the brass ring. A lot will have poor results and some (limited partners) will lose a lot of money," he predicted.
Despite the downturn, investors have to put their money in technology, because it's now 30% of the gross national product, said Kevin Albert, managing director-private equity, at Merrill Lynch Co., New York.
He noted the hot sectors keep changing. On April 10, Safeguard Scientifics Inc., Wayne, Pa., announced it will stop investing in business-to-business companies, and will focus instead on infrastructure investing, because it offers better market opportunities.
"Probably business-to-business got too hot with too many companies in the same sector," Mr. Albert speculated.
But while some venture capital firms are shifting their focus, limited partners are continuing to line up. For example, the investment committee of the $166 billion California Public Employees' Retirement System, Sacramento, was expected to recommend to the board April 17 that it allocate an additional $400 million to Grove Street Advisors for its venture cap program. Grove Street was given $350 million by CalPERS in October 1998 to develop a venture cap fund of funds, which would help the system substantially increase its participation in top-tier venture cap funds.
Even though investors are sticking with their long-term strategies, the increased volatility of the Nasdaq could lead investors to cut their allocations to venture capital, contended Jesse Reyes, vice president of Venture Economics, a Newark, N.J.-based private equity research firm.
If the public markets continue to fall, the distributions will dry up and the amount allocated to venture cap will have to shrink, he predicted.
Returns have skyrocketed because venture firms could exit their investments by taking them public. But if public markets keep skidding, young firms' ability to go public will be harmed.
That hasn't happened yet. As of April 13, there were a record 170 companies in registration, ready to go public.
Because of the huge demand for venture cap, the investment cycle has shortened to three years from six years, Mr. Reyes said. "It's been running on Internet time, leaving less time for doing due diligence and sizing up a deal. No one has been comfortable with that new timetable. This correction could slow things down again."