Jessica Mathews, writing for the Fortune Term Sheet Newsletter, alerted us to the change just made by CalSTRS, one of the largest pension funds in the world. In "CalSTRS taps Sapphire Partners, with an office in Menlo Park, to manage its new emerging manager VC investments," we learned that CalSTRS has hired Sapphire Partners to manage its five emerging manager-focused funds, with $1.4 billion in assets. Sapphire will bring sole focus to CalSTRS' growing investment into emerging managers, a distinct asset class (of which we are a member). We are delighted to hear this news and applaud the decision and its rationale.

Though it may be obvious, when some of the largest and most successful investors in the world decide to redouble their focus on a certain asset class, there's usually a good reason for it. In this case, there are highly compelling economics—in the form of superior returns—coming from emerging managers. New managers, while they don't have an investment "track record" by definition, are often launching new funds because of some kind of significant shifts in markets for which they don't see viable options or for which they have a competitive advantage or discernable investment edge.

The challenge for LPs is being able to select which emerging teams to invest in, since there is a good distribution between top emerging managers and run-of-the-mill emerging managers, who have very little differentiation or specialization.

According to Beezer Clarkson, who leads Sapphire's fund investing business, a key piece for them is simply having an emerging GP being able to articulate why an entrepreneur would pick them as an investor to join a round and why an LP should be interested in their thesis as an investor.  

According to David Zhou, in an interview published by Adam Metz of D.F.A. on his Substack, emerging managers regularly outperform. "My suspicion is that emerging managers have that chip on their shoulder. They have something to prove to the world. They’ll hustle for deals. When founders pick who they want on the cap table, they want people who care about them and their space."

We tend to agree. Nucleation remains the only venture fund focused on nuclear, especially the fission kind. And when you are the only fund  focusing on the specific tech sector (namely advanced nuclear in our case) that a venture is in and you bring decades of experience, deep connections, plus expansive knowledge of the in's, out's, pro's, con's, competition, suppliers and regulators, history and a vision for what will be and a commitment to making it reality, the answer to these questions becomes apparent.  

Nucleation Capital has completed eight quarters of investing, has made ten very promising investments and is starting its third year of operations. If you would like to receive a copy of our newly released Two Year Report, please send your request to us using this link.

Sources

1. TERM SHEET: CalSTRS taps Sapphire Partners to manage its new emerging manager VC investments

By Jessica Mathews
September, 13, 2023

When the California State Teachers’ Retirement System makes any kind of change to its portfolio, people pay attention.

With more than $321 billion in assets under management, CalSTRS is one of America’s largest public pension plans and therefore one of the world’s most important limited partners, with approximately $50 billion in capital strewn across private funds and, naturally, some of the world’s most influential private companies.

CalSTRS’ core private equity portfolio is littered with all the usual suspects: TPG, New Enterprise Associates, Thoma Bravo, Blackstone, and, as of 2021, Tiger Global, to name a few. But 21 years ago, the pension plan also began setting aside a small portion of capital to back first-time fund managers. It has hired out that responsibility to three third-party partners over the years: HarbourVest, Muller & Monroe, and Invesco. 

Now, CalSTRS says that one of those partners—Invesco—is getting out of this line of business, so it is bringing on Sapphire Partners, the $3.6 billion LP arm of enterprise software-focused VC Sapphire Ventures, to manage five funds and $1.4 billion in assets focused on emerging managers. With the change, CalSTRS will, for the first time, have a fund class solely focused on emerging venture capital investors. (Invesco declined to comment for this story.)

“Standardizing one group to focus on venture—because it’s so specialized from an emerging manager standpoint—made a lot of sense for us,” Rob Ross, a private equity portfolio manager at CalSTRS, told Term Sheet in an interview. He added: “We just haven’t been as specialized as we should be, given the nuances of venture capital.” Ross pointed out that, while Invesco did make investments in emerging VC, PE, and growth investor managers over their 18 years working together, this will be the first time emerging VC managers will be singled out. 

Beezer Clarkson, who leads Sapphire’s fund investing business, says that Sapphire will invest CalSTRS’ capital exactly the same way it deploys its own. Sapphire Partners backs VCs raising one of their first three funds, targeting a 3x net return for Series A funds and a 5x net return for seed funds. While Sapphire will look at both specialists and generalists, Clarkson says it’s important that a GP can articulate why an entrepreneur would pick them as an investor, and why she should be interested as an LP. 

“I think the authenticity of that answer is the differentiator,” Clarkson says.

CalSTRS is currently investing out of its fifth fund, a $250 million fund from 2021, and Ross estimated there is approximately $80 million from that fund left to deploy. (CalSTRS filed with the SEC for a sixth fund vehicle in order to shift management responsibilities to Sapphire, though Ross clarifies this is not a new fund and CalSTRS has not set aside any additional capital at this time.)

The change at the pension fund will likely be a welcome one for first-time managers, as fundraising has been pretty dire for those just getting their start. As I wrote about last month, emerging managers are on track to raise less than they have in a decade, based on data from the first four months of the year.

Part of that has to do with risk. Emerging managers, by definition, have fewer than three funds, meaning they don’t have much of a track record to show investors. “Only about 17% of funds make it to fund four,” Clarkson says, citing data from PitchBook. Not to mention, the current market uncertainty has made price discovery more difficult, and LPs are being choosier across all their GPs.

“I think all LPs are being more selective than they had been in the past,” Ross says.

