Some of the largest universities, including Harvard and Yale, have announced plans to sell significant portions of their private equity portfolios. These moves come at a time when universities are facing liquidity pressures due to federal funding cuts and increased taxes on their endowments. Liquidity has also been constrained by slow distributions from their private funds and large outstanding commitments that fund managers can call at any time. The liquidity trap these universities are now navigating can serve as a cautionary tale for individual investors who over-allocate to private markets.
Endowment Model
The “endowment model” is an investment strategy employed by many large institutional investors, such as universities and sovereign wealth funds. It involves investing a meaningful percentage of their portfolios in alternative assets in pursuit of higher long-term returns and greater diversification, at the cost of reduced liquidity. These investors typically manage liquidity risk effectively due to the long-term nature of their liabilities and the diversity of their income sources.
Still, this model is not without its challenges. When institutions begin relying heavily on investment portfolios to fund a significant portion of their operating budgets, their investment goals can shift rapidly from generating long-term capital appreciation to generating short-term cash flow. While Harvard and Yale do not appear to be facing a liquidity crisis, reports suggest they may be willing to accept a 10% discount on the private assets they sell to preserve liquidity.
Considerations for Individual Investors
There are several lessons that individual investors can learn from the situation facing these highly sophisticated endowments. First, it’s important to regularly assess how much cash flow is coming from investment portfolios versus other sources of income – and how stable those sources are. With many private assets, cash flow depends not only on investment performance but also on mergers and acquisitions, as well as other capital markets activities that result in fund distributions. Both aspects must be considered when evaluating investment income stability.
Investors should also monitor the amount of outstanding commitments they have to private funds in addition to their capital balances. One factor that may be driving Harvard and Yale to sell some private assets is that they each have approximately $8 billion in unfunded commitments, which is about 15–20% of the total assets in their respective portfolios. Even if they were able to generate sufficient cash based on present needs, large, unexpected capital calls could significantly impact their operating budgets.
While large institutional investors can use robust secondary markets to minimize any losses they may incur when selling private assets, those opportunities are much more limited for individual investors. As a result, the cost to ‘right-size’ the amount of private assets they have invested may exceed a 10% discount for individuals.
Last year, Patrick Campbell and Steve Blewitt examined how institutional allocation models, including the Endowment Model, can inform a thoughtful approach to private market investing for individuals, as discussed in their article on building a personal allocation framework.
Steve was formerly the Chief Investment Officer and Head of Private Markets at Manulife Investment Management. In this role, he was responsible for leading global investment teams across a wide range of asset classes, including private equity and credit, real estate, infrastructure, timber, and agriculture. Steve has served as a director of many public and private companies during his career, including two of Manulife’s U.S. SEC-registered investment advisors.
Important Notice: Private Markets Navigator does not provide investment advice, and the information should not be construed as such. Investing in private asset funds is risky, with potential for total loss and long-term liquidity restrictions. Read our full dislaimer.