New CalTech Team Digs Deeper into Private Equity –

The California Institute of Technology (CalTech) institutionalized and reorganized its alternative investment program in May 1997 when its investment committee adopted a five-year plan to raise the pension’s allocation for alternatives to 25% from 2%. The plan now targets $100 million annually for the asset class, with two-fifths of the investments geared toward private equity and two-fifths toward absolute returns. The rest will be devoted to inflation hedge funds.

Since restructuring its investment strategy, the $1 billion endowment has had to contend with several personnel changes, but its three-member staff is determined to reach the goals outlined under the five-year plan, says Sandra Ell, acting treasurer and chief investment officer.

Based in Pasadena, Calif., CalTech began scouting venture investments in 1985 when it received an endowment gift in excess of $10 million from a widow in Beverly Hills. “We have venture capital investments which date back to the late 1980s, but we really only had a toe in the water in venture capital at that time,” Ms. Ell says. The pension had permission by the board to invest as much as $8 million of the gift in venture capital, but there was no set asset allocation to alternatives at the time. Investment opportunities were identified by a three-member ad-hoc venture capital committee staffed by trustees with experience in venture capital.

The decision to boost alternatives followed an asset allocation study conducted in collaboration with Cambridge Associates, which determined that higher investments in alternatives would “maximize investment returns and diversify the portfolio,” Ms. Ell explains.

Although CalTech made a more-than tenfold hike to its alternatives allocation, the figure is somewhat standard when compared to other university endowments. “A survey and visits to successful sister university endowments revealed that many had large allocations, and most had ranges of 15% to 25%,” Ms. Ell says. “So we are by no means an exception for large university endowments.”

Under the new plan, CalTech has developed what it calls “fund preferred terms” as well as a target list of blue-chip funds to invest in and more detailed guidelines for its investment decisions.

The “fund preferred terms” identify specific criteria, such as management fees, profit split, clawbacks and percentage of prior funds invested, that a fund must meet to be considered an acceptable investment, says Ms. Ell who declines to provide additional details, but adds that CalTech particularly looks for funds with fair profit sharing and clawbacks.

The target list of blue-chip funds is a list of “specific funds, which trustees, staff and outside experts have suggested are best-of-breed,” Ms. Ell says. While she would not name specific funds on the list, she says it “includes a good number of our past investments.”

The new investment guidelines state that for venture investments, CalTech mainly looks for funds with a long, superior track record and experienced partners with proven working relationships, Ms. Ell explains.

The endowment does not have any specific geographic, industry or stage focus. “A broadly diversified portfolio is our objective,” Ms. Ell says. CalTech, for example, recently has invested in early-stage technology funds such as Accel Internet Fund II, health care-focused funds such as Domain Partners IV and late-stage, balanced funds such as Sprout Capital VIII.

The endowment’s investment staff is not large enough to make direct investments, Ms. Ell says, but CalTech has a non-discretionary relationship with two advisers, Brinson Partners and Knightsbridge Advisors, investing in their funds-of-funds. “We choose this route so CalTech could play an active role in investing, further develop in-house staff expertise and gain access to blue-chip funds requiring smaller dollar commitments,” Ms. Ell says.

CalTech’s investments begin at $3 million and on rare occasion have reached $20 million. However, the endowment’s average commitment is $5 million.

Ms. Ell says the targeted returns on alternative investments since the new plan was approved range from 20% to 30%, but she declined to discuss actual returns. “It would be premature to do so on our aggregate alternative investment portfolio or even on one of the subsets such as venture capital,” she says. Earlier venture investments did not represent a significant part of the endowment’s investment portfolio, but “have delivered excellent returns,” she adds.

In conjunction with its five-year investment plan in alternatives, CalTech also created an alternative investment subcommittee, consisting of the vice chairman and four additional members of the endowment’s investment committee, to approve fund investments and oversee the alternative investment program.

A recent rash of personnel changes, however, has distracted CalTech from reaching its goal to boost its alternatives target. The endowment’s investment staff was essentially restructured in the last year following the departure of three key investment professionals.

Karen Porter, manager for alternative investments, and Michael Beblo, manager of public markets, left CalTech in July and May, respectively (VCJ, September 1998, page 5), Ms. Porter left because her husband took a position at the University of Arizona; and Mr. Beblo joined Hambrecht & Quist Capital Management.

Also this past summer, Treasurer and Chief Investment Officer Philip Halpern left the pension to become CIO at the University of Chicago endowment.

A new investment team, however, was put in place by the end of the summer.

Ms. Ell, who joined CalTech in 1984 and worked in different finance- and treasury-related positions on campus before becoming assistant treasurer at the endowment in 1990, was appointed acting treasurer and CIO in July. The endowment’s board has yet to launch a search for a new treasurer, which could result in Ms. Ell inheriting the job on a permanent basis.

Deborah Goodman, formerly managing director of asset allocation and a member of the investment committee of Wells Fargo Capital Management, was recruited in August as CalTech’s director of public and private markets. In her position, which combines two formerly separate functions, she is responsible for achieving the new target allocation for alternatives. In doing so, early this year she plans to adapt and implement an alternative investment cash flow and commitment model developed by Brinson Partners, which serves as a guide to help the endowment meet its investment goals. The model projects the endowment’s growth, and its adaption will provide information about how much CalTech will really need to commit to alternatives as an asset class and the different alternative asset subclasses, namely private equity, absolute returns and inflation hedge, to reach its 25% allocation target, Ms. Ell explains. The application of the model might slightly change the current $100 million annual total commitment to alternatives and will set specific targets for the subclasses, she says.

Charles Dainoff, CalTech’s investment analyst since October 1997, rounds out the team. A former social researcher for the North Carolina Governor’s Policy Office specializing in substance abuse program evaluation, he now assists Ms. Ell and Ms. Goodman, particularly by recommending new investment opportunities and assisting in due diligence.

So far, CalTech seems on track to reach its new allocation targets. In 1998, it committed $100 million to nearly 20 private equity funds, split roughly equally between venture capital and buyouts.

California Institute of Technology

Total Endowment Asset Allocation,

1997 and Projected

Amount* % of Total Projected

U.S. Equities $642 64% 40%

International Equities 130 13 15

Fixed Income 213 21 20

Alternative Assets 25 2 25

TOTAL: $1,010 100 100

*In Millions

Source: CalTech