Paul Kix explores how VCs made 100s of millions personally while destroying billions of dollars of working class pension money.

Even at this late date, in the early winter of another frustrating year, greed still has the ingenuity to astonish. There’s a story I think of now: of greed and its twin brothers, power and entitlement. The Occupy Wall Street movement had begun, yet New York senators Charles Schumer and Kirsten Gillinbrand stayed mum,saying nothing about the protests for weeks. And then saying only that people were frustrated and had a right to express their opinions. Such carefully worded scripts, following such long silences, proved for many New Yorkers the senators’ obeisance to their Wall Street betters, the ones who’d given them great gobs of campaign contributions over the years. It was, or should have been, a shameful moment for the politicians, self-styled populists who had, in that hour of reckoning, sided with the gilded few over the anger of the many.

And yet, the moneyed class was not pleased. They demanded more of their puppets in Washington. In mid-October, a story in The New York Times summed up the sentiment, quoting a finance-industry veteran, irate that Schumer and Gillinbrand had not actually shouted a defense of Wall Street to the swelling mobs occupying it. “[The senators] need to understand who their constituency is,” he said.

That’s what I mean by the ingenuity to astonish. With greed, there is no enough, no point at which the need for money is sated, no point at which an acquiescence is properly deferential, no end to galling behavior. We are held hostage to greed’s voracity. It perverts the American dream.

And this is the moment we find ourselves in: a very small percent—one percent—of the country is getting richer, while the rest falls behind. And while almost all of that one percent, we like to think, is making all of its money within the boundaries of the law, does that still make it right? How much money is too much money? And, even though it’s legal, is stepping over and on top of the lower classes to make more money moral? We don’t have an answer, and there might not be a right one, but these questions are the main reason why unhappy Americans are occupying every major American city.

All of that brings us to the venture capital world. For roughly 20 years now, VC funds have been making millions of dollars while destroying billions in pension funds. At first, business boomed. The VCs had more money to invest in more start ups than seemed possible, and the pensions saw outsized returns. But the busts of the last decade—Internet, housing, the economy itself—ruined the portfolios of many VC funds and, in turn, the public pensions that believed in them. This would be just another tale of capitalism’s creative destruction were it not for a few pertinent facts. The pensioners were, and still are, working- and middle-class employees of various municipal and state governments. They’re living the last vestige of the 20th century’s promise: your employer will provide for you, even in retirement. The VC funds, the people managing that blue-collar money, drew hundreds of millions of dollars in fees despite destroying billions of dollars in pension-plan assets. This means that at the very time the working class’ finances shrivel, the moneyed class’ grows bigger—partially because the working class is handing over its money.

Now, venture capital firms perform a noble act: providing capital for the entrepreneurs with big ideas. The better those ideas, the more jobs a business produces, and the more that benefits the economy. There is almost no end to the major businesses for which VC firms first provided capital: Google, Apple, Microsoft, the Home Depot, Whole Foods, eBay, Jet Blue, Starbucks, and more. VC firms create a virtuous cycle that not only adds jobs but makes life for mankind better and easier.

But it is not always such a virtuous business. Recently, it has been anything but. In fact, of all the things that personify the divide between the rich and the rest these days, perhaps nothing does it as succinctly, as cynically, as VCs and their supposed public-pension benefactors. And nowhere is this more pronounced than in Pennsylvania.


Arguably the first person to see phenomenal returns on VC investment was David F. Swensen, who for a generation has overseen Yale’s endowment fund. Swensen declined to speak with the Good Men Project, but in his book on his investing philosophy, Pioneering Portfolio Management, he explains how investing in a VC fund is a strange beast, different from any other asset class.

Successful investors in non-traditional asset classes (such as a VC fund) engage in active management, seeking to identify the highest-quality people to manage investment funds. In selecting partners, due diligence efforts center on assessing the competence and character of the individuals responsible for portfolio decisions. Developing partnerships with extraordinary people represents the single most important element of alternative investment success.

In other words, Swensen invests in VC people as much as a VC’s bottom line. This is a key point. A VC firm, at its best, creates jobs by providing the capital for an entrepreneur’s bright idea. The best VC firms create enough jobs to eventually create wealth—for the fledgling business and itself. That wealth is then distributed, in part, to the parties that gave the VC firms the money to give to the entrepreneur to start his or her business. The wealth, if it comes at all, takes years to accumulate. So Swensen’s point is that you should never really invest in the accumulation of wealth but the promise of the accumulation. And who extends that promise? A savvy general partner at a VC firm who can suss out great business ideas from middling ones. And how do you find that savvy general partner? You know basically everyone in the VC field.

