The venture capital industry is in a lot of pain, saddled with so much money, it can’t invest it properly. With the Internet boom over, and investors pulling back from supporting venture capital firms, we’ll see a lot of the mediocre VC firms finally die (see our list of the walking dead).

Which brings me to Oak Investment Partners.

Almost three years ago, I wrote how Oak Investment Partners had become the largest venture capital firm. Despite a very mediocre track record — it hadn’t made real money for its investors for years — the firm managed to raise $2.56 billion from investors. At the time, I wrote how perplexed I was that its investors would cough up that sort of money.

So I was also surprised to find out this week that Oak is trying to raise yet another fund, in this environment, targeted at $1.5 billion. Surprised, because the firm has continued to struggle. As of Sept. 30, the firm’s 2004 and 2001 vintage funds had produced net internal rates of return (IRR) of just 1 percent and 5 percent respectively, according to performance data posted by the Washington State Investment Board. Those rates are significantly below expected returns for such a risky sector (funds are tied up for years, and so investors want to be assured of getting higher returns than market average).

Meanwhile, a 1999 vintage Oak fund was generating a negative 4.2 percent net IRR as of Sept. 30. All of this data comes from before the downturn happened in October. Since then, of course, the chances for strong returns on its remaining portfolio companies have slimmed considerably. The WSJ reported the Oak performance data earlier this week.

But the worrying thing, in my view, is that Oak has done all this while relying in part on public money. One of Oak’s lead investors so far is the State of Washington. For three years, I’ve made multiple calls to the Washington State Investment Board, seeking comment and explanation for why it invested in Oak even though Oak has apparently lost money on the investments for Washington. I’ve never heard back. The silence is odd, given that most public institutions routinely call back reporters when they have questions. Oak also did not respond to a request for comment on this story.

While there’s a huge list of VC firms that are shriveling away, Oak is an example of a firm that continues to stay alive, raising fund after fund, even though it hasn’t performed well. Why? Well, in 1998, it did produce a fund that made good money, at a 55 percent IRR — but that fund was invested back in the run up to the Internet bubble when it was difficult not to make money. For some reason, Oak has been able to stay on the list of trusted firms for investors ever since.

Insiders tell me it’s a case of smug relationships in the limited partner community. Limited partners are those large institutions, such as state pension funds and college endowments, that place large amounts of money in VC firms. To diversify their investments, these LPs chose years ago to mandate that a certain percentage of their money be invested into VC firms. But because making such investments are difficult — you’ve got to do a lot of research to decide which VC funds to invest in — these LPs often took the easy route: They simply selected only a few VC firms to support, to avoid having to do due diligence on multiple investments. And they chose to park their money at the biggest VC firms, because these firms could absorb large amounts of cash. Here’s the catch: It’s often the smaller VC firms that have the discipline to make smarter bets, because they’re investing smaller amounts of cash more carefully. With start-ups being more capital efficient these days, it doesn’t make sense to pump a lot of cash into them.

Cleverly, Oak, along with some other venture firms such as VantagePoint and New Enterprise Associates, realized becoming a massive venture capital firm would help them raise money. Their size allowed them to absorb large checks the large pension funds wanted to give them. Yet, they retained the “VC” status, and thus were appealing to LPs, who at the same time were avoiding private equity and hedge funds because of the crowded nature of those industries. (Indeed, NEA and Oak alone accounted for 20 percent of all VC raised in 2006.) Finally, with legal mandates to invest in the VC sector, the LPS were forced to invest in some weak VC firms. There simply wasn’t enough room in the great VC firms — Sequoia, Kleiner, Benchmark and their ilk — to absorb all the LP money. The vast majority of VC firms actually lose money, and yet many of them have been supported year after year because of the crazy excess of money flowing to the sector.

Another cool thing about being a big VC firm is that its partners can draw huge salaries. Partners typically take a 2 percent management fee, from which they draw their salaries. The math gets insane: Partners take this fee every year for the duration of the fund. And venture funds usually last for 10 years, or the time it takes a firm’s partners to dispense the money, nurture the companies to growth, and then sell them or take them public. In a fund’s latter years, fees taper off to about 1 percent. You do the math: It turns out to roughly 15 percent of $2.5 billion (the size of Oak’s last fund), or $370 million in fees. That’s enough for each partner to make millions a year. Again, I haven’t been able to check any of this, because I’ve had no calls returned.

Here are a few of the investment bets Oak has made recently. They may end up making money, but each one of them looks extremely risky, if not ridiculously so:

–Oak helped plow $146 million into Babystyle, which seemed a misguided venture from the start because the baby retailer was investing in off-line stores at a time when online retailing was the place to be. Can anyone be surprised that Babystyle filed for bankruptcy last year?

–Oak led a $25 million investment into Huffington Post at a reported valuation of close to $100 million, even though Huffington Post hasn’t shown any novel way to make money. It’s largely dependent on internet advertising, like most other media companies.

–Oak led a $100 million investment into Rearden Commerce, a mobile concierge service, at a valuation at half a billion dollars, just as a mass of other free and cheap office and consumer mobile applications are hitting the iPhone and other phone platforms — all valued at a fraction of Rearden’s value.

–Oak has continued to support Visto, a messaging company, even as the company burned through hundreds of millions of dollars, and as others of its peer investors in the company, such as VantagePoint Partners, pulled back their support, fearful of its burn rate, according to our sources. Visto acquired money-losing messaging service Good last year, but we’re hearing that Visto was actually paid good money by Motorola to take Good off Motorola’s hands — because Motorola didn’t want to sustain the losses on its own books. How Visto stops those losses is another question. We also hear that Oak invested in Visto and then recapitalized Visto a few years ago before investing new money into the company (meaning it reset its value very low).

–Oak helped invest at least $130 million into eSolar, which is making large-scale solar thermal utility plants at a time when such investments are really tough to make profitable (the economic downturn has made alternative sources of energy less costly).

We’re hearing now that Oak is having a more difficult time than it expected to raise its next fund. It has pushed back its April deadline for an initial raise of its next fund to June.

Other large firms are taking steps to reduce the target sizes of their funds. New Enterprise Associates has decided to raise only $2 billion to $2.5 billion, instead of an initial $3 billion goal, the WSJ reported. However, NEA, too, is relying a lot on public investors: It has raised $15 million from the Indiana State Teachers’ Retirement Fund, $150 million from the Teacher Retirement System of Texas, and $15 million from the San Francisco Employees’ Retirement System.

Meanwhile, TA Associates wants to raise a $3.5 billion fund, and has hired an agent to help it for the first time, and lowered its carry (the percentage of profits it demands from deals before returning money to investors) to 20 percent from 25 percent. It too is relying on public money: The Massachusetts Pension Reserves Investment Management Board approved a $150 million commitment to the fund, double the amount that it pledged to the fund’s predecessor, according to the WSJ.