The two public pension plans in San Jose, California, may be in Silicon Valley’s self-proclaimed capital city, but neither has any investments in venture capital. That could be changing.
Board documents and video streams of recent meetings of the $3.71 billion San Jose Police and Fire Department Retirement Plan and the $2.23 billion San Jose Federated City Employees’ Retirement System show that both plans are examining the feasibility of implementing venture capital portfolios.
The plans have hired Ashby Monk, executive and research director at the Stanford Global Projects Center, to prepare a venture capital investment plan.
The report is expected by early next year. Monk, known for his expertise on pension plan asset allocation, told the police and fire retirement system board on September 6 that he is in favor of an alternative approach to building VC investments.
“The traditional path is obviously to go to Sand Hill Road and beg for access to the top GPs and happily pay them three and 30 for the right to tap into their network,” he said.
Instead, Monk said he advocates using alternative methods, such as data that businesses report to the city of San Jose, for example, to help identify promising start-ups.
He said San Jose pension plans “might have a comparative advantage that’s different than every single pension plan on earth. Where, with the right people around the table, we could design something that leverages probably the most exciting geography on earth in order to create a return to this pension plan.”
Both pension plans already have allocations to venture capital as part of their asset mix even though they own no venture capital funds. There is a 4% allocation for the federated plan and a 5% allocation for the police and fire plan.
Monk said at the Sept. 6 meeting that large pension plans have been turning away from venture capital because of the difficulty scaling returns, but said the San Jose pension plans’ smaller size would enable VCs to have a “meaningful contribution” to returns.
He said he advocated a “barbell approach” to venture capital—investing in seed companies at their early stages as an angel investor—would do as well as investing in later-stage companies.
Some board members at the meeting expressed concern about the wisdom of investing in venture capital, particularly investing in seed companies, the riskiest part of the venture capital spectrum, because of the extremely high failure rate of new companies.
Board member Ghia Griarte said there was a high number of seed investments “going bust.” Griarte, who works as a private equity firm investment official in addition to her board duties, said that public disclosures required by pension plans doing business with venture capital funds might result in top-tier funds refusing to do business with the San Jose plans.
“[From] what I understand, a lot of the brand name firms do not like the public disclosures that is required of them,” Griarte said, forcing the pension plans to access second-tier funds.
“And below the question is whether the returns of those second-tier funds warrant the risks inherent in them because if you don’t access the top tier, anything below that has a really wide disparity of return,” she said.
City Councilman Johnny Khamis, a non-voting member of the police and fire pension board, said investing in venture capital might be prudent, but difficult politically.
“We have to convince our public that we’re doing that right thing with their money and our employees,” he said.
Khamis said when people in San Jose, including his fellow city council members, hear that “we’re going into a higher-risk investment,” it might not be politically tenable.
“My only concern is how do you coach this politically?” he asked.
Monk responded that he misspoke talking about seed companies and angel investing, noting “that scares people.”
“So, it’s not as if we’re asking single angel investments to deliver performance,” he said. “We’re trying to look at it as a class of investments and access it uniquely.”
Monk said that in the plan, he wanted to explore how to spot emerging companies.
“I would argue that we could identify early-stage investment programs and get to them before the venture funds do,” he said. “The highest-performing asset class in the venture [world] is actually angel investing, it’s just impossible to institutionalize unless you can create a rules-based program based on the data that you have coming out of a city, a university, an accelerator, an endowment.”
Prabhu Palani, the chief investment officer for both San Jose pension plans, told the police and fire board that the investment staff has had two “productive conversations” with Kim Walesh, the San Jose deputy city manager/director of economic development, about accessing city data to identify promising start-up businesses.
“She does seem excited to work with us,” Palani said.
While the police and fire retirement plan has a funding ratio of 72.1%, the federated retirement plan is only 50.4% funded, shows a Nov. 2017 report by Stanford University’s Institute for Economic Policy.
The report, commissioned by the San Jose city auditor, found that San José’s plans underperformed eight other peer plans with a similar amount of assets when looking at one-, three-, five-, and 10-year returns.
Plan dates show that the police and fire pension plan’s one-year return for the 2017 calendar year was 12.1%, but the results still underperformed a policy benchmark of 14%. The federated plan saw returns of 10.6% during the same time period compared to the 13.3% policy benchmark.
The report stated that the two San Jose plans’ ratio of beneficiaries (eligible or currently drawing pensions) compared to members who are contributing funds into the plans is higher and growing faster than other jurisdictions.
The two funds combined have an unfunded liability of more than $3.5 billion. The city tried to cut pension benefits in 2012 after voters approved a referendum that allowed such reductions, but a ruling the next year by a county Superior Court panel found such cuts violated California law.
Monk said at the meeting that to increase funding status, the plans need to increase contributions, reduce benefits, or make it up through investments.
“The only way you invest yourself out of it is by taking on more risk,” he said of the potential venture capital portfolio.