All this takes time. But for someone like Swensen, it pays off. From 1978 to 2007, Yale’s investment in venture capital and the broader private equity asset class returned more than 30 percent per year, according to Pioneering Portfolio Management. Those impressive results steered other investors to venture capital. These were often people who hadn’t taken nearly the time that Swensen had but believed they could also realize his returns. This wasn’t an entirely foolish idea. Andrew Metrick, a professor of finance and management at Yale, says many people have turned to VC over the years because “It’s a place where you can outperform the market.”

Public pension fund managers are just such investors. In testimony before the U.S. Senate’s Committee on Health, Education, Labor, and Pensions this past July, David Marchick of the private equity firm the Carlyle Group, said that public pensions now account for 42 percent of all investment in venture capital and other alternative asset classes.

What do the public pensions get for that? Nothing. A 2009 study from the Kaufman Foundation found that the average return in the VC industry since 2000 had been “negative.” The National Venture Capital Association, the organ for the industry, couldn’t help but state even more gloomy facts in its most recent annual report: 2010 was the fourth-straight year of decline for industry assets, down 38 percent from their 2006 peak. The money that outside investors committed to VC totaled only $12 billion in 2010, down from $104 billion at the all-time peak in 2000. In other words, VC funds are awful investment vehicles and seemingly the only people still unaware of this are the public pension funds that account for nearly half of VC and other alternative asset class investments.

One entity epitomized this irrational behavior: Pennsylvania’s public pension fund, the State Employee Retirement System. In SERS’ annual report, investment in alternative assets like private equity and venture capital comprised a whopping 26 percent of the pension fund’s overall portfolio. And what did the state employees get for that investment? Again, nada. In fact, according to SERS’s most recent annual report, it had poured $1.1 billion more into VC funds in 2010 than it received in returns. That’s a billion-dollar bath. SERS did not return the Good Men Project’s requests for comment.

Overall, the pension fund overall carried an 11 percent return last year, but its bizarre reliance on alternative assets like venture capital caused one nationwide study to dub Pennsylvania’s pension fund “the riskiest in the nation.” The fund managers at first attempted to defend their actions, and then late last year cut their exposure to alternative assets from 26 percent to somewhere around 15 percent. And why? Well, another 2010 study says that Pennsylvania currently has $20 billion in unfunded pension liabilities, an amount that is expected to grow to $55 billion in the next few years. Cutting exposure to poorly performing investments seems to be a good idea.


Every state pension fund is hard up for cash:

Nationwide, states have a combined $689.5 billion in unfunded pension liabilities and $418 billion in government retiree health care obligations, according to data collected earlier this year by The Associated Press.

The problem is bad enough that in Pennsylvania, politicians talk about deliberately underfunding the pension obligations, because a state’s contribution to a fund often comes at the expense of other requirements, like public safety or education. The same is playing out right now in Rhode Island. In this brilliant profile, Gina Raimondo, the general treasurer of the Ocean State, openly debates the unions who guard their pensions as sacrosanct:

That evening in September, Ms. Raimondo walked into the Cranston Portuguese Club to face yet another angry audience. People like Paul L. Valletta Jr., the head of Local 1363 of the firefighters union.

“I want to get the biggest travesty out of the way here,” Mr. Valletta boomed from the back of the hall. “You’re going after the retirees! In this economic time, how could you possibly take a pension away?”

Someone else in the audience said Rhode Island was reneging on a moral obligation.

Ms. Raimondo, 40, stood her ground. Rhode Island, she said, had a choice: it could pay for schoolbooks, roadwork, care for the elderly and so on, or it could keep every promise to its retirees.

“’I would ask you, is it morally right to do nothing, and not provide services to the state’s most vulnerable citizens?” she asked the crowd. “Yes, sir, I think this is moral.”

