A recent headline in the Dartmouth student newspaper reads, “Dartmouth’s endowment posts 46.5% year-over-year returns, prompting additional spending on students”. That seems like really great investing performance. But the sub-headline dismisses it as less-than-stellar, by comparison: “The endowment outpaced the stock market, but fell short when compared to other elite universities that have announced their endowment returns.” After all, fellow Ivy League university Brown notched a 50% return for fiscal 2021, which in turn was surpassed by Duke University at 55.9% and Washington University in St. Louis at 65%. The Harvard endowment fund managers are a bit on the defensive for gaining “only” 34% on the year.
The stock market has done well in the past year, but nothing like these results. What is the secret sauce here? Well, it starts with having money already, lots of it. That enables the endowment managers to participate in more esoteric investments. This is the land of “alternative investments”:
Conventional categories include stocks, bonds, and cash. Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.
It takes really big bucks to buy into some of these ventures, and it also takes a large professional endowment fund staff to choose and monitor these sophisticated vehicles. Inside Higher Ed’s Emma Whitford notes:
Endowments valued at more than $1 billion, of which there are relatively few, are more likely to invest in alternative asset classes like venture capital and private equity, recent data from the National Association of College and University Business Officers showed.
“Where you’re going to see higher performance are the institutions with endowments over a billion,” Good said. “If you look at the distribution of where they’re invested, they have a lot more in alternative investments — in private equity, venture capital. And those asset classes did really well. Those classes outperformed the equity market.”
…Most endowments worth $500 million or less invested a large share of their money in domestic stocks and bonds in fiscal 2020, NACUBO data showed. This is partially because alternative investments have a high start-up threshold that most institutions can’t meet, according to Good.
“You have to have a pretty big endowment to be able to invest in that type of asset class,” he said. “If you have a $50 million endowment, you just don’t have enough cash to be able to buy into those investments, which is why you won’t see big gains from alternatives in those smaller institutions.”
Virginia L. Ma and Kevin A. Simauchi report in The Crimson on Harvard’s Endowment, “Harvard Management Company returned 33.6 percent on its investments for the fiscal year ending in June 2021, skyrocketing the value of the University’s endowment to $53.2 billion, the largest sum in its history and an increase of $11.3 billion from the previous fiscal year.” This 33.6% gain, though, represents underperformance compared to Harvard’s peers; this is rationalized in terms of overall risk-positioning:
However, Harvard’s returns have continually lagged behind its peers in the Ivy League, a trend that appeared to continue this past fiscal year. Of the schools that have announced their endowment returns, Dartmouth College reported 47 percent returns while the University of Pennsylvania posted 41 percent returns.
Narvekar acknowledged the “opportunity cost of taking lower risk” in Harvard’s investments compared to the University’s peer schools.
“Over the last decade, HMC has taken lower risk than many of our peers and establishing the right risk tolerance level for the University in the years ahead is an essential stewardship responsibility,” Narvekar wrote.
In 2018, HMC formed a risk tolerance group in order to assess how the endowment could take on more risk while balancing Harvard’s financial positioning and need for budgetary stability. Under Narvekar’s leadership, HMC has dramatically reduced its assets in natural resources, real estate markets, and public equity, while increasing its exposure to hedge funds and private equity.
There it is again, the magical “hedge funds and private equity”.
Harvard’s fund manager went on to warn that the astronomical returns of the past year were something of an anomaly:
At the close of his message, Narvekar cautioned that despite the year’s success, Harvard’s endowment should not be expected to gain such strong returns annually. “There will inevitably be negative years, hence the importance of understanding risk tolerance.”
The following chart illustrates, at least in Harvard’s case, how extraordinary the past year has been:
Source: Justin Y. Ye
The fiscal year of these funds typically runs September to September, so it’s worth recalling that back in September of 2020 we were still largely cowering in our homes, waiting for vaccines to arrive. The equity markets were still down in September of 2020, whereas a year later the tsunami of federal and Fed largesse had lifted all equity boats to the sky. So, it is not realistic to expect another year of 50% returns.
Final issue: can the little guy pick up at least a few crumbs under the table of this private equity feast? In most cases, you have to be an “accredited investor” (income over $200,000, or net worth outside of home at least $1 million) to start to play in that game. From Pitchbook:
Private equity (PE) and venture capital (VC) are two major subsets of a much larger, complex part of the financial landscape known as the private markets…The private markets control over a quarter of the US economy by amount of capital and 98% by number of companies….PE and VC firms both raise pools of capital from accredited investors known as limited partners (LPs), and they both do so in order to invest in privately owned companies. Their goals are the same: to increase the value of the businesses they invest in and then sell them—or their equity stake (aka ownership) in them—for a profit.
Venture capital (VC) is perhaps the more attractive, heroic side of this investing complex:
Venture capital investment firms fund and mentor startups. These young, often tech-focused companies are growing rapidly and VC firms will provide funding in exchange for a minority stake of equity—less than 50% ownership—in those businesses.
Some examples of VC-backed enterprises include Elon Musk’s SpaceX, and Google-associated self-driving venture WayMo.
Venture capital takes a big chance on whether some nascent technology will succeed (in the fact of competition) many years down the road, which has the potential to make the world a better place for us all. Private equity, on the other hand, tends to be somewhat more prosaic, predictable, and sometimes brutal. Here is putting it nicely:
Private equity investment firms often take a majority stake—50% ownership or more—in mature companies operating in traditional industries. PE firms usually invest in established businesses that are deteriorating because of inefficiencies. The assumption is that once those inefficiencies are corrected, the businesses could become profitable.
In practice, this often entails taking control of a company via a leveraged buyout which saddles the new firm with heavy debt, firing lots of employees, improving some strategy or operations of the firm, and sometimes breaking it up and selling off the pieces. This was the fate of several medium-sized oil companies that got in the cross-hairs of corporate raider T. Boone Pickens. “Chainsaw Al” Dunlop also became famous for this sort of “restructuring” or “creative destruction”.
Private equity activities can be very lucrative. But again, is there any way for you, the little guy, to get a piece of this action? Well, kind of. There are publicly traded companies who do this leveraged buyout stuff, and you can buy shares in these companies, and share in the fruits of their pruning of corporate deadwood. Some names are: Kohlberg Kravis Roberts (KKR), The Carlyle Group (CG), and The Blackstone Group (BX). The share prices of all these firms have more than doubled in the past year (100+ % return). If you had had the guts to plow all your savings into any one of these private equity firms a year ago, you would have had the glory of beating out all those university endowment funds with their piddling 50% returns.