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Geographic restrictions could backfire for PERF: $105 million fund carries lots of potential, risks

June 12, 2006

By restricting the new $105 million Indiana Investment Fund I to deals within state lines, Gov. Mitch Daniels hopes to simultaneously spur economic development and earn a spectacular return for Indiana's retired public employees.

But venture-capital experts warn it's nearly impossible to have it both ways.

"You need to be very, very clear what your objectives are when you invest [pension] money. Is it for economic development or to help the pensioners earn better pensions?" said John Taylor, vice president of research for the Arlington, Va.-based National Venture Capital Association. "You can't do both simultaneously. It doesn't work. Somewhere along that sliding scale, you need to find where you're going to be."

On June 1, Daniels joined officials from the $15 billion Indiana Public Employees' Retirement Fund to announce the formation of the Indiana Investment Fund. Designed as a vehicle for speculative investments, it will consider deals across the whole spectrum of private equity, from taking stakes in early-stage startups to financing expansion debt for mature firms. Its industry focus is similarly broad, ranging across every Hoosier strength, from agriculture and advanced manufacturing to information technology, transportation and life sciences.

The Indiana Investment Fund represents less than 1 percent of PERF's assets. Like many large U.S. pension funds, PERF is aiming to invest 5 percent of its assets, or $750 million, in privateequity instruments. Its board is debating whether to increase that share to as high as 15 percent, or $2.3 billion.

The new fund is clearly modeled after BioCrossroads' $73 million Indiana Future Fund, in which PERF is also an investor. PERF put $14.6 million into that fund, now 3 years old, as part of a syndicate of institutional investors.

PERF is kicking $100 million into the Indiana Investment Fund, making it the dominant stakeholder. Credit Suisse added $5 million. Both stress that the potential for outsized returns, not economic development, are their driving motives.

But Bill Styring, an independent economic consultant with locally based Styring & Associates, pointed out the chicken-or-egg dilemma that has long frustrated Hoosier entrepreneurs: Does Indiana lack money, or just good business ideas? In a free market, worthy deals should auto- matically attract investors. And if they're unworthy, it's unfair to risk pension dollars that belong to retired cops and firefighters.

"If there's plenty of opportunity in Indiana, why do we need PERF to put money into it?" Styring asked. "If there's not, why are we involving PERF?"

PERF Executive Director David Adams fully expects the new fund to match its promise and provide outstanding returns for pensioners. And no matter how it performs, it's only a fraction of PERF's total strategy, which involves investments across the entire market, he said.

"What's key to what we're doing is return on investment. That's paramount to the success of the model," Adams said. "[But] this is a $15 billion pension system of assets under management. If you take $105 million, that represents a small piece of the overall investment."

A $105 million injection fits perfectly with Daniels' overall prescription to modernize Indiana's struggling economy. But finding local deals that promise spectacular returns isn't always easy. Indiana Future Fund money has found its way into just seven companies.

The Future Fund and PERF's new fund share the same manager, New York-based global investment bank Credit Suisse. To earn the right to manage the fund, Credit Suisse defeated 10 other applicants. PERF did not respond before IBJ deadline to a request for information about the also-rans.

"They're very good at what they do," PERF Chairman Ken Cochran said of Credit Suisse. "They're familiar with Indiana, and they also had experience with that [BioCrossroads] fund. But that was not the reason they were selected. It was a competitive procurement. They were selected because they offered the best arrangement for PERF."

To generate deal flow for the new fund, Credit Suisse plans to hire a two-person team to scour Indiana for business plans. The actual investment decision will reside with a committee at Credit Suisse. The fund already has four or five deals "in the hopper" for consideration, said Michael Arpey, managing director of Credit Suisse's Customized Fund Investment Group. But the due-diligence process takes time on every investment.

"Obviously, the goal is not to just put the money out to the first deal that walks in the door," Arpey said. "You want to be thoughtful and pick the things that will meet the return objectives."

About 30 percent of the Indiana Investment Fund's investments are expected to be in venture-capital partnerships that generate their own deals, which is similar to the fund-of-funds model BioCrossroads applied to all the investments from its fund. The other 70 percent will be made directly.

This isn't the first time Indiana state government has attempted to impel private-equity investment inside state lines. In 1981, it granted tax incentives to encourage the formation of Indiana's first venture-capital company. Now known as CID Capital, it has become the state's largest venture firm, with $321 million in assets under management.

CID did very well in its early years by focusing on Indiana. After raising $10 million for its first fund, it returned $42 million. For its second fund, CID raised $27 million in 1988 and returned $68 million.

By the early 1990s, CID had grown large enough that it began to look outside state lines. It raised a fund that focused exclusively on investments in Ohio companies. But the Ohio fund flopped and its investors lost millions.

Even so, CID Managing Director John Aplin said PERF's Indiana Investment Fund has a good chance to succeed because its investment parameters are wider than CID's were in Ohio. CID's more recent funds haven't been geographically constricted-although in recent years, the firm has returned much of its focus to Indiana.

"The issue there was stage. In retrospect, the Ohio fund was focused on veryearly-staged companies, and very technology-focused companies. There's a higher risk component in those transactions," Aplin said. "The risk profile with this [Indiana Investment Fund], from what I've understood, is more balanced."
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