The fund managers for Ivy League endowments somehow managed to flop in this market
The reduced volatility of private equity comes with a cost.
Over the weekend, the Financial Times published an interesting piece on Ivy League endowment returns so far this year. Per the FT, through the 12-month period ending June 2024, six of the eight Ivies underperformed the higher-education average. And, in 2023, all of the Ivies returned below the higher-education average of 6.8%. For context, the S&P 500 was up 24% in 2023.
One reason for the Ivy woes? An overallocation to private equity. From the Financial Times:
“Top endowments have long used aggressive exposure to private investments in pursuit of excess returns they believe are out of reach through public markets. Now, as those investments have yet to pay off, some large endowments like Princeton have issued bonds to meet funding needs, according to the New Jersey Educational Facilities Authority…
Most Ivy League endowments had earmarked more than 30%, and in the case of Yale and Princeton at least 40%, of their assets to PE and VC by the first half of the year, according to Old Well Labs, a financial data provider.”
One reason that Ivy League schools have increasingly turned to private equity is that it offers lower volatility than public markets. Minimizing volatility is important for these endowments because they are responsible for funding a portion of their schools’ operating budgets each year. For example, in fiscal year 2024, Harvard’s endowment distributed $2.4 billion to cover 37% of the school’s operating budget. While the Ivies have underperformed over the last couple of years, that reduced volatility paid off in one year. In 2022, the S&P 500 was down 18.1%, but Harvard’s endowment only fell by 1.8%, and Yale’s endowment actually increased by 0.8%. When you have to make multibillion-dollar distributions each year, minimizing risk is far more important than maximizing returns, and private equity offers lower volatility.
However, the reduced volatility of private equity comes at a cost: illiquidity. There was an interesting phenomenon in 2022, where public markets sold off sharply but private-market valuations were less affected. While some private companies may have been more resilient, firms also sold far less of their portfolio companies in 2022 than the year before: exit volume was down 57% year over year through Q3 2022.
If a bucket of publicly traded fintech SaaS companies fell by 50%, you would think that, by correlation, the value of similar-sized privately held fintech SaaS companies would decline by 50%, too. But if the PE firms that own these similarly-sized fintech SaaS companies can say, “Our valuations have only declined by 15%,” and continue to hold those portfolio companies, then boom, outperformance. Of course, there probably aren’t any willing buyers at this valuation (hence the 57% decline in exit volume), but, at least on their own books, private-equity portfolios looked resilient.
However, because endowments have to distribute cash to help fund their universities’ budgets, valuations and “returns” don’t mean much if they don’t eventually yield exits that return cash, and distributions have been slow over the last three years. The result: Ivy League schools have had to issue nearly $3 billion in municipal debt so far through October 2024, up 650% from the year before, to help meet these cash needs.
Paper returns look good, but at the end of the day, an investment is only worth what someone else will pay for it. If you say your company is worth $1 billion, but no one else is willing to pay more than $700 million to acquire it, is it really worth $1 billion? Probably not, as endowments have figured out.
