Article: OHIO INVESTMENT SCANDAL - BWC poured $346M into venture funds (June 27, 2005)
Nontraditional holdings suffer a 15 percent loss
Risky investments by the Ohio Bureau of Workers' Compensation didn't end with rare coins and a Bermuda hedge fund. Add bagels to the list.
Bureau officials have more than $346 million in venture capital funds, which typically provide start-up financing or loans to firms that have had trouble borrowing from conventional sources.
The list of firms in which the bureau has an interest includes the Colorado parent of the Einstein Brothers bagel chain, which is struggling to emerge from years of red ink.
The venture capital funds are among $951 million in nontraditional investments that the bureau holds, according to a June 7 report.
Representing 7 percent of a $14.3 billion portfolio, they include the rare coins that have made the bureau the object of nationwide ridicule and sparked investigations into missing coins and political cronyism.
The investments are to provide a return, that combined with annual premiums paid by Ohio employers, are used to pay for the medical and living expenses of injured workers. Ohio is one of only a handful of states that operates its own insurance program for injured workers.
While none of the other investments is as unorthodox as rare coins, the sheer size of the nontraditional picks has stunned experts familiar with portfolios of pension plans and private insurance companies.
"What the state fund in Ohio has done is highly unusual and would be viewed as far out of the norm for a private insurer," said Robert Hartwig, chief economist for the Insurance Information Institute, a trade group representing the nation's $400-billion-a-year insurance industry. Little, if any, of the portfolios of private insurers are in hedge funds and venture capital funds, he added.
Pension plans typically devote no more than 4 percent to nontraditional investments, added Keith Brainard, research director for the National Association of State Retirement Administrators.
"They are high-risk investments," explained Laura Ecklar, spokesman for the $58 billion State Teachers Retirement System of Ohio. "They have a potential for high returns but also carry high risks."
Investment analysis
While nontraditional investments are designed to offset lackluster returns from the stock and bond markets, the bureau recorded a 15 percent loss from those picks as of late May.
An analysis of the bureau's investments by The Blade shows:
A review of the bureau's venture capital picks and other nontraditional investments are the first priority of a three-member team appointed by Gov. Bob Taft to review bureau investments in the wake of the scandal, said Tom Hayes, who is overseeing the effort.
A report will be issued by Aug. 1 on the value of each fund and how its performance compared to similar investments, said Mr. Hayes, director of the Ohio Lottery Commission.
Already, the team and consultant Ennis Knupp & Associates of Chicago have learned that two huge funds managed by American Express Asset Management were misclassified as venture capital funds, which are often referred to as private equity funds.
In fact, the funds, with $550 million in bureau money, were hedge funds. The state agency said it plans to withdraw from hedge funds, which engage in unorthodox investment strategies that many experts consider too risky for public funds.
Overall, the review team has discovered that the bureau's reporting on venture capital funds and other nontraditional investments has been sketchy and insufficient, a problem that Mr. Hayes blamed on inadequate computer software and a dozen-person investment staff that is much smaller than at similar-sized funds.
Portfolio breakdown
Like most pension and insurance company funds, the bulk of the Workers' Compensation Bureau's portfolio is invested in relatively safe investments such as bonds and stocks of major corporations.
The breakdown, as of June 30, 2004, was 53 percent bonds, 27 percent U.S. stocks, 12 percent international stocks, and 7 percent in rare coins, hedge funds, and other nontraditional investments.
The total includes four dozen funds holding domestic stocks, 20 with bonds, and nine with international stocks. Most of those funds have consistently earned money, although not as much as before the stock market bubble burst in 2000. They are managed by dozens of private managers, most of whom are affiliated with well-known firms including John Hancock and J.P. Morgan.
Those investments, along with the Workers' Compensation Bureau's nontraditional picks, gained 4 percent in fiscal 2004, according to a bureau annual report on June 30, 2004.
The decline in returns on traditional investments has prompted pension fund managers nationwide to investigate nontraditional investments ranging from risky hedge funds to timberlands, according to investment professionals.
Venture capital funds are also drawing interest. The big attraction: returns that are unavailable in traditional investments.
Typically such funds, whose officials usually are more involved in the management of target companies than other investors, don't begin to yield strong results for five to 10 years, investment professionals said.
Targeted firms range from start-ups with no collateral, to already established firms seeking to expand, to successful companies ripe for a buyout. Over the years, the class of investment has contributed to stellar success stories like FedEx and AOL.
The list of venture capital recipients, however, includes numerous bombs that were never heard from again.
As of December 31, venture investments nationally were providing 1.5 percent annual returns after five years; 13 percent annually after 10 years, and 14 percent after 20 years, according to figures distributed by the National Venture Capital Association.
The Ohio bureau's venture capital investments overall, made as long ago as 2000 and as recently as April, showed gains of 5 percent, according to a report provided by the agency.
Conflicting reports
But it is unclear how reliable that data is because it is based on difficult-to-verify reports from venture fund managers. Also, the BWC reports, which were hurriedly generated in the wake of the resignation last month of administrator James Conrad and other forced resignations and suspensions, contain contradictions and mistakes.
The BWC initially provided to Governor Taft and reporters a report claiming that nearly all of its venture capital funds were a wash - that they had neither made nor lost money. But when The Blade questioned the data, it was provided with a second, more detailed report reflecting profits and losses.
Investment executives at the bureau downplayed the discrepancies last week, saying they reflected two different accounting treatments.