Knowing that—that states are broke—the question shifts to “What obligation do VC funds have to operate morally for their role in public pensions?” A quick lesson for the uninitiated: a VC fund draws a two- to two-and-a-half-percent management fee every year for overseeing money from investors like pension funds. So if you manage a $1 billion VC fund, you’re drawing $20 million every year just to manage the fund, regardless of how well that fund performs. And when it does perform well, a VC fund routinely takes home 20 percent of that cut. So either way a VC fund brings in dough. As one prominent venture capitalist in New England told me, “It’s a ‘heads, I win; tails you lose’ game.”

That game for VCs is often played poorly—and often with poor people’s money. To return to Pennsylvania’s pension fund’s annual report: of the 120 VC funds Pennsylvania invested in, 105 failed last year to return a profit. (It should be noted that most VC funds take at least 10 years to mature, so that does not mean that 105 funds will always fail to return a profit for the pension plan.)

But the numbers themselves are damning. For instance, of the $104 million Pennsylvania gave JP Morgan for a VC fund called JP Morgan Venture Capital Investors, only $38 million was returned, meaning JP Morgan lost $66 million for Pennsylvania. And that’s just one fund. In just one year. There’s another JP Morgan fund that lost $69 million for Pennsylvania last year, and another that lost $54 million.

Just look at  how many dollars in fees a VC fund is keeping versus how much capital it has destroyed for its investors, not just in Pennsylvania but anywhere. You can use the data from Pennsylvania’s public-pension fund to do this. So let’s look at another VC firm, Polaris. The four Polaris funds that Pennsylvania has invested in have a total value of $2.545 billion, according to this estimate of Polaris’ total value. The first fund, Polaris Ventures Partners II, created in 1998, has returned 99 percent of capital to its investors, whether they be in Pennsylvania’s public-pension fund or elsewhere. The second fund Polaris Ventures Partner III, established in 2000, has returned 50 percent of capital to investors. The third, Polaris Venture Partners IV, launched in 2002, has returned 25 percent of capital to investors. The fourth, Polaris Ventures Partner V, created in 2006, has returned zero percent of capital to investors. So, in total, Polaris’ four funds have arguably lost $1.975 billion for investors. And yet Polaris fund managers are taking home at least $50 million in annual management fees.

Polaris Director of Communications John Lacey did not dispute the legacy of hundreds of millions in fees taken by a small handful of individuals.  He did, however, dispute whether the $2 billion in capital that has yet to be return is lost for good.  “This capital is invested in over 100 companies that are growing and will likely generate strong returns for their funds, which mature over 10 years.”  That might in theory be true, but in talking to others industry experts the return of a meaningful segment of that money to the Pennsylvania pension fund or other similar investors seems highly unlikely.

Some of the Polaris funds may still create wealth. Again, it normally takes 10 years or more for a fund to mature, so Polaris Ventures Partner IV and V in particular could still return better than the 25 percent and zero percent they’ve done, respectively, thus far. Also—and this bears repeating—I chose Polaris at random. Peruse through Pennsylvania’s annual report, beginning on page 67, and there 99 funds performing as poorly as Polaris’.  But the larger point about Polaris, and the sector in general remains:  these funds have been taking huge management fees directly from pension funds that are now bankrupt while thus far showing massive negative returns.


So, the question: Is this moral? Is it moral to be Polaris, or JP Morgan, or any of the other 103 VC funds that sucked cash out of a pension fund whose beneficiaries are working class, and for millions upon millions in management fees? Another prominent VCer who did not want to be named for fear of retribution says, “I think it’s naive to consider the morality of a VC fund.” He says its goal is a noble one: to make all people richer. “I think the morality comes into play when you raised that first fund and you saw that it didn’t work, what did you do with subsequent funds. Did you change your strategy? Or did you say, ‘I don’t care’ and continue to take the [management fee] money.”

John Adler, the director of private equity for the SEIU’s Capital Stewardship Program, says his union members in Pennsylvania and elsewhere say the morality of the issue cuts both ways. He wants his union members to see strong gains in their retirement portfolios, and the only way to do that is through investment strategies that are less than 100-percent safe. But on the other hand, the SEIU’s members “are angry about the class disparities they see. The rich are doing just fine, thank you very much.” And money managers epitomize that gilded stereotype.

There is nothing illegal about taking a large management fee. There is nothing illegal about mismanaging money, even accounts that, if they default, as pension funds could, taxpayers would have to pick up. And that’s the frustration for Adler and many people throughout the country, certainly the 99-percenters of Occupy Wall Street, whose goals remain disparate because the problems seem so vast: VC funds are one asset class of an industry that takes home more and more money, a group that’s seen their income triple since 1980, while median household income for middle class families actually decreased for the first time ever.

