Institutional investors like venture capital again

Venture capital is gaining a little love and some new money from institutional investors following a decade-long stretch of poor returns and client withdrawals.

Only a select few managers are benefiting. Some 75% of total capital raised during the first quarter went to six funds: the $1.5 billion Andreessen Horowitz Fund III LP; $600 million Canaan Partners IX; $600 million Bain Capital Venture Fund 2012 LP; $520 million Summit Partners VC Fund III LP; $375 million Charles River Ventures XV LP; and $375 million Vivo Ventures Fund VII LP, according to data from Thomson Reuters and the National Venture Capital Association.

At the same time, U.S. venture capital firms had a 5% increase in the amount of capital raised and a 34% increase in fund closings — $7 billion in 47 funds — from the year-earlier quarter.

European funds meanwhile raised $954 million in 11 funds, an 8% gain in capital raised for the same number of funds from the first quarter of 2011, according to Dow Jones VentureSource.

The rediscovery of venture capital is part of institutional investors' search for returns.

In his latest report to the $152.9 billion California State Teachers' Retirement System's investment committee earlier this month, Mike Moy, managing director in Mission Viejo, Calif., of private equity consultant Pension Consulting Alliance Inc., noted venture capital's potential for attractive long-term returns in the future.

CalSTRS, West Sacramento, is not alone in its interest in the asset class. For the 12 months ended Sept. 30, the latest data available, venture capital investment was up 26% among the top 200 pension funds surveyed by Pensions & Investments, to $34.8 billion. And a number of institutional investors ramped up their venture capital commitments in the past nine months.

In February, the $31.3 billion Tennessee Consolidated Retirement System, Nashville, committed $25 million to Canaan IX and $15 million to Bain Capital Venture Fund 2012.

This is on top of the pension system's prior commitments of up to $25 million to Lightspeed Venture Partners IX in March and up to $25 million to General Catalyst Group VI LP in December.

The $7.7 billion University of Michigan Endowment Fund, Ann Arbor, in January made commitments to two funds of information technology venture capital firm Andreessen Horowitz and is investing alongside Sequoia Capital in its U.S., China, and India venture capital and growth equity funds.

This reawakening of interest has been building since last year.

In October, the C$55 billion (US$ 54.9 billion) Ontario Municipal Employees Retirement System, Toronto, launched OMERS Ventures, a venture capital subsidiary that will invest pension fund assets. So far, the unit is set to invest C$180 million in the next three years, particularly in technology, media and telecommunications.

Also in October, the $83 billion State of Wisconsin Investment Board, Madison, committed up to $80 million to Northgate Capital, a venture capital fund of funds.

Teachers' Retirement System of the State of Illinois, Springfield, announced plans late last year to renew the $36 billion pension fund's venture capital investment program, which has been quiet for the past three and a half years. The retirement system will commit a total of $75 million to $125 million in venture capital over the next three years to bring its exposure closer to its 10% maximum target. Its first step was to commit up to $100 million to Morgan Creek Partners Venture Access Fund I LP, a customized separate account fund of funds. Officials at Illinois Teachers did not return calls for comment.

All the excitement around recent blockbuster initial public offerings of Facebook and other venture capital-backed high-profile social media companies also has stimulated investor interest, said Tracy Lefteroff, San Jose, Calif.-based global managing partner at PricewaterhouseCoopers LLP.

But not all venture capital firms are viewed alike. A long pedigree does not always work, as investors want to see what firms have produced lately.

“I believe there is an appetite for firms that have really good track records,” said Maria Cirino, founder and managing director of Boston-based venture capital firm .406 Ventures. “Investors might have taken a pause in the asset class but did not leave it completely.”

“I still think it's been tough for most venture capitalists,” Mr. Lefteroff said. “They've had 12 years of negative returns ... one of the longer cycles they've had of negative returns.”

The result is that the industry is still in a “weeding out process,” he said.

The reality is that fewer venture capital firms — and less money chasing deals — is good for future venture capital returns, he said.

A good chunk of capital now is being concentrated on Internet-related companies, attracting $1.4 billion in the first quarter, according to the MoneyTree Report by PwC and the NVCA, based on Thomson Reuters data. While that's 3% less than the fourth quarter, it was still the eighth consecutive quarter in which Internet companies attracted more than $1 billion in venture capital investment.

One of the biggest success stories is Instagram Inc., which Facebook purchased for $1 billion in April. Venture capital firms including Thrive Capital Management LLC, Greylock Partners and Sequoia managed to double their money by investing in Instagram because of that sale, even though Instagram still has not produced revenue.

But Ms. Cirino cautioned: “Certainly that (Instagram deal) is the exception and not the rule.”

Instagram does not portend a redo of the 1999 technology bubble, when many companies were sold that had not yet reported revenue, she said. Now there are a lot of great deals with “normal multiples,” in which the purchase price is based on six times and eight times revenue, she said.

Still, not everyone is in love with venture capital.

Thomas Haubenstricker, CEO of New York Life Capital Partners, New York, a private equity manager that also manages funds of funds, said the main problem with venture capital is that long-term returns — between 1990 and 2000 — were inconsistent.

New York Life exited venture capital in 1999 and 2000 and redeployed the assets into traditional private equity, he said.

“The return profile of traditional private equity was more consistent and every bit as good as what we could have achieved in venture capital,” Mr. Haubenstricker said.