A FRESH SLANT

Five years ago, Clinton P. Harris and three partners organized Wellesley, Mass.-based Grove Street Advisors LLC like no other private equity gatekeeper had been organized before. After 13 years as founder and managing director of Advent International Corp., an international private equity advisory firm, Mr. Harris and his partners felt they could change the concept and style associated with traditional gatekeepers by serving only a few large clients with dedicated funds of funds, while giving the large players access to top-tier venture capital funds.

One month after opening shop in May 1998, the firm was hired to manage a total of $350 million for the California Public Employees' Retirement System. The firm now manages $2.8 billion for CalPERS in three captive funds of funds, which have posted a total annualized loss of 18% since January 1999, according to the CalPERS website. Mr. Harris said only $847 million was drawn down as of Sept. 30, including $100 million for general partner fees and expenses, so it will be three to four more years before the three funds will show will be meaningful performance numbers.A few other institutional investors are betting on Grove Street's big idea, including the $32 billion Oregon Public Employees' Retirement Fund and NIB Capital Private Equity NV, a Dutch investment firm that runs $11.5 billion for the €149 billion Stichting Pensioenfonds ABP and €50 billion Pensioenfonds PGGM. Mr. Harris talked with P&I reporter Arleen Jacobius about the private equity business and Grove Street's unconventional approach.

A You need people with operating experience in the industries. We're the first general partners of a venture firm to become a gatekeeper. We can talk the talk. When I was raising money at Advent, I'd sit across from a gatekeeper who would be reading from a list of questions and taking notes and that would be the initial session. In our firm, it is always the senior partner who screens potential portfolio companies. It's better to use senior people to do the screening. People need to say "no" as quickly as possible. There's an art to saying, "no," as quickly and painlessly as possible. In 1987, we were fund raising and we had no clue whether we were in the running. In two cases they were not interested; in two cases we did not do international and they were using us to get information; and the rest needed six months. If Advent could have avoided gatekeepers they would have. Why run processes in a way that drives away good firms? We wanted to run a process in the same style of a high-quality private equity firm.

A The concept has not changed a lot. The original concept was to come to the gatekeeping industry with a different skill set and style. I certainly did not anticipate the bubble and the firm growing as fast (as it did). It was more realistic to think we would run $50 (million) to $100 million and then prove ourselves, and three or four years out get more money. The fundamental concept has not changed that much. We started as a venture shop with three partners. We now have 25 people. … We have a staff of junior professionals who work for us and go back to business school to get their MBAs. It's been a slap in the face to the traditional guys. Our competitors have quality people at the top but not up and down. We're hiring very, very good people at each level. While most traditional firms send a young, inexperienced associate to do the initial due diligence, one of our principals does the due diligence. (Our competitors) are built around non-discretionary accounts, which have lower fees and not enough money to pay quality people. Non-discretionary managers get paid less. They have to do the due diligence and then convince the investor to do it. We get paid half of what a fund-of-funds manager gets but more than non-discretionary.

A There's been no change since I started in May 1998. The concept at Grove Street was to see how traditional gatekeepers work and do it better by changing the concept and style. We hung our shingle in May and met CalPERS in June.

A Our firm tends to grow in ways based on fund-raising cycles in the industry. Instead of a fund cycle of three to four years, it was down to one year. We added Oregon in 2001 and the Dutch pension funds in 2002. We were moving very, very quickly during the go-go time.

A In reality, the timing is partly good. We started committing with CalPERS in 1999 and there was not a high volume until 2000. Between 4% and 6% of CalPERS' capital got invested during the bubble, which is the money that will do badly. The rest will be invested currently. The problem with the industry is that I can tell five years from now how investments were today. It's better to invest in the valley and exit on the rise. It's better to put money to work when it's tough to raise money.

A It has to … I think the pendulum has shifted from general partner (favorable) to limited partner favorable. A lot of new investors want room at the table at the brand-name venture firms.

AThe issue is top-line performance. Buyout firms have had a much bigger appetite for capital and have had to raise money from the bigger institutions. They are more dependent on the institutions. Venture firms can raise everything they want from universities, endowments and foundations. The other issue is when you have money in a small venture (management) firm, one piece of bad publicity can kill the company. It's a fragile situation. Firms are fighting out for an order, and one issue is whether the finances are sound. Venture firms are very, very concerned that disclosure could hurt the company. Buyout companies are bigger and less vulnerable.

A Oregon ran an RFP in 2000, which resulted in a $500 million allocation in a 50/50 with Pathway (Capital Management LLC). CalPERS originally was venture capital, now it's a combination of venture cap and initiating new relationships. … Under the business model, we will have relatively few big clients where you have a high degree of customization and a high degree of service. Whether the business model will include getting five or six more Oregons, we'll have to see. We started the firm trading on a theory that we had the background and the appropriate skill set to run a private equity business. Past performance is a good indication, but we won't be able to prove the funds are invested in our top quartile for three years. CalPERS' data is based on last September and is really preliminary data. The data is less than 25% drawn down. It's too early to tell. The problem is that we'll know in a couple of years how we did in 1999.