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EXCLUSIVE: RI Pension Investment in Raimondo’s Pt. Judith Had Steep Losses

Friday, July 12, 2013

 

The state pension fund investment in Point Judith Capital suffered two years of steep losses before turning a profit, according to new documents that offer the first public glimpse into the performance of the venture capital firm co-founded by General Treasurer Gina Raimondo.

The data shows two straight years of negative returns, sometimes as low as -14.2 percent and -15.3 percent. But since 2011, when Raimondo took office, the returns have been positive, hovering around 10 percent during last year, according to the data, which was obtained by GoLocalProv through a public records request. (The full table is provided below.)

Overall, in the four-year period, the performance of the fund has been weak.

“If you linked the provided quarter to quarter investment return information it shows a total loss of around -16.71 percent for the four-year period,” said Chris Tobe, a public pension consultant who is authoring a book, Kentucky Fried Pensions, about corruption in the state pension system in Kentucky, for which he once served as a trustee.

The swing in returns—from deep negatives to high positives—reflects the high volatility of venture capital, which is considered an alternative investment along with other private equity and hedge funds. “It’s a riskier investment,” said Adley Bowden, the research director for PitchBook, a Seattle-based research firm specializing in private equity and venture capital research. He said the returns for Point Judith reflect the typical performance for a venture capital fund, which normally have 2 percent annual fees and 20 percent shares in any profits, like hedge funds.

Since taking office, Raimondo has shifted about $1 billion in state pension funds over to alternative investments, most controversially hedge funds, as part of a strategy to smooth out returns and avoid the rollercoaster ride of stock market crashes and rebounds. But the lowest returns for Point Judith coincide with the economic downturn, suggesting that at least that one alternative investment was not recession-proof.

Despite the poor performance to date, the state has not actually lost money on Point Judith because it phased in most of its $5 million investment over time: much of the invested money came through during the years of positive returns.

By the end of 2012, state had funded $4.4 million of its $5 million commitment to Point Judith and its account with the firm had an ending balance of $5.8 million, state documents show.

State withholds full records

But there is much the provided documents leave unsaid. For example, there is no cash flow analysis showing when the state made contributions into the fund. “While the stated balances grew it is impossible to ascertain how much of that was contributions and how much was from performances since you do not know the amount or timing of the contributions,” Tobe said.

The data also is not verifiable. GoLocalProv requested the annual audited financial statements for the fund, but the request was denied. Raimondo spokeswoman Joy Fox said the records are considered “confidential and privileged in nature” and therefore are not public under state law. Fox also forwarded a 27-page PowerPoint presentation Point Judith had made before the State Investment Commission, but key data on the historical performance of the firm appears to have been redacted.

“The information provided is not complete or verifiable and therefore investors should be cautious relying upon it,” said Edward Siedle, a Forbes.com writer whose penned a series of highly critical columns that have characterized pension reform in Rhode Island as a Wall Street money grab. Siedle’s firm, the Florida-based Benchmark Financial Services, has since been hired by AFSCME Council 94 to conduct a forensic audit of the state pension system.

Without official records, such as the audited financial statements, Siedle said the public can’t know the answers to key questions, such as into what companies Point Judith has invested the state funds, what really caused the losses in the initial two years, or whether the losses that are claimed are even accurate. “These are the fundamental questions,” Siedle said in an interview.

“It’s information that we all should know,” said Michael Downey, president of Council 94. “My comment is, why all the secrecy?”

Venture fund gamble: negative returns ‘typical’ at first

The state made a ten-year commitment to invest in Point Judith Capital in 2007. In all, the venture capital fund, the second started by Point Judith, drew more than $70 million in investments from a number of investors. Fox said initially negative returns were to be expected.

“As is usual with private equity and particularly venture capital investments, capital flows into the fund—and the capital account statement—gradually over the early years of a fund. Once requested, the capital is deployed in companies where it takes time for the investments to bear fruit. For this reason we expect venture capital funds to have growing capital balances and negative returns in the early years, and to generate positive returns in later years,” Fox said in an e-mail response to a series of questions about the losses.

The pattern is often described as a J curve. “The investment returns are routinely negative in the early years (the dip in the J) as the venture firm incurs costs to improve the performance of the companies it backs. When these early expenditures begin to bear fruit, the performance of the companies improves and their value should increase significantly (the ascender in the J),” Fox wrote.

“It is pretty typical,” Bowden said. “That’s a normal trajectory of returns on a venture fund.”

An official with the national trade association for venture funds agreed. “In the first three years, negative returns is not in of itself a condemnation or all that unusual,” said John Taylor, research director at the National Venture Capital Association, headquartered in Arlington, Virginia.

