SIC private equity investments battered by down markets

The prolonged crash on national stock markets is taking a significant toll on the State Investment Council’s private equity investment program, pushing overall returns down by nearly 7% over the past year, according to the latest quarterly report from the SIC’s private equity advisement firm Mercer.

The losses reflect devaluation of publicly traded companies in the SIC’s venture portfolio, plus lower values for privately held companies, as well.

But record oil- and gas-related tax income continues to shore up the state’s permanent funds, which are managed by the SIC, providing significant capital to continue investing in venture funds that pump money into local startups, despite the downturn on stock markets.

“It’s tough right now in New Mexico and elsewhere,” SIC spokesman Charles Wollmann told the Journal. “The happy days of a few years ago are gone, at least for now, and that’s reflected in the numbers on program returns.”

The SIC is permitted by state statute to invest up to 11% of the value of the Severance Tax Permanent Fund into venture funds that commit to invest — or that cause others to invest — at least as much money in local companies as they receive from the SIC.

Under council policy, however, the SIC has capped its total commitments to the private equity program at 9% of the severance tax fund to retain reserves for market volatility.

“We need that wiggle room because markets go up and down,” Wollmann said.

And, despite current economic uncertainty, a lot more money has continued to flow into the severance tax fund over the past year, thanks to today’s high oil and gas prices, plus gushing production in the state’s oil patch in southeast New Mexico. That generated an unprecedented boom of $1.03 billion in new severance tax money during fiscal year 2022, which ended in June.

“That’s almost the same amount as the $1.08 billion that flowed into the severance tax fund over the last 20 years combined,” Wollmann said.

As of Oct. 31, total money in the severance tax fund stood at $6.64 billion.

Under the SIC’s 9% policy cap, that means the council could potentially commit up to about $600 million to its private equity investment program. But as of June, Mercer reported a total of only $450 million in net deployed capital under the program — representing less than 7% of the severance tax fund at that time — giving the SIC more “head room” to continue investing in venture funds, Wollmann said.

That allowed the council to approve a $100 million commitment in November for the newly formed national venture firm America’s Frontier Fund, which plans to establish “venture studios” in New Mexico to commercialize emerging technologies from the state’s national labs and research universities. And, given that the SIC committed that capital to AFF over 10 years — meaning only up to $10 million per year will actually be deployed — significant funding for the private equity program still remains available in the severance tax fund.

In recent years, the SIC’s venture investments were generating returns in line with expectations, with the key 10-year metric for rolling “internal rate of return,” or IRR, peaking at 6.8% in 2019. During the first year of the pandemic, that slowed to 4.6%, but it began rebounding in 2021, climbing back to 5.2% that year.

With the current crash on stock markets, however, the 10-year IRR plummeted to just 3.8% as of June 30, reflecting sharp drops in the value of publicly traded companies in the SIC portfolio, plus lower valuations for startups that remain in private hands, said Brian Birk, managing partner for Sun Mountain Capital, which manages a $200 million fund for direct SIC investments in local companies.

In fact, the one-year IRR for the SIC’s “co-investment fund” — which is the pool of money managed by Sun Mountain — dropped by 12% in FY 2022, dragging the overall one-year rate of return for all of SIC’s New Mexico-focused private equity investments combined down by 6.6%.

“The drop in public markets is showing up in the co-investment portfolio,” Birk told the Journal. “But it’s not just the co-investment fund — it’s across the SIC portfolio. All the funds are down, reflecting that market correction.”

Still, venture capital investments inherently operate on a long-term perspective to build value in companies over time, and the markets will come back up.

In addition, by statute, the private equity program is focused heavily on “economically targeted investments” that produce significant social benefits, allowing the SIC to accept lower returns than other investments in such things as stocks and bonds. And, over the life of the program, New Mexico has reaped significant benefits.

As of June, the program was supporting 3,300 jobs in 55 companies with a combined $137 million annualized payroll, plus $144 million in annualized expenditures on New Mexico goods and services, according to Mercer’s latest report.