Investing

I wrote last week about the issues of fees in the investment industry. Now it appears that state governments are so enamored with the venture industry that they are investing on margin. According to VentureWire:

Deutsche Bank AG is emerging as a leading source of capital for private equity funds of funds sponsored by state governments.

In the latest instance, Michigan Gov. Jennifer Granholm announced this week that Deutsche Bank had ponied up $200 million to finance the state’s Venture Michigan Fund, which is a fund of funds earmarked for regional venture capital funds.

The Venture Michigan Fund is the second state-sponsored fund of funds that Deutsche Bank has financed. Deutsche also supplied Utah with $100 million for its Utah Fund of Funds in March. That vehicle invests more broadly in in-state venture capital and buyout funds.

Deutsche is said to be negotiating with other states that are also in the process of setting up funds of funds, a person close to the issue said. Deutsche declined to comment.

The Venture Michigan Fund is managed by Credit Suisse’s Customized Fund Investment Group, while the Utah Fund of Funds is overseen by Ft. Washington Capital Partners.

Rather than serve as a traditional investor, Deutsche acts more like a lender to the funds of funds. Both Michigan and Utah pay interest on the value of the bank’s commitment. In the case of the Venture Michigan Fund, the state pays Deutsche more than 6.5% interest on the $200 million it is supplying. And if the fund of funds’ investments fail to generate enough profits to cover the interest payments, Deutsche receives tax vouchers for the full amount as a backstop.

This is the kind of crass stupidity from politicians that bolsters the argument for limited government.

A large amount of the money flowing into private equity and venture capital comes from pension funds. Typical venture funds charge 2.5% fees annually. The pension fund managers also charge a fee (around 0.3%) to manage the entire pension fund. Often, there is an additional layer of fees if the pension fund manager decides to access the venture capital asset class through a fund-of-funds. Fund-of-fund managers typically charge 1% for their services (picking the underlying venture funds). The total fees that an 85-year old nurse is being charged on her pension is therefore close to 4%. And this does not even take into account the 20% of any profits which are allocated to the VC’s, the 5% of profits added to the fund-of-funds manager and the bonus allocated to the pension fund manager.

All this leads me to my broader point: why are people content to give up almost 5% of their life savings annually. The long term returns on stock investing is 8-9% depending on the time frame and those returns are easily accessible to anyone through low cost (<0.2%) exchange-traded index funds. It is unlikely that venture funds will return in excess of 15% annualized IRR over the next few decades. And even if they do, all the compensation for taking on the additional risk goes to the finance industry.

There is a similar phenomenon in the public markets. Mutual fund fees are often as high as 2%. Why are people willing to pay those fees when there is an abundance of evidence that the vast majority of fund managers underperform the indices they are attempting to track?

A wide-ranging look at the state of the US economy and some of the best investment insight you will ever find:

Century Management’s 2004 Investment Newsletter

Century Management has had a stellar track record for 30 years now. Nothing flashy, just plenty of common sense that is so easy to forget. As Cicero said a few thousand years ago:

“The budget should be balanced, the Treasury should

be refilled, public debt should be reduced, the arrogance

of officialdom should be tempered and controlled,

and the assistance to foreign lands should be

curtailed lest Rome become bankrupt.”