NEW HAVEN, Conn. - Yale University, a pioneer in private equity investing, plans to reduce its target allocation to the asset class to 20% of total assets, from 25%, because the $7 billion endowment is having trouble reaching it.
David Swensen, chief investment officer at Yale's endowment, stunned delegates at the recent European Private Equity and Venture Capital Association conference when he announced that he will ask Yale's board of directors at its June meeting to reduce the target allocation.
Yale is believed to have the largest private equity allocation in the country among institutional investors, and Mr. Swensen's moves are watched carefully.
The typical allocation is well below Yale's. University endowments had an average private equity allocation of 12.1% in 2001, according to data from Greenwich Associates, a Greenwich, Conn.-based consulting firm. The corporate funds in Pensions & Investments' survey of the 200 largest pension funds allocated an average 5.8% to private equity as of Sept. 30, while the public funds allocated 4.2%.
Yale's private equity portfolio hit its 25% target allocation in 2000, but since then it has dropped to around 17% of assets, due to a combination of the stock market downturn, distributions and writedowns, Mr. Swensen told the conference delegates. He added that the asset class was less attractive to him than it was 15 years ago, and said private equity was unlikely to remain the endowment's single largest asset class.
Yale's private equity investments helped the endowment's portfolio surge 41% in 2000, according to an analysis by Barton M. Biggs, chief U.S. strategist at Morgan Stanley Investment Management, New York. The university's private equity program has generated a 32.9% annualized return since its inception in the 1970s, after fees. And despite the volatile stock market in 2001, the Yale endowment still managed to reap a gain of 9.2% for the fiscal year ended June 30, Mr. Biggs noted in a paper to clients that he made available to P&I.
Mr. Biggs, who calls Mr. Swensen "one of the best investors in the world," said in his analysis that Yale performed relatively well last year because it sold all private equity share distributions as soon as they were received. "Diversification also paid off, and Yale received superb relative performance from the managers of its other classes. The fund's value orientation also helped," he noted.
Although Mr. Swensen did not say how he might reallocate the trimmed private equity allocation, one good possibility is real estate, because it's currently one of his favorite asset classes, Mr. Biggs noted.
At the conference, Mr. Swensen cited several reasons for his pullback. For one, the largest private equity funds have not been producing sufficient returns to make them attractive to investors; in order to keep collecting high management fees on their funds, the general partners who run them are less likely to make bold investment decisions because they want to protect those fees. "They're less likely to display their aggressive qualities when pursuing investments if the failure of an investment is likely to endanger their access to future management fees," he said.
Also, a shift by the managers toward funds with assets from $1 billion to $1.5 billion in recent years has been hurting performance. "In my opinion, size is the enemy of performance. It would be interesting to turn the clock back to 10 to 15 years ago, when funds were of a more manageable size. Smaller VC funds are much better positioned to land double-digit multiples," Mr. Swensen said.
He also voiced concerns about the "high-tech hangover" and how it hurt the motivation of the managers. He said he was worried about what the Internet bubble has done to motivation of general partners. "Before they were investing $10 million and turning it into $1 billion; now they have to work really hard to turn $10 million into $100 million." In addition, he said that leverage, which had been reduced to three to one, compared with eight to one in the past, in turn reduced returns.
Bruce Rauner, partner at GTCR Golder Rauner LLC, Chicago, one of Yale's general partners, said he wasn't surprised by Mr. Swensen's planned reduction. "Their allocation is double and more than double that of many prominent (limited partners). Given how tough the venture business is now and how much returns are declining because of the lack of leverage, it's understandable that they can't reach their allocation."
And another observer, who declined to be identified, pointed out that some of Yale's private equity funds had done poorly in the last year, including some investing internationally.
Charles Van Horne, managing director at Abbott Capital Management LLC, New York, who has worked with Mr. Swensen in the past, said, "He always preferred to invest with hungry entrepreneurs running smaller organizations, and this isn't the best time for such groups now. He liked groups that were small and have a unique perspective or information advantage."
But Yale's move won't have a major impact on other investors, experts agreed. "If an investor has around 5% in private equity, it's certainly not overweight," Mr. Van Horne said. "Yale's decision won't hurt people who are still building programs."
"A 20% allocation to private equity is still a very large allocation," observed Gary Robertson, senior vice president, private markets group, Callan Associates Inc, San Francisco. "Nevertheless, inquiring minds will want to look at this decision and understand what Swensen is thinking," Mr. Robertson noted.
And Jay Yoder, director of investments at the $900 million endowment at Smith College, Northampton, Mass., said Yale's changes would not influence his plans to ramp up Smith's private equity program over the next five years to 15% of total assets, from its current 6%.
Mr. Yoder doubted Yale's move would affect many other endowments' programs, either, because "Yale's cutting back to a level that most aspire to reach."