VCs: Take Heed of The Washington State Investment Board –

The ears of many venture capitalists are likely to perk up while listening to Ashu Rajbhandari describe his pension fund’s penchant for private equity investing. The Washington State Investment Board prides itself on being an innovator when it comes to alternatives, and the pension plans to continue pouring capital into the asset class at a quickening pace.

“We have more money in distributions coming back than we have been putting out,” says Mr. Rajbhandari, Washington’s senior investment officer. “So we need to employ a lot of capital out there.”

To be precise, Washington plans to invest $800 million in alternatives annually for the next five years, with about 20% of that going into venture capital partnerships.

The public pension is considered one of the most active investors in venture and buyouts; and with 15% of its $50 billion under management carved out for such investments, it ranks as the third largest pension in the country devoted to the asset class. Only 7.2% of the 15% private equity target has been reached, so there is lots of money waiting to be invested, Mr. Rajbhandari says.

Just how active has Washington’s investment staff been lately? Mr. Rajbhandari is busy putting the finishing touches on plans to invest $10 million in Chicago-based Edgewater Private Equity, and the ink has yet to dry on a $90 million March investment in Menlo Ventures’ eighth vehicle. The pension’s investment board also recently approved $20 million for an inaugural fund launched by Great Hill Partners, one of the two firms that recently spun out of Media/Communications Partners (VCJ, March, page 20), and $15 million for Battery Ventures V. As of September, commitments and capital drawn down totaled $1 billion for venture and $2.7 billion for buyouts. Venture commitments for 1999 so far total $620 million in seven partnerships, two in existing relationships and five in new investments.

Washington has had a tradition of high exposure to buyout funds because large amounts of capital can be put to work in that area. But because venture partnerships by nature require smaller dollar amounts, Mr. Rajbhandari and his colleague, Investment Officer Tom Ruggels, have been actively seeking new ways to devote more money to the sector.

Innovative Approaches to Investing

Washington’s strategy was exemplified by the hiring of Pathway Capital Management and Sovereign Financial Services Inc. in 1996 as fund-of-of fund managers. The two financial advisers will make investments of as much as $15 million in vehicles no larger than $250 million, a size Washington’s investment board considers best to get “substantial chunks of assets” into the sector. And the results have been favorable. Through Sovereign, the pension has invested in Spectrum Equity Partners, the Asia-focused Worldview Technology Partners, Swander Pace Capital’s first-time fund and Vision Capital Management, which focuses on transatlantic deals.

“Sovereign has been responsible for keeping us on the innovative edge of things,” the senior investment officer concedes. The pension ceased making direct investments about six years ago.

Fully aware of the intense competition to get into big name funds, the pension has devised a strategy to at least gain a toehold in them. In 1988, for example, when one of Menlo’s funds was oversubscribed and the firm balked at more capital, the pension convinced the venture firm to set up a special fund with Washington as the sole limited partner. Brentwood Venture Capital and HarbourVest Partners L.L.C., previously named Hancock Venture Partners Inc., eventually agreed to the same arrangement.

“I’m now exploring that idea [of a separate special fund] with a couple of managers because I want to put substantial $100 million chunks into those ideas,” Mr. Rajbhandari says, declining to identify the venture firms until negotiations are completed. “I’m trying to bring discipline, a different sort of thinking into the process.”

Apart from its fund-of-fund managers, Brinson Partners Inc. has served as a nondiscretionary adviser to the pension’s nine-member investment board since 1992.

“They have been very good at putting structure into the whole program,” the senior investment officer says, adding that Brinson makes recommendations, conducts due diligence and takes follow-up measures. When Washington conducted its search for fund-of fund managers, Brinson also threw its name into the bid but eventually withdrew out of concern that it would conflict with its advisory role.

Growing Up

Washington’s enthusiasm for private equity is nothing new, but its PE program has admittedly matured and intensified during the pension’s nearly two-decade existence, Mr. Rajbhandari says. A government statute creating the Washington State Investment Board in 1981 specified its main objective was to “maximize return at a prudent level of risk.” And in the 18 years since, the pension’s investment staff has plunged wholeheartedly into alternatives. “Private equity has been a defining feature of our program,” Mr. Rajbhandari says.

As of September, Washington’s IRR since inception stood at 15.8%, a decline that Mr. Rajbhandari blames on last year’s rocky stock market performance. By comparison, the pension’s returns stood at 22.3% for the last five years and 21.8% for the last three years.

Washington’s first stab at alternatives came the year of its inception, with a $3 million investment in Menlo Ventures’ second fund, followed by $13 million in Kohlberg Kravis Roberts & Co.’s first buyout fund. The pension has participated in every successive Menlo and KKR vehicle since then. To date, the pension has assets managed by 67 partnerships in 96 funds.

One fact that remains unchanged is that Washington does not discriminate in its approach to the asset class and is open to all “areas of new opportunity.” Venture capital is divided into early- and late-stage and buyouts into large and medium – there are no sector or geographic restrictions, and there is no aversion to first-time funds.

“We are looking for managers who are taking a different look at the same marketplace,” Mr. Rajbhandari explains. “The point is to be strategic; you want to think through where the new pockets of … opportunity are, and then you want to find people who can execute that.”

Despite Washington’s satisfaction with alternatives, the pension does recognize some pitfalls. Like many in the industry, Mr. Rajbhandari finds it “disturbing” that there is so much capital in the marketplace, noting that “entry prices are getting higher, and people are trying to get out fast.” He also is concerned that private equity investors are getting short-changed because of the industry’s rapidly changing face – as a result of larger fund sizes, more dollars are being invested in deals that fail to produce hefty returns.

With the exception of Menlo and a few other vehicles, Mr. Rajbhandari admits to being wary of “multigenerational funds” that exceed numbers IV or V because he believes at that stage a general partner’s interests “are no longer aligned with the L.P.s’.”

“By the time it comes to [fund] IV, they have made their money in I, II and III,” he explains. “So in IV they will take bigger risks because if they lose, they will lose nothing, and if they win, they take the carry.”

Messrs. Rajbhandari and Ruggels, who make up the pension’s private equity team, report to Chief Investment Officer Christopher Ailman. Recommendations are made to the private market committee, a sub-committee composed of members of the independent investment board, which makes all final investment decisions. The private equity team is in the process of reviewing resumes to fill the spot for another investment officer.

Mr. Rajbhandari, who joined Washington earlier this year, ran a venture capital fund in Malaysia called Premier Technology Capital. Prior to that, he was chief investment officer of the Malaysia-based $6 billion buyout fund Usaha Tegas SDN BHD.