The University of North Carolina has developed a reputation for its high standards. From prospective college students studying for the SATs to private equity players on the fundraising trail, UNC is not afraid to turn away someone if their grades aren’t up to snuff.
“I think the LP community is split between those who think we are in a challenging return environment and are taking a cautious view towards private equity, and those who feel the economy is turning and believe now is a good time to invest,” says UNC Vice President Mel Williams. “We would include ourselves among the former group.”
Much of the speculation at UNC derives from its view that competition in the mid- and large-cap areas of the buyout market has led to lower return expectations, as more money is chasing fewer deals. “I think when we saw the correction in the public markets in 2001, combined with the overhang in the private equity markets that same year, we began to change our expectations… We’d still like the 25%-plus [IRR] we were seeing before, but the reality is that we should expect returns in the mid-teens these days,” Williams says.
While UNC’s expectations has dipped the past few years, its allocation to private equity has not. The fund currently has roughly $1.1 billion of assets under management, with a 15% allocation target for private equity. Right now, UNC is over-allocated with 16% going towards private equity, which is split 55%/45% venture capital to buyouts.
UNC has invested in funds from Bain Capital, Heritage Partners, J.W. Childs Associates, McCown De Leeuw & Co. and Oaktree Capital Management, as well as venture funds from Accel Partners, Battery Ventures, Domain Associates, Foundation Capital and Morgenthaler Ventures. Most recently UNC contributed to Silver Lake Partners, Hancock Park Associates, Rhone Capital and TDR Capital.
To get around the increasing competition, UNC looks for investments that tend to be a little less traditional. “What we’ve done to manage in this environment is to invest in funds that are heavily focused on operations or we’ll look to put money in funds that focus on one particular niche or industry,” says Williams. “We’re also trying to concentrate on the micro cap or small cap segment of the buyout market because we believe the area is less competitive and more open to proprietary deal flow, and we have invested in several European buyout funds across both the large-cap and small-cap segments.”
Perhaps even more unique than its investment strategy, UNC has started raising money for a new fund, The Carolina Venture Fund I, which it will use to invest directly in seed-stage technologies that come out of the school. “We’ve capitalized the fund with $10 million of our own money, and we’re looking to raise another $5 million to $10 million of capital,” Williams says. Investors in the fund include a mix of wealthy individuals, corporate investors and other institutional investors, and Williams expects to close the fund within the next 12 months.
The Admissions Process
While most LPs cite a firm’s track record as the most vital component to investment, at UNC a great transcript does not necessarily induce a contribution from the school. “We’ll look at the track record, but we need to believe that it’s repeatable and actually supports a firm’s investment strategy,” Williams says. And aside from past returns, UNC selects its investments based on four other criteria including the relevance of a firm’s strategy, (whether the strategy fits UNC’s needs) and the investment team behind a firm. The University will also consider the terms of the particular fund, as well as the overall decision-making process employed at a firm.
And while UNC is trying to keep its distance from the middle and large U.S. markets, the University is also keeping its eyes open for other red flags, such as a propensity for club deals. “We see the occurrence of these deals as indicative of two things: too much capital or an aversion to risk at the GP level,” Williams says. “We believe it’s very difficult to execute a buyout strategy with shared control, and as an LP, we probably stand to lose the most from these deals.”
In addition to the competition present in the large market, UNC also prefers to keep its distance from the mega funds that pursue the space because their terms are usually not as appealing. “We’re not big fans of GPs receiving $50 million to $60 million a year in management fees, and we’d prefer to see greater sharing in the transaction and monitoring fees between the GPs and the LPs,” which Williams adds, is becoming more of a trend of late.
As far the disclosure debate goes, UNC is hoping it is not forced to join CalPERS or UTIMCO and share its IRR numbers. “I’m sure someone benefits from greater transparency, but I’m just not sure if it’s us,” Williams says, adding that more transparency will bring more interest to private equity, which in turn will only serve to aggravate the problem of too much capital chasing deals. “I’d rather this industry be as murky and cloudy and difficult to decipher as possible, such that only those investors who dedicate the resources necessary to fully understand the asset class would feel comfortable investing in private equity,” Williams says. “But I think the horse is out of the barn as far as transparency and disclosure are concerned and we’re not likely to get it back in at this point.”
Still Making The Grade
However, in the midst of the disclosure debate, shrinking expectations, over capacity and inflated management fees, UNC is still able to find areas it likes in private equity. And with the correction in the market in 2001, there are some trends that the University is happy to see. “We like the fund-size reductions that have been happening, as well as the renewed focus on operations,” Williams notes. “And we like the fact that the economy appears to be turning around and the appetite of the debt markets is increasing, which both point to a more healthy environment for buyouts.”
University of North Carolina at Chapel Hill
Location: Durham, N.C.
Assets Under Management: $1.1B Target PE Allocation: 15%
Key Personnel: CIO Mark Yusko, VP Mel Williams
General Consultants: Cambridge Associates (information basis only)
Select Investments: FP: Goldman Sachs and Deutsche Bank
Accountant: Bain Capital, Heritage Partners, J.W. Childs Associates, McCown De Leeuw & Co., HarbourVest Partners, Pacven Walden Management and Oaktree Capital Management.