Limited partners would like to invest more in the venture capital asset class, but they can’t get big enough stakes in top-tier funds, and they are reluctant to risk money on new managers.
That was the takeaway from a panel discussion featuring four limited partners at the National Venture Capital Association’s annual conference last month in Santa Clara, Calif. LPs, who’ve long groused that venture returns are concentrated among a handful of firms, said they’re nonetheless looking to expand venture stakes given the low returns they’re getting today from fixed income assets.
“It’s been a long-term problem for us to get meaningful exposure to venture capital,” said Peter Dolan, director of private equity at Harvard Management Co. Since he joined the LP in 1995, Dolan estimates that the endowment has grown from $7 billion to about $40 billion. Harvard is also spreading its wings overseas. About 20% of the private equity portfolio is currently invested outside the United States. Currently, private equity accounts for about 12% of Harvard’s portfolio, down from 15% in the mid-1990s.
However, the university fund has not been able to scale its venture capital investments. As a result, it’s been shrinking as a percentage of its allocation.
It’s not just venture capital. With money market returns at historically low levels, LPs are interested in increasing investments in a range of alternative assets, including hedge funds, real estate and private equity, said Bon French, CEO of Adams Street Partners.
“The headline here for the audience is that the money’s not going away,” said David York, a general partner at Paul Capital Partners, a $4 billion fund manager. He cited a few areas as poised for growth, including investments in overseas managers, which currently constitute about 10% of Paul’s portfolio, particularly in India and China, as well as the cleantech sector.
However, first-time funds continue to encounter difficulty. Panelists said that they rarely invest in funds led by partners who do not already have a successful track record in venture investing.
It’s been a long-term problem for us to get meaningful exposure to venture capital.
Over the past eight years, York said that Paul Capital has invested in just three first-time funds.
Helen Lais, partner at the Netherlands-based asset manager AlpInvest, said her firm typically makes between zero and two investments annually in funds led by emerging managers in the United States. The category includes experienced managers who are starting a new franchise.
Dolan said he prefers smaller, more focused funds when investing in emerging managers. “We look at two types of [new] funds,” he said. “The first are smart talented people with little experience. We try to avoid those. But there are others where they have some experience and a unique, differentiated strategy.”
While they say they are looking to invest more in up-and-coming managers, LPs also say they’ll continue to sell and buy stakes in older funds on the secondary market.
The most likely candidates for a secondary sale, Dolan said, are funds that the endowment has held for 10 or more years that are run by firms with whom it has not made a follow-on investment.
Today, selling a stake to a secondary investor is an industry standard practice that carries little stigma, Dolan said.
But about five years ago, that wasn’t the case. He said he remembers one sale from a fund whose partners had parted ways nine years previously. When one of the partners called to complain, Dolan recalled: “I said at least we hung around eight years longer than you and your partners did.” —Joanna Glasner