I love San Francisco, a city with great diversity and charm and on the fringes of bustling Silicon Valley. And I was about to sing their praise when I read the title of an article in PEI about how San Francisco’s pension fund (SFERS) has split up the roles and responsibilities of Private Equity and Venture Capital investments. As if they had just taken my article to heart, accurately describing their risk as diametrically opposite.
But then I read further as “a person familiar with the program” describes the signals of the musical chairs of asset management that began to subdue my cheers.
The person describes how ”The venture capital programme is at a size where having a dedicated person is critical” and how the new head of venture capital needs to be a person “who everybody likes”, because “It requires an individual who can develop relationships and get organizations that don’t need any money to take [the system’s] money”. I can hear the pre-911 Venture bells ringing again.
Instead, San Francisco’s pension fund should not even bother participating in Venture, here is why:
Venture Capital is not a renewable asset class (or sector) as it lacks the economic construct that is compatible with the needs for groundbreaking innovation to tap into the massive and virtually untouched 80% technology adoption greenfield. Hence a commitment to Venture today is a commitment to a specific player, not the game. In the same way, CalPERS has reduced its commitment to Venture to particular players. However, we do not believe pension funds are well aligned and equipped to independently formulate a cohesive risk profile from investments in individual players, which puts the people’s money at even higher risk.
A handful of VC firms make any(!) money consistently and monolithically in Venture, and tomorrow’s Olympic winner will not be yesterday’s, especially not when “Venture Olympics” are held every ten years or so. The old-boys Venture Capital network is already hanging by a thread on excessive diversification, syndication, and fragmentation, including investment networks complete with stacked and parallel funds in exotic green grass areas that make everyone feel warm inside.
Lack of scale
The $16 Billion pension purportedly plans to dedicate $2 Billion to alternative assets with about $500M to Venture Capital. Given that a Venture Capital fund of less than $250M can hardly make a dent in producing viable returns for the risk deployed (as it avoids the wrath of subprime investing), a syndicated contribution of $100M per Venture Capital fund makes for five allocations. That is about the total number of VC firms that make any money consistently and monolithically in Venture today.
The problem with investing in Venture today is that it does not represent a viable asset class, albeit there are some feasible players. And pretending Venture is an asset class yields overwhelmingly subprime returns that are responsible for negative trailing 12-year average returns for Limited Partners. The temptation to jump into Venture with a few hot IPOs on the horizon is high and will receive renewed interest from Limited Partners. But economically unchanged, the disappointment in Venture will again be more significant than its rewards.
To make Venture viable for investment by pension funds a new economic model needs to be deployed to continually calibrate the merit of investment arbitrage with the supply of groundbreaking innovation. Without it, pension funds are better off trying their luck in Vegas.
Read the referenced article in PEI Online here (subscription required).