NYS Loves Captive FFs; Are They Worth It?

The roughly $3.4 billion that The New York State Common Retirement Fund has committed to 10 captive funds-of-funds since 1998 makes it one of the biggest backers of such programs in the country. But the strategy has yet to really pay big dividends for the $153.9 billion pension fund.

A captive fund-of-funds is a pool of capital with a customized mandate and a single limited partner. Large institutional investors tend to be their biggest proponents, hiring advisors like Credit Suisse, Grove Street Advisors, Hamilton Lane Advisors and others to create tailored programs—a portfolio of European venture capital funds, say, or a portfolio of small buyout funds—that it wouldn’t be economical for them to create themselves. Advisors typically earn both a management fee and carried interest for selecting and managing the portfolio.

New York has used its program to boost its exposure to smaller buyout funds, mid-size buyout funds, venture capital funds, mezzanine funds and special situation funds. Among the larger captive funds of funds in its portfolio: a $700 million commitment to Hudson River Fund II, a portfolio of mid-market buyout and special situation funds managed by Hamilton Lane Advisors; a $500 million commitment to GKM/NY Venture Capital Fund a portfolio of venture capital (mainly) and buyouts funds managed by GKM Newport; and a $400 million commitment to the Hudson River Fund, a portfolio of buyout (mostly mid-market), growth capital, special situation and infrastructure funds managed by Hamilton Lane. (See table on next page.)

As of March 31 2007, New York’s captive funds-of-funds represented about one-quarter of its overall private equity program, which has an allocation of 8.3 percent, or about $13 billion. After corporate finance funds, the captive funds of funds represent the second biggest portion of the private equity portfolio, according to Jim Fuchs, spokesperson.

An examination of the underlying funds in the captive fund of funds program shows that buyout funds have secured about $850 million in commitments, compared with $1.5 billion for venture funds. (Not all underlying funds are disclosed by New York because of confidentiality provisions.) Buyout firms that have secured commitments as part of the program include ACON Investments (a $35 million commitment to Acon-Bastion Partners II LP); Morgenthaler Partners (a $10 million commitment to Morgenthaler Partners VIII LP) and Phoenix Equity Partners (a $27 million commitment to Phoenix Equity Partners IV LP).

Results to date for the New York captive fund-of-funds program have so far been underwhelming, a result that likely reflects much of the money being poured into venture capital firms not long before the dot-com bubble burst. The return multiples for the seven captive funds-of-funds with inception years of 1998 to 2002 range from a 0.8 multiple produced by HarbourVest Partners‘s 1998 Mohawk River Fund to 1.5 produced by Hamilton Lane Advisors’s 1998 Hudson River Fund. Neither firm would comment on performance. All told, the $1.4 billion that has been drawn down by those seven funds has generated $1.7 billion between distributions and estimated remaining value, for a pooled return multiple of 1.2x.

By comparison, New York’s overall alternative investment asset portfolio has achieved an investment multiple of 1.5x. However, that portfolio includes funds backed from 1987 to 2006, and therefore captures a number of younger funds still in their J-curve years. New York State Common declined to comment on performance.

One of the only other captive fund-of-funds programs to approach the scale of New York’s is that of the California Public Employees’ Retirement System. The $230 billion pension fund has nine captive fund-of-funds, to which it has committed about $5.3 billion. Its California Emerging Ventures program, run by Grove Street Advisors, backs venture capital and buyout funds that invest primarily in California-based companies.