Special Report on Venture Capital: Making the case for a new class: Returns on unquoted equity may outstrip the quoted market. Alison Eadie takes a long view

NEW FUNDS have been hard to raise during the recession and searching questions about track records and past performance have been asked. Institutional disenchantment with unquoted equity investment has made the lot of venture capitalists a tougher one.

The British Venture Capital Association has recognised that institutional investors need to be convinced of the merits of unquoted equity, paricularly when their quoted and far more liquid equity investments are booming.

Last year the BVCA set up a committee to make the case for venture capital as a separate asset class. It produced a paper targeted at consulting actuaries and investment performance measurers.

Jeremy Dawson, managing director of Rothschild Ventures and chairman of the Asset Allocation Committee, said evidence from the US suggested that fund managers who have invested in unquoted equity have a better and smoother performance over the years than those who have shunned it.

The UK venture industry is not yet mature enough to produce hard evidence. Mr Dawson added, however, that the quoted sector was being marked up on static earnings and was running ahead of the recovery.

Venture capital returns come when the economy is booming or has boomed. In a time of low growth and low inflation other asset categories need to be considered, he added.

The BVCA's Investment Performance and Valuation Committee, chaired by Iain Tulloch of Murray Johnstone, is collecting data on more than 1,000 investments made in the UK since 1980 - both realised and unrealised. Underpinned by the BVCA's revised valuation guidelines, the pilot project hopes to show that in the long run venture capital returns outstrip the quoted market.

Mr Tulloch says: 'We must produce more information if we want to be considered as an asset class.' He added that standardising performance was a complex task because of the range of UK investment vehicles.

The European Venture Capital Association last month launched its performance measurement principles. Willem Nagtglas Versteeg, of ABN AMRO and chairman of EVCA's investor relations committee, said: 'The launch of the performance measurement principles marks the next step in our efforts to lay the foundations for better communication between venture capital managers and their investors which is of paramount importance for the long term viability of our industry.' EVCA hopes for Europe-wide adoption of its principles.

Much institutional criticism in the past has been directed at the structure of funds and the size of fees. Carol Ames, in charge of unquoted investment at Eagle Star Investment Managers, says fees have been coming down over the past year and more innovative structures have been developed to take account of institutional reluctance to be locked in for 10 years.

Initiatives from some venture managers have tried to overcome the inflexibility of venture investment. Barons mead's Direct Equity Programme allows investors to withdraw at any time and to participate only in deals meeting their specified criteria.

Two institutions have so far signed up - Guardian Royal Exchange and the Merseyside Superannuation Fund - and Baronsmead expects more by the end of this year.

Legal & General Ventures has come up with a plan for one-year rolling funds requiring renewed commitment each year. As well as participating in an equity fund, investors can join an underwriting pool and either take on additional chunks of syndicated deals or simply earn underwriting fees. Deals not wholly taken up by the pool will be syndicated into the venture capital market at large.

A management fee of only 1 per cent is being charged and all profits are being distributed to the partners in the fund. L & G is in a different cost position to independent venture managers as its parent insurance company is sponsoring a large proportion - pounds 100m split equally between the equity and underwriting funds this year.

Investments made before 1987 have performed well and those made from 1990 could turn out even better. But the highly priced, highly leveraged deals of the late 1980s, when too much money was thrown at the sector, have still to work themselves out of the system.

(Photograph omitted)