America’s Ivy League universities have good reason to be suspicious of those wanting to know about their investment activities. In the wake of the global financial crisis, critics turned on them fiercely. Indeed, staff layoffs, budgets cuts and austerity measures on campuses were blamed on huge declines in the value of endowments thanks to in-house investment teams that followed the famous ‘Yale model’, which advocated ramping up exposure to riskier illiquid alternative assets in the name of diversification.
The effect has been quite profound in some ways. In the aftermath of the global financial crisis, Harvard University, for instance, began rationalising commitments to private fund managers to alleviate liquidity problems. Then, once things calmed down, it started shifting its approach towards direct investment via joint ventures with carefully selected real estate operating partners.
To those that do not know them, Harvard University, Yale University, Princeton University, Columbia University and the smaller Ivies of Brown University, Cornell University, Dartmouth College and the University of Pennsylvania represent a secretive sect or closed cabal that choose not to divulge information about their investment programmes, supposedly to maintain a competitive edge over peers. Unlike public US pension plans, these university endowments have little duty to make disclosures. As such, they still remain an opaque set to those outside the magic inner sanctum of their campuses.
Still, as a collective, the Ivy League universities matter to fund managers because they have substantial capital. The top four plus Stanford University, which technically isn’t an Ivy but is viewed as an equal, have around $13 billion of real estate under management, much of it in private real estate funds (see Meet the Ivies, page 34). In fact, according to the Tellus Institute, a Boston-based think tank, US universities and schools had a combined $310 billion in total assets in 2009, underscoring just how much of a financial force they are.
Experts say the Ivy League universities not only have significant capital, but they are savvy and sophisticated. At the same time, they are much more bullish on new funds or new markets in which they previously have not invested and, unlike a public pension plan, some of the Ivy League endowments will take greater risks, such as on start-ups, they add.
Keith Breslauer, the founder of European private equity real estate firm Patron Capital, is one professional who knows the Ivy League well and indeed the greater US university community. His firm counts 31 such endowments among its LP base. “I think you can have a proper conversation with them,” says Breslauer. “The individuals I deal with are highly intelligent and understand the business model. They are people that really look at it from a private business perspective.”
Breslauer adds: “The bottom line is that university endowments fundamentally made Patron Capital. Without them, we would not exist.”
Grey matter
As a collective, Ivy League universities generally have been good for smaller and mid- sized managers of opportunistic real estate funds.
Mark Antoncic, managing partner at Greenwich, Connecticut-based TriLyn Investment Management, says: “Many of these institutions have been total return focussed, so they tend to be at the higher end of the return/risk spectrum. A lot of them are much more opportunistic than you tend to find among other institutional investors.”
The Ivy League universities also are acknowledged to be incentivised differently than, say, a public pension plan when it comes to investing. A key difference is that they typically do not have to meet pension liabilities (though there are some universities programmes that invest to meet both the costs of the school and the pension plans of employees, such as the Massachusetts Institute of Technology).
In general, the Ivy League universities are highly incentivised to make their capital perform at a higher return level because their money is being used to fund rising tuition fees that students cannot afford, as well as the other costs of running a university. The job is not only to protect the endowment but to grow it, and that is where the ‘Yale model’ comes in.
The ‘Yale model’ was introduced by Yale University’s longstanding chief investment officer David Swensen in the 1990s. The Swensen thesis is basically that it is much better to invest with discreet specialised managers in the alternatives space than to be giving money to managers in the equity space. That is why, for the last 10 to 20 years, the endowments actively have been investing in alternatives.
Nori Gerardo Lietz of San Francisco boutique investment advisory firm Areté Capital notes, many universities followed the ‘Yale model’ in eschewing the large opportunity funds. The exception was Lone Star Funds, whose early investors included Stanford.
This had knock-on effects for other universities. “The nascent University of California real estate programme in 2004 was often compared to the established Harvard and Yale programmes, usually to our chagrin,” says Jon Willis, who used to be a real estate investment officer there but now runs consultancy Global Property Strategies. “Their performances at the time were quite robust due primarily to their early participation in opportunistic investment strategies. Since our programme was just beginning, there was an underlying presumption in some quarters that our plan should target similar returns.”
One key difference between the management of the private and public programmes is that the key investment officers in the private programmes could be compensated more in line with the private market. Willis recalls: “There was controversy around 2005 when Jack Meyer left Harvard Management to start his own firm, Convexity Capital, and his team’s market-rate compensation was challenged.”
However, aping Yale in making a headlong dive into riskier illiquid alternatives is precisely what raised the hackles of critics. They pounced when Ivy League investment programmes lost as much as 30 percent of their value in the aftermath of the financial crisis of 2008.
Campus critics
In May 2010, the Tellus Institute published a 100-page paper documenting the event. Called “Educational Endowments and the Financial Crisis: Social costs and the systemic risks in the shadow banking system,” it states that investment risk-taking has jeopardized the security of endowment income.
