Yale's $2.5 billion private equity sale tests its vaunted endowment model

Business Standard

2 days ago

By Allison McNeely, Dawn Lim, Preeti Singh and Marion Halftermeyer
(Bloomberg) -- Yale University's $41 billion endowment, led for decades by the late investing giant David Swensen, has been the envy – and the blueprint — for many US universities eager to secure their financial future.
Swensen was the face of higher education's embrace of private equity, illiquid investments held for the long term. His push beyond the traditional stocks and bonds portfolio was a major part of the endowment's size doubling five times over. And where Swensen went, others followed.
Now the Ivy League school is readying its first major sale of private equity stakes. Massachusetts Institute of Technology, University of Notre Dame and University of Illinois are each considering similar moves.
After tying up swaths of their money in complicated private investments, US colleges are feeling the costs of emulating the Yale playbook more acutely than ever. President Donald Trump's war on elite schools is exacerbating cash pressures during a fallow period for private equity, and now colleges are planning investment shifts and unwinding some old bets.
Yale's unprecedented shift underscores the eagerness of many schools to secure cash. Washington has aggressively cut government funding to universities and is trying to raise taxes on investment income generated by certain private endowments. Trump also threatened to strip schools of their tax-exempt status, and this week said Columbia University no longer meets accreditation standards.
At the same time, private equity investments have been largely frozen amid a deal slowdown. Endowments are continuing to get less cash back from their private equity investments after almost a decade of meager distributions. That's turning secondhand buyers into winners.
The pressures have raised new questions about the purpose of endowments and how to manage them. Universities typically tap about 5 per cent of their endowments every year to contribute to the schools' operating budgets. That amount could balloon if colleges rely more on their endowments to fund ongoing expenses — pressuring investment chiefs to lean on more-liquid assets like stocks.
'What we're seeing now is fear, which is common when there's uncertainty,' said Sarah Samuels, a partner at consulting firm NEPC and a former investor for Wellesley College. Some investors don't have 'a ton of confidence that they should continue committing to private markets at the same pace.'
Secondary sales
The Yale endowment, run by Swensen protégé Matt Mendelsohn, is nearing a deal — code-named 'Project Gatsby' — to offload about $2.5 billion of private equity stakes, according to people familiar with the matter. Secondhand buyers had considered valuing pieces of the portfolio at a 15 per cent haircut, though the overall discount is expected to be less than 10 per cent, the people said, asking not to be identified discussing private information.
Yale declined to comment.
Other major universities have been exploring private-asset sales. MIT's endowment, run by former Yale investor Seth Alexander, is researching a potential sale of private assets, as has Notre Dame, according to people with knowledge of the matter. The University of Illinois is considering a secondary sale as part of its portfolio adjustments, some of the people said.
Some schools are also on the lookout for opportunities to be buyers in the secondaries market.
'Because of our strong liquidity position, we are not considering any secondary sales,' Tim Dolezal, vice president and chief financial officer at Notre Dame, said. 'We have tactically used the secondary market on several occasions over the years as a portfolio management tool, both as a seller and buyer. Given the pricing environment for secondaries, our most recent transactions have actually been strategic purchases.'
MIT also pulled back on an allocation to a private equity firm, slashing its check by two-thirds of what it had originally indicated, according to a person familiar with the matter.
Representatives for MIT and University of Illinois declined to comment.
'A lot of larger endowments have been concerned about liquidity and the potential impact of taxes on their portfolios,' said Jon Harris, the chief investment officer of Alternative Investment Management. 'Whether they are pulling the trigger as of yet or not, many endowments are having discussions on portfolio sales.'
There's no shortage of potential buyers in the secondaries market, as alternative asset managers such as Blackstone Inc., Lexington Partners and Paris-based Ardian have been raising billions to snap up existing private equity stakes. This is expected to be a record year for secondary transactions as firms seize on investors' need for liquidity.
