Come On Out!

By Daniel Kadlec

If a grumpy store manager taking back damaged merchandise is your idea of a good return, you need to come out from under the mattress and take a little risk with your money. Investors are understandably cautious in an economy that is only muddling through, with war as the backdrop. Yet some of the smartest money--professional, private-equity money--is awakening from its bear-market slumber. There are intriguing early signs that private assets, crushed the past few years, will start rising soon even if publicly traded stocks do not.

Warren Buffett has been busy buying private companies, including The Pampered Chef, a kitchenware retailer, and apparel maker Garan (of Garanimals fame). That's promising. It suggests a value gap between the private and public markets because Buffett finds most common stocks still overvalued. Meanwhile, private-asset funds are a contrarian's delight: net new investment in venture-capital funds, which mainly seed technology and medical start-ups, plunged to $1.9 billion last year (the least since '81) amid investment losses that roughly tracked the public markets. Yet over three years and longer, these funds have outperformed stocks. "The tourists have all left town," quips Jesse Reyes, a manager at the research firm Thomson Venture Economics. The fair-weather crowd he is talking about piled into venture funds in the late 1990s, when tech start-ups were soaring. Now, with disillusioned investors gone, less money is competing for assets that have become more attractively priced.

Venture investments are no slam dunk, even today. Many funds have been turning away new money and even rescinding prior commitments. "There aren't that many obvious opportunities for individuals to invest in venture capital," says Jeff Gendel, head of U.S. operations for InvestorAccess, a private-equity publishing firm based in London. But that may change fairly soon. Some of the best venture-fund managers, including Benchmark Capital, Kleiner Perkins Caufield & Byers, Mayfield Fund and Sequoia Capital are rumored to be ready for new money. These are institutional managers, though individuals with $5 million to throw in (and commit for as long as 10 years) are generally welcome. Flag Ventures flagventure.com) which runs funds of venture-capital funds, will probably raise new money as well. Flag's minimum investments run $1 million to $3 million. But other funds of funds let you in for as little as $250,000. On the buyout side, the inflow of money has been fairly steady, with highly regarded institutional managers Apollo Advisers and Blackstone Group having raised money. Wealthy individuals can get access to buyout portfolios directly or through funds of funds as well, with similar minimums.

Some words of warning: private assets are risky and should not constitute more than 10% of the typical portfolio. The best venture managers make money on only 4 of 10 investments but hit enough home runs for the math to work. Unless you have an edge, stay away from private placements where you invest in a single operating company.

For the vast majority of even wealthy investors, funds of funds are the best option. One respected name on the venture side is HarbourVest Partners harbourvest.com) Landmark Partners landmark.com has a well-regarded fund on the buyout side. It's well worth the typical 1% annual fee at big financial institutions like Goldman Sachs and Merrill Lynch--where minimums are lowest--for help navigating these waters, to make sure you are diversified by region, industry and stage of company development.

Finally, those with much less to commit can look at the Firsthand Tech Innovators stock mutual fund, which hasn't done well in the bear market but invests up to 15% of assets in nonpublic equities. It has a large bet on Global Locate, a private firm that makes cell-phone chips tracked by satellite. The fund gives you just a taste of private assets, which is fine. You don't want to leave the mattress only to fall on the floor.