For the past two centuries, endowment management was centred on protecting the principal of endowed gifts and generating reliable income. Investments traditionally were made in relatively transparent, liquid securities such as publicly traded equities, bonds and money-market instruments. In the last 25 years, however, many universities followed the path of schools such as Harvard and Yale, embracing a new model of investing that relied on radical diversification of endowment portfolios into illiquid, riskier asset classes. Among them: private equity and venture capital; hedge funds; and various real assets, such as oil, gas and other commodities, timberland and, of course, private real estate.
“During the boom times, this so-called ‘endowment model’ of investing generated impressive financial returns,” the report continues. “Then came the financial crisis and, in the space of one year, investment losses destroyed tens of billions of dollars in endowed wealth at colleges and universities – up to 30 percent at some of the wealthiest schools.”
Those mounting endowment losses, according to the report, have been used by college administrations to justify some of the severest austerity measures in a quarter century: deep budget cuts, diminished endowment payouts, staff layoffs and other substantial reductions in force and benefits.
Joshua Humpreys, a principal investigator and a lead author of the report, says Tellus was first approached to investigate the issue by a labour union in Boston representing a lot of employees on university campuses. “They asked us: ‘What the heck is going on? Everybody is talking about endowments going down, and they are threatening to lay off a thousand people because of it.’”
The think tank examined six New England schools – Dartmouth, Harvard and MIT included. “What we were surprised to learn was that, when we looked beyond Harvard, Yale and the big schools to the smaller colleges like Dartmouth, the exposure to riskier assets proved to be more widespread than we imagined,” Humpreys adds. “Dartmouth literally had more than 90 percent of the endowment exposed to ‘Level 2 and Level 3’ assets.”
Tellus started analysing that trend, as well as the cult around chief investment officers, which led some small endowments such as Brandeis University to hire star CIOs. “It was kind of a crazy thing, but the pressure to have highly compensated CIOs on college campuses had really become intense because of the competitive dynamic. It seemed like things had really changed in the management of educational assets not just over the last three-and-a-half decades, but even more so over the last decade and a half.”
Humpreys notes that a team led by Harvard Management’s chief executive officer, Jane Mendillo, made $25 million in performance-based bonuses in the very year they “burned” $11 billion in endowment value. “The reason they did that is because some of the traders were beating their benchmarks even though the endowment crashed, and it seems completely misaligned when you consider the university basically laid off 1,000 employees,” he argues.
Harvard reacted to the Tellus report by saying everything in the report already had been addressed. “Of course, that is utterly fallacious if you look at their asset allocation,” says Humphreys. “It is true that Jane Mendillo did take the illiquidity problem seriously, but they basically are operating on the same modern portfolio theory.”
A continuing force
Criticism and recent history aside, it seems that Ivy League universities continue to be a force in real estate as an alternative asset class. Indeed, experts say there is no persuasive sign that the Ivy League or the other universities for that matter are reducing their appetite for the asset class en masse.
“We are not seeing a clear trend in terms of clients increasing or decreasing allocations to real estate,” says Marc Cardillo, co-head of private equity research covering real estate and natural resource at Cambridge Associates, a US firm widely regarded as the dominant force in investment advisory services to university foundations and endowments. However, he does believe those that went large into funds between 2005 and 2007 are more “gun shy” today, and that clients are being more selective in the investments they do make.
“I think they have less capital to deploy,” Cardillo says. “The bar for all private equity commitments is just higher today, as clients are more aware of the illiquidity issue and some of the risks associated with these partnerships, making them more discriminating.”
In hindsight, it was the pace with which the endowments were investing that was too aggressive. “There was a period of time when they weren’t getting distributions back,” Cardillo adds. “It is interesting that it feels like we have been getting more questions about whether private equity real estate is worth doing given disappointing recent returns.”
The Harvard way
For certain universities, it seems like they have responded to the global financial crisis by shifting their approach.
Daniel Cummings, managing director and head of real estate at Harvard Management, is the only investment professional at any Ivy League university that would speak with PERE. He notes that Harvard historically had invested solely via private real estate funds, but things are changing.
“What we have done, in addition to continuing to invest with funds, is invest more directly,” Cummings says. Though there is no hard and fast rule, Harvard likely will put half of any new capital to work directly and the rest through funds.
The market generally knows about this move. “Cummings has spoken about this publicly,” notes one professional who did not wish to be named. “Harvard is trying to do more direct joint ventures so that they can control the management of their portfolios, which makes some sense. He is just doing deals with people with whom he has had longstanding relationships over the last 25 years.”
Another professional adds: “Harvard has hired a bunch of people to execute their programme, whereby they provide 100 percent of the capital to an operating partner. They tell me they have entered into four or five such operating platform arrangements. I think it is reasonable to assume they are doing well because they continue to do this structure. I’d say Harvard is probably one of the trailblazers moving in this direction.”
Cummings says Harvard is typical of the universities in the US in that it is invested with small and mid-sized GPs and funds. Providing a concise history of Harvard before he joined in 2009, he says the portfolio had been heavily tilted towards the opportunistic end of the real estate spectrum. About 70 percent of assets were in the US, with international investments being focussed on more between 2005 and 2008. The 30 percent international portfolio was divided roughly equally between Europe and Asia, as well as smaller investments in South America.
