Endowment growth in 2011 came in no small part because universities have increasingly invested in private equity—the same private equity that has become a hot-button issue on the 2012 campaign trail, with some candidates and commentators calling into question its social value.
Private equity is “of increasing significance” for endowments, according to John Walda, president of the National Association of College and University Business Officers, which conducts an annual study of endowments in partnership with the Commonfund Institute. Mr. Walda says that private equity made up roughly 12 percent of endowment assets in the 2011 fiscal year, up from 8 percent in 2008.
“Endowment managers are looking for greater portfolio diversification,” Mr. Walda says. “That’s something you have to do in a volatile economic environment.”
Private equity performed about as well as endowment returns over all, at 19 percent. But John Griswold, executive director of the Commonfund Institute, says that college endowments are ideal candidates for private-equity investors because they are considered very long-term investors, and are more able to take on the risk of bearing illiquidity and negative returns, such as those from 2009.
For 348 colleges participating in a Commonfund survey since 2007, private equity jumped from representing 19 percent of alternative-strategy investments in 2007 to 26 percent in 2011. That seven-point increase was the largest gain of any alternative-strategy investment.
Although some endowment managers may hesitate to take on risk in light of the economy, alternative investments are thriving, Mr. Griswold says.
Colleges typically invest 53 percent of their endowment funds in “alternative strategies,” such as private equity, hedge funds, and venture capital, according to the NACUBO and Commonfund report. Of those alternative investments, 24 percent are in private equity.
Though wealthy colleges are the biggest investors in private equity, Mr. Griswold says it has also been gaining acceptance among medium- and small-size endowments in recent years.
The move toward investing in private equity comes as controversy over the practice is brewing among some presidential candidates and members of the public—thanks largely to the role of Mitt Romney, Republican presidential candidate, as a founder of the private-equity firm Bain Capital. Mr. Romney’s opponents have accused him of gutting companies, cutting jobs, and practicing “vulture capitalism,” and of benefiting from unfairly low tax rates on capital gains.
But Mr. Griswold says that officials in the endowments sector see the controversy over private equity as “an election-year thing.”
“These folks are investing to provide diversification in their portfolio and to get return,” he says. “They’re not necessarily concerned whether someone’s tax rate is lower.”
The Chronicle spoke with managers at several university endowments—at the University of Texas system, the University of Pennsylvania, and the University of California at Los Angeles—but they said that the controversy over private equity had yet to lead to significant internal debate or a change in investment strategy. “That has not been raised at our investment committee,” says Steve Gamer, associate vice chancellor-development and executive director of the UCLA Foundation. “We’re just looking at how you raise the high level of return for the campus.”
Mr. Walda says that private equity is often a positive thing, noting that these funds provide an opportunity for investors to put their money in small firms and “turnaround opportunities.”
“The positivity of investing in private equity was not called into question until it became a political issue,” he adds. “These funds are there to step in when small business with a potential for great growth needs an infusion of capital.”
A Good Investment?
But not everyone thinks that private equity is such a wise investment for universities.
While some private-equity funds do invest in companies that create new jobs and financial opportunity, the funds can also turn to more destructive strategies to increase companies’ short-term value, such as laying off employees or loading up companies with debt for the tax advantages.
And with the country facing a deficit in the trillions of dollars, many people are now also questioning laws that have allowed private-equity fund managers to rake in huge fees for managing their funds while being taxed at a lower rate than many middle-income earners pay on their wages.
Steven Davidoff, a law professor at Ohio State University who follows the private-equity industry for The DealBook blog, says studies show that private equity does appear to add value; the question is whether that value benefits the economy or accrues “to the private equity barons.”
Dan Apfel, executive director of the Responsible Endowments Coalition, says he welcomes the public debate over private equity’s role in the economy, whether prompted by Mr. Romney’s candidacy or the financial crisis, because it helps to highlight the broad issues of economic fairness that his organization urges universities and other nonprofit endowments to consider when investing.
The growth of private-equity funds has been “enabled and encouraged” by university endowments and other institutional investors’ demand, Mr. Apfel says. That in turn fuels the kind of economic disruptions that are making it harder and harder for some families to afford paying for college. “It helps to create a more stratified society,” he says. Universities that do invest in private equity, he says, should be able to obtain good returns by investing in funds that are “building companies and creating jobs.”
“Forgetting any moral arguments,” adds Mr. Apfel, universities are long-term investors, and “it’s important that they look at the long term of the economy.” Ultimately, he says, “it’s not going to be good for universities” if we destroy companies in the United States and send our capital abroad.
And it may not even be especially good for the institutions themselves. K.J. Martijn Cremers, an associate professor of finance at the Yale School of Management who studies alternative investments, says an analysis of private-equity investments by pension funds shows that their returns have been “very comparable” to the overall market returns over the past 20 years and “slightly worse” in the last 10 years. In part, he says, that’s because of the “very high fees” the funds charge.
In his study of pension funds, he and a colleague also found that many of the smaller ones that have moved more recently into private equity did so not by directly investing, but through fund managers, which adds additional costs. He says many of the smaller university endowments that have begun moving into private-equity investing over the past few years are probably in the same boat in paying those management fees.
But Bruce Zimmerman, chief executive of the University of Texas Investment Management Company, dismissed the fuss over private equity as “election-year demagoguery.” He says that private equity, which represents about 25 percent of the Texas management company’s investments, can produce superior returns when companies invest with the right firms.
“It’s growing. It’s been growing,” he says. “We anticipate it will continue to grow some.”
