Sell or hold? What's an investor to do?
When general partners of a venture capital firm give their limited partners stock distributions from newly public companies, most limited partners are unsure what to do with the stock. As a result, more pension funds and endowments have been hiring post-venture distribution managers to manage the distributions for them.
The $171 billion California Public Employees' Retirement System, Sacramento, in early February issued requests for proposals for a stock distribution manager and expects to select one in April, said Brad Pacheco, CalPERS spokesman.
And in the last several months, both the $56 billion State of Michigan Bureau of Investments, Michigan Department of Treasury, Lansing, and the $1.5 billion Memorial Sloan Kettering Cancer Center, New York, have hired Credit Suisse Asset Management, New York, to oversee their distributions.
Lynn Martin, managing director at CSAM and portfolio manager for the firm's post-venture distribution management group, said the volume of business has surged since 1999 because of the huge number of companies that went public. According to Venture Economics, Newark, N.J., which tracks private equity activity, stock distributions jumped a hefty 323% to $55 billion in 2000 from $13 billion in 1999.
CSAM customizes a client's strategy based on how it wants the stocks managed. It uses a hold-sell mode for 75% of clients and reinvests proceeds in a venture-backed stock portfolio for the remaining 25%. "These are managed to an aggressive growth rate with the assumption that the underlying business is growing faster than 25%," Ms. Martin said.
"We do intensive research on these companies to determine whether it's appropriate to sell the stock based on the client's guidelines. Sometimes we sell in an hour after receiving it. Or we might hold it for five years," she said.
Observed Jesse Reyes, vice president at Venture Economics: "Venture capitalists used to give their (limited partners) the stock and they would liquidate it. Then in 1995, some LPs realized that they shouldn't just hand it over to their small-cap managers to sell, but should manage it. So it developed into a subasset class, which has grown into a $500 billion business."
In addition to CSAM, the other major post-venture managers is Shott Capital Management LLC, Boston, and T. Rowe Price Associates, Baltimore.
CSAM's post-venture group was started in 1989 at Warburg Pincus Asset Management, which was sold to CSAM about 18 months ago.
When the market caps of venture-backed companies such as Netscape Communication Corp. and Amazon.com Inc. surged to the stratosphere and pension fund returns climbed when the firms went public, some pension executives realized they were responsible for the success of their investments and that they should take the credit, Mr. Reyes said.
"They figured it made more sense to let someone else with expertise manage the stock, rather than give it to the small-cap managers at the pension fund, who tended to liquidate it," he added.
That was the situation faced by Elliot Hacker, assistant treasurer at Phillips Academy, Andover, Mass. "We used the Commonfund, which administered our distributions, but then it got out of that part of the business, liquidated the positions and gave us the cash," he recalled.
"It was not our philosophy to simply liquidate, so we gave some distributions to our small-cap managers, but they would sell them almost immediately. These would cause a downtick, because so many holders would sell once the lockup period ended, depressing the stock. That's when we decided to take this other route, and hired CSAM, which sells and holds," Mr. Hacker said.
Michael Gutnick, chief investment officer of the Memorial Sloan Kettering endowment fund, observed: "It's an administrative nightmare to handle all those stock distributions."
His goal is to sell all stock distributions within two years, in order to redeploy the cash into other venture-cap funds. "We've done OK with Credit Suisse, better than I would have done on my own, in what's been a poor investment environment," he said.
At CSAM, 13 research analysts analyze the venture-backed stocks to determine which have the potential to be the next Microsoft Corp. or Intel Corp.
"We track the IPOs before they go public, by going to the road shows, visiting with management, so that we're on top of it and know in advance what kind of fundamentals these companies have. One that was particularly hot last year was Juniper Networks Inc., which Ms. Martin's group liked from the beginning because it has the potential to compete with Cisco Systems. CSAM received distributions of Juniper every month for the last nine months from multiple funds.
It also liked Cisco, from the time of its IPO because of its above-average growth potential. CSAM received a lot of the stock in 1989, which has been held in customers' accounts. "We have reduced the size of our position, because it was becoming too large, but we still own it. We return a lot to our clients, but might also hold a stock depending on its potential," said Ms. Martin.
There still are plenty of distributions, because the venture cap funds own a number of public companies, whose lockups are still expiring. Ms. Martin said she can see broadening her firm's approach to include buyout firms.