At the same time, a high-risk bet on a first-timer can turn into an enormous return. Cambridge Associates reported in 2019 that 72% of the venture industry’s highest-performing funds were run by emerging managers. (This is the most recent metric. Cambridge Associates didn’t respond to my request for updated figures.)   

“There’s no guarantee it’s going to work out well. And because there are so many emerging managers every year, the challenge of picking the ones that will continue is extraordinarily hard—and that’s probably the nugget of why most LPs don’t do this,” Clarkson says. 

For CalSTRS, returns for this class of funds have been strong so far. Here’s a look (I didn’t include the 2021 fund because it didn’t have a long enough track record to judge it fairly):

As it’s become more and more competitive for LPs to get exposure to top-performing funds, it makes sense for large-scale limited partners to be building relationships with promising investors earlier on. And there’s nothing preventing a pension plan or institutional LP from outsourcing most of the work. Just earlier this year, one of California’s other major pension plans, CalPERS, had said it was now working with TPG and GCM Grosvenor to deploy $1 billion into emerging manager funds. 

2. SAPPHIRE Press Release: CalSTRS and Sapphire Partners Join Forces to Invest in New and Next Generation VC Managers

Sapphire Partners will assume management of the CalSTRS New and Next Generation Manager Funds, which includes managing available capital to make new investments into emerging managers focused on early-stage venture capital

WEST SACRAMENTO and MENLO PARK, September 13, 2023 / PRNewswire: The California State Teachers’ Retirement System (CalSTRS), the world’s largest educator-only pension fund with more than $320 billion in assets, and Sapphire Partners, the fund investing strategy of Sapphire, a specialized technology investment firm with over $11 billion in assets under management,⁽¹⁾ today announced a partnership to invest in emerging managers focused on early-stage venture capital. As a part of this partnership, Sapphire Partners will assume investment management responsibilities of five CalSTRS “New and Next Generation Manager Funds” existing funds, representing approximately $1.4 billion in assets under management.⁽²⁾ Sapphire Partners will also have capital available to continue making commitments to new and emerging venture capital managers.

“Emerging managers are critical to the venture ecosystem and an LP’s portfolio, and both CalSTRS and Sapphire Partners have long histories of supporting them on their journey,” said Beezer Clarkson, Partner, Sapphire Partners. “Sapphire believes we are well positioned to identify the next class of rising talent early and help them grow and scale their businesses.”

The announcement comes amid one of the most challenging fundraising environments in recent years, with 91% of emerging managers finding fundraising “difficult or very difficult” in 2023. With many LPs constrained on allocations, Sapphire Partners is excited to be an active and supportive partner for emerging managers seeking to fundraise in this environment and has invested in emerging managers since the strategy’s inception nearly twelve years ago.

“One of CalSTRS’ primary goals since the program’s inception in 2005 is to partner with diverse GPs that represent the demographics of California, and we know greater diversity is a natural byproduct of focusing on small emerging managers,” said Christopher J. Ailman, CalSTRS’ Chief Investment Officer. “This partnership with Sapphire aligns with our long history of finding diverse investment managers. We look forward to partnering with Sapphire on this important mandate.”⁽³⁾ 

Sapphire Partners has been an active Limited Partner since 2012, investing in early-stage venture capital (Seed to Series A) funds within the US, Europe and Israel, with, more recently, a focus on identifying managers Sapphire believes may become the “New Elite” in early-stage VC.

Managers may benefit from Sapphire’s industry insights, its experience investing in emerging managers, and its efforts to demystify the “LP Perspective” through OpenLP, a Sapphire-led resource for the VC community. In addition, the broader Sapphire technology investing platform, featuring a multibillion-dollar direct VC investing strategy, provides managers with market and industry insights from the investment and Portfolio Growth teams and a scaled firmwide infrastructure to tap into where relevant.

This partnership will allow Sapphire to expand its ability to support emerging managers while continuing to focus on established managers through its existing investment platform. Of note, approximately 60% of Sapphire Partners’ relationships began at the emerging manager stage.⁽⁴⁾ Since its inception, Sapphire and the New and Next Generation Manager platform have partnered with approximately 300 funds over their combined history. Today, approximately 70% of Sapphire Partners’ portfolio of existing managers have checkwriters from diverse backgrounds.⁽⁵⁾ 

About Sapphire Partners

Sapphire Partners has been investing in early-stage venture capital funds since 2012 and seeks to identify and support the “New Elite” managers across the US, Europe and Israel who are uniquely suited to invest in the next generation of technology category leaders. Through its underlying managers, Sapphire Partners has indirectly invested in over 3,200⁽⁶⁾ companies since inception. Sapphire Partners looks to partner with managers across their journey as a GP and is focused on adding value beyond its capital commitments through value-add services, industry insights, and its efforts to demystify the ‘LP Perspective’ through the OpenLP initiative. Sapphire Partners is part of Sapphire, a specialized technology investment firm with approximately $11 billion in assets under management across three distinct strategies and with team members across Austin, Menlo Park, San Francisco and London. To learn more, visit the Sapphire Partners website.

About CalSTRS

CalSTRS provides a secure retirement to more than 1 million members and beneficiaries whose CalSTRS-covered service is not eligible for Social Security participation. On average, members who retired in 2021–22 had 25 years of service and a monthly benefit of $4,809. Established in 1913, CalSTRS is the largest educator-only pension fund in the world with $321.3 billion in assets under management as of July 31, 2023. CalSTRS demonstrates its strong commitment to long-term corporate sustainability principles in its annual Sustainability Report.