As stocks plunge, funds lose balance

Market woes changing the landscape for venture investing

When pension fund managers checked their portfolio values for Sept. 30, they had the same pained reaction as individuals opening their 401(k) statements. Assets were down 15.6 percent for the year to date at the Massachusetts state employees fund. At the California Public Employees Retirement System, or Calpers, they had plunged 20 percent since July 1.

But there was another surprise:

Because of sharp declines in stock values, the share of the funds' portfolios devoted to venture capital and other alternative investments rose above their target for that risky asset class. That has led to fear among venture capitalists that the stock market swoon could slow the flow of money into new funds.

While partners at venture firms often invest their own money and serve as "general partners'' in their venture funds -- which bankroll entrepreneurial companies -- the bulk of the capital comes from "limited partners'' that are seeking higher returns -- institutions such as pension funds, university endowments, and foundations.

But many institutional investors have restrictions on the percentage of assets that can be allotted to alternative investments such as venture capital, which tend to be carry more risk than such asset classes as stocks, bond, and cash. With stock values at their lowest level in five years, some investors find themselves overallocated to venture capital, raising questions as to whether they will be able to invest in new funds.

Overallocation could also accelerate sales of shares in venture partnerships. "Certainly you could imagine that institutions might sell some of their partnership interests on the secondary market,'' said Josh Lerner, a Harvard Business School professor who studies venture capital.

Investments in private equity, including venture capital, now make up 9.5 percent of the Massachusetts pension fund, above its 9 percent target. "We'll take stock in January and see if we're overweighted then,'' said Michael Travaglini, executive director of the Pension Reserves Investment Management Board, which invests the fund. But Travaglini said he doubts the state would shed private equity holdings, which historically have generated high returns.

Calpers, the largest US public pension fund, has a 10 percent target for private equity and, because of falling stock values, is "bumping up against 13 percent,'' said Clark McKinley, a Calpers information officer in Sacramento, Calif. McKinley said the Calpers staff has apprised its board of the issue, but no decisions have been made to go lighter on venture capital or other private equity outlays.

Venture capitalists, who have been whispering about the allocation problem for weeks, raised it publicly on a recent conference call to discuss the MoneyTree industry report, which showed venture investing declined 6.9 percent nationally and 2.3 percent in New England in the third quarter. The report was issued by the PricewaterhouseCoopers accounting firm and the National Venture Capital Association, based on data from the research firm Thomson Reuters.

With their stock holdings depressed, most limited partners "are overallocated and overexposed to venture capital,'' warned Jim Healy, general partner at Sofinnova Ventures in San Francisco. Institutions in that position might be pressured to back away from new venture funds or even unload some of their current venture holdings, he suggested.

Complicating the outlook are the different reporting schedules for public and venture funds in institutional investment portfolios. While public funds update investors quarterly, venture funds typically do so less frequently and take longer to recalibrate their valuations, which presumably have also declined in recent weeks.

"Obviously, the public markets change overnight, and it takes six to 12 months for the private companies to catch up,'' said Faysal Sohail, managing director at CMEA Ventures in San Francisco.

The trade publication Private Equity Week raised eyebrows this month when it reported that Harvard Management Co., the world's largest university endowment, with a value of $36.9 billion as of June 30, had retained Cogent Partners Investment Bank to sell part of its private equity portfolio on the secondary market. Private equity investments, including venture capital, make up 13 percent of the Harvard Management portfolio for fiscal year 2009.

Harvard Management declined to confirm the report, and it's not certain a sale would be related to an overallocation in venture capital or other alternative investments. "We do not discuss investment strategy and individual investments,'' said spokesman John Longbrake.

What is certain is that venture fund-raising had begun to slow even before the stock market's precipitous drops this month. In the first nine months of the year, there were 36 new venture funds raised, compared with 60 for all of 2007, according to Thomson Reuters.

Until this year, venture firms had relatively little problem raising money.

Pension funds and endowments that do choose to put their venture fund partnership shares up for sale may find eager buyers among big corporations hoping to forge ties with venture-backed technology and life sciences start-ups they might later acquire.

"It could be an opportunity for corporate venture capital,'' said Val Livada, research fellow at Sloan School of Management at the Massachusetts Institute of Technology. "Potentially, some of the venture firms will be more interested in bringing corporations into deals.''

Other potential buyers, or new investors in venture funds, might be European institutions, which historically have not made significant investments in venture capital, as well as government-owned sovereign wealth funds springing up in Asia and the Middle East.

"This is going to accelerate a change in the composition of the limited partner pool to more non-US partners,'' Lerner said.

Robert Weisman can be reached at weisman@globe.com.