SEATTLE – Before the bubble burst, sky high valuations for developing information technology companies were not mocked as preposterous, they were, simply, business as usual for firms that invested in the sector. VCs were getting rich and investors where clamoring to become limited partners in the funds investing in the Internet revolution.
However in late 1999, during the heyday of outsized returns generated by dotcom investing, the University of Washington (UW) decided to alter its private equity investing strategy. Instead of increasing its exposure to the IT sector, the school chose to increase its involvement with then out-of-favor health-care funds, says Doug Breckel, senior associate treasurer at the school.
“We felt IT valuations had just gotten too high,” he says, adding “so we decided to re-up with our good, experienced and successful IT fund managers, but not to invest in any new IT funds.” At the same time, while most LPs were shunning health-care funds, UW saw that space as a sector which would grow and provide an element of diversity to its venture portfolio, Breckel adds.
UW has been investing in venture capital, buyouts and special situation private equity opportunities since 1990. The purpose of the school’s private equity investing program is to enhance the overall financial performance of UW’s endowment of about $1 billion, Breckel explains. “Why bother being in private equity if you aren’t getting top tier returns?” he says. This means the school has a targeted return of 5% above the performance of the S&P 500 and Russell 3000 stock indexes. Since its inception the program currently boasts a return of 11% above the major market indexes, although Breckel notes that it will come down due to the current upheaval in the public markets.
On the venture side, UW has a bias toward investing in funds targeting early-stage companies in health-care and technology industries, he says. To this end the university has made investments with Frazier & Co. and InterWest Partners, he notes. In the buyouts arena, UW has been focusing on domestic firms investing in the small to middle market space because it is this part of the market that is generating the best returns, he says. The school believes the European buyout market that is heating up and should start generating solid returns, so it has invested in fund-of-funds vehicles raised by Commonfund and HarbourVest Partners LLC to get to this market, he explains.
When evaluating a firm for a potential investment, UW, like most investors, looks for an experienced management team that can point to a demonstrated history of success as a group, Breckel notes. So while UW does not have a specific policy against investing in first-time funds, it is unlikely to do so because a new fund often does not have a demonstrated track record, he explains. However, Breckel says UW may invest in a freshman vehicle if a new fund is managed by investment professionals who have worked together successfully before and can demonstrate experience and real returns.
Investment professionals in firms backed by UW must also have real company building skills they can bring to their portfolio companies, Breckel notes. “We do not like firms that do pure financial plays,” he says. “We expect the people we hire have a real value-add, so they are not just depending on the market or multiple expansions to drive returns,” he adds.
These investment guidelines have led UW to back mostly established venture firms that are able to maintain their abilities over time, Breckel says. However, this does not mean that once UW has invested with a firm it will continue to re-up blindly, he notes. “You have to be cognizant of how firms change over time,” he said. “Usually some core individuals are responsible for the success of a firm, so if a firm is growing you want to make sure you are comfortable with that growth,” he notes, adding “and if the primary principals leave, we may think about not investing again with that fund.” While the consequence of such an action might be never being able to invest again with such a firm, Breckel says this is a risk a wise LP should be willing to take.
Investing by the Numbers
UW devotes a range of 10% to 20% of its endowment to private equity, with a target asset allocation of 15%, Breckel said. The school is currently at a 16% allocation level, he added. While UW does not have specific investment targets for the various private equity opportunities in the marketplace, it has traditionally put 40% to 50% of the capital earmarked for private equity investing into venture funds, 30% to 40% in buyout vehicles and the remainder is invested opportunistically, he adds.
To date, the school has an exposure of $180 million to alternative assets. UW will continue to invest $65 million to $75 million on annual basis to maintain this exposure, he adds, noting this year that figure might be a little smaller, because of current market conditions. “Going forward, we are trying to manage the exposure we want to maintain, so…we are not putting as much capital to work now as two years ago, when we were building that exposure,” he says. The school invests $7.5 million to $15 million in any individual fund, although the school will invest more with a fund manager it considers to be particularly successful, he adds.
Since UW’s treasury office, which oversees investments, only consists of essentially three people, Breckel, Treasurer V’ella Warren and Senior Associate Treasurer Susan Ball – UW does not do any direct investing, he notes. The school maintains an advisory relationship with Cambridge Associates LLC, which performs due diligence on UW’s potential investment managers as well as evaluating the its overall asset allocation and investing strategies, he says.