Although performance mark-to-market was disappointing in the aftermath of the global financial crisis, Harvard had relatively few serious liquidity or catastrophe challenges across the group. However, as values went down so dramatically not only in real estate but in other asset classes, the endowment found itself with much higher levels of outstanding commitments relative to its net asset value than it would have liked. In response, it started limiting or reducing those outstanding commitments, as others did. Indeed, it sold some interests in the secondary markets – and it also bought a few.
Then, as things began to stabilise, Harvard started modifying its approach. “I would describe it as thematic or programmatic investing with carefully selected operating partners that form a relationship and are working exclusively with us for that investment programme,” says Cummings. “We carefully develop a common view on how we manage deal flow and we retain control over deals. We are selecting partners and strategies in which we believe we have an opportunity to enhance the bottom line relatively quickly in the first two or three years of ownership.”
In line with this, Harvard has increased its in-house team from three people at the time when Cummings joined to 11 currently. The university has around 10 active ventures, each pursuing thematic programmes, and is estimated to have acquired more than 50 assets in the last 18 months. Interestingly, it has stayed opportunistic rather than become a core investor as so many public pensions have done.
“We want to be a good partner,” Cummings says. “We try to operate with the same professionalism and standards as the GPs to which we give money and are trying to respond very quickly to our programmatic JVs when we review and underwrite transactions.”
And, as Cambridge Associates’ Cardillo observes, it certainly has not shunned funds. “On the trend towards investing directly, Harvard is clearly moving in that direction and has a desire to build out a more direct platform. They have done that in the past as well, but it is still investing in funds,” he notes, adding that Yale also has always had a model to invest through funds.
Asked whether he sees the endowments of other Ivy League or American universities doing the same as Harvard, Cardillo says Cambridge recently conducted a survey in which it found a few groups were thinking about doing it. “They are asking themselves, ‘Do I build out staff and take the role of an allocator, establishing relationships with just a few local groups and give capital to them?’”
Lessons learned
On the whole, it seems that the Ivy League and other universities currently are a mixed bag when it comes to investing. Some of the smaller endowments continue to increase activity in real estate, while others are gaining exposure through fund of funds or diversified funds.
At the same time, some are still ‘liquidity-challenged’. One investor relations professional says: “I have spoken to one or two that say they are reducing their commitments to illiquid assets and have adopted a tighter process with higher hurdles.”
Peter Lewis, a senior consultant at Towers Watson who used to manage the real estate and real asset portfolio for MIT Investment Management and its pension plan, says: “Some of the endowments over-committed prior to the global financial crisis, having gotten used to receiving substantial distributions from their real estate investments. Those obviously stopped, and managers have indicated to us that they are often seeing smaller commitments to their recent vintage funds.”
In the meantime, the controversy about the way the universities behave does not seem to have subsided. Issues about non-transparency, the use of overseas shell companies for tax purposes, claims of land grabbing in emerging markets and the continued use of the ‘Yale model’, as well as alleged conflicts of interest, still linger.
Two years since the Tellus report first came out, Humpreys maintains that the ‘Yale model’ is not dead, just broken. “It is one thing for Yale or Harvard to re-jig their asset allocation, but it is another for all these small schools to get out of transparent investments that have served them relatively well and embrace some things that are really over their heads,” he says. “The interesting comments after the report was published came from trustees who didn’t go public but just contacted us directly, saying: ‘You guys are right; endowments have gone wild. We don’t know why they are diving headlong into the most opaque corners of the capital markets, but they have and we have lost a sense of purpose.’”
Humpreys says that, if anything, the arguments made in his paper have been boosted by recent events. In February, a group of anonymous former and current faculty, staff and employees of Dartmouth wrote to Michael Delaney, attorney general of the State of New Hampshire, to say: “For over a decade, we have been witnessing the quiet takeover of this great college by a cabal of external, wealthy alumni… They simultaneously have directed the college’s $3 billion endowment to themselves, their firms and their friends; have furthered their own self-interest at the expense of the college and the Upper Valley; have abused the non-profit status of Dartmouth College; and have enriched themselves through managing and directing the $3 billion endowment. In all cases, they have taken gargantuan fund management fees through private equity, venture capital and hedge fund investments, which they manage and own. We believe these conflicts are a violation of the non-profit status of Dartmouth College in the State of New Hampshire.”
These accusations are now being investigated by the New Hampshire Department of Justice, although Dartmouth College itself has issued a rebuttal of the claims made in the letter.
Still, for the chosen real estate fund managers looking for a partner, it seems the hallowed campuses can still provide some real direction. “From a fundraising perspective, the amount of money coming out of the endowment community is a lot less than it used to be, but the number of those investing shows they are active,” one manager says. “Ivy League universities are only different in that they have been around longer and have more money.”
If you do not receive this within five minutes, please try to sign in again. If the problem persists, please email: 