But the J-curve phenomenon doesn’t explain the extent of the losses in the first two years of the fund, according to Tobe. “It’s very doubtful that it’s going to have this much effect,” Tobe said.

Raimondo herself has previously described the performance of Point Judith as strong. “It’s a strong performer. They’ve produced strong returns. It’s still a little bit early,” she said in a recent WPRI.com interview.

Compared to the industry as a whole, Point Judith appears to have underperformed during the recession, but then it outperformed the industry afterwards. In 2009, the industry had a negative return in just the first quarter. In the remaining quarters the returns were modest but positive, ranging from .24 percent to 3.44 percent, according to the U.S. Venture Capital Index, an annual survey of 1,420 U.S. venture capital funds produced by Cambridge Associates for the National Venture Capital Association.

In the most recent year for which data is available, Point Judith was leading the industry, which overall had positive returns ranging from 4.66 percent to .55 percent over the four quarters of 2012. The comparable range for the Point Judith venture fund was 8.8 percent to 11.6 percent.

Raimondo still has a potential stake in the performance of Point Judith’s investments. After her election, Raimondo resigned as partner with the firm and placed all of her assets in a blind trust. The state Ethics Commission has since ruled that she has taken the necessary steps to avoid any conflicts of interest.

Raimondo continues to collect earnings from Point Judith. Last year, she earned between $201,000 and $500,000 in capital gains from the firm, an amount at least double what her salary was as state treasurer, as GoLocalProv reported in May.

Point Judith is currently pulling ahead in another benchmark issued by PitchBook, which shows that the median rate of return for 42 venture funds it surveyed ranged from 3.62 percent in the first quarter of 2012 to 5.6 percent in the last.

Venture funds are considered riskier

Returns typically dip in the early years of a venture capital fund because the money is invested in small start-up companies that haven’t necessarily sold, or even finished developing their products. Often the valuation of a company is based on its potential rather than its underlying cash holdings, Bowden said.

Until one of the start-up companies in which a venture fund has invested are sold, the returns on the investment on can’t be known with certainty, those familiar with the industry say. “This is kind of like real estate,” Tobe said. “What’s the performance of your house? … It’s almost as hard as calculating something like that.”

The inability to track ongoing performance is one reason so many people believe that public pension systems should not use private equity, according to Tobe, who served as trustee for the Kentucky Retirement System from 2008 to 2012. (As a trustee, he hired Siedle to look into placement agent fees in the retirement system.)

It is nonetheless common for public pension systems to use private equity, according to Bowden. He said a pension fund typically has between 5 and 10 percent of its holdings in private equity.

Bowden said venture funds are considered riskier because of the volatility of the returns and because the liquidity of the investment is very limited. Even in a hedge fund, an investor can withdraw their money within a quarter or 90 days of their decision to do so. In venture funds, on the other hand, an investor normally does not get the money back until what ten-year life of the fund has expired, according to Bowden.

There’s also an obvious inherent risk in investing in companies that have no track record of success. A conventional strategy for a venture fund would be to invest in a number of start-up companies at once in the hopes that one will take off, producing large gains that wipe out the losses on those start-ups that failed, Bowden said.

Treasurer’s office touts earnings

It’s not clear from the data provided how much the state has actually earned from its investment in Point Judith.

When Fox was questioned about it, she responded: “Point Judith II has thus far made distributions equal to 22 percent of the capital the fund has called.” “Distributions” is the industry term for earnings that have been paid out. They are analogous to capital gains on stock, according to Taylor.

In layman’s terms, Fox’s statement means that the state so far has earned 22 cents on the dollar. That is slightly below the industry as a whole. For funds that, like the Point Judith were established in 2006, the overall return was 28 cents on the dollar, according to NVCA data. (In industry jargon the year a fund was started is often referred to as the “vintage” year.)

“They’re a little below water,” Taylor said. “That’s not outrageously far out of line.”

In terms of dollars, the state so far has received payments of $965,577 on $4,426,630 it has invested, according to Fox.

The state committed to investing in Point Judith in 2007. In all, the firm collected about $73 million in investments that year, according to a report on the Alternative Assets Network.

At the time, the State Investment Commission, had a preference for in-state funds, according to Marcia Reback, a longtime member of the commission and former leader of the Rhode Island Federation of Teachers and Health Professionals. Point Judith Capital was the only venture capital fund in the state.

“Point Judith had a leg up,” she said.

After Raimondo’s election, Point Judith Capital relocated to Boston. “At the first opportunity, they moved out of Rhode Island,” Reback said. Partners at Point Judith did not return messages seeking comment.

When the state was recently given an opportunity to invest in Point Judith again, Reback said the treasurer’s staff declined.

Stephen Beale can be reached at sbeale@golocalprov.com. Follow him on Twitter @bealenews

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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