However, they were unable to explain why the first report showed one of the hedge funds, managed by American Express Asset Management, losing $8.5 million, while the second report showed it gaining $3.2 million. They promised to look into the matter.
Additionally, bureau officials acknowledged, they incorrectly listed as a distribution of profit from one fund $204 million that actually reflected a transfer of money from one fund to another by bureau personnel.
And some venture investments in the bureau's portfolio have failed to meet even the modest expectations of funds early in their history.
When former stockbroker Sheryl Marshall and her partner Paula Groves formed a venture firm in Boston in 1999, they spoke about the great potential for profit among businesses operated by women and minorities. News accounts described their Axxon Capital Advisors LLC as the largest venture capital firm led by women and catering to women and minorities.
The Workers' Compensation Bureau signed on in early 2001.
But four years later, the bureau has written off its investment in a fund operated by the firm as worthless, listing losses at $1.5 million. Ms. Marshall didn't respond to phone messages or an e-mail.
The biggest single venture capital loss so far is $2.5 million lost in Primus Venture Partner V of Cleveland. The loss is listed at $2.5 million so far, although the bureau still hopes to recoup $9 million of an original $12.8 million invested in December, 2000, from its share of companies in the fund's portfolio.
Loyal Wilson, founder and managing partner of Primus Venture Partners, contributed $2,000 to both of Mr. Taft's successful campaigns for governor.
The contributions played no role in winning the business, said Steve Rothman, Primus finance chief.
Losses in early years
The firm has a policy of not commenting on fund performance, but "It's typical that funds show losses in the early years and show gains at the end of the day," he said.
Another big loss involved the bureau's 2001 investment in the Chancellor V fund managed by New York-based Invesco Private Capital. The bureau lists losses at $2.3 million, but still hopes to recoup $8.2 million from its share of remaining investments by the fund.
Fund officials wouldn't comment, but a news release announcing Chancellor V said it would "focus on early and expansion stage venture investments" in fields such as information technology, communications, and high-speed internet.
Another fund that has suffered losses is the Chicago-based Northcoast Fund II. The bureau says it lost $326,000 on an investment of $5.4 million. The bureau now lists the value of the fund, also known as the Midwest Economic Opportunity Fund, at $4.1 million - or 25 percent less than the original investment.
However, Ohio's State Teacher's Retirement System, which also invested in the same fund, has written off 75 percent of its investment because of poor performance.
"It's been a challenge," said Laura Ecklar, spokesman for the pension plan. Members of the fund partnership replaced the manager with a firm that specializes in floundering venture capital firms, she noted.
Potentially adding to the investment risk at the bureau, experts said, are moves by administrators - encouraged by politicians - to use the $14 billion fund to help diversify Ohio's economy.
Last year, the bureau announced it would move $31 million into seven private equity funds that have said they will loan money to new Ohio companies involved in technology-based industries, biomedical and fuel cell research, and similar advanced fields.
'Helping create jobs'
"This is a solid investment in Ohio's future," Governor Taft proclaimed in a news release touting the investment. Funds selected, he said, "are committed to helping create jobs."
But the purpose of the Workers' Compensation fund is to pay expenses of workers injured on the job, noted Mr. Brainard, of the Retirement Administrators group.
"Such an investment has to be made with the beneficiaries of the plan being the first consideration," he said. "Promoting economic development in Ohio is a worthy objective. But it has to take a back seat to those who rely on these monies."
One of the firms selected for the money, Pittsburgh-based Draper Triangle Ventures, is represented by Brian Hicks, a former top Taft aide who is now a statehouse lobbyist, according to state records.
So far, the firm has drawn $450,000 of $5 million committed by the state in October, according to figures provided by the bureau.
Draper Triangle officials were unavailable for comment.
A venture capital firm with links to Ohio University in Athens has drawn $20 million in bureau investments for four separate funds.
Lottery Director Hayes said he had heard of no instances in which the governor or members of his staff asked officials to invest in a fund for promoting Ohio companies.
But, he said, unlike in the private sector, portfolio managers at the bureau are asked to consider factors such as whether a prospective investment will advance the cause of women and minorities.
Some venture funds are clear winners. The state yielded $7.2 million from San Francisco-based Fremont Partners III in which it invested $6 million in early 2002. Among the fund's successful investments: building products maker Tapco International, sold last fall for $715 million. And the roll isn't over. The fund continues to hold interests in a number of valuable firms.
Funds typically have a specialty, ranging from financing entrepreneurs with a good idea but little track record to loans for expansion programs at established companies. Most funds invest in a range of companies, often involved in telecommunications, biomedical research, and other high-tech ventures.
While the state's venture capital portfolio includes clear winners and losers, only time will tell how some will turn out.
The bureau placed $17.4 million with Halpern, Denny & Co., Boston, in December, 2000. The Halpern Denny III fund has produced a profit of $8.8 million so far, excluding expenses, and the bureau estimates its market value at $7.9 million.
Partner David Malm concedes that one company in which the fund has invested, the New World Restaurant Group, has suffered $163 million in losses over the past five years. But he insists that the Golden, Colo., chain, parent of Einstein Brothers, has turned things around. And it represents just one of the firms in which the fund has a stake, he said.
Contact Gary Pakulski at: gpakulski@theblade.com or 419-724-6082.
posted by Kathie Bracy at 9:02 AM
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