For its part, Yale had been weighing a sale for more than a year. It considered trimming positions across dozens of funds as it sought to clean up older holdings and pare back some leveraged buyout funds. Multiple buyers, including Lexington and HarbourVest Partners, assessed the portfolio, according to people familiar with the matter.
Lexington and HarbourVest declined to comment.
Despite the sale, Yale isn't retreating from private markets. The endowment held about $20 billion across private equity and venture capital in mid-2024 and will continue to invest in funds and new managers.
But the secondary transaction would mark a repositioning for the school. More broadly, universities' efforts to offload private equity stakes signal the potential for a pullback from an asset class endowments once piled into.
'The Yale model worked well for decades for many endowments,' said Philip Casey, founder of technology company Institutional LPs, who has advised endowments and foundations. 'But even David Swensen said it would be susceptible to a liquidity crisis during times of economic uncertainty.'
'Dark corners'
A former banker for Salomon Brothers and Lehman Brothers, Swensen was the CIO of Yale's endowment from 1985 until his death in 2021. When he took over, Yale's portfolio stood around $1 billion and was invested in a mix of stocks and bonds like most other major institutions at the time.
Swensen advocated for endowments with long-term horizons to seek out more complex, illiquid assets. Worthwhile investments 'tend to reside in dark corners, not in the glare of floodlights,' he wrote in his book, Pioneering Portfolio Management, widely considered the bible of endowment investing.
He stressed that not every endowment should follow this path, but dozens of schools emulated the strategy and embraced alternative assets such as private equity, venture capital and hedge funds.
Investors who worked for Swensen went on to become some of the highest-paid endowment chiefs in the mid-2010s, running funds at Princeton, Stanford and University of Pennsylvania. By last year, US higher-education endowments held an average of 56 per cent of their assets in alternatives, according to a study from the National Association of College and University Business Officers.
But the Federal Reserve increased borrowing costs in 2022, and for the past three years, investors have grown increasingly frustrated by a lack of cash distributions.
'Costly and wasteful'
A House Republican bill calls for increasing taxes on an endowment's investment income to between 7 per cent and 21 per cent, depending on the size of the student body and amount of assets in the fund. MIT, Harvard, Princeton and Yale all have endowments that would meet the 21 per cent rate, which would be an increase from 1.4 per cent. The steeper levies could make high-risk bets and frequent trading less lucrative, while making rebalancing more costly.
Pomona College, a liberal arts school in California with almost 1,800 students, said its annual tax bill would increase to about $40 million with the legislation, equivalent to about two-thirds of its financial aid budget. The school said it has paid more than $16 million in taxes on its investments since 2017.
'An increase of this magnitude will make it difficult for institutions like Pomona to further their commitment to making a liberal arts education affordable for students from all backgrounds,' Pomona said in a statement.
The prospect of further economic attacks looms: the Trump administration in March identified 60 colleges under investigation for 'antisemitic discrimination and harassment,' the same rationale that the government used to cut billions in funding to Harvard University and to conclude that Columbia no longer meets accreditation standards.
Consulting firm NEPC is advising clients to be more selective with private equity investments and to explore options to make sure they have enough liquidity, such as holding more cash or Treasuries or exploring a credit line or bond sale, according to Samuels.
Yale's decision to shop its private equity stakes after years of sitting on the sidelines shows that there's less stigma around selling. Those moves can shave underperforming investments and adjust portfolios when a new investing chief arrives.
For skeptics of alternative assets, the pullback boosts their argument that investors do just fine in stocks and bonds over the long term. Alternatives are 'costly and wasteful' for big endowments and pensions — with high fees eroding benefits in returns or risk reduction, according to Richard Ennis, a retired investment consultant.
Endowment portfolios invested heavily in alternatives underperformed a stock-bond mix by 2.4 percentage points over 16 years through June 2024, according to a study he conducted. Yale's endowment generated annualized gains of 9.5 per cent for the decade through mid-2024, beating the 6.8 per cent average of US higher education institutions during that period. The S&P 500 returned more than 12 per cent.