SAN FRANCISCO - Post-venture distribution portfolios have been hammered, losing 60% or more of their value in the past year following the bursting of the Internet bubble.
Many pension funds continue to hold a big portion of those weakened stock distributions in the hopes of an eventual rally. But the San Francisco City & County Employees' Retirement System has directed its post-venture manager, Credit Suisse Asset Management, New York, to alter its strategy and liquidate distributions as soon as possible, and no later than 90 days after receiving them.
The new approach will take effect immediately, said Carl Wilberg, senior investment officer for equities at the $10 billion system.
San Francisco hired Credit Suisse in 1999 to manage the distributions it received from private equity partnerships through a distribution portfolio and a managed portfolio. The former is changing, while the latter is unaffected. Initially, the strategy for the distribution account was to hold on to some of the distributions for a long time, Mr. Wilberg explained. "The mandate was to keep those companies that would be the next Ciscos and Microsofts. A lot of our distributions that were coming out (from the venture capital managers) were great companies, but they were hit by overvaluations, so they fell hard, which is why we decided to take away Credit Suisse's ability to hold them for a long time."
Bad guesses
The wreckage in the pension fund's distribution portfolio primarily was due to wrong guesses by Credit Suisse about large positions in Nortel Networks Ltd., Veritas Software Corp. and JDS Uniphase Corp. The portfolio was down 77.75% for the year ended June 30, according to the system's calculations. And it was down 64.78% from inception through August.
"We were looking for returns of 20% to 25%, and instead, the manager rode these stocks down," Mr. Wilberg said.
Given the miserable performance of high-tech stocks in the past year, the system is now less motivated to hold these distributions. "We're no longer waiting for these stocks to achieve a 20% to 25% growth rate. Now we think they should be sold as soon as possible," he said.
The strategy for the second portfolio, known as the managed account, has not changed. The objective for that portfolio is to invest in venture companies on a long-term basis and to determine through research which stocks should be sold and which should be held.
New valuation
Mr. Wilberg declined to specify how much money the system lost in its distribution account. A year ago, it held $190 million; it now stands at $15.78 million. But the different valuations don't tell the whole story because the system used $50 million from that account to pay retirement benefits. And after some positions were sold, proceeds were diverted to the managed account. The managed account, which now is valued at $188.1 million, was down 36.7% for the year ended June 30 and up 3.12% since inception.
Mr. Wilberg emphasized that Credit Suisse, previously Warburg Pincus, is not being terminated and that the firm is not on watch. "They got astronomical returns for the first six to nine months, then the market turned around."
System trustees were worried about the decline in the distribution account, and the investment staff developed the new plan to improve performance. "If CSAM believes that there is a stock that should be kept, they will notify us, and then we'll decide whether to go along with it," explained Mr. Wilberg. Under the new strategy, Credit Suisse no longer has discretion to manage the distribution account, but it does retain discretion for the managed account.
Lynn Martin, managing director at Credit Suisse and portfolio manager for the firm's post-venture distribution management group, said the San Francisco system's distribution portfolio is not representative of what the firm does for its clients. "From the beginning, we have believed you can bring value to these portfolios through research, and that will determine which companies can outperform the market ... and which ones are going to be lucky to be alive."
Ms. Martin declined to discuss the changes at San Francisco and the devaluation of its distribution portfolio. She said she doesn't talk about individual clients and that compliance rules don't allow her to talk about individual stocks. She did say there has been no change in the firm's fundamental view of the market; however, the market now is shrouded in uncertainty caused by the economic downturn, terrorism and anthrax scares, she observed.
"We work with our clients to be sure we're meeting their needs. If there is no specific need for immediate liquidation, we generally will hold stocks 18 months to three years to figure out which companies have better prospects," Ms. Martin explained. She added the business is somewhat different from a year ago, when returns were generally more than 50%. Now the level of distributions has dried up.
Portfolios customized
"Most partnerships have distributed all the stock they received to their limited partners. We received huge quantities of stock and sold a lot last year. The firm is still holding some distributions from last year, from companies it believes have a strong potential to do well when the market returns. We're still researching companies, searching for the great growth companies of the future. We make decisions about companies on a stock-by-stock basis. Most of our customers hold, sell or reinvest, and we customize portfolio guidelines to suit each client's particular needs," Ms. Martin said.
Michael Gutnick, chief investment officer at the $1.8 billion endowment of Memorial Sloan-Kettering Cancer Center, New York, said the endowment probably lost $25 million in its post-venture distribution portfolio last year. "It's not their fault," Mr. Gutnick said of Credit Suisse, which manages the portfolio. "We gave them two years from the time of receipt (of the stocks) to sell the distributions, and they have been holding most of them. We believe they should have discretion, and as a result lost around two-thirds of the investments. But if you look at the IPO indices, they performed similarly, down around 66%."
At this point, the endowment has not decided whether it will change its strategy on distributions. "We're reviewing all our strategies; but when people make these changes, they often make them at the worst times, so then they lose at the beginning and again at the end. We chose this strategy one-and-a-half years ago and haven't given it a timetable," said Mr. Gutnick.
At the State of Michigan, Bureau of Investments, Michigan Department of Treasury, Lansing, the strategy has been to hold and sell since the $50 billion system hired Credit Suisse to manage its distributions a year ago. "The market took a hammering and these portfolios got hurt, too. The returns are negative, but competitive with the market," said Dave Turner, administrator for private equity.
Under review
Alan van Noord, director of investments, added the program is under review, but said he thinks it's too soon to make a decision about changing it, especially given the poor performance of the Nasdaq composite.
The main issue is whether to have a distribution manager at all, Mr. Turner said. "They've (Credit Suisse) sold a lot, probably more than they kept in the last 12 months. We hired them initially to have them help us deal with the huge volume of distributions, which was broad and complex, although they are still hanging on to a number of stocks. Selling was the right decision in the last 12 months, but it is a short time frame. We'll let it ride for the time being. We don't give them cash to work with; it's structured for us to get the cash back right after the securities are sold. The general plan is a two-year horizon, based on the dynamics of if and when the market recovers."
Mr. Turner wouldn't give returns for the portfolio, but said they probably wouldn't have been any different if the system had managed the selling itself.
