Venture capital firm Oak Investment Partners has raised the largest venture fund ever, despite a decidedly mediocre track record in recent years.

At $2.56 billion, Oak’s twelfth fund is just the latest example of a venture capital firm raising a whopping fund despite recent poor performance. News of the fund was reported by VentureWire this morning (subscription required).

Oak in recent years has moved more toward later-stage investments and some would dispute whether it should really be called a venture firm. The firm, which has offices both on the East Coast and in Palo Alto, and has invested in everything from Compaq to Inktomi to numerous Silicon Valley start-ups, has also done spin-outs and investments in public companies.

That investors are still pouring record amounts of money into a firm that has changed so, and where its super-sized strategy remains unproven, is a little perplexing. Oak did really well with its smaller funds in past decades (sized at $101 million in 1988, for example), bringing home solid returns. But it has moved to raise ever larger funds ($1 billion in 1999, and then the blitz-quick $1.6 billion in 2000), and hasn’t done very well. Sure, those funds were invested during the tough years of 2001 through 2003, but then the firm had marketed itself as especially adept in “down markets”.

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Take, for example, the returns Oak has produced for the state of Washington, an investor in the firm’s last four funds. For the fund it raised in 1998, Oak produced a really good $16 million in profit for the state meaning it returned that much in addition to the $20 million it got from Washington in the first place. But since then, the firm raised larger funds and its performance for Washington has plummeted. Oak’s 1999 fund has lost $30 million in value on the $57 million Washington has invested in it. That is twice the gain the firm made back in 1988, and so Washington state is deep in the hole.

For its 2000 fund, Oak is about break-even so far. We are now in 2006, and so both of the 1999 and 2000 funds technically have some life left in them yet. Funds have a life-time of ten years. But their directions are usually pretty well set after five years, and these 1999 and 2000 funds don’t look that great. Even while Oak manages the struggling investments in those ’99 and 2000 portfolios, the firm in 2004 went back to the trough to raise an even bigger fund to start investing in more fresh companies. It is way too early too tell how that fund will do. Finally, now, just two years later, Oak has raised another record sized fund!

So, eight years later, after only losses with Oak so far, Washington State Investment Board is still investing.

Why? We called the SIB this morning, and were told Joe Deere, the executive director who usually comments on these matters, is out of town. But the public affairs person said they try to get back to us with more info shortly.

We’ve written before about VC firms raising funds despite mediocre past performance. Mostly, big institutional investors (like Washington state) are desperate to invest large amount of dollars into firms because they are trying to diversify, and consider venture capital a good place to do it. Indeed, the VentureWire story suggests investors pressured Oak to raise $2.56 billion, instead of Oak’s planned $2.25 billion. But they’re basing their decisions on past performance. There is much more money circling the venture industry now, and many more firms — and so the market is not as cozy and profits no longer as guaranteed as they were in the 1980s when Oak made its name. The profit outlook doesn’t look that good, and yet these big institutions are forgiving firms like Oak. We find this curious behavior on the part of investors, but perhaps rational at the same time: It is difficult to trust new, younger venture firms. Institutions turn to an older team’s past record, even if they have to go all the way back in that team’s history to get a decent performance (though even then, the team has changed quite a bit). And the hope is that somehow Oak will pull profits from its its recent huge funds now that we are back in the “good times.” It says something about this model of venture capital. As the VSP story also suggests, relationships matter!

We’d like to hear from the VCs among our readers. Even if you use an alias, help us understand if we’ve missed something here. Why is Oak such a compelling investment that people are “flocking” to invest, as the VentureWire article says?