What is their Value, Really?

In a Sunday Wall Street Journal article on universities’ penchant for investing their endowments in private equity (as opposed to instruments bought and sold on public exchanges, these are bought and sold in private deals between the university and one or another private (i.e., not traded on an exchange) entity, or rarely a private deal to which a publicly traded entity might also agree.

A few exceptionally talented, or lucky, endowment managers seemingly did very well in this environment. Yale’s late David Swensen got an annualized return of 13% over the course of his management.

But how valuable are those investments, really? The WSJ‘s subheadline reads

Universities and other institutions have built up large private-equity holdings, but they are now lagging behind the S&P 500 and aren’t easy to shed

And this:

And much of what those funds earned for their investors in that time was on paper; endowments and other institutions were getting less and less cash that they could put to work in the booming stock market.

And this [emphasis added]:

…making it hard for managers to get the prices they want for the companies in their portfolios. Meanwhile, institutions have struggled to find investments that hedge against stocks and private equity without further eroding returns—and the problem has gotten worse with the stock market’s latest rally.

The value of any investment is what someone is willing to pay to get it. The initial value of those private equity investments in these endowments is what the endowment managers paid to get the private entity or a piece of it. Now they’re moving to sell some/most/all of these privately held pieces, but there are few to no buyers at those initial prices or anywhere near those prices.

This is Yale’s continued position:

Yale said in a statement that it remains committed to its private-markets strategy. “We trust that sophisticated investors, especially our partners who know us best, understand this,” the school said.

That sounds like the typical arrogance of Know Betters.

What is, in the end, the true value of those privately held pieces? It’s still whatever a buyer is willing to pay for them. And that calls into question two things: an accurate valuation of those entities and the wisdom of relying so heavily on non-publicly traded entities for endowment investments.

Former Yale endowment private-equity manager Tim Sullivan:

One of the reasons we hire these guys is because they know when’s the right time to sell an asset[.]

The problem here is that a potential buyer won’t necessarily agree that it’s the right time to buy that asset.

It’s tough to grow, or even just to maintain the value of, an endowment based on phantom valuations of its holdings.