V stands for venture and volatility

New performance data for VC confirms the recent collapse in returns and a new report on UK local authority pension fund performance shows that their VC allocations have wilted too.

Figures released this week from investment advisor Cambridge Associates reveals that net US venture capital returns for the quarter ending 31 March 2002 have fallen to minus 7.7 per cent, down from  minus 6.2 per cent for the previous quarter.

Looking back over the year ending 31 March 2002, VC net returns show a negative return of minus 33.3 per cent, which looks unnerving especially when compared to the one year S&P 500 return of 0.2 per cent and NASDAQ Composite of 0.3 per cent return for the same period.

This makes all the more striking the net pooled mean figure that Cambridge reports for US VC over three years of 76.8 per cent. And the five and ten year net figures of 57.3 per cent and 34.4 per cent respectively help affirm the point that US VC has enjoyed spectacular highs and lows in the recent past.

In comparison, Cambridge Associates' figures for private equity returns show that the lows have not been as low but that the pooled means have not reached such highs as VC either. The 31 March quarter net pooled mean figure was minus 0.6 per cent and the year to that date figure was minus 6.9 per cent. But the three year net return was a less than stellar 2.4 per cent – rising only to 8.9 per cent over three years and 8.9 per cent for five years.

One implicit message here is that any pooled mean is going to be affected by the poor performance of certain funds and that top quartile VC (and private equity) funds will deliver exceptional returns far higher than the average.

Cambridge estimate that its US Venture Capital Index tracks 80 per cent of the total dollars raised by VC managers between 1981 and year-to-date 2001. Their Private Equity Index is estimated to cover 70 per cent of the total dollars raised by US leveraged buyout, subordinated debt and special situation partnerships formed between 1986 and year-to-date 2001.

In the meantime, The WM Company, the performance measurement consultancy owned by Deutsche Bank, has released the results of its survey of 93 UK public sector pension funds that show a marked decline in returns. For the year ending 31 March 2002 these local authority pension funds, which manage £85bn of capital, have achieved an average return of minus 0.5 per cent, the second successive year when the average has been negative.

One key message from the survey was that the funds are moving away from an active management of their public equity investments to index tracking. UK equities made up an average of 47.8 per cent of the asset mix for the year and overseas equities were 24.6 per cent.

Much was also made of the fact that VC and private equity returns for the year delivered a negative return of minus 14.7 per cent for the funds, although it should be noted that in terms of overall allocation, the fact that these funds only had 0.9 per cent allocated to VC and private equity means that the impact on overall returns was negligible.

Interestingly, and if further evidence of the recent volatility of the asset class were required, the allocation to PE and VC for the preceding year (ending 31 March 200) had been a similarly lowly 0.8 per cent but the average return had been an impressive 32.5 per cent.

Karen Thrumble, executive director at WM Company, commenting on the VC and private equity returns, said: 'This figure is a painful illustration of the risks which come with the territory for this type of investment. However, over the long-term, the evidence is that investors are adequately rewarded for the risks they take.'

As the outlook for public equity returns continue to look meagre and where fixed income product remains a safe but low returning asset class, so allocations to alternative asset classes – even by risk averse investors such as local authority pension funds – looks set to increase. As Thrumble at WM remarked: 'Local Authorities currently only have 0.9 per cent of their assets in private equity, but we would expect that to grow substantially over time.'