With VC funds, the rich are, quite literally, getting rich off the poor. The money has been handed over, and then destroyed by VC funds. And part of the reason pension plans are so massively underfunded is because of the people who’ve mismanaged the funds’ money. Yet, there is no reprimand for that mismanagement—just more management fees.

It is an abhorrent system, and one that even VC firms recognize. Some veterans—people who backed a fledgling Apple, and other companies that went on to change not only the business world but the world itself—now say the industry would be better off shedding half the firms in operation. But lackluster returns will also mean wizened investors. This has already happened in Pennsylvania, cutting exposure to private equity assets like VC funds to around 15 percent. As one VC expert told me, “The hope is that everybody wakes up to the bad players in our sector. And you can begin to see that happening.”

—Photo dingler1109/Flickr

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About Paul Kix

Paul Kix is a general editor at ESPN the Magazine.


  1. This is an excellent review of the situation we face, where Wall Street is destroying the working class and demanding that their Washington D.C. servitors obey their every whim.

    But… why is it on this site? How is this a men’s issue?

  2. Amazing…Excellent piece.

  3. Mr. Kix:

  4. Over and over again, we reinvent feudalism.

  5. Tom Matlack says:

    PA invested in over 100 top tier VCs. If you go look at the report 99% of them were atrocious while taking huge fees. The article makes the point again and again that venture capital done right (like Yale and Spark) is a winner for everyone. But its completely f’d up that pensions plans, supposedly money for working people, have gotten raped by guys who took huge fees. And that is a pretty categorical inditement.

    The common industry response is that pension plans were late to the party and weren’t unable to get capital into the “good” VCs that make money. But the data that I have seen is that the statement about the “top quartile” just isn’t true. To me that is a rationalization which doesn’t hold water under closer inspection (not too far away from the Polaris guys saying that they haven’t “lost” their LPs any money because their portfolio is filled with the next FB…which is just a rationalization to keep taking that massive fee while the Titanic sinks).

    A lot of the funds PA invested in were in the top quartile at the time. If you look at the list its a who’s who. I agree that there are a very small number of firms that have made money for investors over long periods of time. But that is like a dozen or less. The idea that the vast majority of VC funds have not even been able to return capital to justify fees just screams inequity to me. And that is from a guy who ran a small VC firm that took money in 2000 and had to hump it all the way home to eek out a decent return.

    It would be different if the VC industry as a whole went to a much more performance based scheme where bare minimum expenses were paid for out of fees and everything else was out of a promote so that managers made money alongside investors, not before or in spite of losing them huge sums.

    • Why did so many LPs continue believing in the “Yale Model” for so long, even in the face of crappy returns?

      Also, what about the LPs who agreed to contractual language that incentivizes GPs in a fund to sit on their capital until it rots away, instead of having a performance review and potential partial redemption every few years, or at least at some point in a funds 10 year life cycle?

  6. Author: “With greed, there is no enough […]
    It perverts the American dream.”

    The American dream IS based on greed.
    It’s based on the very same “never enough”.

    While I basically agree on this well-done article and its point, I can’t help but pointing out that “greed” is deep ingrained in the whole USA (yes, living in Europe helps me looking at things from outside :) ).
    Starting on the slaughtering of native Americans (yours is a country born from genocide, no less), the American way has always been greedy (the USA consumes more energy than the rest of the world, and so on…).

    So, it seems to me all these scandals and greedy excesses you’re talking about, are just the tip of the iceberg; they are the extremes of your very own system.

    That’s not to say we in Europe are “saints” or innocent…
    I just mean that greed – “never enough” – is at the basis of your culture, it’s not happening “out of nowhere”.
    And I acknowledge that many people (like here at the GMP) are thinking their way out of this culture…
    but – IMHO – you better become aware how deeply greed is part of your roots.

  7. There’s plenty to complain about going on in the financial industry but the tone of this piece frankly baffles me. If VCs are fleecing SERS, they are not fleecing the janitors at Penn State. The state employees union hires its own money managers, with MBAs and stuff, to manage the pension fund and THEY decide where to invest the money. Why no hate for the state’s own money managers who continue to invest in the VC sector despite horrible returns for a decade? Without them rewarding the lousy VCs, the industry WOULD shake out and while returns might never return to the glory days of 20 years ago, they still would improve.

