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Pension changes fill state's VC coffer: Indiana Investment Fund has $155 million to pour into Hoosier companies

April 30, 2007

The diversification of the state's two enormous public pension funds into private equity is transforming Indiana's venture capital sector.

And their $155 million Indiana Investment Fund is the largest factor in the equation.

If it's successful, the Indiana Public Employees' Retirement Fund and the Indiana State Teachers' Retirement Fund will save Hoosiers untold millions of dollars and help launch a host of new high-tech companies. If it's not, taxpayers will one day have to foot the bill.

Indiana State Budget Director Chuck Schalliol spearheaded the effort to unleash PERF and TRF into local private equity. Formerly head of Eli Lilly and Co.'s Venture Capital Division, Schalliol was a key architect of BioCrossroads' $73 million Indiana Future Fund and its $6 million counterpart, the Indiana Seed Fund.

As a PERF and TRF board member, Schalliol applied Gov. Mitch Daniels' "Buy Indiana" philosophy and pushed both pensions to consider alternative investments in Hoosier companies.

The result: Last June, PERF put $100 million into the new Indiana Investment Fund. In March, TRF followed suit, investing another $50 million. Global investment bank Credit Suisse won a competitive RFP process to become the Indiana Investment Fund's manager. It kicked in the $5 million remainder.

Exclusively Indiana

Indiana Investment Fund instantly became the biggest player focused exclusively on Hoosier opportunities. Although Lilly Ventures and CID Capital have more assets under management, both firms regularly look beyond Indiana's borders.

Schalliol expects Indiana Investment Fund to draw many more venture capitalists to the crossroads of America.

"I think these [efforts] are self-feeding. Creating these kinds of funds will attract more firms to locate and grow here. As that happens, the need for venture money increases," said Indiana State Budget Director Chuck Schalliol. "The more successful we are, the more venture opportunity we have and the more investments we see. It creates a 'virtuous cycle.'"

Since BioCrossroads' Indiana Future Fund already covers the life sciences sector, Indiana Investment Fund aims to speculate more broadly on just about everything else Hoosiers do well. With an investment range from $1 million to $15 million, it will consider deals in manufacturing, logistics, IT, agriculture and alternative energy. Credit Suisse plans, in part, to use the same "fund-of-funds" strategy as the Indiana Future Fund. It will select a series of venture capital firms to handle $90 million in Indiana Investment Fund money, but it will deploy the other $65 million directly into promising Hoosier firms.

Indiana Investment Fund hasn't yet announced any deals. Its management ultimately rests in New York, where its managing director, Mike Arpey, leads Credit Suisse's Customized Funds Investment Group. Last July, Arpey hired Curt Rossman, a Lilly Ventures veteran like Schalliol, to run the fund's Indiana office.

Rossman said Credit Suisse has now selected "some" of the venture capitalists who will manage the $90 million, but he declined to say who they are or how much they got. Even though Indiana Investment Fund is composed almost entirely of public pension money, Rossman said Credit Suisse doesn't have to divulge its activities-and may never share much detail.

"Each time we get into a situation where we evaluate investments, we always sign confidentiality agreements. Therefore, we don't disclose the identity of our investments," Rossman said. "This program is going to make more money available to Hoosier businesses. It's money that wasn't there before. But we will stand by our confidentiality agreements. That's for certain."

To generate potential deals for the Indiana Investment Fund, Credit Suisse has staged a series of "road shows" for entrepreneurs, corporate executives and private equity attorneys. Indianapolis hosted the first on Nov. 1 and Fort Wayne held the second on Dec. 6. Evansville saw the third and most recent on Jan. 30.

Rossman said Indiana Investment Fund regularly meets with other people around Indiana to create investment opportunities.

"We've seen quality deal flow from the beginning. The reason is the relationships of our broader outreach efforts, as well as the Credit Suisse network," he said. "We believe that the private equity market in Indiana is underserved, and we think this fund will help fill that need."

Enormous potential

Schalliol pointed out the enormous upside if Indiana Investment Fund should do well-first and foremost in terms of its direct financial returns to PERF and TRF. Although $155 million is a great deal of money, it's a tiny fraction of the $24 billion in assets the two pensions collectively hold. That money is spread across a portfolio that represents the entire market of bonds and public stocks, as well as other kinds of alternative private equity investments, such as real estate and M&A funds.

To outperform the public markets, Schalliol said, it's important for the pensions to take advantage of the prudent investor theory and put some money to work in venture capital-and a subset of that into local venture capital. He said venture capital investments to date have netted TRF 24-percent compound returns. PERF hasn't been making them as long, so it hasn't seen as many "exit events."

"When you are able to go to markets that are inefficient, smart investors are able to make above-average returns, Schalliol said. "If you're just investing in the stock market, you'll get the returns the stock market does and everybody else gets."

When PERF and TRF do well, it's an enormous boost for the state, because taxpayers are on the hook otherwise for pay- ments to pensioners. When the two funds grow in value, state government can subsidize different priorities instead.

But there are no guarantees. John Taylor, vice president of research for the Arlington, Va.-based National Venture Capital Association, said few states have established vehicles like the Indiana Investment Fund. So few, in fact, that NVCA doesn't track them.

But Taylor warned there are risks to a strategy that prioritizes Indiana over the rest of the world. That's because venture capital success, by definition, is easier said than done.

"It's very, very difficult for even the best funds to return money, even without constraints," Taylor said. "Put constraints on it, and it becomes increasingly difficult to make those returns."

"There's nothing wrong with economic development. And there's nothing wrong with pure fiduciary investment," he added. "But anytime you take a hybrid model, by definition, you're suboptimizing. It's very, very difficult to balance two objectives. You can do one or you can do the other; $155 million is a lot to deploy."

BioCrossroads CEO David Johnson has heard those warnings before. Industry experts said the same thing about the $73 million Indiana Future Fund for the life sciences. But he said economic development can be market-driven.

"We were trying to square the circle with this," he said. "One of the things people have a very hard time truly comprehending is, these funds can be put together as private and fiduciary investment vehicles."

Indiana's success has spurred interest from other states. Johnson said he now regularly fields calls from officials in other states who want to duplicate the Indiana Future Fund and the Indiana Investment Fund. Their activities are also starting to draw attention on Wall Street, where people are always looking for new investment opportunities with a large upside.

Now they're starting to scout Indiana for deals.

"The fact that we have a real fund that is return-driven and has a manager of the name and caliber of Credit Suisse is the most attractive thing about the Indiana Future Fund," Johnson said. "It's serious money, and it's being managed by a serious player in the field. What that tells people is, if Credit Suisse is interested, there must be something there."
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