Venture capital managers face an uphill battle to retain their place in investors' portfolios as the subasset class is rocked by lousy returns and the weakest fundraising in more than a decade.
Venture capital returns were negative 20.9% for the year ended Dec. 31, falling close to 19 percentage points from the 12-month period ended Sept. 30, according to the most recent return data from the National Venture Capital Association and Thomson Reuters.
Plus, the second quarter saw the lowest number of venture capital funds raised since the mid-1990s, according to the NVCA and Thomson Reuters.
Data prepared for Pensions & Investments by Preqin, a London-based alternative investment research firm, show that of the 456 venture capital funds worldwide trying to raise a combined target of $88.7 billion, only 61 of them closed so far this year with a total of $13.2 billion raised.
By contrast, of the 477 funds trying to raise $98.4 billion in 2008, 276 funds raised $55.6 billion.
Such bad news has some industry insiders wondering whether investors should consider putting any more money into venture capital. Some say venture capital is in the down part of the cycle, when investors are likely to trim allocations and managers, resulting in some managers — including big-name firms — fading away.
It all comes down to what kind of returns investors expect and how many firms can deliver them.
“There's an extremely short list of venture capital firms that have compensated limited partners for the risks they are taking,” said Stephen L. Nesbitt, CEO of alternative investment consulting firm Cliffwater LLC, Marina del Rey, Calif. “There are a lot of other groups that have not cut it. After 30 years, is it really an asset class that people are making allocations to or just a small clique” of firms that earn the top returns?
Endowments — the main source of venture capital investments — are cutting their allocations along with other asset classes after failing to consider their liquidity costs. Endowments' average venture capital allocation dropped to 3.2% in fiscal year 2008, down from 3.6% the year before, according to the National Association of College and University Business Officers, Washington.
Harvard University, Cambridge, Mass., counted on its investment pool to fund 35% of its budget. That pool, heavily invested in venture capital and other alternatives, lost 45% of its value in fiscal 2008. As a result, the $29 billion Harvard endowment banned venture capital investments that would bring capital calls for the next five to 10 years, sources said.
Some pension funds are in the same boat.
For example, officials at the $61.3 billion Washington State Investment Board, Olympia, decided in April that they would “not actively pursue” future venture capital investments. Their venture capital gatekeeper, Pathway Capital Management LLC, Irvine, Calif., was terminated, although that was “not a statement of dissatisfaction with Pathway,” Liz Mendizabal, board spokeswoman. Pathway oversaw the fund's $444.1 million venture capital portfolio.