    VC partners DO make hefty salaries but there is no reason to think they are not subject to the same performance pressures as any other high-paid person and unlike corporate CEOs who sit on interlocking boards and give each other raises, VCs actually do have to answer to the marketplace based on their performance every couple of years when they try to raise more money to invest. Also they are generally required to invest substantial amounts of their own money alongside the passive investors, so they ARE on a performance-based scheme. Remember, these are very greedy people and they are not in this business to make the mere $500K or so they get in salary – they want that 20% “carried interest” also.

  8. “Is this moral?” Absolutely! These pension funds are run by PROFESSIONAL money managers. They knew the costs and the risks before they invested. The author has it backwards when he suggests that the pensions are underfunded because they invested their money with VCs. They are underfunded because the employers and employees have not contributed enough. This forces their managers into risky investments in order to make up the difference.

  9. I am completely unsympathetic to this cause for three reasons:

    1) The case made against VCs here ranges from the merely misleading (Comparing a 30 year return in the case of Yale to a 10 year return in the case of Pension Funds), to the downright wrong (from the author’s own link, the 1 and 5 year returns to the Pennsylvania SERS are positive, while the 3 and 10 year returns are negative, meaning that VC actually makes a lot of money when there isn’t a massive recession, last I checked no one was claiming VC was recession proof, and yet the author faults them for failing to be…)

    2) If state pension funds make poor investments, the managers of those funds must, at a minimum, share the blame. It is ridiculous to make pretend that the fund managers are not responsible for the investments they make. If you buy a car without test driving it, don’t get mad at the car when it doesn’t suit your needs.

    3) As someone in his 20s, it strikes me that the true source of immorality in this story are the state employee unions. Decades before I was born, the unions decided to use the threat of strike action to extort exhorbitant benefits from the taxpayers. Worse, they decided that the benefits they wanted would be *for life* meaning that they were essentally stealing money from my pocket before I was born. It is impossible for me to sympathize with someone in their 50s that is demanding I pay for a retirement pension of indefinite period, especially when said pension was agreed to by a generation that was not mine, in an agreement I never got to vote on, and even then only under the duress of a state-employee strike. As far as I’m concerned, the destruction of the pension funds is justice: you tried to steal from me before I was born, and now you’re finding out that you didn’t succeed. I do not feel sorry for you.

  10. Paul Kix clearly knows little or nothing about the investment world in general and the Venture Capital world specifically.

    If the VC world have not delivered Apple and a long list of other computer, software, pharmaceutical winners, as well as winners from other industries, then it wouldn’t exist. The level of risk in VC investments is well known and well understood.

    As for pension funds, well, they have guidelines for risks they can take. They stick to their limits. But based on the way the article was written, it appears to suggest that 42% of pension assets are invested in VC investments. Of course that’s utter silliness. VC investments account for single-digit amounts of pension fund assets.

    Meanwhile,, the Dow Jones Average is now 12,000. Its all-time historical high was 14,000. Pension funds were not overly punished in the years between the Dow peak and today.

    Moreover, you should look into pension accounting and learn the reasons for Unfunded Liabilities.

  11. J P McMahon says:

    “And this is the moment we find ourselves in: a very small percent—one percent—of the country is getting richer, while the rest falls behind.” Falls behind? Falls behind of what? Any argument that the lives of the average people in this country are not materially better than at any point in the past is doomed to failure. Average life span? Goes up every year. Average number of calories consumed? Goes up every year, to our detriment. Number of college degrees conferred? Goes up every year. Poverty index? The amount of income made to be considered in poverty goes up every year. Consumer goods and services available to average people that were only a fantasy 25 years ago? There are too many for me to list here, and that list keeps growing every year. Christ, look at the crowds at any beach, casino, or other place of entertainment, and the traffic jams. People are hardly being forced to chop cotton, or work in a sweat shop. So the whole argument is that some people have a lot more than others, not that those that have less are somehow living worse off than they did before. Tools help people to increase their productivity, and modern technologies (most created with VC) have vastly helped people in the financial sector to be a lot more productive. Business people are in business to make money. The more they make, the more successful they are. Has the author just learned this? Calling someone who is in business “greedy” is like calling someone in the NBA “tall”. I fail to see a moral distinction between greed and envy.


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